SIMPLE IRA - Is this an excess contribution?

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gindie

Full time employment: Posting here.
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Jul 16, 2004
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We're trying to compute the maximum allowable contributions for my wife's SIMPLE. She was self-employed with no other employees.

I thought I read in the IRS pubs that she could defer up to the amount of her net income (gross - 7.65%, assuming no other deductions). The company is supposed to kick in a 3% match.

Example: Gross income $1000, net income 0.9235 x $1000, or $923.50 (no business deductions). She deferred all $923.50 and THEN we added in the 3% employer match.

TaxCut is suggesting we put in too much. Is that the case?
 
Yes, in your example, she's contributed too much.

Your wife is both the employer and the employee, which means the match has to come out of her earnings. In other words, you have $1000, total. There are worksheets at irs.gov to determine the exact amount she can contribute.

Also, the maximum for a SIMPLE is $10,000 + 3%.


P.S. Get a self-employed 401k for higher limits.
P.P.S. I'm not an accountant. Standard disclaimer applies.
 
I believe the maximum simple contribution for 2007 has gone up to $10,500 plus 3% match.

Winnie
 
eridanus -

Thanks for the reply, but we did stay below the $1000. She had the 923.50 in salary deferral plus the 3% match (0.03 X 923.50 = $27.71), for a grand total of $951.21.

Am I missing something?
 
So much for calling these "SIMPLE."

When a name has to be attached to a product to try to promote it, it's usually because it's not what the product really is. Kinda like the "fair" tax.

You probably checked a wrong box in your tax program (or didn't check one that needs to be checked). That's the danger with these programs unless people such as yourself know what the answer should be.

$1,000 * 0.9235 = $924

matching $924 * 0.03 = $28

Total = $952 (so you are correct)
 
The 3% comes from the $1000 so your wife actually made only $970 (the $30 was contributed by her "employer"). After SS tax, she made 895.80. This means that her maximum contribution is $895.80 * 1.03 = 922.67

As you can see, that doesn't add up either. It's an iterative process and breaks down into a few algebra problems.

1000 - ErC (employer contr.) = Y (actual pay)

(Y * .9235) * 1.03 = Maximum contribution = .9512Y = MaxContr

MaxContr + SE tax = 1000

SE tax = .0765 * (1000 - (.9235Y * .03))
= .0765 * (1000 - .0277Y) = 76.5 - .0021Y


.9512Y + 76.5 - .0021Y = 1000 = .9490Y + 76.5
.9490Y = 923.50

Y = $973.04 <== Her maximum pay with a 3% match

Take Y, subtract the SE tax, and then add in the match. ==> $925.56 is maximum contribution



***I just pulled these equations together. There are probably mistakes. You REALLY need the IRS worksheets. Alternatively, you can play with TaxCut until you find a contribution value it likes.

Edit: Correction to a formula. See? Don't trust 'em. :)
 
Thanks all for the answers and attempts, but I believe I finally got the correct answer from an old IRAHelp.com post:

Gross: $1000

Net income = (Gross - business expenses) = $1000 - 0 = $1000

Total Compensation for Self-Employed = (Net income X (1/2 of SE Tax rate)) = $1000 X 0.9235 = 923.50

Max SIMPLE contribution (including both employee and employer match) = lesser of IRS limit ($10,000) and Total Compensation = 923.50

As indicated, the employee contribution plus employer match together must not exceed $923.50. The employer match is capped at 3% of Total Compensation, or $27.71. The maximum employee contribution is then (923.50 - 27.71) = $895.79.

My mistake in all of this is not realizing that the TOTAL of employee and employer contributions must be less than the $923.50.
 
gindie said:
Max SIMPLE contribution (including both employee and employer match) = lesser of IRS limit ($10,000) and Total Compensation = 923.50
Click to expand...

You were correct in your first post. Your net income is $1,000, not $923.50. Your max contribution is $952.
 
eridanus -

Thanks for the link.

In my quest I have reviewed that document several times. However, the opening paragraph of that Chapter 5 indicates that the worksheets are intended only for SEP-IRA (described in Chapter 2) and Qualified Plans (described in Chapter 4). A SIMPLE IRA (described in Chapter 3) is neither.
 
http://www.irs.gov/pub/irs-pdf/f5305sim.pdf

This is a worksheet from the IRS. When I read the definitions of "compensation" for self employed people, I agree with retire@40 on how he calculates the contribution.

Also, this is supported in pub560 which says:

If you are self-employed, compensation is your net earnings from self-employment (line 4, Section A, or line 6, Section B, of Schedule SE (Form 1040)) before subtracting any contributions made to the SIMPLE IRA plan for yourself.

I would call the TaxCut helpline and talk to them.
 
Martha said:
It gives $771 as the maximum contribution (with no catch up) if self employed earnings are $1000.
Click to expand...

So the SE tax is taken off the top before the employee contribution is calculated? Oy.

Where's the missing $76? (1000 - 15.3% = 847)
 
eridanus said:
So the SE tax is taken off the top before the employee contribution is calculated? Oy.

Where's the missing $76? (1000 - 15.3% = 847)
Click to expand...

Actually, it is 1/2 of the SE tax (7.65%) that is taken off, but that still doesn't come anywhere close to matching the $771 that Martha's source came up with! :)
 
retire@40 said:
What's there to be confused about? It just means the calculator is wrong.
Click to expand...

Well I did smile when I said I was confused. ;)

Actually, it is disturbing that all the calculators I come up with have a different answer. It should not be that difficult. I found another calculator that gave $1030 as the answer.

The pensiononline calculator seems to make some sense--look at the breakdown. Retire@40, what do you think?
 
Martha said:
Actually, it is disturbing that all the calculators I come up with have a different answer. It should not be that difficult. I found another calculator that gave $1030 as the answer.
Click to expand...

Like I said a few posts ago, that's why they named this retirement plan "SIMPLE."

Without that title it would be even more confusing for most people.
 
I think the correct answer is $1030. You can contribute up to the lesser of your gross income or $10,000 for 2006. In this case, that would be 1,000. Then, the employer contributes 3 percent of the gross, which is $30, so the total is $1,030.
 
Martha said:
The pensiononline calculator seems to make some sense--look at the breakdown. Retire@40, what do you think?
Click to expand...

Well, they got the SEP-IRA number correct. :)
 
Despite what all these varied calculators say, I am still inclined to think that gindie and you figured it out right from the beginning, so I am not arguing with you. :)

I don't understand how they got to 929.50. It seems like they should have taken their 923.50 number and then added in a 3% employer contribution, but what do I know.
 
FYI, here's what the folks who hold the SIMPLE say:

The employee-side contribution limit is $923.50 ($1000.00 X (1/2 SE Tax rate))

The employer contribution is a 3% match of the gross income ($1000.00 X .03%) for an employer contribution of $30.00

The total contribution in this example is $923.50 +$30.00 or $953.50. Because $953.50 is less than the gross compensation (or 100% of business income) the contribution is allowed.

I need to contact TaxCut to find out why their software is complaining.
 
Yeah! We do a better job than TaxCut, and umpteen calculators. Congratulations Gindie for being right from the get go.
 
Martha said:
Yeah! We do a better job than TaxCut, and umpteen calculators. Congratulations Gindie for being right from the get go.
Click to expand...

Martha -

Actually, retire@40 and I computed the 3% on the 923.50, not the $1000 gross. It's only a couple of bucks; I don't know how much the IRS will scrutinize this.
 
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