Additional IRS Guidance on the Once Per year Rollover Rule and the IRS Can't Be Serious About IRA Transfers

Posted by James M. Carlson
Nov 19 2014

The author of this article is an old tennis nut. JohnMcEnroe’s 1981 tennis exclamation of the 1980’s that “you can not be serious” fits many situations.

The IRS has recently issued additional tax guidance on the once per year rollover rule which goes into effect on January 1, 2015. IRS NewsWire 2014-107 and Announcement 2014-32. This is the third or fourth time the IRS has issued guidance since the tax court’s decision (Bobrow) in January of 2014. The court ruled that aperson is allowed to make only one distribution/rollover in a one-year period regardless of how many different IRA plan agreements a person has.

The initial IRS guidance maybe was not as comprehensive or clear as it should have been. One would hope the IRS wants to provide comprehensive guidance on tax subjects so that everyone involved can perform their tax duties.

The most recent guidance makes clear that that a person who rolls funds from one Roth IRA to another Roth IRA is ineligible to rollover funds from his or her traditional IRA to another traditional IRA during the one-year period commencing on the withdrawal of the Roth IRA funds. And that any subsequent distributions by this person within the one-year time period from any or his or her IRAs will be ineligible to be rolled over tax free.

The IRS has still not yet commented (furnished guidance) whether an IRA trustee must or should inform existing IRA owners of this change in the once per year rollover year. An existing IRA regulation does require an amended disclosure statement be furnished, but the IRS has not explained why this regulation does not apply if they believe that such an amendment is not required.

The IRS portrays itself as being taxpayer friendly. If the IRS was so friendly, the IRS did not need to agree so quickly to follow the tax court decision. One tax court decision need not be the final decision. The IRS could have appealed the tax court’s decision or asked Congress to change the law to expressly authorize the continuance of the old rule allowing rollovers on a per plan agreement basis. One would think this would be a bipartisan topic.

The IRS is in the business of maximizing the tax revenues of the federal government. Limiting the number of rollovers a person is eligible to make will in some cases lead to more individuals having to pay incomes taxes they otherwise would not have had to pay or at least not as soon. Unlike with pension plans, the law and the IRS has not adopted any procedures allowing IRA mistakes to be corrected. The IRS likes IRA mistakes in the sense that additional taxes in many cases will be owed and paid. However, this conflicts with the fact that the more a person pays in taxes on account of his or her IRA mis-takes means less funds for retirement. In some cases, the IRS doesn’t care and the IRS wants to maximize its collection of tax dollars.

The IRS states in its guidance that it encourages IRA trustees to offer to its IRA owners a transfer distribution of funds rather than a distribution followed by a rollover contribution. A transfer is not subject to the once per year rule as there is no actual taxable distribution. Allowing transfers will lessen the impact of the new once per year rollover rule. The IRS understands that IRA trustees are not required by the tax laws to participate in a transfer. The two involved IRA plan agreements must authorize the transfer.

The IRS states, “IRA trustees can accomplish a trustee to trustee transfer by transferring amounts directly from one IRA to another or by providing the IRA owner with a checkmade payable to the receiving IRA trustee.”

The IRS does not give a comprehensive discussion (or any examples) on what it means by making “the check payable to the receiving IRA trustee.” Admittedly, the IRS is trying to give a keep it as simple as possible explanation. But sometimes an approach can be too simple and tax problems are sure to arise.

With the many law changes impacting transfers, some transfers are reportable and some are not. Reportable means one of the IRA trustees must report the transfer distribution on a Form 1099-R and the one of the trustees must report the contribution on the Form 5498 either as rollover, conversion, recharacterization or a qualified HSA funding distribution. In this rollover guidance the IRS offers no guidance as to how reportable transfers are to be handled by the two IRA trustees or by the IRA trustee and the HSA trustee.

Furnishing an IRA trustee or an HSA trustee with only a check will not assure the proper tax administration. In order to assure the correct administration of the transferred IRA funds, the receiving IRA trustee will in somecases need to be furnished certain historical information from the transmitting institution. The IRS does not discuss this topic in any detail. It appears the IRS may be allowing the individual to furnish this information and not require that the remitting institution furnish it. This is short-sighted and it is why this situation is a “you can’t be serious” situation. The IRS should furnish additional guidance.

The IRS seems to authorize the check may be made payable to “ABC Bank” and does not require additional information such as “ABC Bank as Roth IRA trustee fbo Jane Doe” or “ABC Bank as the inherited traditional IRA trustee fbo John Smith abo Mary Smith’s IRA” or “ABCBank as the HSA trustee fbo of Maria Bell.”

