AA with both SEP and ROTH IRAs

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Topic Author
ploldo
Posts: 29
Joined: Sun Oct 30, 2011 1:23 pm

AA with both SEP and ROTH IRAs

Post by ploldo »

It just came to my attention that my SEP IRA is actually a tradition IRA, unlike my ROTH. I have about 90% of my tax sheltered in my SEP now, but that will change. Soon all of my contributions will only consist of me maxing out my ROTH.

I'm guessing since the traditional IRA (SEP) is taxed at withdrawal, I want the funds with lowest taxes in the ROTH?

my funds for tax sheltered: (in order from lowest to highest in taxes, I believe)

VEA,VWO,VIOO,VTSAX,VMVAX,VSIAX

So I plan on maxing out my ROTH with those funds from left to right, unless I'm mistaken.

One final question I have is about converting a traditional IRA to a ROTH. Is there a way to convert my SEP to a ROTH? Google makes this seem possible but this seems like a loophole to allow an even larger amount of money into a ROTH. What's the catch?
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: AA with both SEP and ROTH IRAs

Post by DSInvestor »

Roth IRA contributions are limited to 5K (6K if you're age 50+). This isn't very much. The max contribution to SEP-IRA is 50K but requires quite a high income to hit that limit. How much are you looking to contribute each year? If you're looking to contribute more than 5K/yr, you should contribute to both Roth IRA and SEP-IRA. When I was self employed I contribute max to my Roth-IRA, SEP-IRA and also to taxable accounts.

While withdrawals/conversions from SEP-IRA are taxable as ordinary income, be aware that depending on your tax situation at the time of withdrawal/conversion, the tax rate could be as low as 0%. If you retire early with assets in taxable accounts, have no pension, no social security income, you may be able to do withdraw or convert to Roth IRA for little or no tax. Repeat every year. If you retire with a pension, that changes the situation dramatically since the pension income will consume the 0% tax bracket and other low tax brackets causing your IRA withdrawal/conversion to fall in a higher tax bracket.

You may be interested in TFB's The Case against Roth 401k. It's about Roth 401k but the concepts are similar if you're considering either contributing to tax deductible SEP-IRA or Roth-IRA.
http://thefinancebuff.com/case-against-roth-401k.html

Tax efficiency isn't an issue inside tax advantaged accounts like SEP-IRA or Roth IRA. It's only an issue when you add taxable accounts. You'd want to the least tax efficient funds in tax sheltered accounts and most tax efficient funds in taxable. SEP-IRA assets should be pretax and any withdrawal will be 100% taxable so it doesn't really matter what type of fund you hold in the SEP-IRA.

You can convert SEP-IRA assets to Roth-IRA. I have done it. I had my SEP-IRA and Roth-IRA accounts at Vanguard and the conversion was as simple as a fund exchange from a fund in SEP-IRA to a fund in Roth IRA. There is no limit on how much you can convert from SEP-IRA to Roth IRA. If you have a $5M SEP-IRA and want to convert all $5M to Roth-IRA, you just have to make sure that you have the cash available to pay the taxes.

If you're self employed and using SEP-IRA, you may want to look into Solo 401k which would allow you to contribute more than SEP-IRA. If your income is under 200K, Solo 401k is like SEP-IRA plus 17K. Vanguard's Solo 401(k) plan is called Individual 401(k) and offers the option of up to 17K/yr of employee salary contributions into Roth sub account. Employer contribution is limited to 20-25% of income depending on how your business is organized and must go into the Traditional account. The rules permit you to contribute to your employer plan (SEP-IRA or Solo 401k) and also to Roth/Traditional IRA.

Here's a link to Vanguard's Small business page:
https://personal.vanguard.com/us/whatwe ... llbusiness
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Topic Author
ploldo
Posts: 29
Joined: Sun Oct 30, 2011 1:23 pm

Re: AA with both SEP and ROTH IRAs

Post by ploldo »

Thanks for the great reply.

“How much are you looking to contribute each year?”

I’m looking to max out each every year. I’m a self employed online poker player but with it being blocked in the US now my income from this has drastically decreased and is more uncertain. After this year it will be very little (under 10-20k). I do plan on maxing out my Roth forever though.

Interesting information on SEP withdrawal/conversion tax rates. As a student my income should be very low this year so I will look into a conversion.
You pretty much answered my main question as I was worried about tax rates at withdrawal.

“Tax efficiency isn't an issue inside tax advantaged accounts like SEP-IRA or Roth IRA. It's only an issue when you add taxable accounts. You'd want to the least tax efficient funds in tax sheltered accounts and most tax efficient funds in taxable. SEP-IRA assets should be pretax and any withdrawal will be 100% taxable so it doesn't really matter what type of fund you hold in the SEP-IRA.”

I’m a little confused by this paragraph, especially the last sentence. If SEPs are taxed at withdrawal and a ROTH isn’t, don’t I want the most tax efficient funds in them, compared to the ROTH? (assuming the very most tax efficient funds are in taxable) So it seems tax efficient fund should go taxable, SEP/traditional, ROTH, in that order.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: AA with both SEP and ROTH IRAs

Post by DSInvestor »

ploldo wrote:“Tax efficiency isn't an issue inside tax advantaged accounts like SEP-IRA or Roth IRA. It's only an issue when you add taxable accounts. You'd want to the least tax efficient funds in tax sheltered accounts and most tax efficient funds in taxable. SEP-IRA assets should be pretax and any withdrawal will be 100% taxable so it doesn't really matter what type of fund you hold in the SEP-IRA.”

