Sep and QP in same year

[K-t-F]

Am I going crazy... I thought you could not contribute to a SEP and a QP in the same year. IRS Pub 560, page 7 says you can. Am I missing something?

IRS Publication 560

[Belgarath]

You can have a SEP at the same time as another QP. You just can't do it using the IRS 5305 model SEP document. But there are many places that sponsor prototype SEP's that would allow a combination.

[Lori Friedman]

Pata, Could you be confusing the SEP rules with the SIMPLE plan rules?

[K-t-F]

Nope... guess I was just putting all SEPs into one group. After talking with the one who brought this to my attention am I correct in saying the timelyness of establishing each plan is a concern?

First a SEP... then later on down the line (few years maybe) add a QP... that is ok?

First a QP and then a SEP later... that is not ok?

And to further ask, if the SEP is established and later a QP is added... each plan can be contributed to each year? as long as you dont exceed 415 and 402g ? (and of course everything else)

[Guest DGM]

The issue is whether a self-employed (no other employees) can use the model Form 5305-SEP to adopt the SEP, then later establish a solo 401k, and contribute to both in a given tax year up to the $41/44k max.

The answer is Yes, according to IRS Employer Plans today (by phone)........provided that the later established 401k plan agreement provides that, if there is also a SEP, any excess contributions will come out of the solo 401k. This is because the model SEP form language is silent as to the existence of other retirement plans and is silent as to the matter of excess contributions if more than one plan is funded by the same self-employed person.

The IRS specialist acknowledges this is somewhat of a "gray area", but as long as the issue of excess contributions for more than one plan is addressed by the later 401k agreement and not ignored, the IRS "is not likely to challenge it". The IRS agrees that you could also have a prototype SEP agreement that specifically addresses the issue of excess contributions in the event of more than one plan, or you could have meshing agreements between a prototype (or non-model) SEP and the 401k (or other) qualified plan(s) as to attribution of excess contributions.

It is clear from IRS Publication 560, page 7, that you can contribute to a SEP and other plans for the same tax year, subject to the aggregate deduction limits.

It is also clear that the prohibition against "use" of the model SEP form (5305-SEP) applies only if you "currently maintain any other qualified retirement plan" (Form 5305-SEP instructions) - "currently" meaning at the time the model SEP form is adopted and the SEP set up, not later (or earlier, as in the case where a plan had been terminated prior to the adoption of the model SEP). I asked and IRS confirmed that "currently" means presently - present tense - as of the time of the SEP's adoption, and does not mean "currently and/or later". "Use" of the model form only refers to the execution and adoption of the SEP model form.

IRS also confirmed that you do not have to amend the model SEP form or adopt a new prototype or non-model SEP in order to continue to contribute to the existing SEP and also to later set up and contribute to another qualified plan - you can continue to fund SEP-IRA accounts established under the model form, subject to the overall $41/44k limit.

Thus, it might take longer for an individual with both a SEP and a solo 401k to hit the $100k threshold for filing a Form 5500 or 5500EZ. It also allows an individual with a SEP-IRA in a mutual fund closed to new accounts to continue to add to the SEP-IRA account while also taking advantage of the deferral, etc. available under a solo 401k in the same tax year and invest elsewhere through the 401k vehicle.

[Belgarath]

DGM - this is very interesting information.

From my own perspective, being essentially very conservative on these issues, I wouldn't dare rely on a telephone statement from an unnamed IRS person to go ahead and do this. Until I see, at the very least, some statement from IRS folks at a public forum that allows you to simultaneously contribute to a model SEP and another QP, I wouldn't do it.

Did this individual you spoke with indicate whether the IRS was planning on a formal release with the clarifying information you were given?

Thanks!

[mbozek]

I think the IRS response on currently maintained is a reasonable answer since there is no prohibition on an employer who has adopted a SEP from adopting a q plan at a later date and there is no formal terminaton of a SEP- The er simply does not make any contributions in a future year when contributions are made to the Q plan. In any event the 415 requirement only forbids an er from overcontributing to both a SEP and Q plan not from maintaining both plans.

[Belgarath]

mbozek - the original question was whether you can contribute to a SEP AND another qualified plan in the same year. I don't disagree with you at all that the two plans can be "maintained" in the same year - and that for a non-model SEP it is fine to contribute to both in the same year - but I do question whether the answer given to DGM that it is ok using a model SEP, without some official guidance. It's an open secret that many IRS telephone answers are incorrect.