Current IRS procedures provide that an IRA trustee is not to report a “non reportable” transfer on either the Form 1099-R or the Form 5498. CWF has received quite a few consulting calls indicating that some brokerage firms (some large ones) prepare the Form 1099-R for all transfers. This makes their life easier, but complicates the life of every departing IRA owner since he/she must explain on his/her tax return why the amount on the Form 1099-R is not taxable. The IRS apparently does not fine an IRA trustee which prepares a Form 1099-R not required to be prepared. The IRS needs to start imposing fines on such IRA trustees.

As a reminder there are certain distributions which are ignored for purposes of applying the once per year rule. Making a Roth IRA conversion contribution is not counted as a distribution/rollover. Making an HSA Funding distribution is not counted as a distribution/rollover. However, moving funds from an IRA to a 401(k) does count as a distribution/rollover.

Set forth are various examples illustrating why furnishing just a check will not allow for the proper tax administration. Hopefully, the IRS will again furnish additional guidance.

  1. Jane Doe instructs First Bank that she wishes to transfer $30,000 of her traditional IRA funds to Second Bank. She does not make clear into what type of account the $30,000 is to be reinvested. The check is made payable to Second Bank. No additional information is provided. Jane could instruct Second Bank that she wants the funds to go into a Roth IRA. She should include the $30,000 in her income. However, if both banks treat this transaction as a non-reportable transfer, the IRS will have no way short of a full audit to determine if Jane reports the transaction properly on her federal incometax return. She might escape including the $30,000 in her income. Presumably, the two IRA trustees could be fined for not preparing the Form 1099-R and the Form 5498 as is required when there is a Roth IRA conversion. Funds moving from a traditional IRA to a Roth IRA via transfer or rollover is a reportable transaction.
  2. John Hall instructs First Bank that he wishes to transfer $7,550 of his traditional IRA funds to Second Bank. He does not make clear into what type of account the $7,550 is to be reinvested. The check is made payable to Second Bank. No additional information is provided. John could instruct Second Bank that he wants the funds to go into his HSA. He would exclude the $7,550 from his income. However, if both banks treat this transaction as a non-reportable transfer, there will be non-compliance with the IRS reporting rules applying to an HSA Funding Distribution/Contribution
  3. Mary Long instructs First Bank that she wishes to transfer $45,000 of her inherited traditional IRA funds to Second Bank. Her mom had designated Mary as the beneficiary of her IRA. Mary does not make clear into what type of account the $45,000 is to be reinvested.The check is made payable to Second Bank. No additional information is provided. Mary could instruct Second Bank that she wants the funds to go into her own personal traditional IRA. The mistake could be intentional or unintentional. This means she no longer would have to comply with the required distributions rules. She would not be required to take an RMD until she would attain age 70½. If both banks treat this transaction as a non-reportable transfer, the IRS will have no way short of a full audit to deter-mine that Jane made a nonqualifying transfer.
  4. One last example. Jane withdrew $30,000 from IRA#1 on June 10, 2014 and she rolled it into IRA #4. She will be eligible to take a distribution from IRA #4 and roll it over only if she does so on or after June 10, 2015,and she has taken no other distribution from any of her other IRAs on or after January 1, 2015 which she rolled over. In conclusion, although the IRS states in recent guidance that all that is needed to transfer IRA funds is to issue a check to the other IRA trustee, CWF suggests that IRA transfer forms, IRA conversion forms and the form for an individual to certify the making a a qualified HSAfunding distribution still be used. The goal is to limit the mistakes made by individuals and IRA trustees.

Categories: Pension Alerts

IRA Contribution Limits for 2015 – Unchanged at $5,500 and $6,500; 401(k) Limits Increase

Posted by James M. Carlson
Oct 31 2014

Inflation was approximately 1.7% for the fiscal quarter ending September 30, 2014, 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 2015 for traditional and Roth IRAs did not change – $5,500/$6,500.

The 2015 maximum contribution limit for SEP-IRAs is increased to $53,000 (or, 25% of compensation, if lesser) up from $52,000. The minimum SEP contribution limit used to determine if an employer must make a contribution for a part-time employee increases to $600 from $550.

The 2015 maximum contribution limits for SIMPLE-IRAs is increased to $12,500 if the individual is under age 50 and $15,500 if age 50 or older

The 2015 maximum elective deferral limit for 401(k) participants increases to $18,000 for participants under age 50 and to $24,000 for participants age 50 and older.

