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Please clarify maximums to contribute/defer to SARSEP IRA

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Guest DCarter

We have a SARSEP IRA to which the employer contributes 3% to meet top heavy and HCE requirements. What is the maximum salary reduction that can be contributed by the employee? It would seem to be straightforward, however, everythme I read Form 5305A-SEP and Publication 590, I get more and more confused.

For instance:

Publication 590 says on page 52, under Limits on Deferrals, "..the total income you can defer under a salary reduction agreement... is limited to 10,000. This limit applies only to the amounts that represent a reduction from your salary, not to any contributions from employer funds."

But then underOverall Limits on SEP Contributions, it says: Contributions, including elective deferrals (salary reductions), made by your employer to the SEP-IRA are subject to the overall limit of 15% of your compensation or $30,000, whichever is less."

I interpret this to mean that in the case of Joe, who earns $70,000 a year, is eligible to defer the maximum of $10,000 (70000 x .15 = 10500) max is 10000, that is what he can defer. The employer then makes a total contribution of $2100.

Am I interpreting this correctly? What if the employer wants to increas his percentage to 5%? Is that permitted? Please advise.




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So your confused why 15% "exclusionary limit" doesn't equal 15%. Well it does, but it is 15 percent of "includible" compensation; that is, after reduction for the elective amount.

If ONLY the employee contributes, then 13.043478 of pre-plan compensation will equal 15 percent of taxable compensation (after reduction for salary reduction amounts).

In the case of a SARSEP, the 15 percent limit is determined after the elective amounts have been subtracted from compensation or net earned income (net EI) (if self-employed). Since a 3 percent contribution is already being made, that leaves 12 percent assuming you already know the amount your looking for. Otherwise, the maximum percentage is 10.434783 percent [(15-3)/1.15] of pre-plan W-2 compensation*. {IRC 402(h)] The amount is also subject to the dollar limit, currently $10,000. If the employer were to contribute more, say 10%, then 4.347826 could be contributed by the employee. Since $160,000 is the most that can be used for any calculation, $24,000 is the most that can currently be contributed to a SEP/SARSEP (absent another plan, such as a (e.g.) 10 percent money purchase pension plan, then $30,000, in total).

For a W-2 employee earning $10,000, $1,500 is the most that could be contributed by the employer if the employee defers nothing. The employee could defer 13.04 percent if the employer defers nothing.

Many financial institutionshave prototype SEP/SARSEPs so that contributions can be "integrated with social security" when the employee earns significantly less than the owner (and less than the taxable wage base,curently $72,600). Contributions are made into IRAs established by employees. Hope this helps.

* Additional considerations apply to all self-employed individuals. Somewhere on this site there is software to handle SEPs and SARSEPs.

The employer's 15% contribution limit is based on the same amount.

The employer's contribution of 3 percent must be allocated in accordance with plan provisions (which determine whether the 3% allocation is based on pre-plan compensation or the amount after reduction for the elective contribution).

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Guest DCarter

You still did not answer my question... Please explain as it pertains to my SARSEP IRA. I DO have employer contributions of 3% so how much can an individual earning 100K defer after the employer has contributed 3% ($3000)? Who gets to contribute the $10,000 (15%) maximum? If both can make the $10K (15%) maximum, where does $24K come from? The maximum of $24,000 is where I am most confused.

The 3% contribution is NONelective. So how does that affect the math here?

Is the maximum of $160,000 adjusted for the deduction? If so, then what is the actual "maximum" before deduction?

How much can the 4 owners defer (ineligible for employer contribution, obviously)?

Please advise or direct me elsewhere. I have read Pubs 560 and 590 in their entirety already.

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I think maybe I can help. There are several different limits which come into play here. The maximum salary deferral an employee can make is the lesser of $10,000 or 15% of pay net of pre-tax deferrals, (which is 13.04% of gross pay). The maximum total (employer and employee contributions) which can be allocated to a participant's account is the lesser of 15% of pay net of deferrals or $24,000 (which comes into play when someone's compensation exceeds $160,000 - 15% of $160,000 is $24,000). So, if I make $100,000 and I defer $10,000 from my salary my net pay is $90,000. My employer can make an additional contribution on my behalf of up to $3,500 ($90,000 x 15% = $13,500, $10,000 of which I have already contributed). The $30,000 limit is in the Tax Code but totally irrelevant until the cap on compensation exceeds $200,000. You may run into excess contributions if you make a 3% employer contribution to someone who earns less than $75,000 gross who also makes a salary deferral. I think in that case you would have to treat the excess salary deferral amounts as compensation – I’m not sure on that one though. Best not to let them do it!

NOTE TO GARY: Gary, when I read IRC 408(k)(3)© in my code (may be too old?) it still limits compensation to $150,000 without tying it to 401(a)(17). I’m so used to the 401(a)(17) limit being indexed for inflation that I have used $160,000 as the capped comp in several of my SEP examples. However, I’m now concerned that the COLA doesn’t apply to SEPs – am I off base? Should we be telling people to limit SEPs to $22,500 rather than $24,000? Or is there a later version? Thanks for your help!

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Guest DCarter

Since the employers take a salary of say, 40K each and are shareholders, they do not get the 3% employer contribution that is required to satisfy HCE requirements, so the max (after 125% of average of all deferrals) they can contribute is 13.04%. Correct?

The employer contribution of 3% is based on pre-plan compensation. How and when do I figure that in and come out with percentages for figuring employee deferrals?

And the employee who makes 40K can defer 12% when combined with the MANDATORY 3% employer contribution. That would result in a deferral of 4800 and a contribution of 1200, thereby totalling an IRA deposit of 6000, which equals the 15% max, and has no bearing on the 10000 max. Correct?

The empoloyee making 75K can make a deposit of a total of $11250 (15% of 75K), broken down like so: $2250 contibution from employer and $9000 deferral by employee. This still does not affect the 10000 max, or not?

What I also understand is that the employer can contribute 15% of preplan compensation as opposed to the employee who can only defer 13.04%. Yes or no? This would result in an employer contribution of $7500 on a 50k salary. Or an employee contribution of only $6520. Hmm?

Please help some more...

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DCARTER: $7,304.34; that is, 10.43 percent (subject to the 125% rule) of Joe's pre-plan compensation can be contributed by Joe as an elective amount if Joe's employer contributes 3 percent.

$70,000 - $7,304.34 = $62,695.65

x 15%

= 9404.34 is 15% limit

$7,304 + $2,100 = $9,404 = 15%

The MAX that may be excluded from Joe's income is 15% of what's taxable; that is, after his elective contribution (whatever it is, up to the $/% limit)is subtracted. After the subtraction, not more than $160K can be considered--times 15% = $24K.

That's right 15% by e/er, but only 13.04 if by e/ee only. So the "whales" who won't be getting the 3% can do 13.04 of their pre-plan (which equals 15% post plan) compensation.

CATHY: I always encourage my student to read all Code Section to the very end. The adj. to the $150K limit is found a few subsections later at 408((k)(8) = smile.gif

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Guest DCarter

Thank you so very much, Gary and Kathy.

I can now carry on with my duties knowing that I am capable of figuring this out.

Thank you again!!

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