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IRA Contribution Limits for 2017 – Unchanged at $5,500 and $6,500; 401(k) Limits Unchanged Also

Posted by James M. Carlson
Oct 31 2016

Inflation was approximately .3% for the fiscal quarter ending September 30, 2016, so many of the IRA and pension limits as adjusted by the cost of living factor have not changed or the changes have been quite small.

The maximum IRA contribution limits for 2017 for traditional and Roth IRAs did not change – $5,500/$6,500.

The 2017 maximum contribution limit for SEP-IRAs is increased to $54,000 (or,25% of compensation, if lesser) up from $53,000. The minimum SEP contribution limit used to determine if an employer must make a contribution for a part-time employee remains the same at $600.

The 2017 maximum contribution limits for SIMPLE-IRAs is unchanged at $12,500 if the individual is under age 50 and$15,500 if age 50 or older.

The 2017 maximum elective deferral limit for 401(k) participants is unchanged at $18,000 for participants under age 50 and $24,000 for participants age 50 and older.

  

 

 

Categories: Pension Alerts, Roth IRAs, SIMPLE IRAs, Traditional IRAs

Financial Institution Must Notify DOL It Will Use BICE And Must Comply With Record Keeping Requirements

Posted by James M. Carlson
Sep 28 2016

In order to use the BICE a financial institution must notify the DOL by providing an email to e-bice@dol.gov that it will to use the BICE. The notice can be generic. That is, it need not mention any specific IRA or any specific plan. If the notice requirement has been met, then the financial may receive compensation. The notice remains in effect until it would be revoked by the financial institution.

The financial institution must maintain for six years the records necessary for certain persons to determine whether the conditions of the BICE have been met with respect to each specific transaction. Upon request the following individuals must have the right to exam these records during normal business hours:

  1. Any authorized employee or representative of the IRS
  2. Any plan fiduciary which has participated in an investment transaction pursuant to the BICE
  3. Any authorized employee or representative of a plan fiduciary which has participated in an investment transaction pursuant to the BICE
  4. Any contributing employer and any employee organization whose employees or members are covered by the plan
  5. Any authorized employee or representative of a contributing employer and any employee organization which has participated in an investment transaction pursuant to the BICE

Any IRA owner or plan participant or inheriting beneficiary or an authorized representative of such persons.

None of the non-IRS individuals are authorized to examine records regarding a recommended transaction of another retirement investor, privileged trade secrets or privileged commercial or financial information of the financial institution or information identifying other information.

When a financial institution refuses to furnish requested information for a reason state above, it has 30 days in which to inform the requester of the reasons for denying the request and that the DOL if requested could request such information.

If the required records are not maintained, there is a loss of the exemption only for that transaction or transactions for which the records are missing or have not been maintained. Other transactions will still qualify for the BICE if those records are maintained. If the records are lost or destroyed, due to circumstances beyond the control of the financial institutions, then no prohibited transaction will be considered to have occurred solely on the basis of the unavailability of those records.

The financial institution is the party who is responsible to pay the ERISA civil penalty under section 502 or the taxes under section 502 or the taxes under section 4975 if the required records are not maintained

Categories: Pension Alerts, Traditional IRAs

Election Day November 8th, 2016 and the Politics of IRAs.

Posted by James M. Carlson
Sep 21 2016

You and other voters will go the voting booth on November 8th, 2016.

IRAs are political because they are created by the federal income tax laws. IRA owners receive tax preferences for making various types of IRA contributions or because the IRA has received a direct rollover or rollover contribution from a 401(k) plan or another employer sponsored retirement plan.

The federal deficit is a political issue waiting to be addressed. More and more politicians are starting to seriously look at IRAs and 401(k) plans as sources of tax revenues. Money in traditional, SEP and SIMPLE IRAs is tax deferred, it is not tax-free. When distributed or withdrawn, the distribution amount must be included in the recipient's income and tax paid at the person's applicable marginal income tax rate.

There is approximately 7.2 trillion dollars in traditional IRAs. Assuming an average marginal tax rate of 20% the federal government is looking to collect 1.4 trillion dollars from future IRA distributions. There is approximately 6.8 trillion dollars in 401(k) and other defined contribution plans. Assuming an average marginal tax rate of 20% the federal government is looking to collect 1.3 trillion dollars from future 401(k) distributions. The federal debt is estimated to be 19.5 trillion dollars as of September 30, 2016. IRAs and 401(k) plans cover 13.8% of the federal debt.

The question is, when will these tax revenues be collected?

Some politicians are starting to suggest the IRA rules need to be changed so the federal government starts to collect tax revenues sooner than under existing law.

Senator Ron Wyden represents the State of Oregon. He is a Democrat. There is a 50% chance he will become the chairman of the Senate Finance Committee in 2017 after the November 8th elections. He recently communicated that he and other Democrats will be pursuing the following IRA law changes.

  1. With respect to inherited IRAs, the 5-year rule would apply once an IRA owner dies. This would be a monumental change. A traditional IRA beneficiary would have 5-6 years to take distributions, include such amounts in income and pay tax. The ability to stretch out distributions over the beneficiary's life expectancy would be repealed. A Roth IRA beneficiary would lose the right to have the Roth IRA earn tax-free income for a period equal to his or her life expectancy. The beneficiary would be given only 5-6 years of tax-free income
  2. It is unclear if everyone would lose the right to make Roth IRA conversion contributions or if a person with traditional IRA funds could make a conversion contribution but only to the extent the IRA funds are taxable. That is, a person with basis in his/her IRA or pension plan could not convert any basis. The Obama administration has previously proposed not allowing basis within an IRA to be converted. A total repeal of the right to make a Roth IRA conversion contribution would be radical.

    At least on a short term basis, the federal government likes it when individuals make Roth IRA conversion contributions as tax revenues are collected.

  3. There would be a new tax rule stipulating that the maximum value of a person's Roth IRAs would be limited to $5,000,000 and if this limit was exceeded then the excess would have to be withdrawn. This also would be a radical change.
  4. A non-IRA change would be to change the law governing 401(k) plans. Somehow a person making student loan payments would be given credit under their 401(k)plan so that the loan payments would be treated as an elective deferral contributions so that an employer would have to make a matching contribution.

In summary, IRAs are political. As with other political subjects, each person will need to make their own voting decisions. Taking away IRA tax preferences is in essence a tax increase and individuals will need to decide the degree it will influence how they will vote. We at CWF believe switching to the 5-year rule for an inherited IRA beneficiary should be unacceptable.

Categories: Pension Alerts, Traditional IRAs

IRS Issues Additional Procedure For Waiver of 60-Day Rollover Requirement and Additional Self-Certification Procedure

Posted by James M. Carlson
Aug 15 2016

The IRS issued Revenue Procedure 2016-47 on August 24, 2016. It modifies Revenue Procedure 2003-16. The IRS now in the course of a examining a taxpayer’s individual tax return may determine that the person qualifies for a waiver of the 60-dayrollover requirement.

The IRS has created a third waiver method. The new waiver method is effective on August 24, 2016. The first waiver method set forth in Revenue Procedure 2003-16 requires the taxpayer to file an application requesting a waiver of the 60-day rule and the IRS must grant the waiver. The second waiver method authorizes an automatic waiver of the 60-day rule if four requirements are met.

Why this new IRS procedure?
In January of 2016 the IRS changed the filing fees that a taxpayer must pay when submitting his or her waiver application. In 2015, the filing fee was $500 if the purported rollover was less than $50,000, $1,500 if the rollover amount was less than $100,000 but equal to or more than $50,000 and $3,000 if the rollover amount was $100,000 or more.

The IRS increased the fee to $10,000 for all such waiver applications. Apparently the IRS concluded that it no longer could afford to assign the personnel it had assigned to process these waiver requests. Presumably, many taxpayers and tax professionals have expressed their dissatisfaction to the IRS. The $10,000 filing fee means many taxpayers are no longer able to have the IRS process their application and receive a concrete ruling that they were or were not entitled to a waiver of the 60-day rule. The application process provided a taxpayer with tax certainty.

In Revenue Procedure 2016-47 the IRS authorizes a self-certification procedure that a taxpayer may use to request the waiver of the 60-day requirement rather than using the application procedure.The IRS tentatively grants the waiver upon the making of the self-certification and the taxpayer is permitted to prepare his or her tax return to reflect that he or she made a complying rollover so the distribution amount is not required to be included in his or her taxable income. However, the IRS retains the right to examine the individual’s tax return for such year (i.e. Audit) and determine if the requirements for a waiver of the 60-day rule were or were not met. If the IRS determines the individual was not entitled to a waiver of the 60-day rule, the individual will have to include such distribution in his or her income and will have an excess IRA contribution situation needing to be corrected. The IRS explanation gives a limited discussion of the adverse consequences. If the IRS does not grant the waiver then the person may be subject to income and excise taxes, interest and penalties. One of the penalties which might apply would be the 25% tax for understating one’s income.

