Sim­ple Solutions


Max­i­mize your re­tire­ment in­come with these So­cial Se­cu­rity tips

GET­TING THE MOST out of So­cial Se­cu­rity is all about wait­ing as long as pos­si­ble to start fil­ing for ben­e­fits, right?

Not quite— es­pe­cially if, as a busi­ness owner, you get to de­cide how you are paid.

You can ac­tu­ally live on a lot more money in re­tire­ment if you make some changes right now to your salary and take some steps to ad­just your cur­rent tax bills, says Matthew Allen, a co-founder of New York City–based So­cial Se­cu­rity Ad­vi­sors.

“Self-em­ployed peo­ple gen­er­ally have more flex­i­bil­ity in how to struc­ture their in­come,” he says. “That gives you a lot of good op­por­tu­ni­ties be­cause of the way So­cial Se­cu­rity ben­e­fits are cal­cu­lated.”

The main tac­tic that Allen lays out be­low isn’t over­whelm­ingly com­plex: Start re­plac­ing some of your salary with div­i­dends, as long as you have a le­git­i­mate busi­ness rea­son to do so. (There’s no re­quired sched­ule for div­i­dends, but you may wish to take them quar­terly, for reg­u­lar cash flow.) Mean­while, boost your con­tri­bu­tions to re­tire­ment sav­ings ac­counts.

It’s a sim­ple enough change—but it’s not a very ob­vi­ous strat­egy un­til you un­der­stand how the So­cial Se­cu­rity and in­come tax sys­tems work, and how the two in­ter­act.

What Your Cur­rent Salary Means

To sur­vive in re­tire­ment, you’ll ob­vi­ously have to re­place some of your cur­rent wages with other sources of in­come, in­clud­ing sav­ings or pen­sions or gov­ern­ment ben­e­fits. So­cial Se­cu­rity, of course, is the na­tion’s cor­ner­stone re­tire­ment safety net; it pro­vided some 50.3 mil­lion re­tirees and sur­vivors, or about 15 per­cent of Amer­i­cans, with ben­e­fits in 2016.

If you’re plan­ning on re­ly­ing on So­cial Se­cu­rity, you prob­a­bly al­ready know that the amount you’ll get at re­tire­ment varies de­pend­ing on how much you’ve earned and paid into the sys­tem. What is less well ad­ver­tised is that So­cial Se­cu­rity’s ben­e­fit for­mula fa­vors lower-in­come re­tirees, the as­sump­tion be­ing that those who haven’t earned high wages don’t have much in sav­ings.

Since low-wage work­ers are less likely to have other sources of re­tire­ment in­come, So­cial Se­cu­rity’s grad­u­ated ben­e­fit for­mula gives them the high­est “wage re­place­ment” rates. Specif­i­cally, those who earned av­er­age monthly wages

of $885, or $10,620 per year, get 90 per­cent of those wages re­placed by So­cial Se­cu­rity ben­e­fits. But the re­place­ment rate drops as you earn more, fall­ing to just 15 per­cent for those earn­ing more than $64,000 per year.

In other words, if you earn an av­er­age of $10,620 in each of the 35 years that So­cial Se­cu­rity will use to cal­cu­late your ben­e­fits, you’ll be due a monthly So­cial Se­cu­rity pay­ment of $796.50 at nor­mal re­tire­ment age.

But if you earn 10 times that much—and pay 10 times as much in em­ploy­ment taxes— your monthly ben­e­fit would in­crease only by 3.5 times, to $2,747.92.

Can You Pay Your­self Div­i­dends In­stead?

Here’s where your cur­rent tax bill comes in. You’re pay­ing So­cial Se­cu­rity taxes only on your salary, or earned in­come; div­i­dend and in­vest­ment in­come is ex­empt. So, as Allen sug­gests, you can min­i­mize your em­ploy­ment tax by pay­ing your­self partly through div­i­dends, rather than through reg­u­lar wages.

How­ever, be­cause this strat­egy will re­duce your fu­ture So­cial Se­cu­rity in­come, it is wise to boost con­tri­bu­tions to your re­tire­ment plans at the same time.

