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Can you roll annual SEP contributions into 401(k) each year?


UM1234
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Hi,


Client participates in 401(k) at his W-2 job. Also has a SEP for self-employment income from work completely unrelated to the W-2 job.


Wants to maintain the ability to make a nondeductible traditional IRA contribution each year, and convert immediately to Roth at no tax cost. This will not work if he has money in a SEP IRA.


So, can he contribute to his SEP each year, then immediately roll the money into his 401(k), assuming the plan accepts rollovers? This would leave him with $0 in pre-tax IRAs, and allow him to continue the annual nondeductible contributions with conversion to Roth.


I don't see any reason why he can't do this. For example, the Individual Retirement Account Answer Book, 20th ed., copyright CCH 2014, states in several places that a SEP IRA is treated exactly as a regular traditional IRA, except for contribution limits. So, once his contribution is in the SEP IRA, he should be able to roll it into his traditional IRA.


Thank you for any reaction you can provide!

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Thanks. I received a private reply from someone else saying:

"Just a reminder that the one per year rollover rule does not apply to rollovers from IRAs to 401(k)s.."

Also, it's worth noting that the IRA one rollover per year rule applies only to rollovers, i.e., not to trustee-to-trustee transfers. Quote from IRS website, and link, follow. The link is a very useful summary of IRS guidance on this issue.

"You can, however, continue to make as many trustee-to-trustee transfers between IRAs as you want. You can also make as many rollovers from traditional IRAs to Roth IRAs ("conversions") as you want."

http://www.irs.gov/Retirement-Plans/IRA-One-Rollover-Per-Year-Rule

If anyone else sees a problem with doing annual transfers from a SEP IRA to a 401(k), please reply. I see no problem with it at this point.

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I am not sure that one can transfer (as opposed to roll over) amounts from an IRA to a qualified plan. Confusion abounds in the discussions, but I think you should find some authority for a transfer. An interesting test will be to instruct the IRA custodian/trustee to transfer to the plan, with insistence that it be a transfer and absolute clarity that it will not be a rollover. I expect resistence, bewilderment, or disregard by the custodian. By disregard, I mean that the custodian will report the transaction as a rollover despite talk of transfer.

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Great comment, thank you. I am a registered investment advisor custodying with Schwab and TD Ameritrade. Both custodians' IRA distribution forms use the language "Direct Rollover" to an employer plan. Schwab's form makes clear they would report the distribution using Code G on Form 1099-R. TD's form does not specify what code they would use. I feel the reporting guidance is sufficiently clear that TD would use Code G as well, but I could check with them to be sure.

What do you think about the comment above re: the "one rollover per year" rule not applying to transfers from an IRA to a 401(k)? The language at the above-linked IRS page, as well as the language in the actual IRS Announcement 2014-15 linked below, refers only to IRAs. Also, it seems the IRS would catch violations of the "one rollover per year" rule by looking for more than one IRA distribution with a potentially taxable 1099-R code like 1 or 2. So it also seems like code G, a nontaxable code, would not be flagged by the IRS. And, it feels like the spirit of the "one rollover per year" rule is to limit you to one potentially taxable distribution per year. In the situation I describe, if the IRA custodian makes the check payable directly to the client's 401(k) plan and issues a 1099-R with code G, there is no potential taxation. But, thinking conservatively, no reference to 401(k)s is not the same as explicitly stating that IRA-to-401(k) transfers are not limited by the "one rollover per year" rule.

http://www.irs.gov/pub/irs-drop/a-14-15.pdf

Thanks again for any further thoughts that anyone can provide!

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QDROphile is right. One cannot 'transfer' amounts from an IRA to a QP. I though- still think- the OP meant 'rollover'- based on the original post and subsequent comments. Good catch .

The one per year rollover rule only applies to rollovers between two IRAs. It does not apply to rollovers from IRAs to QPs and vice-versa.

Life and Death Planning for Retirement Benefits by Natalie B. Choate
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  • 2 weeks later...

I got the following comment and wanted to post it to get people's thoughts:

Why not open a solo 401(k) for his SE income and make the employer's (profit sharing) contribution to that account (the same amount that he can put into the SEP) and save the rollover step?

I was thinking we should avoid solo 401(k) because the admin is more complex than a SEP. I am looking at this as follows, comments welcome.

If you do a solo 401(k), you can go two routes. Either use a custodian's prototype document (Schwab, TD Ameritrade, etc.), or pay a TPA to do a plan document for you.

If use prototype document, I see three potential concerns:

1. The prototype documents I've seen require a lot of decision-making and box-checking on the various features of the plan. If a layperson did this on their own, they could easily make mistakes. If I help a client do it, I'm much less concerned but there are still a few arcane choices I'm less familiar with.

2. Even assuming the prototype document is implemented correctly, there is also a risk of it not staying up to date with required amendments over time. I am not sure how proactive the custodians are about pushing out amendments. Even if they are proactive, I would guess the client has to adopt the amendments. Busy clients are not likely to do this, and even if I as a financial advisor work with the client's solo 401(k), I would be concerned about missing required amendments.

3. The custodians' prototype plans that I've seen do not include any recordkeeping or TPA work. The client would be on their own. Assuming solo 401(k), there is no compliance testing so I think the main issues are Form 5500 preparation and recordkeeping. Form 5500 is only needed if plan assets > 250K, and even if required, it's easy to prepare (although it is one more step that the client or I must remember to do each year). I think recordkeeping is the bigger issue. If the client in this example just makes profit sharing contributions, he would only have one source of funds, so recordkeeping might not be needed (?). But, if he rolls an old 403(b) or pension into his solo 401(k), now he has two sources of funds: profit sharing and rollover. In this case, recordkeeping would be useful, but I wonder if it's absolutely necessary since all money is pre-tax?

If use a TPA, I see two potential concerns:

1. Cost for the plan document and the annual admin.

2. Client's time to administer the plan and deal with TPA.

Again, comments would be very welcome on all of this. Thank you!

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I think your reasoning is correct. I would generally recommend a SEP over a solo 401(k) if no employee contributions are desired or allowed (in this case he is participating in a 401(k) and can presumably max in that). My interpretation of the comment is that it was based on saving the rollover hassle, but it does raise the other issues that you note.

If you and the client don't mind the hassle of doing the rollover, then that's probably the way to go.

Ed Snyder

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Just to muddy the waters - how about he opens up a solo(k) plan rather than a SEP, make a token Roth deferral, have the plan allow VOLUNTARY AFTER TAX contributions, and immediately convert the voluntary contributions to Roth.

Doesn't lose anything for deductions, since he was going to pay income tax upon converting to Roth anyway.

All under the approval of tax/legal counsel, of course.

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