This self-certification procedure applies to distributions from any type of IRA and also from a 401(k) plan or other qualified plan and certain 403(b) and 457 plans.

The IRS has stated that it will be modifying the Form 5498 so that an IRA custodian which accepts a rollover contribution pursuant to this self-certification procedure after the 60-day deadline will complete such person’s Form 5498 to report that the rollover contribution was accepted after the 60-day deadline. The IRS will then be able to examine the tax returns of these taxpayers and the purported rollovers.

How does this self-certification procedure work?
The IRA owner will furnish the IRA custodian/trustee with a written certification meeting the following requirements. The IRA owner may use the IRS’ model letter set forth in the appendix of Revenue Procedure 2016-47 on a word-for-word basis or by using a form or letter that is substantially similar in all material respects.

The requirements:

  1. The IRS must not have previously denied a waiver with respect to a rollover of all or part of the distribution involved in the late rollover
  2. The IRA owner must make his or her rollover contribution as soon as practicable once the reason(s) for missing the 60-day deadline no longer apply. This requirement is deemed satisfied if the rollover contribution is made within 30 days after the reason or reasons no longer prevent the IRA owner from making the rollover contribution.
  3. The taxpayer must have missed the 60-day deadline for one or more of the following reasons:
  • An error was committed by the financial institution making the distribution or receiving the contribution
  • The distribution was in the form of a check and the check was misplaced and never cashed
  • The distribution was deposited into and remained in an account that you mistakenly thought was a retirement plan or IRA
  • Your principal residence was severely damaged
  • One of your family members died
  • You or one of your family members were seriously injure
  • You were incarcerated
  • Restrictions were imposed by a foreign country
  • A postal error occurred
  • The distribution was made on account of an IRS levy and the proceeds of the levy have been returned to you
  • The party making the distribution delayed providing information that the receiving plan or IRA required to complete the rollover despite my reasonable efforts to obtain the information.

A person whose reason for missing the 60-day requirement is not included in the list of reasons is unable to use this self-certification procedure. The IRA custodian is authorized to rely on the IRA owner’s self-certification for purposes of accepting the rollover and reporting it unless it has actual knowledge contrary to the self-certification.

The IRS has created this self-certification method because it had to have some alternative procedure to allow taxpayers to seek a waiver of the 60-day rule as discussed in Revenue Procedure 2003-16 as the increased filing fee meant most taxpayers no longer would be using the application process.

This new procedure will help some taxpayers, but it would not have been needed if the IRS would not have imposed the $10,000 filing fee. One can hope the IRS will see reason and will reduce the fees for 2017. Most likely the IRS will not. Although the 11 reasons the IRS lists as warranting the waiver of the 60-day rule are certainly welcomed by taxpayers, there are certainly other reasons for which the IRS should grant relief

Categories: Pension Alerts, Traditional IRAs

Planning Suggestion for an IRA Beneficiary Designation-Consider the Primary Beneficiary Might Want to Disclaim

Posted by James M. Carlson
Jul 11 2016

An IRA accountholder should almost always designate a primary beneficiaryand also designate one or more contingent beneficiary(ies). In some older IRA files the IRA accountholder has not designated a contingent beneficiary. In such situation, almost all IRA plan agreement forms provide that the IRA funds will then be paid to the decedent's estate. Tax options are not as many or as beneficial when an estate is the inheriting IRA beneficiary.

Be nice to your IRA clients and remind them periodically they should review and update their beneficiary designations, if appropriate. Of course, your IRA accountholders should be seeking the guidance of their legal and tax advisers.

Situation. John and Mary are now intheir 80's. Mary has $115,000 in her IRA. John has his own IRA with a balance approximating $75,000. Each has designated the other as their IRA beneficiary, but they did not designate any contingent beneficiaries. They have two daughters and a son. Mary died on July 8, 2016.

John has come into the bank because he wants these funds to go to the three children rather than himself. He believes this is what Mary wanted. That is, he wants three inherited IRAs set up for the three children.

The IRA custodian must not accommodate him. It would be tax fraud. It cannot be done since Mary had not designated the children as her contingent beneficiaries. If she would have designated the three children as her contingent beneficiaries and then John would have executed a valid disclaimer, then the desired result of having these IRA funds be inherited by the three children could have been realized. But this was not done.

If John executes the disclaimer now, Mary's estate will inherit her IRA and would have to comply with the RMD' rules applying to an estate beneficiary. John most likely would be making the situation worse. He will be better-off if he elects to treat Mary's IRA as his own and then withdraws only the RMD each year. He will, of course, name his three chi-dren as his IRA beneficiaries.

In summary, be nice to your IRA clients and remind them periodically they should review and update their beneficiary designations. In order to retain the flexibility of a primary beneficiary disclaiming his or her interest, one or more contingent beneficiaries need to have been designated by the deceased IRA accountholder. If so, additional planning options are then available

Categories: Pension Alerts, Traditional IRAs

More Wealthier Individuals Should Be Making Nondeductible Traditional IRA Contributions - They Just Need Some Help and You Can Provide It

Posted by James M. Carlson
Jun 07 2016

Wealthier individuals should be rushing to their bank to make a non-deductible IRA contribution. This is certainly true if they are a 401(k) participant.

This author admits his bias, many individuals should be making non-deductible traditional IRA contributions and they don’t do so because they (and their advisors) many times don’t understand the benefits, including how the related tax rules apply.

Every person should contribute as much as possible to a Roth IRA. Why? There are very few times under US income tax laws where INCOME is not taxed. That is, no taxes are owed with respect to Roth IRA funds if the Roth owner has met a 5-year rule and is age 59½ or older or the Roth owner is a beneficiary who has inherited the Roth IRA and the 5-year rule has been met.

The federal tax laws have been expressly written to make it impossible for a person with a high income to make an annual Roth IRA contribution. Some people (i.e. many Democrats) don’t want “wealthier” individuals to gain the benefit of contributing funds to a Roth IRA and earning tax-free income. They want them to pay more income taxes. A person who had tax filing status of single was ineligible to make a 2015 Roth IRA contribution if his or her MAGI (modified adjusted gross income) was $132,000 or more. A person who had filing status of married filing jointly was ineligible to make a 2015 Roth IRA contribution if the couple’s MAGI (modified adjusted gross income) was $193,000 or more. A person who had filing status of married filing separately was ineligible to make a 2016 Roth IRA contribution if his or her MAGI (modified adjusted gross income was $10,000 or more.

For discussion and illustration purposes, we will assume that Jane Doe has the following situation. She is age 54. She is married. Her husband, Mark Doe, is a bank president. He is age 57. Their joint income is sufficiently high that neither one of them is eligible to make an annual Roth IRA contribution. Their joint income is sufficiently high that neither one of them is eligible to made a deductible traditional IRA annual contribution.

This article is going to discuss the question, “should these two each make a non-deductible traditional IRA contribution?” The primary concern is Jane’s situation, but we will also discuss Mark’s situation.

For the reasons discussed below, both should make a maximum non-deductible traditional IRA contribution until each is no longer eligible to make a traditional IRA contribution (i.e. the year a person attains age 70½).

On March 15, 2016, Jane contributed $6,500 to a traditional IRA she had established in 1984. She designated her contribution as being for 2015. The IRA balance at the time of contribution was $8,500. With the addition of her $6,500 contribution the IRA balance became $15,000. Since then the account has earned $40 of interest.

It is now assumed that Jane has no other IRA funds in any traditional, SEP or SIMPLE IRAs. The IRA taxation rules require in applying the taxation rules that all non-Roth IRA funds be aggregated. One cannot avoid the pro-rata taxation rule by setting up separate IRAs or having separate time deposits.

The couple’s tax preparer has recently informed Jane that her contribution is non-deductible as her husband participates in a 401(k) plan and their MAGI is sufficiently high that they are not permitted to claim any tax deduction for her $6,500 contribution. What tax options are available to her? What options are unavailable to her?

  1. She may not use the recharacterization rules to make her traditional IRA contribution a Roth IRA contribution as their 2015 MAGI is too high
  2. There is no IRS guidance allowing the IRA custodian to switch the year for which the IRA contribution was made from 2015 to 2016
  3. The IRS has issued rules allowing her to withdraw her 2015 IRA contribution with no adverse tax consequences as long as she does so by 10-15-16, no deduction is claimed on the 2015 tax return and the related income is withdrawn. If she withdraws her $6,500 contribution she is required to withdraw the related income and it is taxable for 2016 since the contribution was made in 2016. The related income is a pro-rata amount of the $40 determined as follows: 6500.15000 x $40 = $17.33. Since she is younger than age 59½ she does owe the 10% additional tax on this $17.33. The bank as the IRA custodian will prepare a 2016 Form 1099-R inserting the codes (81) in box 7, box 1 would show $6,517.33 and box 2a would show $17.33
  4. In 2016 she is eligible to make a Roth IRA conversion of any amount in the range of $.01 to $15,040. If she would convert $15,040 into her Roth IRA she/they would include in income on their 2016 tax return the amount of $8,540. She as many taxpayers does not want to include the $8,540 in her/their income and pay tax on it.

