Client is self-employed and has contributed to her SEP-IRA. Can she also make a nondeductible contribution to a traditional IRA?

Submitted by Michael Philipps on Wed, 2023-12-06 14:35

A 45-year-old client is self employed and has contributed the 25 percent maximum to her SEP-IRA based on 2023 income. Can she also make a non-deductible contribution to a traditional IRA of $6,500 and then convert it to a Roth immediately?

Flag as spam

Permalink Submitted by David Mertz on Wed, 2023-12-06 17:00

First, the maximum permissible SEP contribution by a self-employed individual is 20% of net earnings, not 25%, because the SEP contribution effectively reduces the amount of net earnings on which the 25% maximum is applied. Net earnings are net profit minus the deductible portion of self-employment taxes. See IRS Pub 560.
A nondeductible traditional IRA contribution is permitted. The sum of the traditional IRA contribution, the SEP contribution and the deductible portion of self-employment taxes is not permitted to exceed net profit from self-employment.
There are no restrictions on converting to Roth (except that any excess contributions to a traditional IRA (including a SEP IRA) are not eligible for conversion).

Permalink Submitted by Michael Philipps on Wed, 2023-12-06 17:16

Thank you.

Permalink Submitted by David Mertz on Wed, 2023-12-06 18:16

Also, only a portion of the basis in nondeductible traditional IRA contributions will be allied to any particular distribution from the regular traditional IRA or the SEP IRA because the pro-rata calculation of the amount of the distribution that is nontaxable involves the balances in all of the individual’s traditional IRAs, which includes the SEP IRA.

Permalink Submitted by Alan - IRA critic on Wed, 2023-12-06 18:17

If client is going to make a non SEP contribution (a personal IRA contribution) to the SEP account, the client should carefully flag it as such to the IRA custodian since SEP custodians are inclined to think that all contributions are SEP contributions. Such an error would result in an incorrect 5498. Client should then check the account to make sure the custodian recorded the contribution correctly and have them correct it if there was an error.

Permalink Submitted by William Tuttle on Wed, 2023-12-06 22:40

If the client’s use of a Backdoor Roth was known or advised. The client should not have been advised to use a SEP IRA. As pointed out by DMx, any pre-tax balances in all traditional, SEP and SIMPLE IRA accounts on 12/31 of any year of a Roth conversion will cause prorata taxation of that conversion.
The client should have been advised to use a one-participant 401k which will not interfere with the Backdoor Roth.
This is recoverable if the facts are as presented. 2023 SEP IRA contributions have been made, a non-deductible traditional IRA contribution has not been made and most importantly a Roth conversion has not been made.
Do NOT do a Roth conversion before 12/31/23.
Clarify whether any SEP IRA contribution amount is > 20% of self-employed earned income (net earnings from self-employment) = business profit – 1/2 SE tax. That amount would be excess contributions that must be removed with taxable earnings by the tax filing deadline (04/18/24) including extensions (10/15/24).
If the above is true and there have not been significant taxable earnings on the total contributions. It may be easier to remove all SEP IRA contributions and earnings than a rollover described below.
If the client wishes to utilize the Backdoor Roth. They should adopt a one-participant 401k effective 01/01/23.
If all the SEP IRA contributions and earnings are removed. A properly calculated maximum employer contribution can be made to the one-participant 401k by their tax filing deadline (04/18/24) including extensions (10/15/24).
If the client has not maximized the employee deferral limit (2023 = $22.5K) at other 401k, 403b and SIMPLE IRA employers. They have the same deadlines as for employer contributions, provided they make an employee deferral election by 12/31/23.
Pre-tax balances in all traditional, SEP and SIMPLE IRA accounts should be rolled over to the 401k. If no Roth conversions have or will be done in 2023. There is no requirement for these to be completed by 12/31/23.
The client has until their tax filing deadline 04/18/24 to make 2023 non-deductible traditional IRA contributions. With no pre-tax balances in all traditional, SEP and SIMPLE IRA accounts, the client could make both 2023 and 2024 non-deductible traditional IRA contributions in the 1st quarter of 2024, following by a Roth conversion of the entire balance.
I realize this is a lot to take in. Feel free to ask questions. Alan, DMx, myself or others will respond.
These types of issues and recovery’s are done many many times each year.

The Retirement Savings Time Bomb Ticks Louder

Live Advisor Training with America's IRA Experts

The Retirement Savings Time Bomb Ticks Louder

Client is self-employed and has contributed to her SEP-IRA. Can she also make a nondeductible contribution to a traditional IRA?

Add new comment Cancel reply