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 – July 7, 2014

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

Question: If my client has a simplified employee pension (SEP) plan and works after he turns age 70 ½, can he wait until he retires to start taking RMDs?

Answer: Unfortunately, the IRS says that even though SEP and SIMPLE IRAs are employer-sponsored retirement plans, they are still IRAs, and therefore the IRA rules for RMDs apply. An owner of an IRA must start taking RMDs in the year the taxpayer turns 70 ½, so even if your client keeps working, he will nevertheless be required to take distributions from his SEP plan.

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Ask the Experts – June 12, 2014

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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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Ask the Experts – March 20

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

Question: I have a client who participates in a simplified employee pension (SEP) plan at work. Can she contribute to the SEP in addition to the employer’s contribution?

Answer: Yes; according to the IRS, non-SEP contributions are permitted if the SEP documents allow them. This means your client can make regular IRA contributions up to $5,500 in 2014 ($6,500 if older than age 50).

Employee contributions to a SEP plan are treated like any other traditional IRA contributions. Therefore, the amount of money your client contributes to the SEP as his regular IRA contribution will reduce the amount she can contribute to other IRAs for the year. Additionally, the amount your client can deduct may be reduced or eliminated due to her participation in the SEP plan.

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Ask the Experts – March 12

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

Question: I have a client who participates in both his employer-sponsored 403(b) annuity and a simplified employee pension (SEP) for his own side-business. Can he make the full contribution limits for both, or are there restrictions?

Answer: His SEP contribution limit could be reduced by the amount he contributes to his 403(b) account.

In 2014, the limit on elective deferrals is $17,500 for 403(b) annuities. This limitation is per individual—not per plan. The contribution limit for any pension or profit-sharing plan maintained by the same employer is $52,000. SEP plans are slightly different, where the contribution limit is the lesser of $52,000 or 25 percent of the individual’s income.

An employee can generally contribute the full $17,500 in elective deferrals to one employer’s plan, and also make the maximum $52,000 contribution to another employer’s pension or profit-sharing plan. However, Section 415(k)(4) provides for a special rule between 403(b) annuities and SEP plans that essentially treats both plans as maintained by the same employer for purposes of the contribution limits.

Therefore, the $52,000 SEP limit would be reduced by the amount the participant contributes to his 403(b) annuity. If he contributes the maximum $17,500 elective deferrals to the 403(b) annuity, the $52,000 limit decreases to $34,500. In other words, he can now only contribute the lesser of $34,500 or 25 percent of his income.

This reduction from $52,000 to $34,500 will only affect an individual who earns more than $138,000 in his self-employed business because if his self-employment income is $138,000 or less, such contributions would be limited to 25 percent of his income (i.e. $34,500 is 25 percent of $138,000)—in other words, the $34,500 limit is irrelevant for such individuals. If he earns more than $138,000, he’s limited to $34,500 instead of $52,000.

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