I’m a little confused by this paragraph, especially the last sentence. If SEPs are taxed at withdrawal and a ROTH isn’t, don’t I want the most tax efficient funds in them, compared to the ROTH? (assuming the very most tax efficient funds are in taxable) So it seems tax efficient fund should go taxable, SEP/traditional, ROTH, in that order.
In taxable accounts, every dividend distribution, capital gains distribution and sale of shares is a taxable event. If a tax inefficient fund throws off lots of dividends every year, those dividends are taxed every and your after-tax return will be reduced. Similarly, if you sell shares for a gain, you may have to pay capital gains tax.

SEP-IRA is a tax advantaged account. Contributions are tax deductible. Investment income (dividends) are not taxable when received in the IRA. You can sell shares for a gain inside the IRA and it will not be taxable. Dividends and capital gains are what makes investments tax inefficient. Given that these two things aren't taxed in the SEP-IRA, tax efficiency of the investment isn't a concern for SEP-IRA.

The taxable event for SEP-IRA is when you take money out of the SEP-IRA either in a withdrawal or a conversion to Roth. It doesn't matter whether you used tax efficient or tax inefficient investments inside the SEP-IRA because there is no taxation until money is taken out of the account. If you contributed 10K to a SEP-IRA, you received a 10K tax deduction. The 10K in the SEP-IRA has never been taxed. If that 10K grows to 100K, and you withdraw 100K, you have to pay tax on the entire 100K withdrawal. It doesn't matter what investments you used along the way.
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Topic Author
ploldo
Posts: 29
Joined: Sun Oct 30, 2011 1:23 pm

Re: AA with both SEP and ROTH IRAs

Post by ploldo »

Thank you for the clarification.

I was confusing things in my head. Between my SEP and my Roth I will put the funds with the highest expected return in the Roth. This is what I was thinking of. Emailing my CPA about a conversion. Thanks!
uga2vegas
Posts: 6
Joined: Mon Jan 30, 2012 4:53 pm

Re: AA with both SEP and ROTH IRAs

Post by uga2vegas »

DSI investor,
Sorry, not trying to hijack thread but I am very curious about the solo 401k. I currently have a sep-ira that I have been contributing to for 3 years along with a TIRA that has been active for 1 year. My plan was to max out the sep-ira (50k) in the next month for 2011. If I were to convert the sep-ira to the solo 401k could I contribute 50k into the solo 401k along with also contributing to a new roth account? I have been trying to read about the solo 401k but don't quite understand what the designated roth really means.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: AA with both SEP and ROTH IRAs

Post by DSInvestor »

uga2vegas wrote:Sorry, not trying to hijack thread but I am very curious about the solo 401k. I currently have a sep-ira that I have been contributing to for 3 years along with a TIRA that has been active for 1 year. My plan was to max out the sep-ira (50k) in the next month for 2011. If I were to convert the sep-ira to the solo 401k could I contribute 50k into the solo 401k along with also contributing to a new roth account? I have been trying to read about the solo 401k but don't quite understand what the designated roth really means.
You have missed the deadline to setup a Solo 401k for 2011 contributions. I believe the plan must have been setup by Dec 31, 2011 for you to contribute for 2011. You're stuck with SEP-IRA for 2011 contributions.

There are differences in Solo 401k plans depending on the firm.
Fidelity's plan is called Self Employed 401k. It will allow for rollovers from SEP-IRA, Traditional IRA and many other account types.
Two types of contributions are allowed
1. Employee Salary Deferral Traditional (up to 17K for 2012 22.5K if age 50+)
2. Employer Profit Share Traditional
The sum of employee and employer contributions cannot exceed 50K or 55.5K if age 50+)

Vanguard's Plan is called Individual 401k. It does not allow for rollovers from IRA or 401k.
Three types contributions are allowed:
1. Employee Salary Deferral Traditional
2. Employee Salary Deferral Roth
3. Employer Profit share Traditional
The sum of the employee salary deferral contributions cannot exceed 17K for 2012 (22.5K if age 50+)
The total of employee and employer contributions cannot exceed 50K (55.5K if age 50+)

Designated Roth applies for the employee salary deferral contribution. The 17K employee salary deferral can go into either Traditional or designated Roth account. Mix and match as you please. If you want max tax deduction, contribute the 17K to Traditional.

The employer profit share contribution must be Traditional and is calculated exactly the same way as SEP-IRA. If your income is high enough (200-250K) to max out a SEP-IRA, you could max out a Solo 401k using just the employer contribution. Alternatively, you could mix and match your employee and employer contributions to reach 50K. For example, if you wanted some extra Roth contributions, you could do 17K Roth Employee and 33K employer which adds up to 50K total.

If your income wasn't high enough to max out using only employer profit share contribution, you can use employee salary deferral to contribute up to 17K more.
For example:
S-corp W2 Income = 100K
Employer profit share = 25% of W2 = 25K (same as SEP-IRA)
Employee salary deferral = 17K
Total Contribution = 42K.


If you have questions about Vanguard's Individual 401k, I suggest calling Vanguard's small business group at 800-662-2739.
Fidelity's plan doesn't offer Roth contributions but you may want to talk to them too if you like their rollover options. 800-544-5373.
Last edited by DSInvestor on Fri Feb 10, 2012 2:34 am, edited 1 time in total.
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uga2vegas
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Joined: Mon Jan 30, 2012 4:53 pm

Re: AA with both SEP and ROTH IRAs

Post by uga2vegas »

I really appreciate the help DSI, that cleared everything up for me!
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