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Pre-funding a SEP IRA


Guest gregens
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Guest gregens

I anticipate making 300,000 of schedule C income in 2004. However, much of this money will probably be made towards the end of the year. I would like to fully fund my SEP with $40,000 the first week of January 2004. Can I do this even though I haven't yet earned the income?

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Yes you can. As to whether it would be practical would be a separate issue…since the income is anticipated not guaranteed. Should it be determined at the end of the year that the contribution exceeds the allowable limit (i.e. more than 25 percent of your modified net profit), then you may be subject to a 10 percent excise penalty on the excess amount

Note: For year 2004, the limit will be $41,000.

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Keep in mind that a contribution of $1 to your SEP in early 2004 may effectively preclude you from establishing a Defined Benefit Plan to your maximum advantage later in the year. Should you discover after making a contribution to a SEP in early 2004 that you can provide a larger retirement benefit for yourself through a defined benefit plan (or through a defined benefit plan matched with a 401(k) plan) you will most likely have lost a significant opportunity.

While you can combine a SEP with a defined benefit plan, if you do that you will be limited to a total deductible contribution between the two of 25% of $205,000, which is $51,250.

If you instead go with solely a defined benefit plan (or a defined benefit plan with a 401(k) layered on top) you can generally exceed $51,250.

Here is how the numbers might work out for a 30 year old:

A) SEP alone - as mentioned by Appleby - $41,000 can be deducted

B) SEP w/DB - maximum contribution to the SEP - $41,000 (SEP) + $10,250 (DB) = $51,250

C) Defined Benefit alone - $44,909

D) Defined Benefit w/ 401(k) - maximum contribution to the 401(k) - $41,000 (401(k)) + $23,250 (DB) = $64,250

E) Defined Benefit w/401(k) - maximum contribution to the DB - $44,909 (DB) + $13,000 (401(k)) = $57,909

Check out how the numbers might work out for a 49 year old:

A) SEP alone - $41,000 can be deducted

B) SEP w/DB - maximum contribution to the SEP - $41,000 (SEP) + $10,250 (DB) = $51,250

C) Defined Benefit alone - over $110,000

D) Defined Benefit w/ 401(k) - maximum contribution to the 401(k) - $41,000 (401(k)) + $23,250 (DB) = $64,250

E) Defined Benefit w/401(k) - maximum contribution to the DB - Over $110,000 (DB) + $13,000 (401(k)) = Over $123,000

As you can see, if you are 49, you give up on at least $70,000 of deductible contributions to a retirement program if you put that $1 early in 2004 before you have your options analyzed by somebody who can advise you properly.

The numbers are even bigger if you are older than 49.

There are some people out there that thinkyou can undo a SEP contribution made early in the year and instead create the "E" option mentioned above (Defined Benefit w/401(k) - maximum contribution to the DB) by removing any contributions you have made to a SEP early in the year. There are some, however, that believe once you have put $1 into a SEP, the "E" option mentioned above is forever lost. Why take the chance?

There are some people that could generate higher deductible contributions than what I generated above for the DB plan (at the ages specified). My numbers were based on 5% interest, Unit Credit funding and the most recent IRS Mortality table (94GAR).

DB plans aren't for everybody. You may have circumstances that make establishing a DB plan impractical.

The point isn't that my numbers are precise (they aren't) or that a DB plan is definitively the best solution for you. The point is that you should have somebody advise you on the best course of action FOR YOU before you rush to contribute to a SEP early in 2004.

Good luck.

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  • 3 weeks later...

I'm fairly certain that the only change would be an increase in the DB portion of things, all other things being equal. The age at which the maximum would be greater through a DB plan would reduce, perforce. Note that there is nothing in this reply that implies 412(i) plans are appropriate, as I believe them to be in the vast majority of cases wholly inappropriate. But there are some people who believe in them. They even tell me that they practice full disclosure. Strange, though, when we discuss what full disclosure means, we find we have different definitions.

I feel a heated response, or two, being aimed at this thread.

Yes, there are some circumstances where a 412(i) plan might make a lot of sense.

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