I get the following question at least three or four times a year from our clients:
"I know my income is too high to contribute to an IRA, what other options are there?"
When Congress put in the income limitations on IRA several years ago, there arose a misconception regarding the limit. Many people, including several in the financial advisory business, assumed that if your income was too high you could not contribute to an IRA. The actual law states you can always contribute to an IRA (assuming you have earned income at least equal to the IRA contribution), it is the tax deduction that may be limited. If you are not covered by a retirement plan, you can always deduct an IRA. If you are covered by a retirement plan, then as your income goes above a threshold amount ($95-$115,000 MFJ and $59-$69,000 Single), the deduction is reduced until it is fully phased out.
However, let me reinforce, you can always contribute to the IRA. For 2013, the limits are $5,500 per person plus an additional $1,000 if you are age 50 and over. Roth limitations are similar, however, the income levels before you are unable to make a contribution rise to $178-$188,000 for married couples and $112-$127,000 for singles. These amounts are a combined IRA/Roth limit. You can allocate the totals however you want, but cannot exceed the overall limit. For example, you could put $3,000 into an IRA and $2,500 into a ROTH. However, if you put $3,000 into each, you would be $500 over the limit.
For many of our farm clients, they have faithfully contributed to an IRA each year and with the additional income would like to put more into other retirement plans. There are many types of plans available such as a Keogh, SIMPLE, SIMPLE 401, profit-sharing plans, etc.
For those farmers who would like to contribute up to about $50,000 and are taking fairly small salaries out of their corporation, the use of a 401k plan can make a lot of sense. With this type of plan, each participant can individual set aside up to $17,500 or $23,000 if age 50 and over plus the corporation can contribute and deduct 25% of the participants salary.
As an example, assume Bean corporation has two employees. Farmer Bean normally takes a salary of $50,000 and pays his spouse $20,000 for her bookkeeping and other services. Both are over age 50. By changing the salary levels to $45,000 and $25,000 respectively, they can obtain a net deduction (both at the corporate and individual level) of:
- Farmer Bean 401k deferral - $23,000
- Mama Bean 401k deferral - $23,000
- 25% of $70,000 of salary of $17,500
- Total deduction of $63,500
The deferral reduces the amount of wages that Farmer and Mama Bean will report on their form 1040. The $17,500 paid by the corporation is deducted on the corporation tax return.
If the corporation has employees, then the corporation would be required to match the percentage that the company puts in the Farmer and Mama Bean. In this case, the corporation may elect to reduce the amount they place into the plan, although an effective tool to help motivate and retain good farm employees is to offer a retirement plan. Many farmers view this as investment in employee relations, not a cost.
There are many other examples of how these plans may work, but we wanted to make sure you understand you can always contribute to an IRA even if covered by a retirement plan and show you an option for additional retirement savings.