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

Posted by James M. Carlson
Feb 26 2014

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

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. CWF should have the revised forms ready by March 7.


Excess HSA Contributions - The HSA Custodian Must Not Shirk its Responsibilities

Posted by James M. Carlson
Feb 06 2014

An HSA custodian is required to prepare and furnish Form 1099-SA (Distributions from an HSA, Archer MSA,or Medicare Advantage MSA) to report distributions received by the HSA owner or an inheriting HSA beneficiary. The individual will use the information from the Form 1099-SA to complete their federal income tax return, including Form 8889 (Health Savings Accounts).The individual explains on this form whether all distributions were used for qualified medical reasons and so they are tax-free, whether some of the distributions are taxable since they were not used to pay a qualified medical expense, or whether some distributions are not taxable since they were the withdrawal of an excess contribution.

The IRS takes the reporting of the withdrawal of excess HSA contributions very seriously. Reason code 2 is to be inserted in box 3 of Form 1099-SA when an HSA owner withdraws an excess contribution. The amount of the earnings, if any, associated with the excess contributionis to be reported in box 2. The IRS procedures applying to the withdrawal of HSA excess contributions are very similar to the rules applying to the withdrawal of excess IRA contributions, but there are some significant differences.

Excess HSA contributions can cause tax problems for an HSA owner, but they also cause administrative problems for the HSA custodian/trustee. The purpose of this article is to discuss the tax rules applying to excess HSA contributions so that an HSA custodian will properly perform its IRS reporting duties and also help its HSA owners. The HSA custodian/trustee may well want to have the authority to charge an administrative fee for the additional work which will need to be performed on account of the excess HSA contribution(s).

Based on a number of consulting calls, some financial institutions are adopting the approach that the institution will report all HSA distributions as normal distributions and then instruct the HSA owner that it is up to him or her (and the accountant) to explain things on the Form 8889

This approach is imprudent as it relies on wishful thinking. This approach is contrary to IRS guidance. The IRS may assess a fine of $50 for each Form 1099-SA prepared in error . If the IRS concludes that an HSA custodian has failed to provide a correct Form 1099-SA due to its intentional disregard of the requirement to furnish a correct Form 1099-SA, then the penalty is at least $250 per form with no maximum penalty. The $250 perform penalty may be assessed twice – once with respect to the copy required to be filed with the IRS and also with respect to the copy to be furnished the HSA owner.

Who is primarily responsible for correcting an excess HSA contribution?

The HSA owner is, but in some situations the HSA custodian must be proactive in making sure the excess contribution is corrected. It is the HSA owner who must pay the 6% excise tax if excess contributions have been made to his or her HSA and they have not been with-drawn by the tax filing deadline. Normally, this is April15 of the following year. A special tax rules modifies the deadline to October 15 if the individual filed his or her tax return byApril 15 and paid any taxes owing. The 6% tax applies for each year the excess remains in the HSA.

The HSA plan agreement provides that the HSA custodian is NOT authorized to accept annual contributions totaling more than $7,450 for 2013 and $7,550 for2014. This amount is the family HDHP limit plus$1,000. This provision means the HSA custodian must be proactive in correcting excess contributions which have arisen because the individual and the employer contributed more than this limit. Both the individual and the institution have done something they should not have done. The individual made the excess contribution and the institution should not have accepted it. HSA custodians must have a procedure to monitor (and enforce) the $7,450/$7,550 limit.

In order to illustrate some of the administrative issues which may arise from an excess HSA contribution situation, two situations will be discussed.

Situation #1. Sue Taxpayer, age 39, contributed $6,450 to her HSA on April 1, 2013 for 2013. At that time she thought she had family HDHP coverage for allof 2013. However on July 1, 2013, she went to work for a new employer which covered her immediately under a non-HDHP. Thus, she was eligible to contribute only $3,125 to their HSA and so she needs to withdraw her excess contribution of $3,125 plus the related income, if any.

