Published by Robert W. Huntley, CFP®, CHFC®, CKA® Founder & Wealth Advisor
Many people retire in their mid-50s to mid-60s but continue working on the side as contractors. The side gig is a way to earn some extra spending money and stay engaged mentally and socially.
In this situation, you have an option to fund a SIMPLE IRA plan that can be very attractive and save you some serious taxes. Here’s how it works.
Suppose you retired and are doing consulting work now, earning profits of $20,000 per year. This consulting income must be reported as self-employed income and most people will report it as if they’re a sole proprietor, using a Schedule C form on their personal tax return.
On a Schedule C form, you record your gross income first. Then you deduct legitimate business expenses against the income. Whatever is left over is taxable income to you personally at your normal tax rate. It’s also considered taxable income for FICA tax purposes, and the combined tax rates can easily amount to 37% or more taxation.
Your federal tax rate, for example, might already be 22%. This is often referred to as your “marginal tax rate” meaning the last dollar of income added on top of all the other income is taxed at this rate. In 2019 your taxable income, married filing jointly would need to be $78,950 to hit the 22% rate. It would only need to be $39,475 if you were filing single.
Keep in mind that your income to hit those rates would include pension, social security, IRA distributions, annuity, and investment income. If you’re filing married-jointly, your spouse’s income is also added into the mix. So, it’s not hard to get to those levels. The self-employed income is added on top of all that other income to end up with the tax rate described.
The FICA & Medicare tax rate for someone who’s self-employed is a combined 15.3%. That’s because you’re paying both sides of the tax burden. The employer and employee shares.
So, the two rates together might be 22% + 15.3% equaling 37.3% tax rate on the profit.
This is where the SIMPLE IRA can be so useful.
In 2019, the IRS allows you to put up to $13,000 and another $3,000 catch up (if you’re over age 50) into a SIMPLE IRA. You also get to do a matching contribution of as much as 3% of your taxable self-employed income. These contribution amounts are available if you have at least that much taxable income to report on your Schedule C.
In our example, you have $20,000 profit on your Schedule C. So, you could contribute $13,000 + $3,000 + $600 for a total of $16,600 into your SIMPLE IRA and get a full deduction for the contribution. That saves you the 22% federal income taxes. Unfortunately, it doesn’t reduce your FICA taxes. Those are only reduced by normal business expenses. However, 22% of $16,600 is still a nice saving.
What’s unique about the SIMPLE IRA is it lets you contribute the maximums if you have at least that much income. Another common self-employed retirement plan is the SEP plan. However, SEP plans limit you to contributing 25% of profit so in order to get up to the funding limits of a SIMPLE IRA you’d have to have much higher profits.
To contribute $16,600 to a SEP, you’d have to have a self-employed profit of closer to $66,400. Most people aren’t earning that much as part-time contractors, so the SIMPLE IRA is usually easier to fund at higher levels. In our $20,000 example, a SEP would only allow you to contribute $5,000. That makes the SIMPLE IRA more attractive in this situation due to the higher contribution limits.
You can read more about these plans on the IRS website links below:
As always, it’s best to talk with someone you trust who can explain your options. I have seen the SIMPLE IRA work well for many people. Feel free to reach out to us if you have any questions about your personal options.
This piece is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific tax or other professional advice.
