Correcting Traditional IRA contribution made by mistake

Submitted by Keith Kim on Thu, 2023-12-07 19:54

Hello,
Thank you for your time in advance.
Client contributed $6500 in a traditional IRA earlier this year, but is considering adding a SEP IRA for this year for bigger deduction.
Their AGI is above the phaseout level, so the traditional IRA will not be deductible any way.

I was thinking about following options and questions for each.

1. IF possible, take out the $6500 back within this year as if it didn’t happen. He’ll only get taxed in case only there’s a gain?
2. Report it as non-deductible IRA and convert it to a Roth. But would having a SEP IRA complicate this because of Pro-rate rule?’
Also, non-deductible IRA is not a separate registration type right? it’s just a traditional IRA not deducted on the tax form?

Thank you!!



Submitted by Alan - IRA critic on Thu, 2023-12-07 20:18

  1. Yes, option is to request the return of the 2023 contribution adjusted for gain/loss.
  2. Depends. If he has no other IRA/SEP/SIMPLE balance on 12/31/2023 he can convert the 2023 contribution tax free except for any gains on that contribution. He could make the 2023 SEP contribution after year end as that would not affect 2023 conversion taxes.
  3. Correct, there is no separate registration. 
  4. The above conversion falls under the back door Roth strategy, but it will only work for years in which there is no other non Roth IRA balance at year end. After this year the SEP IRA balance will trigger pro rating of the conversion and most of the conversion will be taxable.

Submitted by William Tuttle on Fri, 2023-12-08 04:12

  • I don’t understand why a SEP IRA still seems to be the default choice. When a one-participant 401k has been available for more than 20 years.
  • Unlike 12/31 balances in all traditional, SEP and SIMPLE IRA accounts. One-participant 401k balances do not interfere with a tax efficient Backdoor Roth.
  • While it is getting close to year end. It still should be very possible to adopt a one-participant 401k by 12/31. The client just needs to get moving.
  • Even if not done by then, the client has the same deadline as a SEP IRA. The client has until the businesses tax filing deadline including extensions to adopt either a SEP IRA or a one-participant 401k and make employer contributions.

Submitted by Keith Kim on Fri, 2023-12-08 04:37

Thank you for great ideas. I’ll confirm their employees’ length of employment. by the way for Solo K to be adopted, they should have no eligible employees right? regardless of total number of employees Thank you. 

Submitted by William Tuttle on Fri, 2023-12-08 13:29

  • No “eligible” employees. Note: Vanguard’s Individual 401k does not allow any employee eligibility restrictions.
  • The Tax Code and IRS regulations allow these 401k employee eligibility restrictions:
  • < Age 21 restriction
  • Service restrictions have increased by the two SECURE Acts.
  • >= 1,000 hours/year for one year prior to the original SECURE Act
  • >= 500 hours/year over three years with the original Secure Act effective 1/1/2024
  • >= 500 hours/year over two years with Secure Act 2.0 effective 1/1/2025

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