Adding a Spouse to Qualified Retirement Plan - January 1, 2002 (updated to
reflect new limits on January 1, 2004)
Spouses working for family owned or closely-held business are oftentimes
excluded from the business's qualified retirement plan due to the 15.3% of
compensation cost attributable to FICA taxes (7.65% deductible Social Security
and Medicare taxes paid by the business and 7.65% non-deductible taxes paid by
employee). In addition, many business owners remain unaware that onerous
family aggregation rules that had generally limited the contribution and
benefit amounts of owners and spouses in a common plan were
repealed as of January 1, 1997.
Starting in 2002, the increase in the
individual 401(k) deferral limit, the availability of the new 401(k)
"catch-up" contributions, the increases in the maximum individual contribution/benefit
limits, the increase in
the limit on maximum individual compensation used in determining
contributions/benefits, and in the employer deduction limits, provide
significant new planning opportunities relative to the inclusion of a spouse
in the qualified retirement plan of the family owned or closely-held business.
The purpose of this article is to explore the factors involved in the
considering the inclusion of a business owner's spouse in the qualified
retirement plan sponsored by the family business. In the context of this
discussion, a business is any employer including an independent contractor, or
a single or multiple owner business entity (self-employed individual or
partnership, subchapter "C" or "S" corporation, LLC or LLP) whether or not the
business entity employs any common law employees (typically an employee who
receives W-2 income form the employer).
The factors to consider relative
to the inclusion of the spouse are:
Justification and extent of compensation for services rendered
Business income available for payment of services rendered
The extent of the plan contribution based on payment for services
rendered
The cost attributable to FICA taxes (Social Security and Medicare) by
both the business and the spouse
(and the
relatively small cost for FUTA or SUTA taxes)
Justification and extent of compensation
for services rendered
Compensation paid to an employee is deductible as a business expense only if
services are rendered in connection with such payment. In addition, the
amount of compensation paid must be considered reasonable in light of the type
of services rendered.
Business income
available for payment of services rendered
Although
services rendered by a spouse may be considered as justifiable for purposes of
the deductibility of compensation, the business may not have adequate income
to provide payment. The benefits provided by this planning opportunity
may induce the business owner to consider a less aggressive stance relative to
the deduction of certain business expenses, thereby providing additional
business income provide compensation to the spouse for services rendered.
Click here to view Case Study
illustrating the benefit of including a spouse in lieu of aggressive deduction
of business expenses
The extent of the plan contribution based on payment
for services rendered
The
increase in the individual 401(k) deferral limit permits the spouse to
contribute 100% of compensation to the business's qualified retirement plan.
This means that the spouse can earn as little as $14,500 and contribute
$12,000 to the plan (the additional income above $13,000 is necessary to
permit the spouse to pay the FICA, FUTA and SUTA taxes).
If the spouse is
age 50 or older, the availability of the new 401(k)
"catch-up" contribution permits the spouse to contribute 100% of
compensation to the business's qualified retirement plan. This means
that the spouse can earn as little as $17,500 and contribute $16,000 to the
plan (the additional income above $16,000 is necessary to permit the spouse to
pay the FICA , FUTA and SUTA taxes).
In addition, the increases in the maximum individual contribution
limits to the lesser of 100% of compensation or $41,000, the increase in
the limit on maximum individual compensation used in determining
contributions to $205,000 and in the increase in the employer profit sharing
deduction limit to 25% allow spouses to contribute significant amounts to
plans while minimizing the taxable income necessary to provide maximum
benefits. Click here
to view Case Study illustrating a $41,000 plan contribution for a spouse
earning $41,000
The
cost attributable to FICA taxes (Social Security and Medicare) by both the
business and the spouse
The key factor in considering the addition of the
spouse is the 15.3% of compensation cost attributable to FICA taxes (7.65%
deductible Social Security and Medicare taxes paid by the business and 7.65%
non-deductible taxes paid by employee)as well as the
relatively small cost for FUTA or SUTA taxes.
The analysis must consider the amount of the contribution, and the compensation
earned by the spouse and the business owner.
Positive Outcome: $1,791 FICA
tax, $5,888 tax savings, shelter $16,822
Bottom Line In
general, the additional FICA tax required by adding a spouse to the plan is
justified by the increase in tax deductible plan contributions.
However (as illustrated by the examples above), the
specific business profile (owner income, number of eligible employees, etc.) and
the extent of spouse income has a significant impact on the outcome of the
analysis.
We intend the information in this publication as a general resource, not as legal or plan compliance advice or counsel. If you consider any actions discussed in this update, we suggest that you consult a tax or ERISA professional. Milberg Consulting LLC and Barry R. Milberg do not warrant and are not responsible for any errors and omissions from this update.
