Tips for Self-Employed Retirement Planning

Tips-for-Self-Employed-Retirement-Planning

Do you own a successful small business with no employees and want to set up a retirement plan? Or do you want to upgrade from a SIMPLE IRA or Simplified Employee Pension (SEP) plan? Consider a solo 401(k) if you have healthy income and want to contribute substantial amounts to a retirement nest egg. Keep reading to learn tips for self-employed retirement planning.

This strategy is geared toward self-employed individuals including sole proprietors, owners of single-member limited liability companies, and other one-person businesses.

Go It Alone

With a solo 401(k) plan, you can potentially make large annual deductible contributions to a retirement account.

For 2022, you can make an “elective-deferral contribution” of up to $20,500 of your net self-employment (SE) income to a solo 401(k). The elective-deferral contribution limit increases to $27,000 if you’ll be 50 or older as of December 31, 2022. The larger $27,000 figure includes an extra $6,500 catch-up contribution that’s allowed for these older owners.

On top of your elective-deferral contribution, an additional contribution of up to 20 percent of your net SE income is permitted for solo 401(k)s. This is called an “employer contribution,” though there’s technically no employer when you’re self-employed. (The amount for employees is 25 percent.) For purposes of calculating the employer contribution, your net SE income isn’t reduced by your elective deferral contribution.

For the 2022 tax year, the combined elective deferral and employer contributions can’t exceed:

  • $61,000 ($67,500 if you’ll be 50 or older as of December 31, 2022), or
  • 100 percent of your net SE income.

Net SE income equals the net profit shown on Form 1040 Schedule C, E or F for the business minus the deduction for 50 percent of self-employment tax attributable to the business.

Pros and Cons

Besides the ability to make large deductible contributions, another solo 401(k) advantage is that contributions are discretionary. If cash is tight, you can contribute a small amount or nothing.

In addition, you can borrow from your solo 401(k) account, assuming the plan document permits it. The maximum loan amount is 50 percent of the account balance or $50,000, whichever is less. Some other plan options, including SEPs, don’t allow loans.

The biggest downside to solo 401(k)s is their administrative complexity. Significant upfront paperwork and some ongoing administrative efforts are required, including adopting a written plan document and arranging how and when elective deferral contributions will be collected and paid into the owner’s account. Also, once your account balance exceeds $250,000, you must file Form 5500-EZ with the IRS annually.

If your business has one or more employees, you can’t have a solo 401(k). Instead, you must have a multi-participant 401(k) with all the resulting complications. The tax rules may require you to make contributions for those employees. However, there’s an important loophole: You can exclude employees who are under 21 and employees who haven’t worked at least 1,000 hours during any 12-month period from 401(k) plan coverage.

Bottom Line

For a one-person business, a solo 401(k) can be a smart retirement plan choice if:

  • You want to make large annual deductible contributions and have the money,
  • You have substantial net SE income, and
  • You’re 50 or older and can take advantage of the extra catch-up contribution.

Be sure to do your research for self-employed retirement planning. Before you establish a solo 401(k), weigh the pros and cons of other retirement plans — especially if you’re 50 or older. Solo 401(k)s aren’t simple but they can allow you to make substantial and deductible contributions to a retirement nest egg. The experienced team at Ramsay & Associates can help. Contact us before signing up to determine what’s best for your situation.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

How to Gauge Benefits Tax

How-to-Gauge-Benefits-Tax

Some people who begin claiming Social Security benefits are surprised to find out they’re taxed by the federal government on the amounts they receive. If you’re wondering whether you’ll be taxed on your Social Security benefits, the answer is: It depends. Here’s what to know and how to gauge benefits tax.

The taxation of Social Security benefits depends on your other income. If your income is high enough, then between 50 percent and 85 percent of your benefits could be taxed. (This doesn’t mean you pay 85 percent of your benefits back to the federal government in taxes. It merely means that you’d include 85 percent of them in your income subject to your regular tax rates.)

Formulas and Fine Print

To determine how much of your benefits are taxed, first calculate your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse if you file a joint tax return. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:

  1. If your income plus half your benefits isn’t above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.
  2. If your income plus half your benefits exceeds $32,000 but isn’t more than $44,000, you will be taxed on one half of the excess over $32,000, or one half of the benefits, whichever is lower.