In January of 2014, Sue visits the HSA custodian and states she needs to withdraw $3,125 as an excess HSA contribution plus the related income. The HSA custodian must assist her. The withdrawal cannot be coded as the withdrawal of a normal HSA distribution. Note that even though this distribution relates to a 2013 distribution, it will be reported on a 2014 Form 1099-SA. The rule is – the income, if any, withdrawn and shown inbox 2 is taxable for the year withdrawn (2014) and not 2013 which is the IRA rule.

Situation #2. John Taxpayer contributes $14,000 to his HSA in 2013 for 2013. He says he was unaware of any contribution limit. His beginning balance as of January1, 2013 was $600. He made monthly contributions of$1,000. His HSA’sending balance as of December 31,2013 was $200. His distributions for the year totalled $14,400. Of this $12,400, John knows that $8,800 was used to pay qualified medical expenses and the remaining $5,600 was used to pay the premiums for the HDHP. The institution does not know how John used the funds.

The HSA custodian has initially coded all of the HSA distributions as being normal HSA distributions and a code “1” would be inserted in box 3 on the 2013 Form1099-SA. The HSA custodian, however, knows that John made excess contributions of at least $6,950 ($14,000-$7,450). This amount is no longer in the HSA as it only has a balance of $200 at year end. Whether John knew it or not, when he took a distribution he was withdrawing an excess contribution. The HSA custodian cannot continue to report this amount as the withdrawal of a normal distribution. It must change some of withdrawals to show that he withdrew $7,950 as an excess contribution, plus the earnings, if any.

Be aware that the IRS has not furnished specific guidance on Situation #2. The IRS should do so. Note that John used the funds to pay the premiums for the HDHP. As discussed in a previous newsletter article, if he had taken a normal distribution he would have had to include the $5,600 in income and also pay the 20% penalty tax as the funds were not used to pay a qualified medical expense. But he does not have such adverse tax consequences as he withdrew an excess contribution.

An HSA custodian must adopt procedures to properly report the withdrawal of an excess HSA contribution(s). Such withdrawals must not be reported as normal distributions.


Be Aware - Rolling Over an Old Keogh Plan Into an IRA May Lead to Serious Tax Problems

Posted by James M. Carlson
Jan 10 2014

Your financial institution may have a customer who wants to rollover to an IRA an old Keogh that he or she has at another financial institution. Or, such customer may have the old Keogh at your institution. An institution wants to understand the tax laws applying to this situation so that it can decide what course of action should be adopted.

A number of banks in 2013 called CWF regarding a customer wanting to rollover an old Keogh plan; we know some banks will call us in 2014. An old Keogh plan is one which the customer did not update as the tax laws required. For example, the customer’s most recent plan document was last updated in 1987, 1991, 1994, 2001, etc. Plans which once were Keogh plans in the 1970’s generally became profit sharing plans in the 1980’s and later.

A person or business which established and maintained an old Keogh or profit sharing plan received substantial tax benefits. First, the sponsoring business, including a one person business, was allowed to claim a tax deduction for the contribution amount. The current maximum contribution for 2013 is $51,000 and is $52,000 for 2014. Second, the earnings on the contributions are not taxed until distributions commence. When a distribution occurs (actual or deemed), the amount withdrawn is in included in income and is taxable. When a plan document in not updated by an applicable deadline, the amount in the old Keogh or profit sharing plan is deemed distributed. This is true whether the individual knew of the deadline or not. The individual should have paid tax on this amount and an additional 25% tax is imposed when a person understates his or her tax liability.

The individual is NOT entitled to resolve his or her tax problems by rolling such funds over into a traditional IRA. Distributed qualified plan funds are eligible to be rolled over into an IRA only if the funds are distributed from a “qualified” plan. A plan which has not been timely updated is no longer qualified.

The IRS has a special correction program called Employee Plans Compliance Resolution System (EPCRS). The IRS has adopted this tax administrative program to promote voluntary compliance with the tax pension rules. The concept is – an employer which has not complied with certain tax rules is able to pay a modest compliance fee and modify the plan so there is now compliance. If this is done, the IRS will treat the plan as qualified so that a distribution will be able to be rolled over.