"The issue is whether a self-employed (no other employees) can use the model Form 5305-SEP to adopt the SEP, then later establish a solo 401k, and contribute to both in a given tax year up to the $41/44k max. The answer is Yes, according to IRS Employer Plans today (by phone)........provided that the later established 401k plan agreement provides that, if there is also a SEP, any excess contributions will come out of the solo 401k. This is because the model SEP form language is silent as to the existence of other retirement plans and is silent as to the matter of excess contributions if more than one plan is funded by the same self-employed person."

[Guest DGM]

Belgarath -

I too am conservative when it comes to deciphering regs, code, guidance, and the like. And phone advice....I know there have been occasional pitfalls.

I informed the first IRS EP specialist who got on the line (after a 10 minute hold) that I am an attorney and had specific questions about a SEP and individual 401k plan. I was transferred (after another 5 minute hold) to another EP specialist who, I was graciously informed, was "the right person to talk to".

After about a 10 minute question and answer give-and-take, I came away with the answers I needed and was very satisfied with the apparent seasoning, comprehensive knowledge, and responsiveness of the IRS EP specialist who fielded my call (I have the name and ID #). A couple of times it did sound like some minor, related info was being read from an internal Q&A manual/screen. Given my personal interest in this issue, I wanted to make sure I got it correct. Check and re-check. Trust but verify.

Frankly, I wouldn't expect that there will be more explicit written pronouncements on this issue. The reason? The SEP model form instructions and the contents of Publication 560 are already quite clear, according to the EP specialist.

As to your lingering doubt about more than a SEP plan being contributed to in a given tax year, from IRS Pub. 560, page 7, under the heading "Deduction Limits for Multiple Plans":

"SEP and defined contribution plan. If you also contribute to a qualified defined contribution plan, you must reduce the 25% deduction limit for that plan by the allowable deduction for contributions to the SEP-IRAs of those participating in both the SEP plan and the defined contribution plan."

Harmonious language appears re employer deduction limits/multiple plans on page 14 of Pub. 560.

Conversations I've had with TPA's and pension plan generators since yesterday have been in agreement. They point out that almost all of the individual 401k plans they see or generate deal with the issue of excess contributions in the event of a SEP or another QP also being funded - the single caveat that the IRS specialist emphasized where you have an existing model form SEP and want to establish another qualified plan and contribute to both.

As I previously indicated, there is an even more conservative approach to take (prototype/non-model SEP) but I was assured that it was not necessary to go that far as long as the later 401k plan document deals with the issue of excess contributions where both a SEP and the 401k are contributed to in a given tax year.

The answer makes a lot of sense. The IRS knows that the model SEP form is the most commonly adopted SEP form and has designed (and revised) it for ease of use, clarity, and absence of conflict. Just about every mutual fund company uses the model SEP form for setting up this simplified, consumer-level retirement plan.

Based on all of this, one must conclude that there is no prohibition against a self-employed person continuing to make contributions under an existing model SEP arrangement and later establishing and contributing to another qualified plan, such as a solo 401k, provided the excess contributions issue is adequately dealt with in the later established 401k plan document.

It's a sensible result. After all, if there was any such prohibition, you wouldn't have to guess about it for very long, because all of these retirement plans reduce present revenue flow to the Treasury. (Flash - the government wants/needs your money!). The IRS would let us all know about any such prohibition in big, black letters (or the "Caution!" italicized notes that dot the IRS publication/instruction landscape) and they'd further revise the 5305-SEP form, instructions, and Pub. 560. Inquiry or audit letters from IRS for 2002/2003 tax years would have been flying already. Have you seen or heard about any?

BTW, in my prior post, I should have added that $41/44k are the maximum aggregate limits for 2004 tax year. As you know, the limits are increasing annually over the next few years.

Let me take this opportunity to wish you and your families all the best of the holiday season, a very joyous Christmas, and that you all have a wonderful and prosperous New Year

(of course after you take care of all the last-minute guys (like me) who want to start a solo 401k by December 31).

[Belgarath]

Thanks for the followup posting!

[Gary Lesser]

I question the accuracy of the answer received from the EP Specialist (as well as the Specialist's authority in this matter).

The model document is clear as to when it can be used. If a qualified plan is maintained, the model SEP is not a suitable document. Without a suitable SEP document, there is no SEP. The excess is in the SEP. IMO, all SEP contributions made for the year are excess contributions that should be treated as "wages" for all purposes (e.g., FICA, FUTA).

