Prospective clients that have funded a SEP IRA

[SteveH]

I find very often that prospective clients will tell me that they have funded a SEP already for the year, but are looking for a larger tax deduction. Of course they are just uninformed and don't realize that by funding the SEP prior to year end they have eliminated other planning opportunities.

I have heard "people" mention that if the SEP contributions are backed out as a mistaken contribution because the deposits were ineligible, you can then fund a qualified plan. I suppose this is more of a grey area, but I am looking to see what other people are advising clients.

The clients aren't looking to deduct contributions to both plans, its just that no one told them they shouldn't fund. In fact their financial advisor is probably telling them should fund as soon as possible to get the assets under management.

So what are you guys and gals doing? Is it just tough luck, you have to wait till next year?

[Blinky the 3-eyed Fish]

To "undo" the contributions to the SEP you are going to need the IRA custodian to play along. I believe many are unwilling to do so.

Tough luck is the route I take.

[Effen]

I agree, they are "SOL"

[Guest Carol the Writer]

Our understanding is that contributing to the SEP in the same year as contributing to a qualified plan disallows the deductibility of the SEP contribution and has no bearing on the deductibility of the qualified plan contribution. If that's your understanding, that might help. Backing out a contribution made by a "mistake" actually received the IRS' blessing in a PLR announced a few weeks ago and reported on BenefitLinks.com. Carol Caruthers

[Blinky the 3-eyed Fish]

Carol, to be clear, contributing to a SEP and a qualified plan in the same year is allowable. You are confusing the rules that apply to SIMPLE plans. The issue here is the SEP contribution probably caused the DB opportunity to be lost because of 404(a)(7).

Also, non-deductibility is not a mistake of fact that allows legitimate removal of contributions, so while I didn't research the PLR you reference, I doubt it applies.

[Guest mjb]

Under IRC 404(h) a SEP is regarded as a DC plan for deduction limits and under 415(k)(1) is regarded as a DC plan for 415 limits. An employer who contributes to a SEP can establish a 401k plan for salary reduction only before year end and employees can contribute the difference between $44,000 (49,000 if age 50) and the SEP contribution up to a max of 15,000 (20,000 if age 50) which are not subject to the 404(a) deduction limits for DC plans. Contributions by HCE would have to meet ADP test.

[Belgarath]

We take Blinky's and Effen's approach. However, we would consider accepting a DB plan if they have a SEP, IF they sign a hold harmless after consultation with their attorney. But we first explain, as Blinky mentions, that the combined plan situation brings them under the combined plan deduction limitation. Since the DB cost (in these types of cases) nearly always exceeds 25%, then the SEP contribution is nondeductible. This subjects them to the nondeductible contribution penalty tax for EACH year that it remains nondeductible. Since the DB cost is likely to exceed 25% for many years, the SEP contribution remains nondeductible for many years, and this gets expensive.

Once we explain this, and once they go to their attorney (attorneys generally hate hold harmless statements) they never install the plan - they wait until the next year. But I suppose if they had made a very small contribution to the SEP, that the larger DB deduction could make it all worth it in certain very select situations. We just haven't had one where it works out.

[SteveH]

So if I am reading some of the unsaid words, if the SEP was below 6% of total salary that might be ok?

[Belgarath]

Be careful - you'd have to have a non-model SEP. I don't think this would fly under the current IRS model 5305-SEP form.

[JAY21]

Perhaps a positive spin might be to still put the DB plan in at a very modest level due to 404(a)(7), just to get the YOP for 415(b) limit, then ratchet the formula up dramatically in the 2nd year and you've now got the extra YOP in for 415 limit purposes that should increase your 2nd year and thereafter contributions.

[SteveH]

Intersting thought. Maybe for owners over the age of 55 though. Conceptually isn't this like adopting a 0% accrual formula? That's definitely interesting.

I always thought people hawking 412(i) plans must have been great salesmen, but I suppose if I could convince someone to adopt a DB plan with a 0% accrual that would be quite an accomplishment. "Yes there is a fee, and no you can not contribute to it this year."

[WDIK]

a very modest level due to 404(a)(7)

Conceptually isn't this like adopting a 0% accrual formula?

I do not think that a "modest level" requires a 0% formula.

[AndyH]

Belgarath's last comments do not appear to have sunk in. Most SEPS are invalidated (for lack of a better term) if they are not the exclusive plan.

I don't know how many non-model SEPs exist but my guess is that they are a small minority.

After all, their very purpose is consistent with the one paragraph plan "document".