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IRA Contribution Limit Workaround

Written by Nickel - 11 Comments

I recently ran across an article on SEP (Simplified Employee Pension) IRAs over at Blueprint and, as I read it, I had an epiphany. The upshot was that if you have any self-employment income (like ad revenue from blogging), you can open a SEP-IRA and then make contributions to it as your own employer. This shields your earnings from both income tax and self-employment tax on at least the employer contribution. But in reading this article, I got to thinking that a SEP-IRA might also provide a way of socking away more retirement funds than would otherwise be allowable under the Traditional and/or Roth IRA contribution limits.

A bit of digging revealed that employer SEP contributions don’t appear to count against your limit for Traditional or Roth IRA contributions (again, you’re your own employer, so you can make these contributions on your own behalf). Assuming this to be true, you can max out your regular IRA and contribute to a SEP. But wait! It gets better… You can also rollover your SEP-IRA into your Traditional or Roth IRA. Thus, you can take advantage of the SEP-IRA without having to keep track of an extra account over the long term… Rather, you can open your SEP account, fund it, roll it over into your Traditional or Roth IRA, and then close it. While it’s a bit of extra work, it might be a good way of supercharging your retirement savings if you have any self-employment income lying around.

Published on March 16th, 2006
Modified on February 19th, 2008 - 11 Comments
Filed under: Retirement, Saving & Investing, Taxes

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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11 Responses to “IRA Contribution Limit Workaround”

  1. 1
    Dus10 Says:

    Brilliant! I always feel that everyone who cares about their personal finances should have their own business in order to take advantage of all the benefits. This is another example of what can be done with a little bit of creative thinking! I love it!

    Hey, what would you expect from someone who hates Social Security? I can avoid all the expenses associated with FICA, FUTA, etc… It is great! As a matter of fact, I would suggest (if you may enough money from your self-employment) that you avoid the Traditional/Roth IRAs until you have surpassed the SEP IRA limit. You pay FICA on anything that you make through normal employment (and your employer pays FUTA and matches your FICA), but you have the opportunity to have up to the amount you earn in revenue have none of the taxes.

    That is why I am also considering not using Coverdell ESAs for my children. I am hoping that I will be able to get my income up to a level where I may be prohibited from contributing to a Coverdell for my children… I could always give the money to my children, and they could contribute… but the limit is $2000/year, and if they do not spend the money by their 30th birthday (on qualified education expenses), it has to be rolled over to another eligible person, or it is penalized. However, any principle in a Roth IRA can be withdrawn, without penalty, after five years. Further, earning can be withdrawn, without penalty, for qualified education expenses. So, why use a Coverdell ESA? Just have a Roth IRA for your children. The contribution limit is twice as high as the Coverdell ESA, and the funds can be held without penalty after the 30th birthday, as it is a retirement account. Better yet, you could use both a Coverdell ESA and a Roth IRA and get up to $6000/year/kid.

    The caveats are as follows:
    Coverdell ESA – annual limit of $2000/child
    Roth IRA – annual limit of $4000/eligible person, must be from earned income, which means the child has to be working. The child can start working in your home business at the age of eight, and can begin contributing funds. The funds are essentially tax free (income tax, FICA, FUTA, etc) up to the standard deduction. Beyond that, the child would begin in the lowest tax bracket for funds over the standard deduction. Further, funds you pay your child lower your AGI, and can put you in a lower tax bracket.

  2. 2
    Emma Says:

    I believe you can also, as opposed to rolling over the SEP to IRA, consolidate them into an IRA. I suppose the only difference would be there’s no hassle with closing the SEP.

  3. 3
    nickel Says:

    Yeah, the main reason I suggested closing the SEP is that some people object to having too many accounts to keep track of.

  4. 4
    JLP at AllThingsFinancial Says:

    This shields your earnings from both income tax and self-employment tax.

    This doesn’t work if you are a sole proprietor because the contributions must go on Line 28 of Form 1040.

  5. 5
    nickel Says:

    So… Are bloggers sole proprietors?

  6. 6
    Making Our Way Says:


    Hmm…this troubles me. I own a business and have made individual 401k and SEP IRA contributions in different years. Currently I prefer individual 401ks because you can put the first $15k (this year) earned without having to worry about the 25% income limitation of SEPs.

    You can’t put more than 25% of your income into a SEP.

    When I made individual 401k contributions this year, my corporation was required to pay payroll tax (SS, unemp, etc…) — even though the contributions were made directly by the corporation to the individual 401k.

    My point is this:

    a. you might be able to make larger overall contributions, but you will still have to pay self-employment tax — check this out with a CPA to see if I’m right (I could be wrong).
    b. your Roth contribution may count toward to $15k limit of deferred salary you can put away in the individual 401k or the SEP IRA.

    This is definately a CPA question.

    Since contributions are reported annually,the IRS will know about this matter and decide if it’s a mistake or not – so I recommend a CPA decide on it for you before the IRS does.

    Good luck and have a wonderful Thursday,
    Making our Way

  7. 7
    Making Our Way Says:

    Five Cent,

    What a wonderful question you’ve raised!! It got me thinking so I spent some time researching the issue at IRS website and think I’ve come up with an answer.

    You can find it at my blog:

    The bottom line is that you probably do have to pay self-employment taxes.

    My posting also provides quotes from the relevant IRS documents.

    Making Our Way

  8. 8
    2million Says:

    Making Our Way,
    When you paid self employment taxes on the employer 401(k) contributions were you a sole proprietor?

    I have been activiely reading up on this and the secret I believe is that being incorporated (S or C corporation) allows you to avoid paying self employment taxes on the empployer contributions although I haven’t been able to get a definitive answer yet.

  9. 9
    Sanjay K Says:

    I understand the S-corporations and such can contribute to Coverdell Accounts without any income limits.

    I would like to take advantage of that but am not sure of how to classify the expense in the corporation. I am the owner and the only employee of the corporation. Where would it go on my W2?

    Appreciate any thoughts/advice on this.


  10. 10
    diane Says:

    I am an llc and in great debt. I was thinking to close my sep ira and pay off credit cards and vendors. Any thoughts?

    trying to keep afloat in small business!

  11. 11
    Barry Says:

    A more interesting question is…if you max your SEP (in 2009 at $49K) can you also max a traditional IRA for the same tax year (at up to $5K or $6K depending on age)?

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