Advanced Underwriting Consultants

Ask the Experts – July 2, 2015

Question:  My client has an IRA with substantially equal periodic payments set up in order to avoid the additional tax on early distributions.  Can she roll out part of the funds in the IRA if they are not needed to satisfy the SEPP requirements?

Answer:   No.

As we discussed in the preceding question and answer, substantially equal periodic payments can be established as a way to avoid the additional 10% tax on distributions from a qualified account if money is needed before a person reaches 59 ½. A person who has established a SEPP plan cannot modify the payments or the account. If a modification occurs, the IRS will go back and retroactively apply the additional 10% penalty tax on all of the distributions that have been made  from the account pre 59 ½. The IRS however allows for a modification or termination of the SEPP plan when the owner reaches the age 59 ½ or has taken the SEPP distributions for 5 years, whichever is longer.

If a person tries to roll over part of the money in an account being used for SEPP distributions, the IRS will consider the SEPP plan busted. The IRS will apply the additional 10% tax to all of the prior distributions taken to that point.

Ask the Experts – June 12, 2014

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client is trying to decide between setting up a SIMPLE or SEP IRA for her small business. What should I tell her?

Answer: Without more details, you can only speak in generalities. You should start with the differences between the two.

A SIMPLE IRA (savings incentive match plan for employees) is very similar to a 401(k) plan in that it’s primarily a way for an employee to choose to contribute the employee’s money to a pension plan.

SIMPLE IRAs may include both employee deferrals and employer contributions. The employer must either (1) match the employee’s deferral dollar-for-dollar, generally up to 3% of the employee’s salary; or (2) make a 2% nonelective contribution to all eligible employees—regardless of whether the employee made a contribution.

An employee’s deferral limit for a SIMPLE IRA is $12,000 (in 2014, indexed for inflation).  The employee’s deferral must be deposited by the employer within 30 days from the end of the month in which the election was made, and the employer’s matching or 2% nonelective contribution must be made by the time tax returns are due in the following year.

To implement a SIMPLE IRA, an employer must have 100 or fewer employees who receive more than $5,000 per year. Every employee who earns at least $5,000 from the employer is an eligible employee and must be allowed to participate in the SIMPLE plan.

A SEP IRA (simplified employee pension) is easier to describe and implement than a SIMPLE IRA. It’s essentially an IRA set up on behalf of an employee to which the employer makes contributions based on a percentage of the employee’s compensation (the maximum compensation taken into account is $260,000 in 2014). The percentage contributed must be the same for every eligible employee.  There are no employee deferrals into a SEP plan.

An eligible employee is one who (1) is 21 years or older, (2) has worked 3 of the last 5 years or more, and (3) earned $550 in compensation. The contribution limit is 25% of the employee’s salary, or $52,000 (in 2014, indexed for inflation), whichever is lesser.

Understanding the differences between these plans can help your client decide which plan makes more sense. For example, if the business consists of only your client, the most important aspect is probably the contribution limits.

If the business generates relatively small amounts of income, a SEP IRA will limit the owner’s contribution. For example, let’s say your client has a side business bringing in $16,000 per year in salary. Under a SEP, the most he may contribute is $4,000 (25% of $16,000). On the other hand, with a SIMPLE IRA, he may make the full $12,000 contribution and have the business make a matching $480 contribution (3% of $16,000).

But if he earns $100,000 per year through his business, the business may contribute $25,000 (25% of $100,000) under a SEP, and he can only defer $12,000 (plus a $3,000 matching contribution from the business) under a SIMPLE plan.

Sources: I.R.C. § 408(k), (p); § 402(h)(2)(A).

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