Jane as many taxpayers would like to convert only her non-deductible contribution of $6,500. This would allow her to pay no taxes since she would not be converting any of the $8,540.

The tax rules require use of the standard pro-rata taxation rule when an IRA has taxable funds and non-taxable funds. If she converts $6,500, a portion would be taxable and a portion would not be. The taxable portion is: $6,500 x $8,540/$15,040 ($3,690.82) and the non-taxable portion is $6,500 x $65,00/15,040 ($2809.18) . Jane made a nondeductible IRA contribution for 2015. She is required to file Form 8606 and attach to the couple’s Form 1040. If it was not filed with the original return, an amended tax return should be filed and the 2015 Form 8606 attached. She is not relieved of this duty because she withdraws the $6,500 or converts it. A $50 penalty applies to a person who fails to file Form 8606 unless she could show a reasonable cause why she did not file it. A person must pay a $100 penalty if a person overstates the amount of nondeductible contributions.

Note that Jane will also be required to file a 2016 Form 8606 regardless if she withdraws a portion or all of the $6,500.

Having to include in income the amount of $8540 and pay tax on this amount should not influence Jane or any other wealthy person to not make non-deductible contributions. But it does. Tax on $8540 should not be that material to a couple who are ineligible to make annual Roth IRA contributions.

From a practical standpoint, Jane could convert her traditional IRA over a 2-4 year time period to lessen the amount of income which would be taxed each year.

The best of all “planning” situations would be if Jane would either work for an employer that had a 401(k) plan written to accept rollovers from traditional IRAs or if she could work for the bank and become eligible under the bank’s 401(k) plan. Why? If Jane was a participant of a 401(k) plan, the tax rules have been so written that if she wants to make a rollover contribution, the amount rolled over “first” is the taxable portion. The prorate rule does not apply in this situation.

If Jane only rolls over $8,540, this means that the $6,500 remaining in the IRA are non-taxable. She may then convert such amount to a Roth IRA. This is her goal, this any person’s goal.

In summary, Jane wants to make as make non-deductible IRA contributions (currently $6,500 but his amount which change as it is indexed for inflation) as she can between ages 54-701/2 because she should convert all such funds into a Roth IRA.

What about her husband, Mark? He too wants to make the maximum amount of nondeductible IRA contributions from ages 57-70½ and at some point convert such contributions to a Roth IRA. The sooner the conversion can be completed the better as the earnings realized after the conversion will be tax-free if the qualified distribution rules are met.

Most likely Mark participates in a 40(k) plan which will allow him to move “taxable” IRA money into his 401(k) account. If not, he probably has the ability to rewrite the plan so he would have this right.

The 401(k) plan in which he participates may allow him to make Designated Roth deferrals and he exercises that right to the maximum. This would be $24,000 for 2016 ($18,000 + $6,000). Good for him. But why not contribute an additional $6,500 to his traditional IRA as a non-deductible contribution and convert it? Contributing $6500 for 12 years would result in an additional $78,000 in a Roth IRA.

In summary, Mark too should want to make as many non-deductible traditional IRA contributions as he is eligible for until he is no longer eligible to make traditional IRA contribution.

Categories: Pension Alerts, Traditional IRAs

Warning – Determine if Your IRA Processor Has Prepared Some of Your Institution’s 5498 Forms Incorrectly

Posted by James M. Carlson
Jun 07 2016

An IRA custodian called CWF with the following situation/question. Jane Doe has her own personal traditional IRA and she has an inherited traditional IRA arising from her mom. The IRA processor prepared just one combined 2015 Form 5498. Is this correct or permissible?

It is incorrect. Two 5498 forms must be prepared. It is understandable why a software engineer would think that it is better and simpler if just one form 5498 record is prepared rather than multiple forms. It is not simpler. The IRS rules do not permit aggregation of the data when there are multiple IRA plan agreements. The IRS has had the rule for a long time that contributions, distributions and fair market value statements are prepared and reported on a per plan agreement basis.

IRA tax data may be aggregated on a per IRA plan agreement basis, but it is not permissible to aggregate data from multiple IRA plan agreements. For example, Jane Doe age 53 has IRA Plan #1 and makes three $2,000 contributions for tax year 2015 on 3/10/15, 9/10/15 and 3/1/16 and she made a rollover contribution from a 401(k) plan to IRA Plan #1 of $12,000 on 6/10/15 and another rollover contribution from her 401(k) plan of $23,000 on 10/10/15. Box 1 will be completed with $6,000 and box 2 will be completed with $35,000.

As the discussion below illustrates, there is tax logic to the rule that there must be a separate IRA reporting form prepared on a per IRA plan agreement basis rather than allowing the reporting entity to aggregate the information and then furnish one form.

For example, Jane Doe has her own traditional IRA and she has has also inherited her mom’s traditional IRA. There must be two also separate 5498 forms prepared for her. For income taxation purposes she does not aggregate her IRA with the inherited IRA from her mother.

Preparation of a combined Form 5498 is a violation of IRS requirements. The IRS has the authority to assess a fine of $50 for each incorrect form and $50 for each missed form. Remember, the fines are doubled in the sense that one form goes to the IRS and one copy to the individual. Most likely the processor in its contract tries to have the IRA custodian be liable for this type of mistake. It’s CWF opinion that if the processor has written its software to not comply, it should be liable for any IRS fines.

What tax harm is being caused by such impermissible aggregation?

A person must do separate tax calculations for distributions from personal IRAs and inherited IRAs. This capability is lost if the data is aggregated.

If two 5498 forms both show a rollover contribution, most likely the IRS will determine that only one of them qualifies to be a rollover contribution because of the once per year rule and the other would be a taxable distribution. This audit capability is lost if there is just one combined Form 5498 prepared. The IRS prepares many statistical studies based on the info set forth on the 5498 forms. Many analytic capabilities are lost if there is not one Form 5498 prepared for each plan agreement.

Categories: Governmental Reporting, Pension Alerts, Traditional IRAs

CWF's Guidance on Transfers and Direct Rollovers

Posted by James M. Carlson
Jun 02 2016

Direct rollovers from 401(k) plans into traditional IRAs average more than $75,000.

The tax rules applying to a transfer contribution are very different from those applying to rollover contribution (direct or indirect).

Procedures must exist to minimize IRA custodian errors. Errors arise because IRA personnel do not understand that the tax rules differ from transfers and direct rollovers. They are not the same and IRA staff sometimes fail to know this.

For example, a check for $65,000 is sent to First State Bank (FSB) fbo Jane Doe's traditional IRA. The personnel of First State Bank process the contribution as a transfer as they forget to ask the question, "what type of plan issued the check?". The problem is, the check was issued because Jane Doe had instructed her former employer's 401(k) plan to directly roll over her 401(k) funds to a traditional IRA. Since the check was processed as a transfer, FSB did not report this contribution on the Form 5498 as a rollover as it is required to do. No doubt the IRS will contact your customer who will contact you and the IRS will be interested in learning why FSB did not report this rollover on the Form 5498.

Solution. Determine that you and your IRA staff know what is needed to be known regarding transfers, direct rollovers and rollovers. We at CWF can assist. Call us at 800.346.3961 or visit our website for information on webinars, IRA Tests, IRA Procedure Manual and IRA Rollover Certification Forms.

If your IRA rollover form has a print or revision date prior to 2015, it is obsolete and should be discarded.

Categories: Pension Alerts, Traditional IRAs

CWF Discusses - Non-Deductible Traditional IRA Contributions by Bank Presidents and other High Income Individuals

Posted by James M. Carlson
May 24 2016

More Wealthier Individuals Should Be Making Non-deductible Traditional IRA Contributions - They Just Need Some Help and You Can Provide It.

Wealthier individuals should be rushing to their IRA custodian/trustee to make a non-deductible IRA contribution. This is certainly true if they are a 401(k) participant.

Many individuals should be making non-deductible traditional IRA contributions and they don’t do so because they (and their advisors) many times don’t understand the benefits, including how the related tax rules apply. Every person should contribute as much as possible to a Roth IRA. Why? There are very few times under US income tax laws where Income is not taxed. That is, no taxes are owed with respect to Roth IRA funds if the Roth owner has met a 5-year rule and is age 59½ or older or the Roth owner is a beneficiary who has inherited the Roth IRA and the 5-year rule has been met.