The IRS compliance fee for not updating a plan document is in the range of $375-$750 if the plan covers less than 20 participants. The employer or the employer’s representative must make a special IRS filing. CWF’s fee to prepare such a filing would be in the range of $500- $1,500 as these filings are very time consuming. It normally takes 6-15 hours to prepare the necessary IRS filing materials.

As you would expect, individuals in this situation may not be inclined to pay the IRS $375-$750 and certainly do not want to pay an attorney or accountant $500- $1,500. From CWF’s position, these individuals should jump at the chance to get tax relief by paying relatively modest amounts. An individual with a non-updated Keogh or profit sharing plan with $100,000 might well be required to pay $30,000-$65,000 in taxes, penalties and interest should the IRS discover his or her non-compliance.

For this reason, one would think a person paying $1,000-$2,000 to resolve the situation is more than reasonable and is a prudent thing to do. Many people, however, don’t think this way. They don’t want to pay the IRS anything and they may learn a tax lesson the hard way.

What if the old Keogh funds were located at another financial institution, the individual has withdrawn the funds, and he wishes to make a rollover contribution into his IRA?

If a financial institution has information showing that the purported rollover is ineligible to be rolled over, it must not accept the contribution. A nonqualifying rollover contribution is an excess IRA contribution and a 6% excise tax will apply each year. For example, an individual rolls over $100,000 in December of 2013 even though if he is ineligible to do so. Ten years later the IRS audits this person and discovers the impermissible rollover. Since the $100,000 is an excess contribution, he will be owe $6,000 plus interest and penalties for each of the ten years. If the financial institution has no information showing that the plan is “old” and if the individual completes a rollover certification form, the rollover contribution may be accepted.

What if the old Keogh funds have been located at your financial institution, but the plan was not updated when it should have been?

A financial institution was and is allowed to discontinue its sponsorship of a Keogh or profit sharing plan document. As long as the the institution gave the individual notice that it would no longer be providing this service and would assist with a transfer to another financial institution, such institution should have no liability. You may inform the individual about EPCRS.

If the financial institution may have some responsibility for the individual not updating his plan, then the financial institution and the individual should make a EPCRS filing to correct the situation. The two parties would need to decide how the costs would be borne or shared. One can expect the IRS and the bank regulators would impose substantially harsher tax and banking consequences if the sponsoring business has knowledge of plan errors and does not choose to use the correction methods which are available.

Update on Profit Sharing Prototypes. The IRS appears to be on schedule to meets its April 1, 2014, deadline for issuing new favorable opinion letters to all prototype mass submitters, including CWF. Then, as in past years a sponsoring employer of a prototype plan is given 12-months in which to amend and restate its plan by completing and signing the updated adoption agreement.

By doing so, the plan is considered to be qualified for the period of 2006-2011/2012.


Faulty IRA Information – Roth IRA Article From Certain Investment Firm and the Two Roth IRA 5-Year Rule(s)

Posted by James M. Carlson
Jan 10 2014

IRAs hold over 27% of all retirement plan assets in the United States. People are and should be writing about IRAs. Some articles, including brochures, will sometimes contain errors. A certain investment firm has recently sent a fax to some financial institutions discussing Roth IRAs and some incorrect statements were made. Your institution may have been sent the fax.

November and December are month when some traditional IRA owners decide they are going to do a Roth IRA conversion. Within this article we do not directly name the investment firm, but it is a major firm. The main error within the article is to state that there is always a separate 5-year time period for each distinct Roth IRA conversion contribution.

Why this newsletter article? Many times a CWF client will call us and ask, “why does this article state the tax rules differently than what you have previously told us?”

CWF’s answer is, let us review what you are reading and let us make a determination if we are wrong in our understanding of the tax rules or if the investment firm is wrong?

There are actually two 5-year rules which may apply to a Roth IRA distribution. You, your customer, and their advisors want to understand both rules.

The first 5-year rule relates to whether the distribution of income from a Roth IRA will be taxable or not taxable. There is only one 5-year time period for this 5-year rule.

