Month: February 2024

Do Millenials know what a Defined Benefit Plan is?  How often do Millennials think about their retirement plans? Retiring is like that high school crush you never quite figured out. Intriguing yet perplexing, offering promises of golden years filled with leisure, yet fraught with the complexities of financial planning. As millennial small business owners, we’re steering the ship of our enterprises through the choppy waters of the present, but it’s crucial to keep an eye on the horizon. And by the horizon, I mean retirement. Yes, that seemingly distant future where we hope to reap the rewards of our hard labor. But as we chart this course, weighing the anchor of retirement plans with a balanced perspective is essential. Let’s dive into the pros and cons, with a dash of wit, as befits our generation that grew up on a diet of memes and existential humor.

The Good #1: Defined Benefit Plans are Tax Advantages Galore

A Defined Benefit Plan is a Millennial cheat code for taxes. First up, let’s talk about the wonderful world of tax breaks. Enrolling in any retirement plan can be like finding a cheat code in the tax game. Contributions to plans like 401(k)s, SIMPLE Plans, or IRAs can lower your taxable income in the year of the contribution.  This means Uncle Sam gets a lot less and you keep a lot more.

An added benefit is that your investments will grow tax-free until you decide to cash out and buy that dream villa in Thailand.

The Good #2: Attract and Retain Top Talent with your Defined Benefit Plan

I considered this for a long time.  Due to the cost, Defined Benefit Plans are usually used by family-run, sole proprietors, and husband/wife businesses.

If you have the kind of business that needs technically adept employees (in whatever niche you are working), then it might be more important to your business’s success to have continuity with your employees.  If that’s the case, offering a Defined Benefit Plan to your list of employee benefits may be the cherry on your employment sundae.

The Good #3: Compound Interest, Baby!

I love compound interest.  Every investor should.  Curiously enough, this is a concept that confuses folks.  If you aren’t confused, skip ahead.  If you are, let’s take a look at how it helps.

We learned that contributions are tax deductible.  We also learned that appreciation and income from your investments are tax-free at the time it is earned.

Compound interest is free money.

Let’s say you contributed $100,000 to your DBP on January 1, 2020.  Annual earnings on your investments earns 5% per year.

Your balance on January 1, 2020 is $100,000

Your January 1, 2021 balance is $105,000 ($100k x 5% = $5k, $100k + 5k = $105k)

Your balance on January 1, 2022 is $110,250

Why isn’t it another $5k?  Because you are also earning income on the income you earned the previous year.  $5,000 x 5% = $250.

That’s compounding in a nutshell.

The Good #4: It’s a Motivation Booster

I’ve had clients tell me this.  At first, I didn’t think much of it, but as I aged I started to get it.

Having a retirement plan in place is like having a tangible representation of your dreams and aspirations for the future. It’s a constant reminder that you’re not just working for the weekend (something all too familiar to those of us who are self-employed).

You’re building towards something bigger, something that’s waiting for you down the road. This can be a powerful motivator, driving you to push through the tough times and aim for the stars—or at least a comfortable recliner by the beach.

The Bad #1: The Complexity Conundrum

Now, let’s address the elephant in the room: retirement plans can be as complicated.  If this isn’t your world, it can feel like you’re playing a game you don’t know the rules to.

A Defined Benefit Plan is one of the most complex retirement plans available, and any Millennial considering one should really do a lot of research.

With terms like “vesting schedules,” “contribution limits,” and “required minimum distributions,” it’s enough to make your head spin. And this doesn’t begin to illustrate the administrative duties required.  And did you know your retirement plan will now have its very own tax return?

For small business owners already juggling a million tasks, delving into the intricacies of retirement plans can feel like learning a new language. But fear not, for the internet (and financial advisors) exist.

Make sure your financial advisor is aware of the administrative requirements and that they can handle them.

The Bad #2: The Cost of Commitment Can Be Steep

Offering a retirement plan isn’t just a verbal promise.  With it comes financial commitments and administrative responsibilities that will be around for as long as you offer the plan.

There are setup fees, annual fees, and sometimes, matching contributions to consider. It’s akin to adopting a pet; it’s rewarding, but it requires ongoing care and attention (and yes, money). 

