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Last year was a tough year for many small business owners, and many are
looking for corners to cut to conserve cash. One corner that you
should not cut unless you are desperate is contributing to your retirement
plan. Not only do these contributions help you fund your future
retirement, but they can also provide you with a current tax deduction
when you contribute to a self-employed retirement plan or to most traditional
IRAs.
The benefit derived from the deductions for pension contributions is based
upon your tax bracket. The higher your tax bracket is, the larger
the tax savings; thus, higher-income taxpayers benefit the most.
For example, John and George both wish to contribute $5,000 to their retirement
plans. John is in the 15% tax bracket, and George is in the 35%
bracket. Assuming both contribute to a deductible plan, George will
save $1,750 on his tax bill by making the contribution while John only
saves $750.
Here is where some tax-planning strategies come into play. Distributions
from deductible plans are taxable when withdrawn at retirement, while
distributions from Roth IRA accounts are tax-free at retirement (provided
a five-year holding period is met and withdrawals are made after age 59½).
Thus, John may find it more beneficial to make a Roth contribution and
forego a current tax deduction while having tax-free retirement income.
George, on the other hand, would benefit from a nice deduction now but
still may wish to consider the Roth options. However, he will be
barred from making Roth IRA contributions because his income exceeds the
AGI phase-out limitations. Instead, George might consider making
a nondeductible traditional IRA contribution and then converting it to
a Roth IRA in 2010 when the Roth IRA AGI limitations for conversions are
removed.
There are a number of retirement account options available to a self-employed
individual. The 2009 limits for the most commonly encountered plans
are:
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Traditional IRA - Contributions are limited to $5,000
($6,000 if age 50 or over) and are deductible, but the taxpayer can
elect to treat the contribution as nondeductible. If the taxpayer
participates in another pension plan, the deductibility may be limited
depending on income.
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Roth IRA - Contributions are limited to $5,000 ($6,000
if age 50 or over), and the contributions are nondeductible. Contributions
are limited for higher-income taxpayers. The yearly contribution
limit for traditional and Roth IRAs is a combined limit.
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Self-Employed Retirement Plan (SEP) - The contribution
limit is 25% of the net profits from self-employment (20% of the net
profits before deducting the contribution itself) but not more than
$49,000. If you have employees, you generally must contribute
the same percentage amount of their wages for the year to their SEP
accounts (but not more than $49,000).
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Spousal IRA - Frequently overlooked is the fact that
the spouse of a self-employed individual may also be able to make a
contribution to either a traditional or Roth IRA based on the self-employed
spouse's self-employment income.
There are additional requirements that must be met for these plans as
well as other options. Please call this office for further details
and/or assistance with selecting the pension option that best suits your
current situation and your long-term needs.
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