SEP refunds

[Lori H]

a builder,who is the sole employee, wants to establish a 401(k) and add a DB or possibly a 412(i) plan, but has already put in the max into his SEP for 2007. What is to prevent him from requesting those funds back, paying the penalty and setting up the aforementioned plans? It would benefit him despite the penalty.

[Belgarath]

I'd sure check with tax counsel before attempting this. If the IRS doesn't buy this little legerdemain, then under 1.415(g)-1 the SEP plan is disqualified LAST. So it seems a little risky to me.

[Lori H]

yeah, i tend to agree. The gentleman's f.a. was throwing it out there as a possible option. I might just have him contact the IRS directly.

[Gary Lesser]

Agreed. If DB adopted the amount in excess of 6 percent of applicable compensation may not be deductible, but that does not make it an excess contribution that can or should be removed from the IRA. Consider, however, that the DB deduction might make a recurring 10 percent penalty seem small. Another DC plan would make absolutely no sense.

[J Simmons]

For future years, using a 401k instead of SEP, in conjunction with the DB, would allow not only 6%-of-pay ER contributions to the DC, but would also allow for 401k elective deferrals that a SEP (unless it is truly a SARSEP) would not provide.

[Guest mjb]

Q1 Since the SEP is regarded as a separate profit sharing plan for the purposes of 404(a)(7), see IRC 404(h)(3), what additional benefit would be provided through a 401k plan outside of 5k catch up contribution?

If owner is 50 401k plan could be established for 5k catch up in 07.

Q2 Why cant the DB plan be adopted for 07 to max out deductions under (a)(7) and the SEP account rolled over to a 401k plan?

For a sole employee plan, the only advantage in a 401k plan over a SEP is catch up contributions since in either plan the employer contributions reduce taxable income of the employee. Elective deferrals outside of catchups dont provide any additional benefits since they are counted as part of the 45k limit for 401k plans.

[J Simmons]

If an EE accrues a benefit under both a DB plan and a DC plan of the ER for the year, the deduction for the ER's contribution is limited to the greater of (1) 25 percent of the compensation paid or accrued for that year to the EEs in all such plans or (2) the amount necessary to meet the minimum funding requirements of the DB plan for the year, but not less than the amount of the DB plan's unfunded current liability (Code Sec. 404(a)(7)(A)). Elective deferrals to the DC plan are not impacted by this limit.

PPA now provides that the first 6%-of-pay contributed by the ER to the DC plan are not factored into this limitation.

Now with PPA, looking at a SEP-DB combination for a year, the ER could fund the DB plan to the greater of its minimum funding requirement or unfunded current liability. The ER may also contribute 6%-of-pay to the SEP. If the contributions to the DB total less than 25% of the eligible EEs' earnings, then the difference could also be contributed to the SEP.

If the DC plan in the combination with the DB is a 401k rather than a DB, then the EE can also make elective deferrals of $15,500 (or $20,500 if at least age 50 by the end of the year), in addition to what is described in the foregoing paragraph for a SEP-DB combo.