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The single most common mistake we see from clients wishing to reduce their income tax burden is their failure to maximize deferrals and contributions to retirement plans. Whether the plan is a 401-K, 457, 403-B, SARSEP or Simple-IRA, the client desiring tax savings MUST maximize deferrals to these plans. Most employers have matching programs for some portion of the 401-K deferral and failure to maximize the deferral misses this benefit of free money from the employer.

Maximum deferrals for 2019 are:
$13,000-SIMPLE IRA & SARSEP (plus $3,000 over age 49 catch-up)
$19,000-401-K, 403-B, 457 (plus $6,000 over age 49 catch up)

One of the single best tools for tax planning is to take the deferral type plans and double-dip when working for two unrelated employers. The maximum deferral is the most that may be deferred by 1 taxpayer in the year 2019 for all deferral plans (Simple & 401-K & 403-B) even if with different employers ($19,000). However, this taxpayer’s maximum deferral rule does not apply to participants in 457 plans under IRC Section 402(g)(3).

The limits on deferrals are applied per taxpayer, but the limit on employer contribution amounts are applied per employer. The only employer limit is the maximum contribution rule limiting the employer to the lesser of 25% of compensation or the current year limit.

Example 1:

Walt Whitman works for Yosemite, Inc. for the first six months of the year and defers his maximum amount of $19,000. Yosemite deposits the maximum amount for Jack of $37,000 to hit the maximum contribution for the year for Jack of $56,000 for 2019. The employer deposit rule is applied as:

The maximum contribution from all sources this year       $56,000
Plus over 49 catch-ups, where applicable                                    0
Less employee deferral                                                      –19,000
Equals employer maximum contribution                            $37,000

On July 1, 2019, Walt leaves Yosemite and goes to work at Teton. Walt is unable to defer any more money this year because he has hit the taxpayer maximum deferral from all sources for 2019 of $19,000. However, Teton, a separate independent company from Yosemite, applies the employer limit and contributes $56,000 for Walt as follows:

The maximum contribution from all sources this year         $56,000
Plus over 49 catch-ups, where applicable                                      0
Less employee deferral                                                       –          0
Equals employer maximum contribution                             $56,000

Assuming Walt earns at least $224,000 at Teton this year he needs to participate in the 401-K but not defer since ($224,000 x 25% =$56,000) and if WorldCom decides to make a 401-K profit sharing contribution Walt may receive up to $56,000.

Summary. In this case, Walt would be able to deposit, between his own deferrals and the employer contributions, $112,000 this year! (19,000 + 37,000 + 56,000).

Example 2:

What if in Example 1 above, Walt left Teton before year-end and went to a third employer? In the wildest case scenario, Walt would again be unable to defer anything because he has hit the maximum taxpayer deferral limit for the year, but the employer could still deposit up to $56,000 in Wat’s 401-K.

Example 3:

What if in Example 1 above, Walt left Yosemite before year-end and went to work for the State of California and participated in their 457 plan? The maximum annual taxpayer deferral rule does not apply to 457 plans as noted, and Walt could defer another $19,000 with the State of California 457 plan, for a total 2019 deferral of $38,000!

Example 4:

What if in Example 1 above, Walt never left Yosemite, but instead started his own consulting business for deferred tax calculations. Could Walt set up a 401-K personally?

Because Walt’s consulting business is unrelated to Yosemite, he could set up a new 401-K, defer nothing, but he could deposit the employer maximum of $56,000 if he made at least $224,000 in the consulting business. (Remember the employer deposit is limited to 25% of compensation). This provides Walt a much better benefit than establishing nearly any other type of retirement plan for his part-time business.

Example 5:

What if in Example 1 above, Walt started his own consulting business but established a SEP-IRA: could he deposit $56,000 in it? Yes, again because it is an independent company. We prefer the solo 401-K because of the availability of an over age 49 catch-up that is not available to the SEP.

Could Walt establish a SIMPLE-IRA? Again yes, but he could not defer anything because he has already hit the annual taxpayer deferral limit at Yosemite. He could put in 2% of compensation into the SIMPLE, but the 401-K allows 25% and both are voluntary, so the 401-K is again the better choice.

Source: TaxSpeaker, 4403 Hamburg Pike, Suite B – Jeffersonville, Indiana 47130

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Manning & Associates and/or MANNINGTAX.COM.  This information is published for informational purposes only.