SEP IRA, Roth IRAs and the Roth Conversion

By Jason Watson, CPA
Posted Monday, December 30, 2024

If you want your retirement savings to grow tax free, you need a Roth IRA or Roth 401k. If tax-free growth is generally preferred, you can accomplish this outside of the business. However, there are some problems, or at least potential problems.

A quick recap of the limitations of a garden variety Roth IRA- a Roth IRA is only available to those who earn less than $246,000 per year for married filing joint taxpayers ($165,000 for single taxpayers) for the 2025 tax year, and a Roth IRA has very low contribution limits of $7,000. What can be done? Two things- a Roth 401k, which grows tax free, can accept business profit sharing and has a much higher contribution limits of $23,500 (for the 2025 tax year) or $31,000 with catch-up as we’ve already discussed. That is option #1.

Another Roth like option involves two steps. You create a SEP IRA in 2024 and take your deduction on your 2024 tax return. You convert the SEP IRA into a Roth IRA in 2025, and this in turn creates a taxable event for 2025 but no penalty. You then create another SEP IRA in the same year to counter the tax consequence of the conversion. Imagine putting $70,000 (for the 2025 tax year) into a Roth IRA each year- amazing. Frankly the ability to convert might not last long, but we’ll take advantage of it as long as we can. However, SEP IRAs can be viewed as the middleman, and we always want to cut out an unnecessary stop. Implementing a 401k plan circumvents this.

If you have a traditional IRA you can do the same thing. Be careful about shooting your income into the stratosphere in terms of marginal tax brackets. Too many financial advisors and taxpayers mess this up. Let us help. Let us model this taxable event.

Another option along the IRA lines is to make a non-deductible traditional IRA contribution and then convert that into a Roth IRA the following year. This has zero tax consequence since it was never deducted in the first place. Therefore, if you make too much money for a Roth IRA contribution you can contribute to a non-deductible traditional IRA and later convert it.

You are limited to one rollover or conversion per year per account (there is mild controversy within the IRS publications and industry practices on the number of allowed rollovers).