If someone were to offer you something free, you would probably run away as fast as you could. In most cases, fleeing would be the correct response. However, when it comes to setting up a retirement plan for your small business, fleeing may be costly. Let’s see why.
Suppose a hypothetical business had five employees who collectively earned $200,000 while the owner earned $160,000. Earnings of $160,000 would place the owner in the 28% marginal tax bracket. If he/she sets up a SIMPLE IRA, it would allow the employees and the owner to save directly from the earnings. While there are a few nuances, a SIMPLE IRA basically requires the owner to match dollar-for-dollar. The result is a 3% savings for the employees and the owner.
The maximum salary savings is 100% of earnings or $12,500, whichever is less. If the person saving is age 50 or older, the savings limit is $15,500
If the owner, in this example, saves the $12,500 maximum, he/she will also receive a $4,800 match (3% of $160,000) gives him/her $17,300 of pre-tax and tax-deferred savings. Should all the employees save at least 3%, a $6,000 match will be needed (3% of $200,000). Including the owner’s savings and personal match, the net gain for him/her equals $23,300.
Now the fun begins. The U.S. Tax Code provides the owner a 28% deduction on the $23,300 contribution or $6,524. The owner’s total outlay for all the employees is $6,000. Thus, the net cost to the owner is $524. The employees have a positive, tax qualified, savings plan and the owner has $17,300 tax-deferred savings invested.
If the owner, in this example, is age 50 or older, the savings could become $15,500+ the match increasing the tax deduction. Additionally, if any employee chooses not to save or is ineligible, no match is required.
SIMPLE IRAs need to be established by October 1st (unless this is the business’ first year) to be effective for a calendar year. Even if the deadline is missed, IRAs offer an excellent savings springboard into the upcoming year. There are no government filings or expensive administration when establishing a SIMPLE IRA.
If you would like to learn more about establishing a SIMPLE IRA, contact us today at 612-294-9208.