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Simple IRA to simple 401K - same year


Guest pnj789
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I know this topic has been approached before, but I'm still a little confused. Here goes:

I established a simple IRA in 2006 for my self-employment income.

For 2007, my self-employment income has increased, and I would like to essentially replace the simple IRA with a simple 401K to increase my contributions. However, I already put in $3000 in April 2007 as an Employee contribution to my Simple IRA. From other posts, it seems like there is still a way around this.

1. Can I withdraw the $3000 + earnings and count that as excess contribution? (I know I will have to pay a steep penalty for this)

2. Then, can I establish a simple 401K for 2007?

3. If I do establish a Simple 401K for 2007, am I penalized for not contributing to my Simple IRA?

Thanks.

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Let's start by noting that if you had a SIMPLE IRA in place for 2007 but simply didn't fund it, there would be no problem at all with starting a SIMPLE 401(k) for 2007 (or a regular 401(k) for that matter; I get the idea you have no employees and the only reason for a SIMPLE 401(k) instead of a regular 401(k) is to avoid non-discrimination testing, which is moot if you have no other participants).

If you start a 401(k), that invalidates the SIMPLE IRA, and to the extent you have made contributions, they are disallowed. Now exactly what happens to them is not certain, at least in my mind. I think that they are supposed to then be treated as regular IRA contributions, and if it turns out that you would not have been allowed to make regular IRA contributions (deductible or non-deductible), then you should be allowed to withdraw them by the due date of your tax return. I don't think there's a big issue with penalties, only tax on the earnings. But in practicality, I don't know that it's that easy...a SIMPLE IRA isn't quite the same as a regular IRA, and once the money is there I don't know how easy it is to undo it, or go through the steps of making it a "regular" IRA as just described. I think I might call the investment company and ask what happens if it turns out that the contribution that was made was no good. (I'd be curious to know that answer...I'm pretty sure they'll have to think about it a while.)

Ed Snyder

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Thanks for the response. I had contacted my brokerage company several months ago and it took awhile for them to come up with an answer. (Apparently, it's not a request that comes up often)

Basically, they are taking the $3000 + calculated earnings out of my Simple IRA and writing me a check. The check is listed as an IRA distribution which they told me I would need to report on my 1099-R. Does this make sense? Hopefully, this will allow me to start proceeding with the Simple 401K.

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No, that's a bad result, at least as described. There's a difference between a return of excess contributions and a distribution. It sounds like they are treating it as if you put the money in, claimed a deduction, and then just decided that you wanted to take the money out because you felt like it, not because it was an ineligible contribution. You will be taxed and penalized, with the penalty is 25% for a SIMPLE IRA. And if you don't claim the deduction, but pay tax on the amount distributed, you've generated taxable income that you didn't really have.

You need to contact them again, re-explain it (to another representative no doubt) and if you don't get the message across, ask to speak to someone else until you happen to find someone that understands what is going on.

Ed Snyder

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I was afraid that may be the case. I think the damage is done, since I've already deposited the check. If I were to put in money into a simple 401K for 2007, would that $3000 for the Simple IRA become an excess contribution?

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You mean if you now make a SIMPLE 401(k) contribution, will that retroactively make it an excess contribution? I think in theory, yes. The challenge will be to either get the investment company to change their coding for the 1099-R, or to convince the IRS that they incorrectly reported it when they issue the 1099-R next year saying it was a premature distribution, not return of excess.

Ed Snyder

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For 2007, my self-employment income has increased, and I would like to essentially replace the simple IRA with a simple 401K to increase my contributions. However, I already put in $3000 in April 2007 as an Employee contribution to my Simple IRA. From other posts, it seems like there is still a way around this.

Thanks.

A SIMPLE 401(k) would not permit more contributions than a SIMPLE IRA. In fact, compensation allowing, it is possible to get more in a SIMPLE IRA than a SIMPLE 401(k).. because the compensation cap applies to SIMPLE 401(k) matching and non-elective contributions, while it applies only to non-elective contributions to a SIMPLE IRA.

Therefore, if that is your primary goal, you are heading in the wrong direction…

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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Guest pnj789

Thanks for all the input. Sorry ... I've been using the wrong name. I was talking about a "self-employed 401K" with profit sharing, NOT a simple 401K. According to my brokerage company, the maximum Employee contribution to this 401K is around $15,500 this year and the Employer contribution can be up to 25% of annual compensation (Both contributions totaling no more than 44K). This is far more than I would have been able to put into a Simple IRA, right?

I will work on getting the investment company to change their coding for the 1099-R. If not, I'll be paying a lot! My tax advisor is very conservative and he hasn't been much help. In the mean time, I'd like to start putting money into this 401K, which has been such a pain to start.

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I was talking about a "self-employed 401K" with profit sharing, NOT a simple 401K.

That doesn't shock me, and it validates my prior comments, although I'm sorry about being careless with the terminology myself.

This is far more than I would have been able to put into a Simple IRA, right?

I guess it depends on your profits and definition of "far more." But probably "yes." Keep in mind that your contribution reduces your taxable income, so your maximum employer contribution is roughly 20% of your pre-contribution profits, not 25% (there's an adjustment in there for self-employment taxes too).

My tax advisor is very conservative

There's "conservative" and there's "right." No matter how badly you bungled this, you canNOT wind up with phantom taxable income. The proper way to fix it, I think, is to get the 1099-R issued as an excess contribution. Good luck.

Ed Snyder

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