My Spouse is Not Working. Now What?

Adding your non-working spouse to the company payroll is a big decision. But is it the right one?

Business owners often ask whether they should add their spouse to the payroll to increase their Social Security benefits. The question is especially important when a spouse leaves the workforce to raise a family, care for elderly parents or for some other reason.

When considering the matter, we need to understand how Social Security benefits are determined and how much they cost.

Under the current regulations, the non-working spouse already qualifies for benefits worth fifty-percent (50%) of the working spouse’s Primary Insurance Amount (PIA), calculated as the benefit earned when a worker reaches full-retirement age.

With this in mind, the question becomes, “Does it pay to give my wife (or husband) a salary so that she (or he) can qualify for their own Social Security benefit? And how much will they need to earn for their PIA to be greater than what they currently have?”

Should I pay my spouse a salary from my business to increase their Social Security benefit?

There are several options to consider. First, the owner can pay the spouse a minimal wage to provide basic Social Security benefits.

Second, the owner can try to maximize the benefits of each spouse by paying both of them  a high salary.

Or third, the owner could limit his or her salary to the annual benefit base set by Social Security and designate the extra wage to his or her spouse to increase their Social Security benefit.

Viewing the matter as an “investment” will help owners come to the best answer for their situation. Start by asking the following:

If the business pays my non-working spouse $ XXX over a period of Y years (Investment), what impact would this make on his or her PIA (Return)?

How much will it cost to put my spouse on our company’s payroll?

Social Security. Keep in mind that self-employment taxes are high. Business owners pay both the employee’s and the employer’s share of Social Security and Medicare taxes for the wages earned from their company, up to the program limits. Currently, for 2017 the annual limit for Social Security, known as the contribution and benefit base, is set at $127,200.

Owners earning this amount or more will pay 12.4% of their salary (both the employee and employer contribution of 6.2% each) totaling $15,772.80 in Social Security taxes.

Medicare. Owners also pay the employee and employer portion of Medicare, adding another 2.9% to their tax burden. Unlike Social Security, Medicare does not have a contribution limit and is applied to all wages.

Furthermore, the 0.9% Medicare surtax that was a part of the Affordable Care Act of 2010 is now in effect. This additional tax targets high wage earners and is applied to earnings over $200,000 for individuals, $250,000 for couples who file jointly, and $125,000 for spouses filing separately.

Depending on where you live, state or city taxes may also come into play. Be sure to add these to the overall costs of your decision.

Will adding my spouse to our payroll really increase her Social Security benefits?

Social Security uses a progressive formula and provides higher benefits for those who have earned more throughout their working career. The question is, “Will adding my spouse to the payroll be worth the additional costs?”

Using the Quick Calculator found on the Social Security Administration’s website helps estimate the benefits.

Example. Bob and Barb, are both 50 years old. This year Bob took a salary of $170,000 from his company; an amount greater than the maximum Social Security wage base. He plans to to continue to pay himself a good wage until he reaches Social Security’s full-retirement age – 67 –   at which time he will receive his Primary Insurance Amount (PIA). Currently this is estimated at $2,829 per month in today’s dollars, or $33.948 per year.

At that time, Barb will receive a spousal equal benefit equal to one-half of Bob’s PIA. This comes to $1,415 per month or $16,980 per year, estimated in today’s dollars.

Added together, the couple’s estimated Social Security benefit is $4,244 per month or $50,928 per year.

When the children were born, Barb left work to care for them on a full-time basis and has not drawn a wage for 20 years. Concerned about her Social Security benefits, the couple has considered reducing paying Bob’s salary by $40,000 per year and paying it to Barb.

Even with the salary reduction, Bob would be earning more than the maximum Social Security wage base of $127,200. But now, the $40,000 going to Barb would be subject to these and other taxes. At the very least, she would pay 15.3% in Social Security and Medicare taxes, or $6,120 per year.

Table

By drawing a salary until she too, reaches full-retirement age, the couple would pay more than $104,000 in Social Security and Medicare taxes. For this, Barb would qualify for a monthly Social Security benefit of $1,178 per month; considerably less than her current spousal benefit.

Going back to our “investment” discussion: The couple lost money!

Is there a retirement plan my non-working spouse can begin?

Fortunately, there are other options for them to consider, the first being a Spousal IRA.

Although the rules for contributing to an IRA generally require the owner to be employed, there is an exception for unemployed spouses, provided they meet certain conditions. In most instances the employed spouse or business owner can make an IRA contribution on behalf of his or her non-working spouse provided:

  1. The couple is married;
  2. The couple files a joint income-tax return;
  3. The couple has enough earned-income equal to or greater than the amount they contribute to their IRAs;
  4. If using a Traditional IRA, the spouse must be under age 70 ½ for the year the contribution is being made, however there are no age limits when contributing to a Spousal Roth IRA.

How much can we contribute to a Spousal IRA?

The contribution limits for a Traditional or Roth IRA apply. For 2017 an individual may contribute up to $5,500 to their IRA. If you are 50 years old the limit increases to $6,500 per year.

Unlike the couple’s savings, checking or other joint accounts, the IRA is held separately and established in spouse’s name using their own tax identification number (typically their social security number). Even so, the contributing spouse or business owner may be named as the beneficiary to the account.

How does a Spousal IRA impact our retirement planning?

The Spousal IRA provides additional retirement funding to the spousal benefit available through Social Security. Remember, Barb can already claim one-half of Bob’s PIA. In today’s dollars, this is estimated at $1,415 per month ($16,980 per year).

Instead of drawing a salary from the family business and paying extra taxes, she and Bob opened a Spousal Roth IRA and each year contributed $6,500 or slightly more than what would have been paid had Barb drawn a salary from their business. They did this for 17 years, at which time Barb too, reached her full-retirement age.

Assuming a 6% tax deferred and compounded return, her retirement fund is estimated to grow to about about $235,000. While this return cannot be guaranteed it is below the 20-year return of both the S&P 500 (7.8%) and the Barclay’s Capital US Aggregate Bond Index (6.5%).

IRA

If Barb draws $800 per month from her IRA, she will increase her retirement income by more than 50%, giving her about $27,000 per year in today’s dollars.

Clearly, for her and Bob, the Spousal IRA is a better alternative than placing Barb on the payroll.

What does this mean for a business owner and his or her non-working spouse?

When planning their retirement, business owners may be tempted to add their non-working spouses to the payroll to increase their combined Social Security benefits. If doing so proves to be too expensive, a Spousal IRA could be a more effective strategy.

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