Daycare Tax Tips

Saving for Retirement with a SIMPLE IRA

This is my favorite self-employed pension plan for child care providers

We all need to save for retirement. Profitable day care providers (as well as other self-employed sole proprietors) can contribute to a Traditional or Roth IRA (Individual Retirement Arrangement), just as wage-earners can. As a business owner, however, you can contribute more than the regular IRA limits will allow by setting up a self-employed retirement plan. The SIMPLE (Savings Incentive Match Plans for Employees) IRA is a good choice for small business owners.

SIMPLE IRA Advantages

(1) The maximum annual contribution is more than twice that allowed for a regular IRA contribution,

(2) Even child care providers showing a modest profit on Line 31 of their tax return Schedule C (Form 1040) can contribute the annual maximum,

(3) Required contributions for eligible employees are relatively modest, and

(4) SIMPLE IRA administrative costs are low. Many financial institutions (including mutual fund companies and low-cost brokerage houses) will administer a SIMPLE IRA plan for free.

One big catch is that SIMPLE IRA plans must be set up by October 1 of the contribution year. Unless you have employees, you are not required to CONTRIBUTE anything by October 1, but you must choose a financial institution and do the initial paperwork. Even with employees, contributions that come from the business owner's pocket can generally be made after the end of the year. (Read more about contribution deadlines later in this article.)

SIMPLE IRA vs. SEP IRA: Most Child Care Providers Can Contribute More to a SIMPLE Plan

Another option for child care providers is the SEP (Simplified Employee Pension) IRA. SEP IRAs are popular with self-employed business owners because the maximum annual contribution is very high (over $50,000) and because accounts can be opened all the way up until the tax return due date, including extensions.

The trouble with SEP IRAs, however, is that the maximum contribution is only about 20% of business profit. In contrast, under a SIMPLE IRA plan, you can contribute close to 100% of profit, up to the annual maximum. This is a much better option for low and middle-income businesses.

The SIMPLE IRA allows the vast majority of family child care providers to make a higher retirement contribution than a SEP IRA will allow. It's only when profit approaches $100,000, that the maximum SEP IRA contribution starts to exceed the maximum SIMPLE IRA contribution, as illustrated in the examples shown below.

Three SIMPLE IRA vs. SEP IRA Scenarios

(1) Leslie Low Profit is a child care provider with a Schedule C profit of $5,000. For 2010 Leslie's maximum SEP IRA contribution was $929 and her maximum SIMPLE IRA contribution was $4,757.

(2) Marcia Medium Profit is a child care provider with a Schedule C profit of $50,000. For 2010 Marcia's maximum SEP IRA contribution was $9,293 and her maximum SIMPLE IRA contribution was $12,885.

(3) Hannah High Profit is a child care provider with a Schedule C profit of $100,000. For 2010 Hannah's maximum SEP IRA contribution was $18,587 and her maximum SIMPLE IRA contribution was $16,771.

Regarding scenario (3), even though Hannah could contribute somewhat more to a SEP IRA., the SIMPLE IRA was a better choice for her. SEP IRA contributions are always made by the employer and it turned out that Hannah would have to make a $9,500 SEP IRA contribution for her employee. (Her employee was paid $38,000 in wages in 2010.) By going with the SIMPLE IRA, she reduced that to an employer matching contribution of $1,140. This made the SIMPLE IRA much more attractive overall.

Employee Contributions and Employer Match

As self-employed business owners, child care providers make SIMPLE IRA contributions for themselves as both "Employee" and "Employer." This SIMPLE IRA worksheet shows the Employee contribution on Line 2 and the Employer matching contribution on Line 6. The provider's total contribution for the year is shown on Line 11.

Be careful about setting up a SIMPLE plan, or any self-employed retirement plan, if you have employees. Different types of plans have different rules. Determine which employees must be covered under a given plan and how much the employer is required to contribute. Consider how this will impact your bottom line.

When it comes to Employer contributions, the SIMPLE IRA again has the advantage over the SEP IRA. The maximum eligibility requirements are higher (so you have more control over which employees qualify to participate) and mandatory employer contributions are lower. Any employee who received at least $5,000 in compensation during ANY two years prior to the current year, and reasonably expects to receive at least $5,000 during the current year, must be allowed to participate in the employer's SIMPLE plan. You can choose to loosen eligibility requirements and make it easier for employees to participate, but you cannot make eligibility more restrictive.

Employees who meet the eligibility requirements can decide whether or not to participate in the employer's SIMPLE plan. Those who choose to participate make elective deferrals from their wages, usually as a percentage of compensation. This means that the bulk of contributions made to an employee's SIMPLE plan account come from the employee's own funds through payroll withholding. The employer must match those contributions, but only up to a small percentage of wages.

Employer Contributions

Employers contribute to employee SIMPLE IRA Plan accounts by either:

(1) Making matching contributions for all participating employees equal to the employee elective deferrals, up to a maximum of 3% of compensation. Employers can elect to match at a rate lower than 3%, but not lower than 1%, and not for more than two out of five years.


(2) Making nonelective contributions equal to 2% of compensation for all eligible employees, not just those who choose to participate.

For a child care assistant making $25,000 per year, the maximum employer contribution under option (1) would be $750 (3% of compensation). All in all, not too much of a burden, especially compared to a SEP IRA, where the required contribution for this assistant could be as high as $5,000 (25% of compensation).

Once a SIMPLE plan is established, the Employer contribution is mandatory for the self-employed owner, as well as for participating employees. A child care provider can decide whether to contribute the maximum, less than the maximum, or nothing, towards their own Employee elective deferral. On the other hand, the Employer contribution is required, even in a low income year. So unless the business has zero income or a loss for the year, the owner (even those without employees) will have to budget for at least the minimim Employer contribution each year.

SIMPLE IRA Plan Contribution Deadlines

Employee elective deferrals must be contributed to their SIMPLE IRA Plan account within 30 days after the end of the month in which the contribution was deducted from the employee's paycheck.

Child care owners must make their own "Employee" contribution no later than 30 days after the end of the year, or January 30.

Employer contributions (for employees and for the child care owner) can be made up until the due date for filing the owner's Form 1040 income tax return, including extensions. The final profit shown on the business owner's Schedule C will determine the amount of the owner's Employer contribution and their maximum Employee deferral contribution.

There are certain things to learn about operating a SIMPLE IRA plan, more so if you have employees, but it's pretty manageable. I have tried to provide information that is accurate as of the date shown below, but be sure to confirm all the particulars through your own research and guidance from your tax advisor and your financial institution.

Last updated 13 August 2015

Posted on 2013-06-07 01:16:43