The federal tax laws have been expressly written to make it impossible for a person with a high income to make an annual Roth IRA contribution. Some people (i.e. many Democrats) don’t want “wealthier” individuals to gain the benefit of contributing funds to a Roth IRA and earning tax free income. They want them to pay more income taxes. A person who had tax filing status of single was ineligible to make a 2015 Roth IRA contribution if his or her MAGI (modified adjusted gross income) was $132,000 or more. A person who had filing status of married filing jointly was ineligible to make a 2016 Roth IRA contribution if the couple’s MAGI was $193,000 or more. A person who had filing status of married filing separately was ineligible to make a 2016 Roth IRA contribution if his or her MAGI was $10,000 or more.

For discussion and illustration purposes, we will assume that Jane Doe has the following situation. She is age 54. She is married. Her husband, Mark Doe, is a bank president. He is age 57. Their joint income is sufficiently high that neither one of them is eligible to make an annual Roth IRA contribution. Their joint income is sufficiently high that neither one of them is eligible to made a deductible traditional IRA annual contribution.

This article is going to discuss the question, “should these two each make a non-deductible traditional IRA contribution?” For the reasons discussed below, both should make a maximum non-deductible traditional IRA contribution until each is no longer eligible to make a traditional IRA contribution (i.e. the year a person attains age 70½).

On March 15, 2016, Jane contributed $6,500 to a traditional IRA she had established in 1984. She designated her contribution as being for 2015. The IRA balance at the time of contribution was $8,500. With the addition of her $6,500 contribution the IRA balance became $15,000. Since then the account has earned $40 of interest. It is now assumed that Jane has no other IRA funds in any traditional, SEP or SIMPLE IRAs. The IRA taxation rules require in applying the taxation rules that all non-Roth IRA funds be aggregated. One cannot avoid the pro-rata taxation rule by setting up separate IRAs or having separate time deposits.

The couple’s tax preparer has recently informed Jane that her contribution is non-deductible as her husband participates in a 401(k) plan and their MAGI is sufficiently high that they are not permitted to claim any tax deduction for her $6,500 contribution. What tax options are available to her? What options are unavailable to her?

She may not use the recharacterization rules to make her traditional IRA contribution a Roth IRA contribution as their 2015 MAGI is too high.

There is no IRS guidance allowing the IRA custodian to switch the year for which the IRA contribution was made from 2015 to 2016.

The IRS has issued rules allowing her to withdraw her 2015 IRA contribution with no adverse tax consequences as long as she does so by 10-15-16, no deduction is claimed on the 2015 tax return and the related income is withdrawn. If she withdraws her $6,500 contribution she is required to withdraw the related income and it is taxable for 2016 since the contribution was made in 2016. The related income is a pro-rata amount of the $40 determined as follows: 6500.15000 x $40 = $17.33. Since she is younger than age 59½ she does owe the 10% additional tax on this $17.33. The bank as the IRA custodian will prepare a 2016 Form 1099-R inserting the codes (81) in box 7, box 1 would show $6,517.33 and box 2a would show $17.33.

In 2016 she is eligible to make a Roth IRA conversion of any amount in the range of $.01 to $15,040. If she would convert $15,040 into her Roth IRA she/they would include in income on their 2016 tax return the amount of $8,540. She as many taxpayers does not want to include the $8,540 in her/their income and pay tax on it. Jane as many taxpayers would like to convert only her non-deductible contribution of $6,500. This would allow her to pay no taxes since she would not be converting any of the $8,540. The tax rules require use of the standard pro-rata taxation rule when an IRA has taxable funds and nontaxable funds. If she converts $6,500, a portion would be taxable and a portion would not be. The taxable portion is: $6,500 x $8,540/$15,040 ($3,690.82) and the non-taxable portion is $6,500 x $65,00/15,040 ($2,809.18) . Jane made a non-deductible IRA contribution for 2015. She is required to file Form 8606 and attach to the couple’s Form 1040. If it was not filed with the original return, an amended tax return should be filed and the 2015 Form 8606 attached. She is not relieved of this duty because she withdraws the $6,500 or converts it. A $50 penalty applies to a person who fails to file Form 8606 unless she could show a reasonable cause why she did not file it. A person must pay a $100 penalty if a person overstates the amount of non-deductible contributions. Note that Jane will also be required to file a 2016 Form 8606 regardless if she withdraws a portion or all of the $6,500.

Having to include in income the amount of $8,540 and pay tax on this amount should not influence Jane or any other wealthy person to not make non-deductible contributions. But it does. Tax on $8,540 should not be that material to a couple who are ineligible to make annual Roth IRA contributions. From a practical standpoint, Jane could convert her traditional IRA over a 2-4 year time period to lessen the amount of income which would be taxed each year.

The best of all “planning” situations would be if Jane would either work for an employer that had a 401(k) plan written to accept rollovers from traditional IRAs or if she could work for the bank and become eligible under the bank’s 401(k) plan. Why? If Jane was a participant of a 401(k) plan, the tax rules have been so written that if she would rollover a portion of the $15,040, the amount rolled over “first” is the taxable portion. The prorate rule does not apply in this situation. If Jane only rolls over $8,540, this means that the $6,500 remaining in the IRA are non-taxable. She may then convert such amount to a Roth IRA. This is her goal, this any person’s goal.

Jane wants to make as many non-deductible IRA contributions (currently $6,500 but his amount which change as it is indexed for inflation) as she can between ages 54-70½ because she should convert all such funds into a Roth IRA. What about her husband, Mark? He too wants to make the maximum amount of non-deductible IRA contributions from ages 57-70½ and at some point convert such contributions to a Roth IRA. The sooner the conversion can be completed the better as the earnings realized after the conversion will be tax free if the qualified distribution rules are met.

Most likely Mark participates in a 40(k) plan which will allow him to move ‘taxable IRA money into his 401(k) account. If not, he probably has the ability to rewrite the plan so he would have this right. The 401(k) plan in which he participates may allow him to make Designated Roth deferrals and he exercises that right to the maximum. This would be $24,000 for 2016 ($18,000 + $6,000). Good for him. But why not contribute an additional $6,500 to his traditional IRA and convert it? Contributing $6500 for 13 or 14 years would result in an additional $84,500 or $91,000 in a Roth IRA. Those individuals attaining age 70 between July and December 31st are eligible to make a contribution for their "70" year whereas those who attain age 70 and 70½ are ineligible.

Be aware that under existing laws Roth IRA funds are ineligible to be rolled over into a 401(k) plan. This is true even for 401(k) plans having Designated Roth features.

Mark too should want to make as many non-deductible traditional IRA contributions as he is eligible for until his 70½ year.

In summary, a bank president and his/her spouse want to make as many non-deductible traditional IRA contributions as possible prior to his/her 70½ year. With some pre-planning, it will be possible to convert these to be Roth IRA conversion contributions.

Categories: Pension Alerts, Traditional IRAs

No Form 1099-R Prepared to Report IRA Funds Moving From the Decedent’s IRA to an Inherited IRA

Posted by James M. Carlson
Apr 21 2016

Some mainframe software vendors just don’t understand the IRS procedures for reporting once an IRA accountholder dies. These mainframe software writers have incorrectly adopted the approach that the Form 1099-R is to be prepared when an inherited IRA is being established.

A Form 1099-R is prepared only if there is a reportable distribution. Establishing an inherited IRA involves transferring the IRA funds from the decedent’s IRA to one or more inherited IRAs. Such transfers are not to be reported on the Form 1099-R.

Preparing a Form 1099-R which is not required to be prepared is an incorrect form and will result in penalty. The penalty is now $250 (times 2) if an IRA custodian submits an incorrect Form 1099-R

It may not be the best way, but the IRS has the IRA custodian complete the Form 5498 in a special way to inform the IRS that the decedent’s IRA funds have moved to an inherited IRA for one or more beneficiaries. Using the title, “John Doe as beneficiary of Jane Doe,” informs the IRS that funds have been moved from Jane Doe’s IRA into a inherited IRA for John Doe. The Form 1099-R is not used for this purpose.

The software vendor is causing real problems for the individual if it prepares an incorrect Form 1099-R as he or she must explain the distribution on his or her tax return. A non-spouse beneficiary is unable to rollover a distribution from an inherited IRA Putting a 0.00 in box 2a does not make things better.

Categories: Traditional IRAs

Charging a Fee For a Direct Rollover of IRA Funds to a 401(k) Plan

Posted by James M. Carlson
Jul 21 2014

A financial institution should consider instituting a fee if it agrees to directly rollover a customer’s IRA funds to his or her account within an employer’s 401(k) or 403(b) as discussed in the following email situation/question. It is only logical and right that a financial institution receive a reasonable fee for helping a customer when it agrees to issue a check directly to the 401(k) plan. You are helping your customer and also the 401(k) plan.

