If you own a business and you are the only employee, or you and your spouse are the only employees, this blog post is for you.
Let’s start with a look in the rear view mirror: How much of your hard-earned small business dollars did you fork over to Uncle Sam in 2009? If you’re newly self employed like many Americans, my guess is that you paid higher taxes than you expected.
In Ohio, where I live and work as a business owner, we’re socked with Federal, State and local income taxes for a combined tax rate of up to 42 percent. Next, layer in self employment taxes of 12.4 percent in Social Security up to income of $106,800 (granted, half this tax is deductible) and 2.9 percent in Medicare taxes on unlimited income. You don’t need a fancy calculator to see that it’s possible that nearly 50 cents of every dollar earned by business owners like you could go towards taxes– and that’s before the tax increases expected to offset the ballooning Federal deficit.
Heard enough already? Paid enough already?
Now, let’s look forward. Now is a good time for small business owners to consider a legitimate strategy which will reduce taxes and create a more secure financial future: a small business retirement plan.
If you’ve worked as an employee, you may be familiar with corporate-sponsored retirement plans. Many for-profit companies offer 401(k) plans and non-profit entities offer 403(b) plans. In both cases, employees contribute a portion of each paycheck into a retirement plan investment account. Employers may match savings with their own contribution. Participation has two unique benefits: the income and gains in the retirement account are sheltered from taxes until money is withdrawn, and the amount contributed is deducted from taxable income, which reduces income taxes. In other words, saving a dollar towards retirement actually costs less than a dollar considering the tax savings. In this example, see how $10,000 of retirement savings actually costs $6,500.
Tax Savings = $ Retirement plan savings X your % marginal Federal, State and local tax rates
$3,500 = $10,000 x 35 percent
Small business retirement plans work similarly, but offer the potential for significantly higher contribution limits and thus, greater tax savings. If you want to learn more about how to save taxes while shoring up your retirement, talk with your financial planner about the options: SEP IRA, Simple IRA, and Individual or Solo 401(k). Some plans must be set up before year end. Act now while you’re still feeling blue (or red) about taxes.
Karin Maloney Stifler, CFP®
True Wealth Advisors