As a more practical solution (for the current year), why not just adopt a SEP prototype that does not contain such a restriction. To the extent of identical participation, the P/S deduction is reduced by the allowable deduction. Thus, remaining elective and more employer contributions cd be placed in the 401(k) and the QP limits (contribution/deduction) reached.

Even assuming the word "currently" is applied to the moment, rather than the plan year; it makes no sense that the order in which the two plans are adopted would make any difference or have any different effect. Prior rules prevented a model SEP from being used when the e/er maintained a terminated DB. That language was dropped because all QP language had to contain coordination provisions (see LRMs). The language that remains in the model is the language that is--and not much can be done about it. I would wonder too, whether the alternate DOL reporting and disclosure rules would apply, or whether the SEP would be subject to full blown disclosure (SPD, and so on). Honestly, I would not rely on the Specialist's answer--the explanation doesn't really support the agent's conclusion.

[Guest DGM]

Gary -

I do not disagree that your preferred approach is a more conservative one, and surely acceptable. The IRS/EP specialist said as much.

That was immediately after the specialist said that IRS/EP’s suggested procedure re excess contributions should make the scenario I presented acceptable to IRS. Just the fact that IRS/EP even offered a procedure re excess contributions for when contributions are going to to more than one SE plan supports the acceptability of a less conservative approach.

So, it looks like we can get to the same party in different cars.

IRS/EP’s response may well reflect a kinder, gentler policy over these types of situations concerning personal retirement savings plans, particularly by the self-employed of which there are so many. A SEP, being a simplified pension arrangement, is intended largely to be a starter-level pension plan for small business/SE’s. The solo 401k is the latest method on the scene (via EGTRRA) and clearly a product of the Bush administration's recent and nascent push towards increased reliance on personal savings/retirement plans. The solo 401k is somewhat less simple and slightly more costly than a SEP, but can be a relative bonanza for the small business/SE.

IRS is probably aware that there remains some lack of consensus among some SE’s (and some accountants, CFP’s, attorneys, consultants, compliance folks, etc., on this forum and elsewhere) about how to read and interpret the vocabulary used in the model SEP instructions/Pub. 560, so it may be that they are saying: “Let’s try to keep the 'simple' in simplified plans and not play ‘Gotcha’ with or set booby traps for the unwary small business/SE’s over whether present tense words in the instruction/publication should be interpreted as implicitly including other tenses of the words.”

Again, the fact pattern I presented is simple and common. A SEP using the model form is set up and funded (let's say for 2003 tax year) by an SE - no other employees. The SE wants to both continue to contribute to his SEP-IRA account for 2004 and also start up and contribute to a solo 401k in 2004 (together not exceeding the aggregate $41/44k maximum - a multiple plan arrangement clearly contemplated in Pub. 560, p.7).

Assuming that the words from the model IRS SEP form instructions and Pub. 560 can be read and understood in plain meaning and tense, and after checking with IRS/EP which says you do need to have certain language in the later-established solo 401k plan document that if the SE makes excess contributions in the tax year the excess will come out of the 401(k) -

Voila! IRS says, in effect: "No damage, no foul."

And why not? Where’s the beef? Why not give this teensy vocabulary break (it’s not really such a stretch, is it?) to the thousands of model SEP taxpayers who now are suddenly milling to start solo 401(k) plans, whether through the mutual fund houses (almost all use model form SEP’s) or through pension plan consultants, et al.? Why snag unsuspecting regular folks on something as insubstantial as whether they used a proffered or suggested model IRS SEP form?

What's wrong with an occasional tilt of the reasonable-construction-of-words scale in favor of the small business/SE saver and simple-form-filler-outer over the interests of the many tribes of tax reg./pension marketeers and the academic purity of procedural mullahs.

You’d think a more relaxed view on this would be welcomed by tax/pension professionals, too. They wouldn’t want to charge breathless prospective solo 401(k) customers extra fees for also drafting (and possibly submitting to IRS for approval) non-model or prototype new SEP agreements - of course with the addition of “magic language” regarding allocation of the disgorgement of excess contributions for multiple plans and "permission" for any other qualified retirement plan to be established - for the hundreds of thousands of SEP’s set up with the model SEP forms..............now would they?-).