Technically, a direct rollover cannot occur between an IRA and a 401(k) plan as the law defines a direct rollover as only being between an employer sponsored plan and an IRA. But the IRS has adopted the rule that the reporting rules applying to a direct rollover from a 401(k) plan to an IRA are also to be used if the funds move from an IRA to a 401(k) plan.

The email question/situation:

Question regarding an IRA rollover from our bank to the customer’s 403b retirement plan. Assume the best is to issue a check directly to the customer and code the 1099-R as a G code? The customer will have to sign an IRA distribution form?

Please let me know if this is correct?, I have not had a request like this before, it is usually the reverse from a retirement plan into an IRA at the bank. Thanks so much for your help!

CWF’s answer/response:

The easiest approach for the bank is to issue the check to her and you would use code 1 if she is under age 59½ and 7 if she is over age 59½. You treat it as a normal distribution. Then she makes a rollover contribution to the plan.

The tax code does not require an IRA custodian to issue the check to the plan. However, many plans require the check to come from the IRA issued to the plan since this simplifies the plan administrator’s administrative concerns regarding accepting a rollover contribution.

If your institution decides to be nice and accommodate your customer, you will issue the check to ABC 401(k) Plan fbo Jane Doe. Use CWF’s Form 69 or a similar form as prepared by the plan administrator. And then you would use the reason code G in box 7 of the Form 1099-R. When G is used box 2, taxable amount, is to be completed with 0.00 as you know the amount the is non-taxable as you sent the funds directly to the plan. As you indicated it is the reverse of a direct rollover coming from a pension plan to an IRA.

An IRA custodian may have a fee for this special service as long as it has been disclosed. Like with transfer fees, we expect many customers would be willing to pay a fee for this special service.

Categories: Pension Alerts, Traditional IRAs

No Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account

Posted by James M. Carlson
Jul 21 2014

Those who work in the legal profession like to think the law is primarily logical and efficient. After all we are a nation of laws rather than individuals. We tend to forget that laws are enacted by politicians with input from their constituents. Many times there are self-serving motives. And sometimes judges do not like the laws which they must interpret and enforce or at least they see flaws needing to be corrected. Rather than have the legislature correct such flaws, sometimes courts choose to correct such flaws by a court ruling.

In 2005, the federal bankruptcy laws were changed. One major change dealt with credit card debt. It is now much harder to eliminate credit card debt by a bankruptcy filing. A second major change dealt with increasing the amount of funds in retirement plans and IRAs that a person could exempt from his or her bankruptcy estate. In general, the limit for IRAs is now $1,000,000 and the amount for funds in an employer sponsored pension plan is unlimited.

The public policy of the bankruptcy laws is that a person should be able to provide for himself or herself during their retirement years. However, the granting of such a large exemption for IRAs and pension plans means that many times creditors are left unpaid when an individual files for bankruptcy. Some people, including many judges, would consider such a large exemption amount to be contrary to the legal framework for bankruptcy. Yes, a person should be able to have a fresh start after incurring financial difficulties, but creditors are still entitled to be paid a reasonable and fair amount and that an individual should not have a “free pass” to an unfettered new and improved financial health.

The U.S. Supreme Court recently decided the case, Clark v. Rameker. Ms. Clark had inherited an IRA from her mother with an original balance of approximately $450,000 in 2001. The amount in her inherited IRA was approximately $300,000 when she filed for bankruptcy in October of 2010. Rameker is the bankruptcy trustee and has argued that Ms. Clark is not entitled to exempt the $300,000 from her bankruptcy estate. The bankruptcy court adopted the trustee’s position that Ms. Clark was not entitled to the exemption. Ms. Clark then appealed to the District Court. The District Court reversed the decision by ruling that Ms. Clark was entitled to exempt the amount in her inherited IRA. The trustee then appealed to the 7th Circuit Court of Appeals that which reversed the District Court. Since there had been split decisions in the circuit courts, the Supreme Court agreed to rule on the case to settle the issue.

The U.S. Supreme Court affirms the 7th Circuit position of no exemption for inherited IRA funds.

The legal analysis and rationale. The U.S. Supreme Court ruled, by a unanimous vote, that “The text and purpose of the Bankruptcy Code makes clear that funds held in inherited IRAs are not retirement funds within the meaning of section 522(b)(3)(C) is bankruptcy exemption.” Justice Sotomayer wrote the court’s opinion.

As discussed below, the U.S. Supreme Court had to strain the law to reach the result that allowed the bankruptcy trustee to win and Ms. Clark to lose.

How does Bankruptcy Code section 522(b)(3)(C) read ?

Bankruptcy code section 522(b)(3)(C) provides an exemption for “(C) retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.” Code section 401 defines the laws for a qualified plan. Code section 403 defines the laws for tax sheltered annuities. Code section 408 defines the laws for traditional IRA and IRA annuities. Code section 408A defines the laws for Roth IRAs and Roth IRA annuities.No Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account

Note that there is no special tax code section for inherited IRAs. An inherited IRA is not a special type of IRA as the court tries to define it. An inherited traditional IRA is simply one that comes into existence after the IRA accountholder dies.

Also note that there is no express indication that the retirement funds must be the retirement funds of the bankruptcy debtor. This is what one expects when one has funds in a 401(k) plan or an IRA. These funds are within a legal and tax entity independent of the individual’s will or estate. There is a 401(k) plan agreement or an IRA plan agreement which requires the individual to designate one or more primary beneficiaries. Such plan indicates that the beneficiary acquires his or her share upon the death of the participant or IRA accountholder.

Notwithstanding that the account is called an inherited individual RETIREMENT account, the U.S. Supreme Court on June 2, 2014, ruled that funds within an inherited IRA are not retirement funds within the meaning of Bankruptcy Code section 522(b)(3)(C).

Federal bankruptcy laws allow an individual to exempt certain property from his or her bankruptcy estate. This is property he or she is allowed to keep after the bankruptcy and that cannot be claimed by the bankruptcy trustee. The approach of the bankruptcy laws is to give a person the ability to have a fresh start after incurring financial difficulties. Of course, there should be and there are limits as to the ability of a person not to pay his or her debts.

The attorney for the bankruptcy debtor argued that Bankruptcy code section 522(b)(3)(C) was clear – funds within any traditional IRA, including an inherited traditional IRA, as established under Code section 408 were entitled to the exemption. The District Court in this case, the Fifth Circuit in a different case and the Eighth Circuit in a different case had the same understanding. The rationale of the District Court was that the exemption covers any account containing funds originally accumulated for retirement purposes. This is consistent with the legal operation of a traditional IRA. It is a special tax-preferred revocable trust. It has two express purposes. Contributions and the investments will be used for the retirement of the IRA accountholder and then after his or her death will be used to benefit the designated beneficiary over a time period which may be as long as the life expectancy of the beneficiary.

The U.S. Supreme Court reached a different conclusion. In order to be entitled to claim the exemption of Bankruptcy Code section 522(b)(3)(C) , the court ruled that an individual has to meet two requirements, not just one requirement. First the funds must be retirement funds. Second, such funds must have been in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.”

The U.S. Supreme Court wrote that the two words “retirement funds” as set forth in Bankruptcy Code section 522(b)(3)(C) mean more than just funds in the enumerated tax code sections. A cardinal rule of statutory construction is, “a statute should be construed so that effect is given to all its provisions, so that no part will be in operative or superfluous. The first six words, “retirement funds to the extent that” in order not to be superfluous must have a meaning or purpose independent of the enumerated sections.

The court then found that since there was no definition of “retirement funds” within the Bankruptcy Code that it must define the term and it did so. It defined retirement funds as sums of money set aside for the day an individual stops working.

The court then reasoned that there are three principal reasons why inherited IRA funds are not retirement funds. First, the beneficiary is unable to make any additional contributions. Second,No Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account the required distribution rules apply to an inherited IRA and distributions must be taken long before retirement age. Third, the 10% penalty tax does not apply to a beneficiary and so the beneficiary is able to take a distribution at any time and use the funds for current consumption. It is this later reason which seems to have influenced the court’s decision the most. The court stated its dislike for the possibility that a person who has an inherited IRA could file for bankruptcy, claim the exemption for retirement funds and then after the bankruptcy has been granted eliminating his or her debts immediately withdraw funds from the inherited IRA for personal consumption reasons. In essence the debtor would have a free pass which is not the intent of the Bankruptcy laws. The court was unwilling to give this free pass.

Additional Litigation

There will be additional litigation by bankruptcy trustees as a result of his case. The U.S. Supreme Court has made clear it is receptive to consider cases involving whether or not - the exemption of Code section 522(b)(3)(C) is available to a bankruptcy filing.

This case settles the issue with respect to an inherited traditional IRA.

The case of In Rousey v. Jacoway, settled that a traditional IRA was a retirement account within the meaning of Bankruptcy code section 522(b) (3) (C) and was entitled to be exempted from the individual’s bankruptcy estate.