The second 5-year rule relates to whether a person who is under age 59½ when he or she does a conversion will owe the 10% additional tax if he or she takes a subsequent withdrawal from the Roth IRA before he or she has met a second 5-year requirement. For this purpose, there is a 5-year time period determined for each conversion. When a person under age 59½ does a conversion, he or she does NOT owe the 10% additional tax as generally applies when a person is not yet age 59½.

If there was no requirement to leave the converted funds in the Roth IRA for a certain time period after the conversion, any person under age 59½ who wanted to take money from his or her traditional IRA would first convert it to a Roth IRA and then take the distribution from the Roth IRA to avoid the 10% tax.

The lawmakers could have decided on any time period: 3-years, 6-years, 10-years, but 5-years was selected. Having two different 5-year rules is confusing.

The 10% additional tax is not owed by a person who has done a conversion once he or she attains age 59½ or meets the 5-year rule with respect to that particular conversion. For example, a person who is age 57 at the time of the conversion is subject to the 5-year rule and also the 10% additional tax for any distribution he or she would take between age 57 and 59½. The 10% tax is not owed once a person attains age 59½.

Below are various incorrect statements made in the article:

  1. “Unlike the 5-year rule that applies to contributions, the 5-year rule applies to each conversion separately; each conversion has it’s own 5-year waiting period before a qualified distribution may occur.” These two statements are categorically incorrect.
    Error #1. The 5-year rule does NOT apply to each conversion separately. Reg. 1.408A-6, Q/A-2 provides there is only one 5-year period for both annual and conversion contributions. The IRS regulation provides, “The 5-taxable year period begins on the first day of the individual’s tax year for which the regular contribution is made to any Roth IRA of the individual or, if earlier, the first day of the individual’s tax year in which a conversion is made to ANY Roth IRA of the individual. The 5-taxable year period ends on the last day of the individual’s fifth consecutive tax year beginning with the tax year discussed in the preceding sentence.”
    Error #2. The article states the the 5-year rule applying to “annual” contributions is different from the 5-year rules applying to a conversion contribution. The regulation indicates the 5-year period may be different, but it need not be. For example, a conversion made on December 2, 2013, means the 5-year period begins on January 1, 2013 whereas an annual contribution made on March 1, 2014, for 2013 will also have a 5-year period which begins on January 1, 2013
  2. “Recharacterization is only available in connection with converting amounts into a Roth IRA. It is not available for conversions within a qualified plan.” This is not well-written. It is true a qualified plan participant who converts taxable funds into a Designated Roth account cannot recharacterize such conversion. However, the first sentence is wrong because a person is permitted to recharacterize an annual contribution by going from a traditional IRA to a Roth IRA or going from a Roth IRA to a traditional IRA.
  3. The statement is also made that “IRA conversions can be recharacterized up to October 15 of the year following the conversion.” Not everyone qualifies for this extended deadline. The actual law is, a person has until April 15 of the following year to recharacterize a contribution (be it a conversion or an annual contribution). However, if a person filed his or her tax return by April 15 and paid any tax owing, then he or she is given until October 15 to complete the recharacterization.

CWF’s explanation is consistent with IRS guidance as set forth in the Regulation 1.408(A) and IRS Publication 590. See Q&A’s 2 and 5 of the regulation. Any article on Roth IRA distributions should explain that the law mandates that distributions come out in the following order: annual contributions, the conversion contributions in order of time (oldest come out first), and then earnings come out last. A person never owes income tax when he or she withdraws a contribution (annual contribution or a conversion contribution) because such contributions were made with after-tax funds.

A person never owes income tax when he or she withdraws the income or the earnings and the distribution is “qualified.” A person does owe income tax on the earnings when he or she withdraws the earnings and the distribution is NOT qualified (e.g. not 59½ or 5- year rule not met). And if this person is under age 59½, he or she will owe the 10% additional on such earnings.

In summary, the investment firm’s Roth IRA article contains a number of errors. In 1999 the law was changed so that there is only one 5-year time period for purposes of determining whether nor not a Roth IRA distribution is qualified (tax-free) or not. Believe it or not, everyone should congratulate the lawmakers as they did try to simplify the tax calculation. The original law effective only for 1998 would have required a person to have separate 5-year time periods for Roth IRA conversion contributions versus annual Roth IRA contributions for purposes of whether the income was taxable or not.