Here is an example to illustrate:

Let’s say you and your spouse have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. So, your income plus half your benefits is $32,900 ($20,000 + $2,400 + half of $21,000). You must include $450 of the benefits in gross income (½ [$32,900 − $32,000]).

(If your combined Social Security benefits were $5,000, and your income plus half your benefits were $40,000, you would include $2,500 of the benefits in income: ½ [$40,000 − $32,000] equals $4,000, but half the $5,000 of benefits [$2,500] is lower, and the lower figure is used.)

Note: If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50 percent of those benefits, an unplanned increase in your income can have a triple tax cost. You’ll have to pay tax on the additional income. You’ll have to pay tax on (or on more of) your Social Security benefits (since the higher your income the more of your Social Security benefits are taxed). And you may get pushed into a higher marginal tax bracket.

For example, this situation might arise if you receive a large distribution from an IRA during the year or if you have large capital gains. Careful planning might avoid this negative tax result. You might be able to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock with gain that can be offset by a capital loss on other shares.

Stay Ahead of the Game

If you know your Social Security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make quarterly estimated tax payments. Keep in mind that most states do not tax Social Security benefits, but 12 states do tax them. Contact the experienced professionals at Ramsay & Associates for assistance on how to gauge benefits tax or for more information on social security benefits.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Do You Have a Tax-Favored Strategy for Retirement?

Do-You-Have-a-Tax-Favored-Strategy-for-Retirement

Do you have a tax-favored strategy for retirement? Does it include a traditional IRA or a Roth IRA? Both have been around for decades, and the rules surrounding them have changed many times. What hasn’t changed is that they can help you save for retirement on a tax-favored basis. Here’s an overview.

Here’s the skinny on traditional IRA contributions

You can make an annual deductible contribution to a traditional IRA if:

  • You (and your spouse) aren’t active participants in employer-sponsored retirement plans, or
  • You (or your spouse) are active participants in an employer plan, and your modified adjusted gross income (MAGI) doesn’t exceed certain levels that vary annually by filing status.

For example, in 2022, if you’re a joint return filer covered by an employer plan, your deductible IRA contribution phases out over $109,000 to $129,000 of MAGI ($68,000 to $78,000 for singles).

Deductible IRA contributions reduce your current tax bill, and earnings are tax deferred. However, withdrawals are taxed in full (and subject to a 10-percent penalty if taken before age 59½, unless one of several exceptions applies). You must begin making minimum withdrawals by April 1 of the year following the year you turn age 72.

You can make an annual, nondeductible IRA contribution without regard to employer plan coverage and your MAGI. The earnings in a nondeductible IRA are tax deferred but taxed when distributed (and subject to a 10-percent penalty if taken early, unless an exception applies).

You must begin making minimum withdrawals by April 1 of the year after the year you reach age 72. Nondeductible contributions aren’t taxed when withdrawn. If you’ve made deductible and nondeductible IRA contributions, a portion of each distribution is treated as coming from nontaxable IRA contributions (and the rest is taxed).

Contribution allowances

The maximum annual IRA contribution (deductible or nondeductible, or a combination) is $6,000 for 2022 and 2021 ($7,000 if age 50 or older). Additionally, your contribution can’t exceed the amount of your compensation included in income for that year. There’s no age limit for making contributions, as long as you have compensation income (before 2021, traditional IRA contributions weren’t allowed after age 70½).

The finer points of your Roth IRA

You can make an annual contribution to a Roth IRA if your income doesn’t exceed certain levels based on filing status. For example, in 2022, if you’re a joint return filer, the maximum annual Roth IRA contribution phases out between $204,000 and $214,000 of MAGI ($129,000 to $144,000 for singles). Annual Roth contributions can be made up to the amount allowed as a contribution to a traditional IRA, reduced by the amount you contribute for the year to non-Roth IRAs, but not reduced by contributions to a SEP or SIMPLE plan.

Roth IRA contributions aren’t deductible. However, earnings are tax-deferred and (unlike a traditional IRA) withdrawals are tax-free if paid out:

  • After a five-year period that begins with the first year for which you made a contribution to a Roth, and
  • Once you reach age 59½, or upon death or disability, or for first-time home-buyer expenses of you, your spouse, child, grandchild, or ancestor (up to $10,000 lifetime).