When one reads this case, one certainly has the idea that an inherited Roth IRA would also be found to not be retirement funds for bankruptcy Code section 522(b)(3)(C) purposes.

What about standard Roth IRA funds? Although we expect that the rules of Rousey would apply to a Roth IRA and the exemption would apply, this issue has not been firmly settled. One can expect that a bankruptcy trustee will make the argument that Roth IRA funds are not retirement funds since the Roth IRA accountholder never has to take a distribution while alive.

What about inherited 401(k) funds still within the 401(k) plan? One can expect a bankruptcy trustee to argue that inherited 401(k) funds also are not retirement funds within the meaning of Bankruptcy Code section 522(b)(3)(C). ERISA protects such funds from creditors, including a bankruptcy trustee, as long as such funds are within the 401(k) or other pension plan. Many 401(k) plans have been written to require an inheriting beneficiary to withdraw or direct rollover his or her inherited funds within a short time period.

This bankruptcy ruling is going to result in more IRA accountholders seeking legal and tax advice regarding whether a trust should be the IRA’s designated beneficiary rather than directly naming family members and other individuals.

Additional Legislation.

This case is going to make people nervous. Congressional representatives will hear from their constituents that a person who has inherited an IRA should be able to exempt a reasonable amount from his or her bankruptcy estate. If the definition of retirement funds needs to be changed, then it should be changed. What amount is reasonable will need to be discussed and settled.

In summary, the unanimous decision by the U.S. Supreme Court in Clark v. Rameker was surprising. Although an inherited IRA is certainly a retirement account for tax purposes, it is notNo Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account retirement funds within the meaning of the Bankruptcy Code. Code section 522(b)(3)(C) did not seem so unclear that it needed to be rewritten by the Court, but that is what the Court did. The Court simply could not condone a bankruptcy debtor claiming an exemption for funds within an inherited IRA and then once the bankruptcy filing was finalized (and debts extinguished) to be able to take immediate distributions from the inherited IRA for any personal consumption purpose. Time will tell if Congress will choose to define more specially what funds qualify as retirement funds for purposes of the exemption. We expect there will be new legislation in 2014-2015.

Categories: Pension Alerts, Traditional IRAs

What is the status of myRA ?

Posted by James M. Carlson
Jul 21 2014

Presumably, the IRS on behalf of the U.S. Department of the Treasury is in the process of developing what is needed to implement and administer the myRA program. There will need to be created myRA plan agreements, investments and computer software.

In January of 2014 the U.S. Department of Treasury announced that it was developing the myRA (“My Retirement Account”) program. This was discussed in the February 2014 newsletter. You may find this article at www.pension-specialists. com/myra.pdf

The U.S. Treasury stated that it will begin rolling out the myRA forms and procedures in late 2014. This means after the November 4th elections. It will be possible for eligible employees of participating employers to enroll by signing up for a myRA account online.

It is presently unclear if an individual’s contributions would be invested in an investment created and administered by the U.S. Treasury or whether the U.S. Treasury would select various financial institutions to serve as the myRA custodian or trustee. An employer’s duties under this program would be limited to sending by direct deposit the contribution amounts withheld from employee paychecks to each employee’s on-line myRA. Once the U.S. Department of the Treasury furnishes the promised guidance, we will inform you.

Categories: Pension Alerts, Traditional IRAs

Helping A father Who Has Inherited His Daughter’s 401(k) Account

Posted by James M. Carlson
Jun 12 2014

Raul, age 58, has been a bank customer since 1998. He presently does not have an IRA. He does have a 401(k) account at his employer. His daughter Laura, age 31, died March 2014, in a car accident. Laura had designated her father to be the beneficiary of her 401(k) account. The 401(k) plan administrator had contacted Raul to inform him that he was Laura's beneficiary and that her account balance was approximately $60,000. He has come into the bank seeking some help.

Raul is fairly sure that he will decide to establish an inherited IRA with your financial institution.

Raul will want to ask the 401(k) administrator to provide him the following information: a copy of the plan's summary plan description, a copy of plan's distribution form and a copy of Laura's most recent participant statement showing her various investment account balances.

The summary plan description will provide a discussion of the rights of a non-spouse beneficiary once he has inherited the 401(k) balance of a deceased beneficiary. The plan could be written to allow him to keep the funds within the 401(k) and then withdraw annual required distributions from such plan. Most likely the plan will be written to require Raul as a non-spouse beneficiary to withdraw the inherited IRA funds within a 3-5 year period. One of his options will be to instruct to directly rollover the inherited 401(k) funds into an inherited traditional IRA and/or an inherited Roth IRA. He then could withdraw annual required distributions from the inherited IRA using the life distribution rule. The 401(k) distribution form must present Raul with the following three options. Sometimes the distribution form does a poor job of explaining that there is the third option.

Option #1. He could elect to withdraw the entire balance of $60,000. Since he, as any non-spouse beneficiary, does not have the right to rollover this $60,000, the rule requiring mandatory withholding at the rate of 20% does not apply. The tax rules would require that 10% of the distribution be withheld, but he would have the right to instruct to have no withholding. If he chose to withdraw the $60,000, it would be prudent for him to have 15-25% withheld since he will need to include the $60,000 in his income and pay the applicable tax liability. As a beneficiary he is does not owe the 10% penalty tax even though he is younger than age 59½.

Option #2. He could elect to directly rollover the $60,000. He has three (3) sub-options. First, he could elect to directly rollover the $60,000 into an inherited traditional IRA. Although he is required to commence taking required distributions, he will be deferring taxation on most of the funds until later. Second, he could elect to directly rollover the $60,000 into an inherited Roth IRA. Such a distribution will require him to include the $60,000 in his income and pay the applicable taxes. He will also be required to commence annual required distributions from the Roth IRA. Once the 5-year rule has been met all such distributions will be tax-free. Third, he could directly rollover a portion to an inherited traditional IRA and then he could directly rollover the remaining portion into an inherited Roth IRA.

Although the law provides a general rule that if the five-year rule applied to the distributions under the 401(k) plan then this rule is to continue to apply to the inherited IRA, there is a major exception which allows the beneficiary to elect to use the life distribution rule. Two requirements must be met. First, the funds must be directly rolled over before the end of the year following the year of death. Secondly, the life distribution rule must be determined using the same non-spouse beneficiary.

Option # 3, He would withdraw some of the $60,000 and then he would directly rollover the remaining balance. For example, he could instruct to withdraw $10,000 and then he would directly rollover the remaining $50,000 into an inherited traditional IRA and/or inherited Roth IRA. The withholding rules as discussed under Option #1 would also apply to the withdrawal of the $10,000.

Raul will complete this 401(k) distribution form and furnish it to the 401(k) administrator. Raul should also furnish a copy of this form to you as the IRA custodian of his new inherited IRA. He will need to execute the inherited IRA plan agreement and instruct you how he wishes to have such funds invested. When the funds are sent to your bank, you will be able to process the direct rollover check as he and the 401(k) administrator have instructed.

The right of a non-spouse beneficiary to set up an inherited IRA for funds arising from decedent with a 401(k) account did not exist until January 1, 2007. There will be mothers, fathers, brothers, sisters, and friends who will wish to establish an inherited IRA. You want to be ready to service these individuals. Almost always, they will be long-term customers, as they will be taking partial distributions over their life expectancy.

Categories: Pension Alerts, Traditional IRAs

IRS Postpones New Rollover Rule to January 1, 2015

Posted by James M. Carlson
Mar 10 2014

IRS Postpones New Rollover Rule to January 1, 2015

The IRS is beginning a one-year pilot program on June 2, 2014, to help individuals and partnerships that failed to file one or more 5500-EZ forms. Such filers will be able to be relieved from paying the maximum penalty of $15,000 per year for failing to file a Form 5500-EZ by filing such non-filed form or forms. The IRS announced this special program in Revenue Procedure 2014-32 as published on May 16. This relief will apply to 5500-EZ forms filed during the period of June 2, 2014 until June 2, 2015. Forms filed after June 2, 2015 will not be entitled to the relief.

Since 1995 the Department of Labor (DOL) has had a correction program available to employers of plans covering multiple participants. It is called the Delinquent Filer Voluntary Compliance (DFVC) program. Sponsors of multiple participant plans use the DFVC correction program to come into compliance with the law on a voluntary basis by filing the missed forms and by paying a correction fee much less than the amount owed if the DOL and/or the IRS discovered the failure to file the 5500 forms.

In 2002, the IRS adopted the administrative practice that it would not impose applicable tax penalties (in addition to the DOL penalties) on an employer for it not filing the Form 5500 as long as the filer was eligible to use the DOL’s DFVC program and satisfied the requirements of such program by filing the non-filed 5500 forms.