IRA Contribution Limits for 2014 - Unchanged at $5,500 and $6,500

Posted by James M. Carlson
Jan 10 2014

The 16-day government shutdown impacted the IRS. The IRS reopened on October 17. On October 31 the IRS released the 2014 IRA and pension limits. Inflation was very low for the fiscal quarter ending September 30, 2013, 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 2014 for traditional, Roth and SIMPLE IRAs did not change – $5,500/$6,500 and $12,000/$14,500 respectively.

The maximum contribution limit for SEP-IRAs is $52,000 for 2014 up from $51,000 for 2013.

The maximum limits for 401(k) participants for 2014 are also unchanged at $17,500/$23,000.

The IRA compensation limit changes were small, either $1,000 or $3,000.

Contribution limits for a person who is not age 50 or older.




Categories: Pension Alerts

2011 Rollover Contributions

Posted by James M. Carlson
Sep 26 2013

IRAs hold more than 25% of all retirement assets in the United States. Much of those assets arise from rollover contributions coming from the distributions of participants of employer sponsored pension plans rather than annual IRA contributions.

The 2011 total contribution amount due to rollovers was $76,566,000,000 whereas it was $5,962,000,000 for annual contributions. That is, the amount contributed as rollover contributions was 13 times the size of the annual contributions. These amounts and ratios are consistent with such amounts and ratios derived from IRS data.

This rollover article is based on an article written by Craig Copeland with the recommended citation, Craig Copeland, “Individual Retirement Account Balances Contributions, and Rollovers, 2011.” This article is copyrighted, but it may be used without permission as long as there is a citation of the source.

The number of IRAs within the EBRI data base receiving rollover contributions was 1,058,000 whereas it was 1,601,000 million for annual contributions. The average annual contribution was $3,723. The average rollover contribution was $72,398. There is a reason that most financial institutions direct their marketing campaigns towards rollover contributions and direct transfers in the case of inherited IRAs.




Categories: Traditional IRAs

Moving Non-deductible Funds from a 401(k) Plan Into a Roth IRA.

Posted by James M. Carlson
Sep 26 2013

This article discusses moving basis within a 401(k) plan or a profit sharing plan into a Roth IRA.

A customer wanting to make a direct rollover or rollover contribution of pension funds containing basis should always be advised to consult with his or her tax advisor as this is complicated tax subject. One reason is – the IRS has not been willing to give definitive written guidance.

Discussion of a hypothetical situation is helpful. Let’s assume Jane Doe has a 401(k) balance of $50,000, it is comprised of two portions – $40,000 (deductible/taxable contributions and earnings) is taxable and $10,000 is nontaxable (i.e. basis).

Is it possible for Jane to directly rollover the $40,000 of taxable money in the 401(k) plan to a traditional IRA and then directly rollover (i.e. convert) the $10,000 of basis into a Roth IRA?

No. When there is a direct rollover or direct rollovers the pro-rata taxation rule will not allow only the basis to go into the Roth IRA. That is, if $10,000 goes into the Roth IRA, $8,000 of it will be taxable and $2,000 will be nontaxable under a direct rollover approach. Jane will include the $8,000 in her income and pay tax on it. This means she will still have $8,000 of basis with the traditional IRA.

This is not the result she wants. She wants to have no basis within the traditional IRA and she wants only basis to go into the Roth IRA so she will not have to pay any income tax.

Is there an approach allowing Jane to pay no tax with respect to the $10,000 she puts into her Roth IRA?

Yes, but she will need to have access to some additional funds ($8,000) as explained below.

Jane will need to instruct the 401(k) administrator that she wishes to have her plan balance of $50,000 paid to her in cash. She cannot do a direct rollover and achieve the desired result. Since she is paid cash, the plan administrator will withhold 20% of the taxable amount of the distribution. The plan will give her a check for $42,000. 20% must be withheld from the $40,000 or $8,000. 0% must be withheld with respect to the basis (i.e. her own nondeductible contributions). Thus, she is paid $42,000 ($32,000 + $10,000).

