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March 17, 2011

SEP IRA Effect on Active Participant Status

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SEP IRA Effect on Active Participant Status

I am a sole proprietor. My small business has never had a retirement plan, but I just established a SEP on 3/3/11 and I am going to make a SEP contribution IN 2011 FOR 2010 tax year. My MAGI will be approx. $180K and I’d also like to make a deductible traditional IRA contribution. I saw a post on a bulletin board that suggested I could do this because active participant status for SEP plans is based on the timing of the SEP contribution not the tax year it is for. I just wanted to verify that I am understanding this correctly … on your website you refer to “active participant in a retirement plan” but the term used in the IRS instructions is “covered by a retirement plan” and I am wondering if those two phrases are synonymous or perhaps cover different situations. Thanks!

Your understanding is correct. The two phrases “active participant status” and “covered by a retirement plan” mean the same thing for purposes of being able to take a tax deduction for a contribution to a traditional IRA.

SEP Contribution Rules and Active Participant Status

With a SEP IRA, you are usually considered an active participant for the year in which the SEP contribution is deposited to your SEP IRA. For instance, since you are depositing your 2010 SEP IRA contribution in 2011, you are considered an active participant for 2011. See footnote for exception [1. Therefore, unless you received contributions or benefits under another employer sponsored retirement plan for 2010 or in 2010 depending on the type of employer sponsored plan, your contribution to your traditional IRA for 2010 is fully deductible, regardless of your modified adjusted gross income (MAGI). For more on this, please see the article Active Participant Status–Can You Deduct Your IRA Contribution.

PS: We have updated our definition of active participant to address your question about whether it means the same thing as ‘covered by a retirement plan’.

This question was answered by http://applebyconsultinginc.com/DeniseAppleby.php Denise Appleby

[1] When profit sharing or SEP IRA contributions for two years are made in one year, the result is ‘active participant’ status for two years. While the general rule for profit sharing plans and SEP IRAs is that the individual is an active participant for the year in which the contribution is deposited to the profit sharing/SEP account, an exception applies. Under this exception, if contributions for two separate plan years are made in the same year, the contribution for the later year is deemed to be made in the next year. This prevents a participant from unintentionally circumventing the active participant status for one year when contributions for two years are made in the same year.

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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