Until now, the IRS has not had a correction program for One-Person plans. The DOL has no authority over One-Person plans except for the prohibited transaction topic.

Under this special IRS relief program, an individual with a One-Person plan will not be required to pay any fee for participating in the IRS pilot program. The IRS is asking the public if this pilot program should be adopted on a permanent basis, and, if so, how the correction amount or fees, should be determined.

Individuals who are not in compliance will generally want to take advantage of this special opportunity. The IRS has said that the pilot program will end on June 2,2015. CWF will prepare such a filing for $150 per plan.

For discussion purposes, assume that Sarah Andrews, a sponsor of a One-Person profit sharing plan failed to file a 2011 Form 5500-EZ even though her profit sharing plan had a balance of $280,000 as of December 31, 2011. Sarah forgot that a filing was required when the plan balance exceeded $250,000 as of any December 31st. She did file the 2012 Form 5500-EZ showing a year-end balance of $325,000 and the 2013 Form 5500-EZ showing a year-end balance of $365,00. Sarah will wish to use this special pilot program to file her missed 2011 Form 5500-EZ and avoid the penalty amount due of $15,000.

The tax penalty is $25 per day to a maximum of $15,000 per return. The $15,000 is reached when a filer is 600 days late. Many times this 600th day is reached as many times the IRS has not yet determined that the employer had not filed a required form. For example, in the Sarah example, since her plan had never exceeded the $250,000 limit, the IRS did not know that she had missed a required filing.

When is a filing required for a One-Person plan which was terminated during the year? Always is the IRS position. However, the IRS has done a poor job of communicating this position.

The IRS discusses in Revenue Procedure 2014-32 that not withstanding the PPA 2006 provision that a One-Person plan with assets of $250,000 or less at the end of the year are not required to file Form 5500-EZ, the IRS has “determined” that a filing is required when a plan is terminated and all of the assets have been distributed. The IRS does not cite any legal authority for its position. An individual who has failed to file a Form 5500-EZ has two courses of action. He or she may file under this pilot program or may use the general rule that such penalty is to be waived if the IRS finds the individual had a reasonable cause as to why the form was not filed. A request for relief for reasonable cause may be attached to the delinquent return or it maybe filed separately. A reason must be given explaining why the return is late. It is not be filed with the IRS office where the most current Form 5500-EZ is to be mailed

Categories: Pension Alerts, Traditional IRAs

Warning: U.S. Tax Court Rejects IRS Policy on the One Rollover Per 12-Month Rule

Posted by James M. Carlson
Feb 26 2014

Commencing immediately, an IRA custodian/trustee will need to start applying a new rule for when it is receiving an IRA rollover contribution.

Since at least 1989 the IRS has stated in Publication 590 that the once per year rollover rule applies on a per IRA plan agreement basis and not to all of a person’s IRAs. That is, if two distributions are taken from the same IRA, then only one of them could be rolled over. A distribution taken from a different IRA could be rolled over even though a person had taken a distribution from another IRA and rolled it over within the 12-month period. The 2013 version states the following on page 25.

Waiting period between rollovers. Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover.

The 1-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA.

Example. You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA.

However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.

A recent U.S. Tax Court case is a classic illustration that there are times the IRS wants to collect taxes so strongly from a particular taxpayer that the IRS personnel in charge is willing to have the decision cause the general public large tax administrative problems. Such is the result of a recent U.S. Tax Court case, A.L. Brobrow and E.S. Brobrow v. Internal Revenue Commissioner, T.C. Memo 2014-21 as decided on January 28, 2014.

The court expressly holds that the one-year restriction between rollovers applies to all distributions from all IRAs and is not limited to the same IRA. The court found the applicable statute expressly authorizes just one rollover during the 12-month period commencing on the date of distribution when such distribution is rollover. The court did not discuss the subject if the IRS had the authority to modify this provision. The court wrote,

Section 408(d)(3)(B) limits a taxpayer from performing more than one nontaxable rollover in a one-year period with regard to IRS and individual retirement annuities. Specifically, section 408(d)(3)(B) provides:

This paragraph [regarding tax-free rollovers] does not apply to any amount described in subparagraph (A)(i) received by an individual from an individual retirement account or individual retirement annuity if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in that subparagraph from an individual retirement account or an individual retirement annuity which was not includible in his gross income, because of the application of this paragraph.

The reference to “any amount described in subparagraph (A)(i)” refers to any amount characterized as a non-taxable rollover contribution by virtue of that amount's being repaid into a qualified plan within 60 days of distribution from [*9] IRA or individual retirement annuity. The one-year limitation period begins on the date on which a taxpayer withdraws funds from an IRA or individual retirement annuity and has no relation to the calendar year.

The plain language of section 408(d)(3)(B) limits the frequency with which a taxpayer may elect to make a non-taxable rollover contribution. By its terms, the one-year limitation laid out in section 408(d)(3)(B) is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer. Section 408(d)(3)(B) speaks in general terms: An individual may not receive a non-taxable rollover from ''an individual retirement account or individual retirement annuity" if that individual has already received a tax-free rollover within the past year from ''an individual retirement account or individual retirement annuity." (Emphasis added.) In other words, a taxpayer who maintains [*13] multiple IRAs may not make a rollover contribution from each IRA within one year.

What were the facts of this case?

Mr. Brobrow maintained two traditional IRAs at Fidelity Investments. One was a rollover IRA. His wife maintained her own traditional IRA. The couple must have had cash flow problems. Fidelity's advisers apparently told him he could to do the following.

  1. On April 14, 2008, he withdrew $65,064 from his IRA #l. He did take two distributions. It may be he needed these funds to pay tax liabilities, which had to be paid by the April 15th.
  2. On June 6, 2008, he withdrew $65,064 from his IRA #2
  3. On June 10, 2008, he made a rollover contribution of $65,064 into IRA #l. The funds had come from his personal checking or investment account
  4. On July 31, 2008, she withdrew $65,064 from her personal traditional IRA. These funds were deposited into a joint account
  5. On August 4, 2008, Mrs. Brobrow made a rollover contribution of $65,064 into his IRA #2. The funds for this rollover came from their joint account
  6. On September 30, 2008, she made a rollover contribution of $40,000 into her traditional IRA. The funds came from their joint account. Note her withdrawal of $65,064, however, was taxable as she made her rollover contribution on day 61 and not on day 60.

If the court had followed the IRS statement set forth in the 2007 or the 2008 Publication 590, Mr. Brobrow’s two withdrawals of $65,064 would not have been taxable. He rolled over both within the 60-day time period. He had not rolled over a previous distribution from the two IRAs within the preceding 12 months.

Actions by an IRA Custodian/Trustee.

CWF is in the process of revising its rollover certification forms to state the 12-month rule is no longer a one per plan agreement. The Disclosure Statement of the IRA Plan Agreement booklet will also be revised. An IRA custodian/trustee will want to send an amendment to its IRA accountholders informing them of this change. It must be remembered that any distribution after the one which is rolled over is now taxable. One way to inform the existing accountholders would to furnish the 2013-2014 Comprehensive IRA Amendment, which discusses this change.

Categories: Pension Alerts, Traditional IRAs

Proposed IRA Law Changes by Senator Hatch

Posted by James M. Carlson
Aug 01 2013

On July 8th, Senator Hatch introduced a tax bill which would change many IRA and pension laws. Set forth is a summary of the IRA changes. The pension plan changes are discussed in a separate article. The insurance industry and the securities industry are suggesting changes benefiting their members to the detriment of banks, credit unions and trust companies.

In general these changes would apply to 2014 (i.e. plan years commencing in 2014). Some changes would be effective as of July 8, 2013.

Considering the political situation, the fate of these proposals is uncertain. It may be possible that some will be enacted to show there can be bi-partisanship between Republicans and Democrats.

Mortality Tables for RMDs Must be Updated. Within one year of enactment the IRS shall either update the existing mortality tables or provide new tables. Any “new” table shall apply to plan years beginning after the date which is one year after publication. The IRS is to issue new tables at least every five years thereafter.

RMD will be Eligible to be Converted to Roth IRA. Under current law a person is ineligible to convert funds within a traditional IRA to a Roth IRA since the law does not permit a person to rollover a required distribution. The proposal would allow RMDs to be rolled over or converted to a Roth IRA.

Expand Law on Correcting Errors to Include IRAs. Except for the special letter program for missed rollovers the IRS has not developed any procedures to correct errors occurring with respect to traditional IRAs and Roth IRAs. Substantial filing fees apply to use the rollover letter program ($500-$3,000). The IRS has adopted procedures for SEP-IRAs and SIMPLE-IRAs. For its own reasons the IRS has not been proactive in providing additional guidance on correcting IRA mistakes. The IRS seems to forget that IRAs hold 27% of retirement assets while pension plans hold 22%

The proposed law would be, as for pension plans, any inadvertent RMD error with respect to an IRA shall be able to be self-corrected, without the imposition of the 50% tax as long as the late distribution is distributed no more than 180-days after it was required to be made.

