By Ryan Johnson, Wealth Management Partner
Being an independent contractor provides financial flexibility including the ability to save substantially for retirement… and subsequently enjoying a significant tax break. Some of the basic tax-deductible retirement accounts available for 1099 physicians are covered in a previous blog. For those wanting to make significantly higher tax-deductible contributions ($100k+), a Defined Benefit Plan might be the way to go. Not ready to make quite that large of a commitment? Hiring a spouse is a nice strategy to save more for retirement without being as aggressive as what a Defined Benefit Plan would require.
What do I mean when I say hire your spouse? Make your spouse your Chief Financial Officer. Your spouse can help you with the business side of being an independent contractor….accounting tasks, business expenses, etc. It is a good idea to document the duties your spouse performs to validate the work being done justifies the salary being paid. Once your spouse is hired, he/she can now make tax-deductible retirement contributions to a retirement plan.
So how do you determine how much to pay your spouse? It is important to understand you will be paying social security tax (12.4%) on your spouse’s income. You only pay social security tax on the first $137,700 you make. Therefore, the money you are paying your spouse is likely money you are currently not paying social security tax on. Subsequently you will be paying that extra tax when you pay your spouse (typically, the benefit of being able to contribute to a tax-deductible retirement account outweighs this drawback). Therefore, you want to pay a low salary so you don’t pay more than necessary in social security tax. Your spouse’s salary will then be used to fund a retirement account. The Individual 410(k) is the best plan for this scenario because your spouse can defer 100% up to the first $19,500 of salary. The amount of gross pay to your spouse does have to be high enough to cover the deferral, FICA tax, and any employer match (total around $30,000). Work with a CPA to determine how to best design this. As the employer, you will need to contribute 25% of your spouse’s salary. This means your spouse is putting away a total of $27,000* into a tax-deductible retirement plan. In total, you would be putting away $84,000…$57k for you (the working physician) plus $27,000 for your spouse (and if you are both over the age of 50, you can add another $12,000). Additionally, you will be deducting $84,000 from your taxable income (meaning you won’t be paying income tax on the $84,000…saving you quite a bit of money). Of course, if $84,000 doesn’t fit into your budget but you want to do more than $57,000, you can tweak the approach to meet your needs.
The key thing to remember? A physician should only consider hiring a spouse if he/she is an independent contractor who is, 1) maxing out his/her own retirement savings, and 2) wanting to save more in a tax-deductible retirement plan. Work with your financial adviser and CPA to determine what makes the best sense for your specific scenario.
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*another $6,000 can be added for age 50+