For small businesses operating on tight margins, the costs may not be worth the outcome.  I love these plans for Sole Proprietors and Husbands/Wife teams.  When you start including employees, the contribution and admin costs will go up exponentially.

The Bad #3: The Lock-In Effect

This is the issue where I get the biggest pushback.  I get it. You grew up in a different world than my old ass.

A Millennial contributing to a Defined Benefit Plan will no doubt feel constrianed. The “lock-in” effect feels different to different people.

In essence, the “lock-in effect” means your retirement savings are earmarked for retirement, so access is a little more complicated.

How complicated?  Well, not really.  If you need to access the funds you may have an early withdrawal penalty of 10% (and whatever your state may charge).

Your retirement savings are not like a regular savings account where you can dip in for a spontaneous trip to Tahiti or that Porsche 992 you have your eye on. These funds are meant for your retirement years, and accessing them before the IRS retirement date can come with penalties and taxes (you get a deduction for the contribution, you pay tax when you withdraw). It requires discipline to keep these funds untouched, which can be challenging when life throws a curveball (or several).

…And Finally: Millennials and Defined Benefit Plans

As a millennial small business owner, you’re not just planning for the next quarter; you need to be looking decades ahead. Integrating a retirement plan into your business and financial strategy is a move done sooner rather than later, one that also promises massive tax advantages, especially for the Sole Proprietor.

Yeah, there are complexities, some big costs, and commitments to navigate.  If you are looking for a path to a comfortable and secure retirement, then think of it like planting a tree. The best time to plant it was yesterday, and the second-best time is now.

So, let’s embrace the challenge with the same enthusiasm we apply to all aspects of our lives, from mastering the latest social media trends to prioritizing sustainability. After all, retirement planning isn’t just about securing our future; it’s about building a legacy that reflects our values and aspirations. And who knows? By the time we’re ready to hang up our entrepreneurial hats, we might have figured out the plot of “Inception.”

Your S Corp payroll can save you MONEY! As an S Corp shareholder, you are required to be on the companies payroll.  Let’s look at the best way to “pay” yourself as an S Corp owner.

Introduction

S Corporations (S Corps) can be looked at as a great blend of a pass-through taxation and liability protection.

What this means is you have an entity that pays tax like an LLC (or partnership), but gives you the business structure of a corporation.But as an S Corp, you are required to be on payroll.  This allows you to set your payroll salary at a level which the IRS would be happy with, but also allows for distributions, which save on payroll taxes.

Navigating the intricacies of payroll as an S Corp owner is important for compliance and tax savings.  Let’s check out a few strategies that help S Corp owners make the most of their payroll structure.

S Corp Payroll

You must be on payroll if you actively participate in running the business and are a more than 2% shareholder.  This is only a requirement if you actively work in the business.  If you don’t actively participate in the business, you aren’t required to be on payroll.

This balance of compliance with IRS regulations is the key to maximize your tax savings. The key lies in determining a reasonable salary and strategically utilizing a mix of salary and distributions.

What is a “Reasonable Salary”?

This part of your S Corp payroll is required. This is always the hard part.  Mostly because the IRS has no real guidance other than the wage must be “reasonable”.

The easiest way to establish a baseline is to determine what you would pay someone to do your job.  Put together a job description and we can use that to research comparable pay.

To establish what a “reasonable salary” is for your specific business, you should consider industry standards, their skills, experience, and responsibilities to avoid the risk of “unreasonably low” salaries.

When I’m assisting a client with finding their “reasonable salary”, I always review what other companies are paying.  Indeed.com, Salary.com and Payscale.com are a few sites I look through.

Another consideration is the success of the business in question.  If you can’t afford, or the business doesn’t generate enough income to pay a salary based on your findings, then pay less.

Generally, a shareholders salary must be at least 50% of your net earnings before paying yourself.

You Are Tax Planning Even If You Didn’t Know It.

Finding the best balance between your salary and distributions is the ultimate in tax planning.

I’ll tell you why.

If you take all of your profits via payroll, you are paying more in payroll taxes than really required.

Let’s pretend you made $100,000 in net income (before payroll) last year.  Your net take home pay in this example would be around $71,500.  I used California as the state.  A Digital Nomad (i.e. no state return filed) would end up with about $76,500.