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

Tax Year Amount Tax Year Amount
2008-12 $5,000 2008-12 $6,000
2013 $5,500 2013 $6,500
2014 $5,500 2014 $6,500
2015 $5,500 2015 $6,500




Categories: Pension Alerts

IRS Expands the Rules on Rolling Over After-Tax QP Funds to a Roth IRA and Other Plans

Posted by James M. Carlson
Sep 26 2014

On Thursday, September 18, 2014, the IRS adopted a new tax position for those individuals who have after-tax (basis or non-taxable funds) within an employer sponsored retirement plan. Under existing IRS rules, many individuals are unable to contribute only the after-tax amounts into a Roth IRA unless the individual uses the complicated approach discussed in the July, 2013, Pension Digest.

This change is very favorable to taxpayers and will be well received by taxpayers and their tax advisors. Taxpayers have been waiting for many years for the IRS to issue additional guidance on the topic of converting after-tax funds. Tax certainty for taxpayers has improved. With some limits, the IRS will apply the new rules retroactively.

The IRS issued Notice 2014-54 setting forth its new position on how a taxpayer is to allocate after-tax amounts (i.e. basis) when he or she receives a distribution from a 401(k) plan or other plan containing both taxable and nontaxable amounts and a portion of the distribution is to be directly rolled over to a traditional IRA and another portion is to directly rolled over to one or more other plans such as a 401(k) or a Roth IRA. As described, the IRS’ new position modifies the pro-rata taxation rule in a radical manner. It does not eliminate the pro-rata rule. The new rules will apply to distributions made on or after January 1, 2015. The IRS has also issued guidance as to what rules apply to distributions occurring before January 1, 2015. The IRS has stated it will modify the safe harbor rollover explanations for pension plan distributions it has previously furnished. An explanation of the new allocation rules will be set forth in the revised safe harbors.

In Notice 2009-68 the IRS had furnished guidance confirming that a pro-rata taxation rule must be applied when a person with both pre-tax and after-tax funds within a QP takes a distribution from a plan containing both types of funds. For example, a person who had $100,000 in her 401(k) comprised of $80,000 being taxable and $20,000 be nontaxable was NOT allowed to directly rollover only the $20,000 of nontaxable portion into her Roth IRA.

As result of this notice, the person described above will be able to directly rollover the $20,000 of non-taxable funds into her Roth IRA and the remaining taxable funds of $80,000 into her traditional IRA.

An individual will no longer be required to follow the complicated procedures as discussed in the July, 2013, Pension Digest in order to be contribute the $20,000 of after-tax dollars into her Roth IRA.

What are the new allocation rules?

Rule #1. A person will be treated as receiving a single distribution even if the funds are sent to multiple destinations such as a portion to a traditional IRA, a portion to a Roth IRA, or a portion to another 401(k) plan. This true even if multiple distributions from the same plan are considered made as of the same time. This is true even if there are actual differences due to administrative timing issues.

Rule #2. If the pre-tax amount is less than the amount which is directly rolled over to one or more eligible plans, then the entire pre-tax amount is assigned to the distribution amount which was directly rolled over and the participant may select how the pre-tax amount is allocated among the multiple plans. The participant must inform the plan administrator of the allocation prior to the time of the direct rollover(s).

Rule #3. If the pre-tax amount equals or exceeds the distribution amount directly rolled over to one or more eligible plans, the pre-tax amount is assigned to the portion which was directly rolled over up the amount of the direct rollovers. Each direct rollover would consist solely of pretax amounts. If there are any remaining pre-tax amounts, such amounts will be assigned to any standard rollover up to the amount of such standard rollovers. If there is a pre-tax amount remaining after all direct rollovers and standard rollovers, then any remaining pre-tax amount is to be included in the person’s income. A standard rollover is when the distribution has been made to the person who then complies with the standard rollover rules. If the remaining pre-tax amount is less than the amount rolled over in the standard rollovers, then the individual can select how to allocate the pre-tax amount among such plans. If the amount rolled over to an eligible retirement plan exceeds the portion of the pre-tax amount assigned to the plans, the excess must be an after-tax amount.

In order to discuss these new rules the IRS furnished the following examples as modified by CWF. Employee A participant in a 401(k) and she has balance of $250,000 of which $200,000 is pre-tax and $50,000 is after tax. The plan covering Employee A does not authorize any Designated Roth contributions.