Let’s say your busi­ness earns you $100,000 an­nu­ally, of which you con­trib­ute $10,000 to your re­tire­ment plan. If you take the rest of your earn­ings in wages, you’ll pay roughly 33 per­cent in em­ploy­ment and in­come taxes. But if you take $15,000 as div­i­dends and in­crease your re­tire­ment con­tri­bu­tions by $5,000 an­nu­ally—thus cut­ting your wages by $20,000 a year—your over­all tax rate drops to roughly 27 per­cent, for wages and div­i­dends com­bined. In both cases, your af­ter-tax take home is around $60,000—but if you adopt the latter strat­egy, you’ll save about $5,000 in taxes each year.

Then, when re­tire­ment rolls around, you’ll get slightly less in monthly So­cial Se­cu­rity ben­e­fits—about $316 per month in this ex­am­ple. But you’ll also have dra­mat­i­cally more saved for re­tire­ment: about $750,000 more, as­sum­ing a 7 per­cent av­er­age re­turn over 35 years. That’s enough to pay you $3,322 per month for 35 years—about $3,000 more than you “lost” in So­cial Se­cu­rity ben­e­fits.

Make Your Div­i­dends Count

There’s one big caveat. You need le­git­i­mate rea­sons to pay your­self div­i­dends, rather than sim­ply wages, for this to pass muster with the In­ter­nal Rev­enue Ser­vice, says Philip J. Holt­house, part­ner with the Los An­ge­les ac­count­ing firm Holt­house Car­lin & Van Trigt. Other­wise, the IRS is likely to challenge your strat­egy and “rechar­ac­ter­ize” your in­come as wages, levy­ing the ap­pro­pri­ate taxes and penal­ties in the process. And a tax court may agree.

So what are le­git­i­mate rea­sons to pay your­self div­i­dends rather than wages? When a por­tion of your com­pany’s profits are de­rived from some­thing other than your work as a “key em­ployee.”

If you em­ploy any­one other than your­self (and any co-own­ers), or if you in­vest in machin­ery or equip­ment that is re­spon­si­ble for gen­er­at­ing a por­tion of your com­pany’s rev­enue, it’s con­sid­ered rea­son­able to take wages for your work and div­i­dends for the profit that was de­rived from your other em­ploy­ees or com­pany as­sets.

There’s no set for­mula for de­ter­min­ing what por­tion of your in­come should be claimed as wages ver­sus div­i­dends. But re­al­ize that you may have to jus­tify what­ever for­mula you choose, so you should have a rea­son­able ap­proach. You could re­search com­pet­i­tive wages in your in­dus­try and take any ex­cess profit over that amount as a div­i­dend, for in­stance. Or if you’re able to di­rectly at­tribute rev­enue to em­ploy­ees— or as­sets—that could work too.

How­ever, the more of the com­pany’s earn­ings you take as div­i­dends ver­sus wages, the more likely you are to be ques­tioned by the IRS, warns Holt­house. And if you run your busi­ness full time, you al­ways have to pay your­self at least some wages.

“The idea that you could earn no wages from a busi­ness where you work full time has been pretty uni­ver­sally re­jected by the IRS and the courts,” says Holt­house. “Other­wise, if you have an ar­gu­ment with eco­nomic sub­stance, you could very well win. It gets very fact-spe­cific.”

Given that this sort of div­i­dend-in­come strat­egy could pique IRS scru­tiny if mis­used, you may want to con­sult a tax pro­fes­sional be­fore adopt­ing it.

“So­cial Se­cu­rity is es­sen­tially one big math prob­lem lay­ered with 2,000 dif­fer­ent rules,” says Allen. How­ever, he adds, many cou­ples could end up col­lect­ing around $1 mil­lion in ben­e­fits over their life­times: “I can’t think of any­thing else where it’s as im­por­tant to get it right the first time around.”

Start pay­ing your­self div­i­dends and you could save hun­dreds of thou­sands of dol­lars more for re­tire­ment.

MONEY MAGIC A rel­a­tively sim­ple strat­egy can earn you much more for re­tire­ment—as long as you know how to nav­i­gate the tax code.

Newspapers in English

Newspapers from USA

© PressReader. All rights reserved.