Employee retirement plans
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Questions about simple IRAs and taxes. October 2, 2001
Question
I’m looking to set my employees up with a retirement plan. Specifically, a Simple IRA plan. What I’m unclear about is what taxes to deduct, if any.
I know that IRAs are tax deferred at least on the federal level, so no federal taxes will be deducted. But what about FICA and state tax?
Forum Responses
From contributor F:
Your question is clearly one for your accountant. There are no taxes. You might get some info from Charles Schwab or similar, as there is plenty of good info out there.
Here in California, we have to deduct taxes on everything except federal and state income taxes. All of the rest of the taxes apply. The employee pays the income taxes when he/she withdraws the money from the fund. But check your state and federal rules.
From contributor F:
I said there are no taxes. Wrong! Actually, the taxes are deferred and paid when the money is withdrawn, as stated above. Years later, usually. The Simple IRA contribution is made with "pre-tax" dollars. The Simple IRA is a very good vehicle for a small business, and most of us in this industry and at visit this forum are small businesses. Each pay period, the taxable income is reduced by the "contribution" to the IRA. Or... earn $900, pay tax on $900, unless you have a Simple IRA, then earn $900 less contribution (say $60), pay tax on balance, or $840. Best to talk to the accountant or the financial advisor. I have a Simple IRA. I use Schwab as an advisor, as suggested by my accountant, and I'm happy.
From the original questioner:
Okay, here’s why my head is spinning.
My accountant tells me basically what contributor F is saying. The entire contribution is paid into the employee’s simple IRA account without being taxed. The same as if I were to provide a health plan for my employees. None of the premiums would be considered taxable from their perspective.
To me, this didn’t seem right. Yes, federal and state taxes will be paid at age 69 1/2, but what about FICA? If retirees pay no FICA when they start to withdraw from their IRAs, that means they’ve gotten away with paying the tax at all.
That didn’t seem to add up to me, so I called a financial advisor at Smith Barney. His advice? Talk to your accountant! (I’m still amazed he didn’t know. It’s almost as if HE asked ME how to turn on the table saw and me not having an answer!)
I have a Simple IRA from MFS for my employees. My shop is in NJ and our tax law (according to my broker) dictates that an IRA of this nature is entirely tax deferred and that means you as an employer are never responsible for taxes tied to that money. The individual is responsible for paying taxes when they are of age to withdraw the funds. As far as FICA goes, the retirees are not getting away with anything, the system is set up this way. You should look in the MFS Simple Plan book--most of this info is in there.
From contributor F:
The reason the broker refers you to the accountant is that each is licensed and those licenses restrict what each can do professionally. This is over-simplification of the law and the fiduciary responsibility of each, but you get the idea. Kinda like your doctor doesn't pull teeth, right?
From contributor D
I am not sure what you are describing as a "simple IRA". You may want to ask your accountant about a SEP retirement account. It basically has you paying retirement funds based on your profits. Seems like a good incentive for employees to be productive. You can still have individual IRAs, also. I currently have a SEP IRA, and 2 spousal IRAs in my family. Remember to include retirement costs in your overhead calculations. Another hint: shop around for accountants, as their differing philosophies will have an impact on your financials.
From contributor F
To contributor D: Better check out the Simple IRA. It fits some small business better than a SEP.
We went with a Simple IRA over other retirement accounts for a purely selfish reason. In most retirement accounts you have highly compensated testing, whereas, the owner may only contribute 2% more then the average of what his/her employees are contributing.
In a Simple plan, there is no testing. The max an employee (any employee) may withhold is $6000. The only requirements you have is that you have to provide 2% of wages to everyone's account OR match up to 3% of wages of what the employee puts in. We do 3% because not everyone participates. Thus, 3% of participating is cheaper then 2% of everyone. And the big plus is I can put in 6000 plus the companies matching 3% of wages. This also can work for a spouse. If the spouse does part time work and makes $6000, you can elect to withhold all $6000 to a retirement account. No federal or state taxes.
There are plenty of sites out there that will explain the plusses/minuses. We chose and like the Simple Plans.
Here's how Simple Plan contributions affect our company's payroll deductions (PA).
As you mentioned, federal withholding tax is deferred on the money an employee contributes to the simple plan.
So, for example, if the employee's wages are $500 and he is contributing $100 to the simple plan, that $100 is not subject to FWT. The other $400 *is* subject to FWT, and we withhold FWT from that $400.
All his wages are subject to SS and Medicare, so we withhold SS and MC from the entire $500.
Also, here in PA, all $500 of the wages are subject to PA withholding tax so we have to withhold that as well.
As many of the other people who responded have pointed out, different states have different rules, so checking in with an accountant is probably the first step you should take. It might also be a good idea for your employees to talk with an accountant to help them determine how much they could, or should, contribute.
The comments below were added after this Forum discussion was archived as a Knowledge Base article (add your comment).
Comment from contributor V:
I'm a CPA and must confess that some of the best guidance out there is available to accountants and non-accountants. The IRS has great guidance available to small business owners. On page 11 of Publication 560, it states that the employee contributions to a Simple IRA withheld from their checks are not subject to federal income tax, but they are subject to Social Security, Medicare, and Federal Unemployment taxes. Most state unemployment taxes mirror the federal wage base, but you'll have to look into that for your specific state.
Comment from contributor J:
The previous contributor is correct. I setup SIMPLE plans for employers, and they are subject to FICA, Medicare and fed unemployment taxes. Otherwise, tax deferred until retirement. Why wouldn't your accountant know this? Maybe you need a new accountant! As Contributor V said, it's published on the IRS web site on qualified retirement plans.
