H. Quincy Long
Ira N. Richer, a 56 year old self-employed consultant, his wife, Hope Tobe Richer, Ira’s 51 year old stay at home wife, and their 17 year old son, Will B. Richer are interested in saving money in self-directed accounts at Quest IRA, Inc. How much money can they contribute based on Ira’s $30,000 net earnings from his consulting practice?
Roth and Traditional IRAs
Roth IRA – Anytime from January 1, 2008 through April 15, 2009, Ira and Hope can both contribute to a Roth IRA for 2008.Even though Hope does not earn wages, she can still contribute to a Roth IRA based on Ira’s income, assuming they are married filing jointly for federal tax purposes.Even if he doesn’t claim net earnings from self-employment of over $30,000, Ira can contribute $6,000 into each Roth for 2008 ($5,000 base contribution plus a $1,000 catch up contribution since they were both at least 50 years of age by December 31, 2008).Assuming their son Will has compensation of at least the amount of his contribution, he may also contribute $5,000 to his own Roth IRA for 2008.
Traditional IRA – Ira and Hope could have contributed the amounts described under the Roth IRA into Traditional IRAs, but their total contributions to both their Traditional IRAs and their Roth IRAs cannot exceed the annual contribution limit of $6,000 per person over the age of 50.In this case they elected to put the entire contribution into their Roth IRAs.If neither Ira nor Hope were covered by a retirement plan at work, their contributions to a Traditional IRA would be fully deductible, no matter how much income they earned.
Roth Conversion – If Ira or Hope has money in a Traditional IRA (including a SEP IRA), that money can be converted into a Roth IRA provided that their Modified Adjusted Gross Income (MAGI) is $100,000 or less in the year they do the conversion.Any amount they convert is added to their taxable income for the year, but no penalties are assessed for doing a Roth conversion.Important Note:in 2010 the amount of modified adjusted gross income made by Ira and Hope will not affect their ability to do a Roth conversion.Also, they may split the taxes from the 2010 conversion and pay 50% in 2011 and 50% in 2012.For conversions in 2011 and after, taxes must be paid on the conversion income in the year the Traditional IRA was converted to the Roth.
Ira can also have an employer plan based on his self-employment consulting income.With any of the work plans discussed below, Ira must also cover any other employees under the plan.This may affect which of the plans he chooses for his business.We will assume that Ira has no employees.Having any of the work plans discussed below does not affect Ira’s or Hope’s ability to contribute to a Traditional or Roth IRA, but above certain income levels it will affect the deductibility of a Traditional IRA contribution.
SEP IRA – Ira can choose to have a SEP IRA plan into which he can contribute up to a maximum of 20% of his net earnings from self-employment, or 25% of his W-2 wages if he is paid through a company.Net earnings from self-employment are calculated for SEP IRA purposes by deducting one-half of his self-employment tax from his net profits as shown on Schedule C.The plan can be set up and funded at any time prior to Ira’s tax filing deadline, including extensions (ie. October 15, 2009 if Ira files for an extension).Since Ira’s net earnings from self-employment were $30,000 in our scenario, he can contribute up to $6,000 into his SEP IRA at Quest IRA, Inc. (the contribution limit would be $7,500 if Ira were paid W-2 wages from a company instead of reporting his income on Schedule C as self-employment income).If he wants to, in January of 2009 Ira can begin making contributions for 2009 to his SEP IRA.
SIMPLE IRA – Another alternative is for Ira to have a SIMPLE IRA for his consulting business.This type of plan is appropriate for those with lower income levels or for those who have employees and who don’t want to contribute an equal percent into their employees’ retirement plans as they do for themselves.Assuming he had the plan set up by October 1, 2008, Ira can contribute $10,500 of his net earnings from self-employment for 2008, plus an additional $2,500 catch up because he is over age 50 by December 31, 2008.The $13,000 is considered salary deferral and must be contributed by January 30, 2009.Ira can also contribute an additional $900 as an employer contribution by his tax filing deadline, including extensions (ie. October 15, 2009).For SIMPLE IRA purposes, net earnings from self-employment are calculated based on 92.35% of Ira’s net Schedule C income.Ira is considered both the employer and the employee since he is self-employed.The total 2008 SIMPLE IRA contribution is $13,000 in salary deferral and $900 in employer contribution for a total of $13,900.This is an improvement over what he can contribute to a SEP IRA at his income level, but at income levels above around $60,000 (or around $48,000 if under age 50) the SEP is more advantageous, absent other factors.
