Simple IRA and Pro Rata Rule for a business owner

Submitted by Melissa Leathers on Fri, 2021-08-27 12:12

A client is a small business owner who uses a Simple IRA as the company retirement plan for himself and his employees, including his wife. He and his wife have large amounts in their Simple accounts. He would like to do Roth conversions for some small IRA’s they hold and future back-door Roth strategy. I know that Simple IRA balances are included in the pro rata rule calculation for back-door Roth conversions, but does that fact that he is the business owner allow him to consider the plan an EMPLOYER plan (typically 401k’s and 403b’s).

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Permalink Submitted by William Tuttle on Fri, 2021-08-27 13:25

There is nothing unique to a Backdoor Roth that makes it potentially subject to pro-rata taxation. It is simply a process of two actions. One or more non-deductible traditional IRA contributions followed by one or more Roth conversions.
Pro-rata taxation occurs on the pre-tax balances of all traditional, SEP and SIMPLE IRA accounts on 12/31 of the year of all Roth conversions that year. There must be little to no such balances by 12/31 to do a tax-efficient Backdoor Roth.
Being the business owner of a SEP or SIMPLE IRA employer plan is not revelant.
The only way for the client to do so is to consider adopting a small business safe harbor 401k effective 1/1/2022. The safe harbor minimum employer contribution rates are only 1% higher than a SIMPLE IRA. There are startup and administrative fees, but the employee deferral limit is $6,000 higher than a SIMPLE IRA. There are TPAs offering low-cost investment options and administrative fees in the $1,000 – $2,000 range.
They would have to have to have this option ready before the 11/2 SIMPLE IRA annual notice/enrollment deadline.
They would want to make sure to adopt a safe harbor 401k plan that accepts IRA rollovers. Also, you can’t rollover a SIMPLE IRA until 2 years after the first contribution.
Once the pre-tax and only the pre-tax SIMPLE IRA and any other IRA balances are rolled over to the 401k. Tax-free Roth conversions and the Backdoor Roth can be done