Optimizing payroll for S Corp owners involves finding the right balance between salary and distributions. Understanding the advantages of each and utilizing business deductions are essential for minimizing taxable income and maximizing tax efficiency.

If you determined your salary should be $50k (instead of $100k), you would be right at a 50/50 split between salary and distributions.  This would save (in payroll taxes) about $4,000.

See.  Tax planning.

You Must Comply With IRS Requirements

Congress recently passed legislation which increased the IRS budget by $79.4 billion over the next 10 years (this is in addition to the annual budget given for operations).

One of the things they will use this money for is audits of S Corps, specifically as it relates to shareholder payroll.  This is low hanging fruit and can generate billions in payroll taxes and the related penalties and interest involved.

I have started seeing these audits and the IRS is taking a position that ALL of your net income should be paid out using payroll.  The best course of action is to pay yourself with a nominal salary.  You can pay yourself a bonus periodically to increase your pay to reflect at least 50% of net income.

I don’t advise simply paying yourself a small salary each month, taking the rest in distributions.  You are in no better of a situation if your pay balance is 10/90% (payroll/distributions) vs 45/55%.  You’ll mitigate penalties and interest, but this will be a minor expense related to the actual payroll taxes. 

Employee Benefits for S Corp Owners

If you are an S Corp shareholder, the only legal way for you to receive benefits would be via payroll.

Without a paycheck, you can’t contribute to a Solo 401K or SEP plan. 

If you’re not on payroll, you can’t get an auto supplement.

Without a paycheck, you won’t be able to deduct your health insurance.

If you pay yourself via payroll, you open up the world of benefits you can receive as an employee of your own corporation.

Without a paycheck, your corporation cannot pay for benefits on your behalf.  If you do, you must 1099 yourself for the amount paid out.  You will report this income on your personal income tax return as self employment income.

Should You Hire an Expert?

There are two parts to this question:

1  Determine a salary amount which you can show is “reasonable”

2  Run your S Corp’s payroll at least monthly (this is the legal minimum).

You should be able to determine a reasonable salary by using one of the salary sites I referenced above.  Be sure to save your research in the event the IRS questions the amount of salary you give yourself.  You will need a persuasive argument when dealing with the IRS.

Where you should consider an expert is in the preparation of payroll.  While the actual calculation is easy (heck, there are hundreds of web pages to calculate your payroll).  The important part is tracking and reporting your payroll each quarter.  I advise your payroll reports be prepared by an expert.

I haven’t had many clients in my career who were able to properly calculate AND report payroll.  Payroll tax issues are also one of the most prevalent issues small business owners experience.  Let a pro handle this aspect of your business.  This also frees you to make more money.

A Simple Case Study

You will see the benefits of this even with a simple situation.  In this example, it’s just me.  Not as a licensed tax professional, but as a guitar player.

I’m an ok player and have a few set gigs a week, with the occasional event.  I’ve been around a while and have made $100,000 each year for the past 5 years (just to make the math easier).

Earlier, we noted that a $100k salary would give you about $71,500 after taxes were withheld.  Cutting your salary in half saves about $4k in payroll taxes.

It really is that simple.  The complication is figuring out what your MINIMUM salary can be.  The balance between compliance and savings.  This is a personal calculation.  If you can prove your salary amount is reasonable, the rest can be taken as a distribution saving payroll taxes from being paid out.

Conclusion

Figuring this out is the easiest way to save real money with tax planning.

You must comply with S Corp payroll requirements for active shareholder participants.  This fancy talk for “pay yourself what you’d pay someone else to do your job”.

Your salary should be AT LEAST 50% of what your net earnings are for any given period.  I’ve spoken with auditors who use a 75/25 split to start.  I would negotiate this down to be closer to the 50/50 split.

The easiest way to do this is to set yourself up with a nominal salary to be paid every month. Give yourself a bonus every quarter that increases your pay to the 50% figure we aim for.

You must pay yourself as an employee if you work for your S Corp.  You may as well do it right and save a little money!

That’s it for now.  Hit me up if you have questions.  Until then, stay cool.

JKC