Profit Sharing/401(k) Plan – The plan into which Ira can put the most money is an Individual 401(k)/Profit Sharing plan.An Individual 401(k)/Profit Sharing plan must be set up by December 31, 2008 if Ira wants to contribute or defer compensation for 2008.In this plan Ira can defer $15,500 plus $5,000 catch up for 2008 out of his $30,000 net earnings from self-employment.Net earnings from self-employment is calculated for Individual 401(k)/Profit Sharing planpurposes by deducting one-half of his self-employment tax from his net profits as shown on Schedule C.In addition, Ira can contribute up to 20% of Ira’s net earnings or 25% of his wages if he is paid by a company into the plan, or $6,000.These contributions must be made by Ira’s tax filing deadline, including extensions.This means that for 2008, Ira can contribute $26,500 into his Individual 401(k) plan with only $30,000 in earned income!
Even better, starting in 2006, Ira’s salary deferral can be a Roth 401(k), which means that he will pay taxes on his salary deferral when he contributes, but will pay NO TAXES when the funds are distributed to him, provided they are qualified distributions.What an opportunity!Although Ira qualifies for a Roth IRA because of his income level, even if he makes too much money to qualify for a Roth IRA he can defer salary into a Roth 401(k).The employer contribution ($6,000 in Ira’s case) is pre-tax, so part of Ira’s withdrawals from the plan will be taxable and the portion relating to the Roth 401(k) will be tax free.
Besides Traditional or Roth IRAs and an Individual 401(k) plan, SEP IRA or SIMPLE IRA for Ira’s consulting business, the Richer family can also have two other types of accounts.These are the Health Savings Account (HSA) and the Coverdell Education Savings Account (ESA).Like the other accounts they have at Quest IRA, Inc., the HSA and the ESA can be self-directed.Neither of these types of accounts is directly related to how much money Ira earns, although above certain income levels Ira and Hope could not contribute to Will’s Coverdell Education Savings Account.
Health Savings Accounts – Ira and Hope can save on taxes for 2008 by opening a Health Savings Account, or HSA.In order to do this, they have to have a special type of insurance plan, called a High Deductible Health Plan, or HDHP.Just having a plan with a high deductible does not necessarily qualify you for an HSA.Assuming Ira and Hope have a family plan, they can contribute up to $5,800 for 2008 up until April 15, 2009.Because Ira is over 55 years old, he can add a $900 catch up contribution for 2008 in addition to the regular contribution.Ira and Hope can split the contribution into 2 separate accounts or put all of it into one account.Starting in 2007 contributions are no longer limited by the deductible amount, as they were in years past.Even if Ira and Hope have the minimum deductible of $2,200 for a family plan, they can contribute the maximum of $5,800 for the year plus the catch up contribution. Contributions to HSA accounts are tax deductible, and there is no tax on the distributions if the money is used for qualified medical expenses.This truly is the best of both worlds!
Coverdell Education Savings Accounts (formerly Education IRA) – Since Will is under age 18, Ira can put up to $2,000 into a Coverdell ESA for 2008.Ira will receive no deduction for the contribution, but any earnings which are withdrawn for qualified education expenses are tax free.Qualified education expenses include certain expenses for grade school and high school as well as for college.
For the tax year of 2008, here is the maximum amount of money that the Richer family can put into self-directed accounts at Quest IRA, Inc. :
For Richer Family
Ira’s Roth IRA$6,000
Hope’s Roth IRA$6,000
Will’s Roth IRA$5,000
Ira’s Individual (k)$26,500
Assuming all distributions are qualified distributions, the earnings from the Roth IRAs, the Roth 401(k), the HSA and the ESA are tax free forever!This means that the Richers can get richer by investing as much as $46,200 tax free and the balance on a tax deferred basis.All of these accounts can invest in real estate, real estate options, promissory notes, both secured and unsecured, LLCs, limited partnerships, private stock and much more.They can invest individually or in combination with each other.To find out more about these accounts, contact your closest Quest IRA, Inc. office today!