SEP Changes

Submitted by IRAQuestion5 on Wed, 2022-07-13 19:59

Hello-

Client currently has a SEP IRA for his business.

1. If he makes a SEP IRA contribution now can he still switch to a 401k later in the year and make 401k contributions?

2. If he makes a SEP IRA contribution now and later in the year hires a new employee does he also have to make a SEP contribution for that employee?

In either case, does he have the option of undoing (backing out) the SEP contribution?

Thank you!



Submitted by John J. Ernst on Wed, 2022-07-13 20:10

Hi: Generally, a SEP IRA is a profit sharing plan for a small business.  So, if he funds the plan for 2022, then he has created a retirement plan for 2022. No new 401k plan can be created for this year. Regarding his new employee, he can hold out newly hired employees for up to two years.  If he wishes to fund a generous amount into his retirement plan, he can look into a Solo K Plan, which is the self employed version of the 401k plan for companies.  A soloK can work fine until he has employees. The Solo k allows up to $20,500 plus age 50 catch up contributions of $6,500. Then, he would need to switch to a regular 401k plan if his new employee becomes eligible to contribute. The other option for your client would be a Simple IRA.  This allows him to save $13,500 annually plus a $3,000 age 50 catch up contribution.  He would need to match 100% up to 3% of his or an employee’s pay in the plan.He can hold out new employees for up to 2 years.   



Submitted by William Tuttle on Thu, 2022-07-14 12:56

  • Why not just adopt the one-participant 401k in the first place and circumvent the problem?
  • You can not “maintain” a 5305-SEP IRA and a 401k for the same tax year. A SEP IRA is maintained for any tax year there are contributions and a 401k is maintained from adoption until termination. If you have a prototype SEP IRA from Schwab, Merrill Edge, etc… you can also adopt a one-participant 401k. The annual addition limit applies.
  • If not, you can remove the SEP IRA contribution and earnings as an excess contribution. The SEP IRA will no be longer maintained for that tax year. You will be free to adopt a one-participant 401k and make the full contributions subject to limits and your compensation. Since we are in a bear market, it is unlikely you willl have taxable earnings, but again why go thru the hassle?
  • An employer can elect to require an employee to be age 21 and have $600 in compensation in up to 3 (not 2) out of the previous 5 calendar years to participate in a SEP IRA. Note: This applies to all employees including the owner, but the election can exempt existing employees. If the business has existed >= 3 years and the owner originally adopted or amends the SEP IRA plan requiring 3 years of service before hiring new employees. They would be subject to these eligibility requirements 
  • An employee is eligible to participate in a SIMPLE IRA plan if they have had $5K of compensation in any 2 previous calendar years and are expected to have $5K of compensation in the current year.


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