Retirement Planning for the Closely Held Business...What's the Spouse for Again?

There are many ways for a small business owner to fund retirement.  Although according to US News in a survey done in 2018, 34% of all small business owners had saved nothing for retirement.   That’s not good.  And interestingly, 42% of small business owners, according to The Motley Fool, June 2018, are counting on the sale of their business to constitute a major source of retirement income.  That’s seems like a pretty big bet to me.  Who is going to buy those businesses again?

So what might a small business owner do with respect to planning for retirement?  In most pass-through tax entities – S-Corps, Partnerships, and LLCs – the most viable, tax advantaged way to plan for retirement is through a qualified retirement plan.  The amount that can be contributed to a defined contribution plan is dependent, in large part, on the owners earned income, but can be as high, for 2019, as $56,000 or 25% of wages, whichever is less.

In working with smaller companies, I often see an owner trying to maximize the contribution at $56,000.  Simple math says that $56,000 is 25% of $224,000.  In other words, if an owner pays himself anything more than $224,000 in wages, he is not getting any benefit as far as his defined contribution plan is concerned.  He would be better off taking amounts above $224,000 as passive income, if that is an option, and paying taxes at a lower rate.

However, if there is a spouse gainfully employed, or a spouse that could be so employed, there could be an argument that we should pay the spouse some of the income that might have otherwise gone to the owner above $224,000.  Why would we do this?  Those additional wages going to the spouse are now earnings that can be considered for our 25% limitation.  We can’t give our owner any more contribution, but if we pay the spouse $100,000, for example, we could make a contribution of up to $25,000 into her account
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As you might expect, there are many considerations that must be factored in before we rush to take the action noted above.  The additional payroll taxes for the spouse might be steep.  But then again, getting a benefit from Social Security might be good.  Who knows?  The additional $25,000 deduction good, right?  Lots to consider.  Make sure you work with someone qualified and experienced to walk you through the pros and cons around these scenarios.
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In fact, work with me.