Oops: SEP IRA and Backdoor Roth = Pro-rata Rule

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Wealth_Builder
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Oops: SEP IRA and Backdoor Roth = Pro-rata Rule

Post by Wealth_Builder » Tue Jan 23, 2018 1:25 pm

I've made the error of having a SEP IRA and Backdoor Roth contributions during 2017 and have just learned about the pro-rata rule. Is there anyway of avoiding it at this point? Can my SEP IRA be converted into a self-employed 401(k) and rolled over?

Traditional IRA Contribution: $5,500 in January 2017
SEP IRA Contribution: ~$3,000 in April 2017
IRA Back-door Conversion: November 2017

I'm fairly young and new to investing. The contributions aren't huge, but I'm thinking this would result in a tax bill of about $600. See below:
Pro-rata Rule Exercised:
3000/(3000+5500) = 35% of IRA contributions are pre-tax
35% X 5500 = NEW taxable contribution (this would have been tax-free via backdoor) = $1925
Additional Taxes Due: 1925 X 30% (marginal tax rate) = $578

Any chance I can avoid this amount due? :oops:

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White Coat Investor
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Re: Oops: SEP IRA and Backdoor Roth = Pro-rata Rule

Post by White Coat Investor » Tue Jan 23, 2018 3:40 pm

Not an easy fix, especially with the new laws about recharacterization. Best bet is converting the whole darn thing to a Roth IRA. Is the SEP small enough that you can afford to do that?

Edit: Oh, it's only a $3K SEP? Just convert it and pay the taxes on that $3K. Easy peasy. And use a solo 401(k) instead of a SEP going forward. And don't give me crap about having to pay taxes on that $3K. If you make so much you have to do your roth contribution indirectly, you certainly make enough to pay the taxes on a $3K roth conversion.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Earl Lemongrab
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Re: Oops: SEP IRA and Backdoor Roth = Pro-rata Rule

Post by Earl Lemongrab » Tue Jan 23, 2018 5:47 pm

I believe that 2017 conversions can still be recharacterized. The new law only applies going forward from 2018.
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niceguy7376
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Re: Oops: SEP IRA and Backdoor Roth = Pro-rata Rule

Post by niceguy7376 » Tue Jan 23, 2018 6:38 pm

Wealth_Builder wrote:
Tue Jan 23, 2018 1:25 pm
I've made the error of having a SEP IRA and Backdoor Roth contributions during 2017 and have just learned about the pro-rata rule. Is there anyway of avoiding it at this point? Can my SEP IRA be converted into a self-employed 401(k) and rolled over?

Traditional IRA Contribution: $5,500 in January 2017
SEP IRA Contribution: ~$3,000 in April 2017
IRA Back-door Conversion: November 2017

I'm fairly young and new to investing. The contributions aren't huge, but I'm thinking this would result in a tax bill of about $600. See below:
Pro-rata Rule Exercised:
3000/(3000+5500) = 35% of IRA contributions are pre-tax
35% X 5500 = NEW taxable contribution (this would have been tax-free via backdoor) = $1925
Additional Taxes Due: 1925 X 30% (marginal tax rate) = $578

Any chance I can avoid this amount due? :oops:
Are you the employer that did the SEP or just an employee of a company that has SEP?
A SEP IRA contribution of 3K is very low amount (since it is a fixed amount or % by employer to all employees) compared to your salary where you were ineligible for the direct ROTH IRA

Spirit Rider
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Re: Oops: SEP IRA and Backdoor Roth = Pro-rata Rule

Post by Spirit Rider » Tue Jan 23, 2018 8:40 pm

Earl Lemongrab wrote:
Tue Jan 23, 2018 5:47 pm
I believe that 2017 conversions can still be recharacterized. The new law only applies going forward from 2018.
This is correct. The OP could recharacterize the 2017 Roth conversion, rollover the SEP IRA to either their primary employer's 401k/403b/457b plan or a one-participant 401k plan and redo the Roth conversion in 2018.

However, I'm with WCI. Move on, pay the taxes on the 2017 SEP IRA conversion and adopt/use a one-participant 401k for 2018.

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