Example #1. Employee A instructs the plan administrator that she wishes to withdraw $100,000 with $70,000 being directly rolled over to a traditional IRA and the remaining $30,000 paid to her. Under the new rules, the $70,000 directly rolled over to her traditional IRA arises solely from her pretax funds. This is so because the pre-tax amount ($80,000) exceeds the amount directly rolled over ($70,000) . The other $30,000 is paid to Employee A. $10,000 of this $30,000 is taxable and the other $20,000 is non-taxable. Employee A does have the right to rollover such distribution (or a portion) as long as the 60 day rule is met. If Employee A only rolled over $10,000, it would be comprised of the remaining pretax funds.

If Employee A chooses to roll over $12,000, $10,000 would be pre-tax and $2,000 would be after- tax. If Employee A chooses to roll over the distribution(s) which were not directly rolled over, then the participant will need to decide how the pre-tax amount is allocated if there are multiple destinations. The participant must inform the plan administrator of the allocation prior to the time of the direct rollover (s).

Example #2. The same facts apply as Example #I, except Employee A directly rollovers $82,000 and she is paid $18,000. She directly rolls over $50,000 to her new employer’s qualified plan and she directly rolls over $32,000 to her traditional IRA. She has directly rolled over more than her pre-tax amount being withdrawn of $80,000.The new qualified plan does separately account for after-tax amounts. Since the direct rollover amount of $82,000 exceeds the pre-tax amount of $80,000 she has directly rolled over $2,000 of after-tax dollars.

She will have the right to allocate the pre-tax amount of $80,000 between the new qualified plan and the IRA. Conversely, she has the right to allocate the aftertax amount of $2,000 between the new qualified plan and the IRA She must do this prior to the time the direct rollover are made.

Example #3. The same facts apply as Example #2, except the new qualified plan does not account for after-tax contributions. This means the $2,000 of aftertax contributions must be allocated to the traditional IRA. Thus, the $50,000 directly rolled over to the qualified plan must all be pre-tax. The $32,000 directly rolled over to the IRA would be comprised of $2,000 of after-tax and $30,000 of pretax funds.

Example #4. The facts are the same as in Example #I, except the individual directly rolls over the entire $100,000 by sending $80,000 to a traditional IRA and $20,000 to a Roth IRA. She is able to allocate the pretax amount of $80,000 to the traditional IRA and the after-tax amount of $20,000 to the Roth IRA. Effective date of new rules and IRS reporting duties. The new rules will apply to distributions occurring on or after January 1, 2015.

The IRS also discusses what rules will be applied for distributions occurring before January 1, 2015. For distributions occurring between September 18, 2004, and December 31, 2014, taxpayers may apply a reasonable interpretation of the “old” rule or the “new” rule. Without a doubt, individuals with after-tax funds within an employer plan have been extremely hesitant to move such funds into a Roth IRA or a designated Roth IRA account as the law has been murky. The IRShas removed much of the uncertainty.

For distributions occurring before September 18, 2004, taxpayers may generally apply the same reasonableness standard as now applies to the remainder of 2014. However, this standard does not apply to any distribution from a designated Roth Account. In such case, the allocation of the pretax amounts must conform to the rules set forth in 402A regulation in effect on the date of the distribution.

These new rules may or may not require the IRS to rewrite its instructions for completing the Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc.) .

The IRS will be furnishing additional guidance. When a participant withdraws funds from an employer plan and such distribution includes a distribution of after-tax funds, box 5 must be completed to report such amount. It may be that each distribution may be reported on a separate Form 1099-R even though under the new rules multiple disbursements to different destinations are treated as a single distribution.

What About Designated Roth Funds?

Such funds arising from the individual’s elective deferrals are after-tax funds and are not taxable when withdrawn by the participant. The distribution of the related earnings, however, will be taxable unless the distribution is a qualified distribution. The Roth regulation provides that such funds are treated as a separate contract from other accounts within the employer plan when applying the taxation rules. In plan English this means, the designated Roth funds are not aggregated with other funds within the employer plan, including the earnings on such designated Roth funds.

A qualified distribution of the earnings related to the designated Roth funds is tax free (i.e. not includible in gross income). Currently, the Roth IRA regulations provide in part that “any amount paid in a direct rollover is treated as a separate distribution form any amount paid directly to the individual.”

Such regulation will be amended to adopt the new rule.

The IRS’ release of Notice 2014-54 was unexpected. Taxpayers and their advisors will start to use these new rules immediately. Others will wait until January 1, 2015. Such rules will certainly make it easier for an individual to move after-tax funds into a Roth IRA or a designated Roth account where that fantastic goal of tax free income may be realized.

