I have heard that I can make a contribution for prior years. How does this work?

Plans can be structured so that they provide for prior services provided. Basically, you can look back to prior years and use compensation from those years to make a larger credit in the current year.

In the year of set-up, you would then make a one-time opening credit for this past service. It’s almost like a “catch-up” contribution. This contribution is tax deductible in the current year and you do not amend prior tax returns.

This strategy allows a business owner to make maximum contributions that will exceed the targeted contribution in that year. You can then get a tax deduction in a year when income will be high.

But be careful, prior service is applicable to any eligible employees who worked for the company. You may have to contribute for employees who may no longer work for the company.