Yes, IRS may lack some academic purity with respect to this minor “gray area” but I would think IRS will compensate with administrative practicality. Accepting a less restrictive approach reduces or eliminates the time and resources IRS would need to “bust” the SEP’s of self-employed individual taxpayers who - horrors! - used the IRS’s own model SEP form when they, in fact, did not “currently maintain” any other qualified retirement plan at the time of use. And, boy, that’ll get a federal judge mad.

Quoting Captain Renault in "Casablanca": “I am shocked...shocked...”

So, after all of this are we back to scrutinizing the plain meaning of the present tense words ”use” and “currently maintain” in the model SEP form instructions and Pub. 560? Back we go to English and Contracts classes as to how to ascertain the plain meaning of words.

I will certainly stay tuned, Gary.

Like you, I am of the generation raised (and by profession trained) to question authority wherever asserted - in court, on the phone, even online ;-).

[Gary Lesser]

IMO, it would be foolish to rely on the agent's answer; especially when an amendment to a prototype SEP would solve the problem. I would suggest that client get a ruling.

The order in which the two plans are adopted should make no difference (under current law). Whether the SEP exists is a more important matter. If it doesn't, then none of the SEP contributions are any good and the 401(k) correction itself would cause additional problems. Plan document provisions should be followed. Both plans need language for coordination and the model SEP doesn't contain such language. I would interpret the model document's language to be applied on either a plan year or fiscal year basis.

SEPs can be very unforgiving. Is it really worth the risk?

[Guest DGM]

The only really good reason I can think of, Gary, for an SE (no other employees) to want to contribute to both a SEP-IRA and a solo 401k plan was the one presented to me: an SE has an existing SEP-IRA account (under his TIN, his own social security number) partly invested in a now-closed mutual fund where the mutual fund will not allow him to open an account for his brand-new personalized solo 401k plan under the solo 401k plan name and TIN number (no question the trust has to get its own TIN - it's a separate legal and tax entity).

He wants to continue to add to his holdings in his closed mutual fund SEP-IRA account and invest the remainder of the annual retirement contributions to a newly estabished 401k plan account invested in open mutual funds.

Frankly, for the client and the amount involved, an application for a private letter ruling or even the preparation of non-model documents is going to be too costly and time consuming.

I will let you know if anything follows.

In the meantime:

Merry Christmas to all and to all a good night!

[Appleby]

DGM…But that does not prevent him from amending the existing SEP to a Prototype SEP. If the mutual fund company offers a prototype, he could use their document to amend the existing SEP and ask them to reflect the amendment of their records. This allows him to keep the same investments, and maybe even the same account number. For some financial institutions, the amendment may include changing the account title or type to designate the plan as a prototype instead of the model SEP, for other’s is just simply having the documentation on file…

[Guest DGM]

Appleby -

(Voice of Ed McMahon): You are correct, Sir!

Sorry to be back to you after days. Busy. Solstice event.

Here, the mutual fund, although otherwise well-regarded, does not lead the way in either convenient retirement plan documentation or availability of brass to help provide a convenient cure. Not as retail as Fido, TRowePrice, etc.

However, in the interim, the presented problem may have found solution.

Clue: They like to keep your money when you’re a steady eddie.

Don’t worry, be happy.

Good 2005 to all.

[could be me maybe not]

I question the accuracy of the answer received from the EP Specialist (as well as the Specialist's authority in this matter).

I question the translation of the language in which the IRS tele-"specialist" was speaking!

Aren't most of them students of the program "English as a seventieth language?"

[Guest DGM]

Could be/maybe -

Point made/taken.

IRS rep was cogent, female, mature...

Fine.

[Earl]

Say you have a non-5305 SEP so you can contribute to both.

Would you aggregate the SEP contributions with the Profit Sharing

contributions for 401(a)(4) testing?

Say the owner is the only one eligible for the SEP but the employees are eligible for 401(k) Plan.

Would a SEP contribution kick in a Top Heavy minimum contribution

requirement for the 401(k) Plan?

Thanks

[Gary Lesser]

The SEP is not considered in 401(a)(4) testing of the qualified plan.

The SEP is not top-heavy if the only eligible employees are key employees. However, the SEP may be part of an aggregation group if a key employee is a participant; in which case, a top-heavy contribution may have to be made to all eligible non-key employees in the aggregation group. [iRC 416(g)(2)]

Hope this helps

[Earl]

Very much. Thanks