CWF is proud of the fact that we had asked/suggested to the IRS in prior years to furnish additional guidance on some of these issues. CWF will be suggesting to the IRS that it change its section 402(f) rules and direct rollover rules to require that the plan administrator furnish both the individual and the traditional or Roth IRA custodian (or plan administrator) a copy of the completed form whereon the individual sets forth his or her instructions regarding the allocation of the after-tax and pretax amounts.

Without question these direct rollover plan transactions are becoming more complicated, and the IRS should adopt procedural changes so that all parties will be better informed


SIMPLE-IRA Summary Description — IRA Custodian Must Furnish by October 2014 for 2015

Posted by James M. Carlson
Aug 18 2014

What are a financial institution’s duties if it is the custodian or trustee of SIMPLE IRA funds? After a SIMPLE IRA has been established at an institution, it is the institution’s duty to provide a Summary Description each year within a reasonable period of time before the employees’ 60-day election period. CWF believes that providing the Summary Description 30 days prior to the election period would be considered “reasonable.”

The actual IRS wording is that the Summary Description must be provided “early enough so that the employer can meet its notice obligation.” You will want to furnish the Summary Description to the employer in September or the first week of October. The employer is required to furnish the summary description before the employees’ 60-day election period.

IRS Notice 98-4 provides the rules and procedures for SIMPLEs. This notice is reproduced in CWF’s 2014 IRA Procedures Manual.

The Summary Description to be furnished by the SIMPLE IRA custodian/trustee to the sponsoring employer depends upon what form the employer used to establish the SIMPLE IRA plan.

As you are probably aware, the employer may complete either Form 5305-SIMPLE (where all employees’ SIMPLE IRAs are established at the same employer-designated financial institution) or Form 5304-SIMPLE (where the employer allows the employees to establish the SIMPLE IRA at the financial institution of his or her choice).

There will be one Summary Description if the employer has used the 5305-SIMPLE form. There will be another Summary Description if the employer has used the 5304-SIMPLE form. If you are a user of CWF forms, these forms will be Form 918-A and 918-B.

The general rule is that the SIMPLE IRA custodian/trustee is required to furnish the summary description to the employer. This Summary Description will only be partially completed. The employer will be required to complete it and then furnish it to his employees. The employer needs to indicate for the upcoming 2015 year the rate of its matching contribution or that it will be making the non-elective contribution equal to 2% of compensation.

However, in the situation where the employer has completed the Form 5304-SIMPLE, the IRS understands that many times the SIMPLE IRA custodian/trustee will have a minimal relationship with the employer. It may well be that only one employee of the employer establishes a SIMPLE IRA with a financial institution. In this situation, the IRS allows the financial institution to comply with the Summary Description rules by using an alternative method.

To comply with the alternative method, the SIMPLE IRA custodian/trustee is to furnish the individual SIMPLE IRA accountholder the following:

  • A current 5304-SIMPLE — this could be filled out by the employer, or it could be the blank form
  • Instructions for the 5304-SIMPL
  • Information for completing Article VI (Procedures for withdrawal) (You will need to provide a memo explaining these procedures.)
  • The financial institution’s name and address. Obviously, if an institution provides the employee with a blank form, he/she will need to have the employer complete it, and, the employee may well need to remind the employer that it needs to provide the form to all eligible employees.

CWF has created a form which covers the “alternative” approach of the Summary Description being provided directly to an employee. The penalty for not furnishing the Summary Description is $50 per day.

Special Rule for a “transfer” SIMPLE IRA.

There is also what is termed a “transfer” SIMPLE IRA.

If your institution has accepted a transfer SIMPLE IRA, and there have been no current employer contributions, then there is no duty to furnish the Summary Description. However, if there is the expectation that future contributions will be made to this transfer SIMPLE IRA, then the institution will have the duty to furnish the Summary Description.

Reminder of Additional Reporting Requirements The custodian/trustee must provide each SIMPLE IRA account holder with a statement by January 31, 2015, showing the account balance as of December 31, 2014, (this is the same as for the traditional IRA), and include the activity in the account during the calendar year (this is not required for a traditional IRA). There is a $50 per day fine for failure to furnish this statement (with a traditional IRA, it would be a flat $50 fee).


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

U.S. Government Enters the Roth IRA Business with myRA !

Posted by James M. Carlson
Jun 12 2014

The Obama administration has done many things to expand the role of the federal government in the lives of ordinary Americans, but it has recently taken a giant step forward so that the federal government can take a more active role with respect to retirement savings and investments.