Jane now has 60 days to rollover this $42,000 distribution. She may do so by making multiple rollover contributions. First, she wants to rollover the $40,000 into her traditional IRA. Later, she wants to rollover the $10,000 into her Roth IRA. Since she only has $2,000 as the other $8,000 was withheld, she will need to add her own $8,000 to make the $10,000 rollover. This $8,000 can come from other personal funds or possibly from a loan.

Why must she do it this way? Code section 402(c)(2) provides that when a person has basis within the 401(k) plan and takes a distribution, that the taxable amount comes out first and the nontaxable amount comes out second. Because of this rule, she may make a roll over contribution of $40,000 to her traditional IRA and then a rollover contribution of $10,000 to her Roth IRA. The $10,000 she contributes to her Roth IRA will be her basis or the nontaxable amount. In this situation, the pro-rata rule is not used. Although asked numerous times, the IRS has not confirmed that this approach works so that all of the $10,000 going into the Roth IRA is basis and nontaxable.

Categories: Pension Alerts, Roth IRAs

QCD Season and RMDs

Posted by James M. Carlson
Sep 26 2013

Soon it will be August and soon it will be the RMD season. That is, it is the time many of your 701/2 and older IRA accountholders are paid their RMD for 2013. Many times the RMD is moved by a pre-authorized transfer from their IRA to a savings or checking account. Or, a check is mailed.

Some of your 70½ IRA accountholders (and also inheriting beneficiaries) may want to make a QCD if they only knew and understood the applicable tax laws.

QCDs are authorized for 2013 as long as made by December 31, 2013. QCDs will apply to 2014 only if there is tax legislation enacted extending such rules to 2014/2015 and possibly subsequent years. Another extension of this law is not a sure thing. If the idea is to collect more tax revenues one does not want to extend the QCD rules.

Your local charities and other non-profits benefit when qualifying individuals make QCDs. The individual benefits also. A QCD is a tax-free distribution and it also counts as an RMD. Qualifying IRA accountholders are those age 70½ and older, including inheriting IRA beneficiaries age 70½ and older.

Your institution can benefit also. Earn some goodwill by informing your qualifying IRA accountholders that your institution is willing to help them make their QCDs.

CWF has a brochure explaining the QCD rules and benefits and also an administrative form which acts much like a transfer form. Remember that one of the critical rules is that the check must name the charity as the payee. There is no requirement by an IRA custodian to use the QCD administrative form. One uses the form for good administrative practices. The administrative form may be sent to the charity. Your institution may decide whether or not you would require the charity to sign it. The charity’s signature is not required.

To order brochures or forms go to: www.pension-specialists.com/orderforms/QCD order form.pdf

Categories: RMDs, Traditional IRAs

Can't Directly or Indirectly Rollover a Roth IRA to a 401(k) Plan.

Posted by James M. Carlson
Sep 26 2013

401(k) participants sometimes wonder if they can and should move their Roth IRA funds into their 401(k) plan. Current tax law does not authorize a person to move their Roth IRA funds into their employer’s 401(k) even if the 401(k) plan authorizes Designated Roth contributions. The 401(k) plan does not authorize such a rollover because current law does not authorize this movement as being nontaxable.

Maybe the law will permit this someday, but not at the present time.

There will be a tax mess both for the 401(k) plan and the individual if such a rollover is made. Most likely the IRS would NOT allow the Roth IRA funds to be returned to the Roth IRA if the 60-day period to complete a rollover has expired. The person might try to argue that he or she received poor advice from an advisor, but there is going to come a time when the IRS will not so readily accept this argument. The IRS will make the argument – you withdrew the funds from your Roth IRA and you did not complete a timely rollover; your funds are no longer entitled to be returned to the Roth IRA. Such a distribution may or may not have any current income tax consequences. What is known, such funds will not earn tax-free income as would have been the case had they stayed in the Roth IRA.

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Categories: Pension Alerts, Roth 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.

  1. 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.

  2. 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.

  3. 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

  4. 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.

  5. 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.

  6. 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.

  7. 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.

  8. 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, Traditional IRAs