In addition the IRS is to amend its EPCRS program to provide that inadvertent IRA errors may be corrected as long as such errors were not the fault of the IRA owner. Some of the errors which may be corrected are those discussed below, but it is intended that additional errors may also be self-corrected.

There needs to be a waiver of the 60 day deadline for a rollover where the deadline is missed for reasons beyond the reasonable control of the accountholder.

A non-spouse beneficiary will be allowed to return a distribution from an inherited IRA if the distribution was caused by the inadvertent error of the IRA custodian which gave the beneficiary the reasonable belief he or she could rollover such distribution so that the distribution would not be taxable

New Joint Authority for the IRS and the DOL Regarding Prohibited Transactions Associated with IRAs and Pension Plans. Under current law the authority to grant exemptions for prohibited transactions related to pension plan and IRAs is held by the DOL.

The proposed law would give joint authority to the IRS and the DOL. The IRS and DOL would be required to issue joint rulings. This change would be effective as July 8, 2013.

The securities industry does not like how it is being treated by the DOL. The DOL has agreed to only offer a limited prohibited transaction exemption and the securities industry finds this unacceptable. The power of the DOL will be reduced.

Authorize an Employer to Substitute a Safe Harbor 401(k) Plan for a SIMPLE-IRA Plan. Under current law an employer sponsoring a SIMPLE-IRA plan is not allowed to terminate the plan before January 1 of the following year. An employer would be authorized to terminate the SIMPLE-IRA plan during the current year as long as the employer substitutes a safe harbor 401(k) plan as of the date of termination. A combined elective deferral limit would apply.

Authorize New Rollover to an IRA. Under current law, if a qualified plan holds on behalf of a participant a qualifying insurance contract, such contract is not eligible to be directly rolled over into a traditional IRA. The insurance contract either must be liquidated for cash or distributed to the individual in-kind. This law would be changed to allow the rollover or direct rollover of an insurance contract within a qualified plan into a traditional IRA even though the general rule is that IRA funds may not invest in life insurance contracts.

New Type of Deemed IRA. Current law authorizes funds within a 403(b) custodial account then the custodial account will become a deemed IRA with the financial institution holding the 403(b) assets as of the date of the termination. The deemed IRA will be created only if the financial institution holding the assets has demonstrated to the IRS that it is qualified to serve as a IRA trustee/custodian.

Required Distribution Rules Modified for IRAs, 403(b) and Defined Contribution Plans When a Deferred Annuity is Bought Prior to Age 70½. It is ironic. The IRS cannot be persuaded to voluntarily update the RMD tables so people will be allowed to take smaller RMDs, but the IRS and the DOL are enamored with the planning features of deferred annuities. The argument being made by insurance companies and people who sell annuities is that people are living longer. Therefore, to ensure they will have money when they are in their 80’s they should be able to reduce their RMDs when in their 70’s.

The RMD proposal would be that amount invested in a deferred annuity would not be counted as part of the IRA’s fair market value for the RMD calculating. In order to receive this treatment the following rules must be met.

  1. Under such an annuity, payments are deferred past age 70½ but such payments must commence no later than the date the individual attains the age of 85
  2. The annuity must be a commercial annuity, a single life annuity for the life of the individual, providing substantially equal periodic payments at least annually. Or the annuity may be a qualified joint and survivor annuity which is the actuarial equivalent of the singe life annuity
  3. The annuity must be purchased on or before the individual’s required beginning date
  4. The individual’s investment in the annuity cannot exceed 25% of the individual’s entire interest in all plans (defined contribution, IRA and 403(b)) determined as of the close of the calendar year preceding the calendar year in which the purchase occurs. A special rule applies if the individual dies before his or her required beginning date and he or she does not purchase a qualified deferred annuity and the designated beneficiary is his or her spouse. In this case, the surviving spouse may invest any portion of the entire interest (not 25%) in the same manner as the spouse who died, but the required beginning date and the deferral period will be based on the dates the deceased spouse would have attained age 70½ or 85.

The deferred annuity has features very similar to those found in a lifetime income investment. A lifetime income investment is to have a lifetime income feature. This means a feature that guarantees a minimum level of income at least annually for the remainder of the employee’s life (or the remainder of the employee’s life along with his or her designated beneficiary) or an annuity where the payments are made in substantially equal periodic payments over the employee’s life (or the remainder of the employee’s life along with his or her designated beneficiary).

Categories: Pension Alerts, RMDs, Traditional IRAs

Will the IRS Revise the IRA/Pension Life Expectancy Tables in the Near Future?

Posted by James M. Carlson
Jul 18 2013

We are awaiting an answer from the IRS. The IRS has recently updated various morality tables for defined benefit pension plan purposes. More Americans are living longer. This fact certainly affects pension plans and it also affects to IRAs. The IRS will inform the public in the near future whether the IRA/pension life expectancy tables have been or will be revised to reflect individuals living longer. If so, the RMDs of most individual RMDs would decrease slightly. This would be true for both accountholders and also inheriting beneficiaries.

Since smaller distributions means less tax dollars collected, it may be the IRS will not adjust the IRA life expectancy tables. As discussed below, there is no tax law requiring the IRS to make such an adjustment in 2013, but public policy would seem to support the adjustment. Most IRA accountholders age 70½ and older want to take only their required distribution and not a penny more.

Section 634 of EGTRRA (2001) instructed the Secretary of the Treasury to modify the life expectancy tables for purposes of the minimum distribution rules to reflect current life expectancies. In 2002-2003 the IRS in its final regulation adjusted these tables to reflect improvements in mortality from 2000-2003. The Uniform Lifetime table, the Joint Life Expectancy table, and the Single Life table were changed to reflect mortality improvement from 2000 to 2003. Earlier the IRS had adjusted various tables to create the Annuity 2000 mortality table. And such revised tables were created by combining on a basis of 50% male and 50% female. The mortality of females is superior to that of males as the tables demonstrate.

These mortality tables are of critical importance for administering defined benefit pension plans. An employer sponsoring a defined benefit plan will be required to make larger contributions if mortality improves. The plan benefit (i.e. amount) an employee is entitled to be paid at his or her normal retirement date will be larger if mortality has improved. The IRS has recently released Notice 2013-49. This Notice provides updated static mortality tables for the years 2014 and 2015.

Code section 430 does contain a provision providing that periodically (at least every 10 years) these mortality tables shall be revised to reflect the actual experiences of pension plans.

What about IRAs? 10 years or more have passed since the IRS last updated the IRA/pension life expectancy tables.

We expect the IRS will respond to CWF’s question within the next 2-6 weeks. We will let you know what we are told in a future newsletter. We hope the IRS will revise the life expectancy tales thereby allowing accountholders and inheriting beneficiaries to take slightly smaller required distributions.

Categories: Pension Alerts, RMDs, Traditional IRAs

IRA Limits for 2013

Posted by James M. Carlson
May 15 2013

After many years, the maximum IRA contribution limits for 2013 will be $500 larger. For 2008-2012, if a person was not age 50 as of December 31, then his or her maximum contribution was $5,000 assuming he or she had compensation of at least $5,000. This limit increases to $5,500 for 2013. For 2008-2012, if a person was age 50 or older as of December 31, then his or her maximum contribution was $6,000. This limit increases to $6,500 for 2013. The annual catch-up contribution limit for individuals age 50 or older remains at $1,000. Hopefully, contributions for 2013 will be larger than those for 2012 and end the recent decrease in IRA contributions.

Categories: Pension Alerts, Traditional IRAs

Military Death Gratuity and Service-members Group Life Insurance Payment and Roth IRAs.

Posted by James M. Carlson
May 14 2013

A special type of rollover contribution is authorized. If a person receives a military death gratuity or a payment from Servicemembers’ Group Life Insurance (SGLI), this person may roll over all or part of the amount received to his or her Roth IRA. Such payments are made to an eligible survivor upon the death of a member of the armed forces.

If you are the person and you are a member of the decedent’s family, then you may make a rollover contribution to your Roth IRA. The maximum amount eligible to be rolled over is the total of the survivor benefits less any amounts already rolled over on your behalf of another family member’s behalf to a Roth IRA or other Coverdell ESAs. The amount of survivor benefits contributed to the Roth IRA will be basis and will not be taxed when withdrawn.

This special rollover must be completed within one year after the date the individual received the death benefit gratuity or the SGLI payment. The once per year rollover limit applying during a 12-month period does not apply to rolling over a military death gratuity or a SGLI payment.

This special rollover is not subject to the annual contribution limits applying to Roth IRA contributions.

Categories: Pension Alerts, Roth IRAs, Traditional IRAs