The United States is going into the IRA business, more specifically the Roth IRA business. myRA is a Roth IRA, nothing more and nothing less. The Treasury Department does not make this fact as clear or as transparent as it should. There is no discussion that the maximum contribution amount for a person younger than age 50 is $5,500, for a person age 50 or older is $6,500 and that these limits are reduced by other IRA contributions. There is no discussion of the fact that an individual’s maximum contribution amount is reduced when his or her MAGI is in the range of $114,000-$129,000 and $181,000 to $191,000. There is no discussion that a person must have compensation in order to make a contribution to a myRA just as if he or she must have when making a contribution to a Roth IRA.

Rather than investing a person’s Roth IRA contributions in a time deposit, certificate of deposit, or savings accounts as offered by an FDIC insured financial institution or other non-insured investments as offered by investment firms, the myRA contributions will be invested in a special investment or deposit account that “will earn interest at the same variable rate as the Government Securities Investment Fund in the Thrift Savings Plan for federal employees.“ myRA’s will be backed by the full faith and credit of the United States.

The U.S. Department of the Treasury will either administer the myRA Program itself or hire a financial institution to serve as the Roth IRA custodian/trustee and administer these accounts. Under current law, the governing IRA regulation does not authorize the U.S. government to serve as an IRA custodian/trustee. Late 2014 is the tentative goal of the Treasury to implement the myRA program. Most likely this program will not be implemented until after the November 2014 elections. Many new forms will need to be written for the myRA and computer software will need to be developed and tested.

The main features of the myRA program are:

  1. Small contributions may be made. An initial contribution of $25 is required and subsequent contributions would need to be $5.
  2. No administrative fees would be charged – opening, closing, transferring, distributions, investing, etc. A guarantee is given that there may be no investment loss.
  3. myRA is initially to be a payroll deduction program. That is, the individual cannot make his or her contributions via the web. Rather, the individual’s employer must withdraw the contribution amount from each individual’s payroll and that day the employer will send a direct deposit to each participating employee’s myRA. The employer’s role is limited to providing information to its employees as to how the myRA program works, having the employee complete a form as to how much is to be withheld and then transmitting such myRA contributions. An individual would sign-up online.
  4. Distributions may be taken at any time. It will be interesting to see if a person will be able to withdraw funds online. Rollovers will also be permitted. Additional guidance will need to be furnished by the IRS. An individual will be able to voluntarily roll over his or her myRA to another eligible retirement. Under current law, the only plan to which Roth IRA funds may be rolled over to is another Roth IRA. Presumably, the only plan that myRA funds may be rolled over to is a Roth IRA. Once the balance in the myRA reaches $15,000 or after 30 years, the balance in the myRA must be rolled over to a Roth IRA as authorized by current law. The Treasury Department seems to give the impression that there might be other private sector retirement accounts that could accept such a rollover. There is no discussion of transferring funds from a myRA to a Roth IRA.

What is the Obama administration and the current Treasury Department leaders trying to accomplish by creating this myRA program?

The Obama administration does want more individuals to save for retirement. This is an important public purpose. The reality is, however, too many individuals are not making the IRA contributions one would expect or hope would be made. Not everyone participates in a 401(k) plan. Due to the complexity of the federal tax laws applying to pension plans, many small employers don’t sponsor pension plans for their employees. Once the economy improves, it may be that such employees would make IRA contributions.

The myRA program is a trial program. It may be an unspoken trial program, but that is what it is. Many in the Obama administration would like to see the U.S. government do much more than is presently being done to assure the majority of low and moderate income individuals will have retirement funds in addition to Social Security.

After seeing how the myRA program works or doesn’t work, the Obama administration may try to seek to have all employers, even small employers, sponsor and make contributions to federally run profit sharing/pension plans or federally run employees’ IRAs. That is contributions by employers become mandatory rather than voluntary as under existing law. And the government makes the investments rather than the individuals, as too many individuals tend to make poor investments.

Time will tell if sufficient employers will voluntarily participate in the myRA program to make it a success. We have doubts. Certainly the goal to increase retirement savings is worthwhile, but a simpler approach has a better chance of accomplishing this. The simplest approach is that the individual makes a contribution into his or her own IRA without involving the employer.


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 Grants Temporary Relief to Sponsors of One-Person Plans Who Failed to File One or More 5500-EZ Forms, Including For a Terminated Plan

Posted by James M. Carlson
May 23 2014

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