You can make Roth IRA contributions even after reaching age 72 (if you have compensation income), and you don’t have to take the required minimum distributions from a Roth. You can “rollover” (or convert) a traditional IRA to a Roth regardless of your income. The amount taken out of the traditional IRA and rolled into the Roth is treated for tax purposes as a regular withdrawal (but not subject to the 10-percent early withdrawal penalty).

Be sure you know the specifics if your tax-favored strategy for retirement involves a traditional or Roth IRA. The knowledgeable professionals at Ramsay & Associates can help you understand the ins and outs. Contact us for more information about how you may be able to benefit from and save money for retirement with these types of accounts.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Is Your Estate Plan Up to Date Following a Divorce?

Is your estate plan up to date following a divorce?

If you’ve recently divorced, your time likely has been consumed with attorney meetings and negotiations, even if everything was amicable. Probably the last thing you want to do is review your estate plan. But you owe it to yourself and your children to make the necessary updates to reflect your current situation.

Keep assets in your control

The good news is that a divorce generally extinguishes your spouse’s rights under your will or any trusts. So, there’s little danger that your ex-spouse will inherit your property outright, even if those documents haven’t been revised yet. If you have minor children, however, your ex-spouse might have more control over your wealth than you’d like.

Generally, property inherited by minors is held by a custodian until they reach the age of majority in the state where they reside (usually age 18, but in some states it’s age 21). In some cases, a surviving parent — perhaps your ex-spouse — may act as custodian. In such a case, your ex-spouse will have considerable discretion in determining how your assets are invested and spent while the children are minors.

One way to avoid this result is to create one or more trusts for the benefit of your children. With a trust, you can appoint the person who’ll be responsible for managing assets and making distributions to your children. It’s the trustee of your choosing — not your ex-spouse’s.

Consider a variety of trusts

As part of the post-divorce estate planning process, you might include a variety of trusts, including, but not limited to a:

Living trust.

With a revocable living trust, you can arrange for the transfer of selected assets to designated beneficiaries. This trust type typically is exempt from the probate process and is often used to complement a will.

Credit shelter trust.

This trust type typically is used to maximize estate tax benefits when you have children from a prior marriage, and you also want to provide financial security for a new spouse. Essentially, the trust maximizes the benefits of the estate tax exemption.
Irrevocable life insurance trust (ILIT). If you transfer ownership of life insurance policies to an ILIT, the proceeds generally are removed from your taxable estate. Furthermore, your family may use part of the proceeds to pay estate costs.

Qualified terminable interest property (QTIP) trust.

A QTIP trust is often used after divorces and remarriages. The surviving spouse receives income from the trust while the beneficiaries — typically, children from a first marriage — are entitled to the remainder when the surviving spouse dies.

Make the necessary revisions

If you’re currently in the middle of a divorce, contact us to help you make the necessary revisions to your estate plan, as well as to discuss changing the titling or the beneficiary designations on retirement accounts, life insurance policies and joint tenancy accounts.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Don’t Choose Your Executor Too Hastily

choosing-an-executor

Haste makes waste. Or, in the case of estate planning, it can lead to other problems and, possibly, financial loss. Notably, if you don’t take enough time to choose the best executor for your estate, this “wrong call” can cost your family.

Many responsibilities

You may think that there’s not much to the job, but an executor’s responsibilities are extensive. As your personal representative, he or she will be entrusted with several significant duties, including collecting, protecting and taking inventory of your estate’s assets; filing the estate’s tax return and paying its taxes; handling creditors’ claims and the estate’s claims against others; making investment decisions; distributing property to beneficiaries; and liquidating assets, if necessary.

Whom should you choose as executor? Usually, it comes down to a decision between a family member or close friend and a professional.

Your first thought might be to choose a family member or a trusted friend. But this may be a mistake for one of these reasons:

  • The person may be too grief-stricken to function effectively,
  • If the executor stands to gain from the will, there may be a conflict of interest — real or perceived — which can lead to will contests or other disputes by disgruntled family members,
  • The executor may lack the financial acumen needed for the position,
  • The executor may hire any necessary professionals, but they might not be the professionals you’d hire.

To avoid these risks, you might instead consider choosing an independent professional as executor, particularly if the professional is familiar with your financial affairs.

Form a team of executors

Finally, it’s common to appoint co-executors — one person who knows the family and understands its dynamics and an independent executor with the requisite expertise. Whether you decide to use co-executors or only one, be sure to designate at least one backup to serve in the event that your first choice is unable to do so. Contact us with questions about choosing an executor.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.