Why should I pay myself more salary and contribute to retirement plan such as a SEP IRA, profit sharing plan, Solo 401K

Pay yourself more and contribute to a retirement plan in Scottsdale, Phoenix, or Paradise Valley

One of my client’s who lives in Detroit is concerned about contributing to a retirement plan and having to pay more salary resulting in having to pay in more social security (FICA) and Medicare.

Jack: (for confidentiality reasons, I changed the name): Here are some interesting thoughts from my wife Joan.
Bear in mind she is not a fan of Big government, and is concerned about a Communist takeover, nationalizing our savings as the government is in a death struggle unable to pay international debt, And she sees 401KS as low hanging fruit for the politicos.

Jeff: Jack, fortunately I do not agree! There would be too much pressure on Congress should they try to allow the government to take over the 401Ks and other retirement plans.

Jack: The part about social security is interesting, I have to pay not only what is withheld from Joan and my checks but the matching corporation payments. That is a lot of money!.

Jack: I do not see the wisdom of a 401K because you are putting your money under government regulation. Doesn’t this mean government could decide to put more severe restrictions on withdrawal i.e. ownership of that money? Or even in the extreme decide that the crisis is so severe that all 401K’s need to be frozen? On to the most paranoid scenario, that monies from 401K’s need to be forfeited?

Jeff: I definitely do not see this as a problem! My biggest concern is that you fail to fund a retirement plan and pay too much in taxes and you fail to build enough retirement plan assets up to generate enough income in your retirement!!!!

1.If you do not believe that Social Security will be around when you are ready to collect, then you need to put away more dollars to self fund your retirement!
2.You only have $300K in investable assets,
3.You no longer can work, you will have to depend on getting cash from your investable assets,
4.If $300K generates only $12K per year in cash flow and inflation grows at 6%, you will have to cut back your lifestyle, take out a reverse mortgage and start eating into the $300K. If you are down to $200K that generates only $8K. If a few unexpected and unpleasant financial events occur, you could be on the street!
My concern for you and Joan is more likely to happen than the government freezing retirement plans!!

Jack: Why are we voluntarily putting our own money out of our own 100% control? To save taxes? We are going to have to pay taxes on it sooner or later.

Jeff: You will probably be in a much lower tax bracket in future years. For example, I have a client who is 82 years old and we have been using his S corporation losses created by personal expenses converted into legitimate business expenses to reduce his taxable income from IRA distributions, dividends, interest and pensions! The government subsidizes you when you fail in trying to generate new business and taking classes even if they are in Hawaii and you spend 4 hours and 1 minute in class!!

Jack: I understand that there could be fewer taxes later is assumed, because lower income is assumed but what if tax rates go up because of the government’s financial disaster like what is happening in Greece?

Jeff: In school we learned about the time value of money (present value). I would prefer to save a dollar today in taxes than in 20 years. The dollars saved by paying lower taxes can be invested in diversified assets other than bank accounts. For example, investors in Greece are investing in U.S. stocks outside of Greece.

Jack: Why would we want to assume that?

Jeff: My 40 years experience has proven that over and over again! Non-business owners do not get to write off personal expenditures. Jack, you as a business owner have a big advantage over non-owners!
Jack: And in any case, we are in essence potentially giving away 100% of that money now, in order to save, what, 10-20% taxes on it later?

Jeff: No, you are saving much more than that because if you are in the 35% marginal bracket now, a $50,000 profit sharing plan contribution is only costing you $32,500. However if you can get a 6% return on your investment for 12 years, the $50K will grow to $100K AND this is for only one year!! If you did this for 5 years, you would be looking at $500K! If you just kept your money and did not invest it, you would have paid $17,500 ($50,000 less $32,500 remaining after paying the tax). In 12 years, you would be semi-retired and may only have gross income of $25,000 with expenses of $15,000 or $10,000 taxable income for your S corporation. You will definitely be in a much lower tax bracket. You will then start paying out the retirement plan money with our eyes focused on what your tax bracket is!! You also have most of $25K revenue collected in your pocket because most of the expenses you are paying out are probably expenses you would be paying out in your retirement. An excellent website that details out the benefits of contributing to a retirement plan is: https://www.expertplan.com/faq401k/faq_taxes.jsp. Jack, you have a real advantage over other employers who have employees other than spouses on their payroll. You get the SOLO 401K benefits meaning you do not have to contribute retirement plan dollars to a none family member!

Jack: And should we decide we need it now, we will have to pay a penalty to get our own money back, and have to pay taxes on it anyway.

Jeff: Jack, you will not have a penalty because you are over 59.5 years of age! If you are hard up and need the money that probably means that you have had a terrible year and you will be in the lowest tax bracket before the distribution of your profit sharing plan money.

Jack: A. Excuse me but this seems like a little pipe dream that we’ve all been indoctrinated into believing in.
Jack, the one reason that I am financially independent and will not run out of money is because of legally using the tax system. The first retirement plan rules that I remember were promulgated around 1972 (called ERISA rules) and the retirement plan system is more “sacred” than Medicare or Social Security system. I do see where people like myself who are financially independent will not get the same Medicare benefits as people who have much less income. In fact, Shari has now qualified for Medicare and because of our income, we are paying a lot more for medicare coverage!!

Jack: B. Joan is getting a paycheck, so that more money can be put into the 401K. With my regular employee paycheck, towards the end of the year they stop withholding social security. I don’t know if this is based on it reaching a fixed amount, or if it’s calculated by percentage.
Jack, it is based on reaching a certain amount which is $113,700 for 2013. By maximizing your profit sharing plan and by implementing my tax reduction strategies, we can decrease your payroll, which decreases your payment of FICA (social security tax) and Medicare tax! You also planning on buying new equipment and possibly a new vehicle using Section 179 depreciation write off and so your payroll will be less and you will pay less in payroll taxes (FICA and Medicare)!

Jack: But given “b” above, doesn’t having two people paying SS mean more money going to SS?

Jeff: Yes, but you are able to reduce your taxable income by the retirement plan Solo 401K. We only paid your wife the minimum amount to maximize the SOLO 401K for her. The tax you are saving more than makes up for the additional Social Security tax!

Jack: C. And assuming the answer to “b” is yes, then how much extra money are we really getting by having the extra salary — just so that it can be put into 401K?

Jeff: $23K to the Solo 401K for your wife means that if you are in the 35% bracket there is tax savings of about $8K and your retirement fund is being built up for future use!! You have an advantage that few people have and it is your chance to work towards financial independence! Jack, Please let me know if you have any questions. Thank you very much! Jeff

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009
Email: jeff@jbrookswa.com