IRA BLOG

OPENING AN IRA ACCOUNT AND IRA ROLLOVERS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

Hello,

I am aware of the IRA one-rollover-per-year rule. What I can’t find is if a married couple that files jointly violates the rule if they each do a rollover from their own individual IRAs?

For example: One person has an IRA in their name and takes a distribution and rolls it over within the 60-day limit avoiding the taxable distribution. Now, can the other spouse also take a distribution from their own IRA and do the same without incurring a taxable distribution?

Thanks so much.

Maggie

Answer:

Hi Maggie,

Good news for married couples! While the once-per-year rule is strict and limits an IRA owner to rolling over only one IRA distribution in a 365-day period, this rule applies per person, not per couple. In your example, each spouse could do a rollover within the same 365-day period without concern about the once-per-year rule.

Question:

I am 71 years old as of March 2020.  Does the SECURE Act permit me to open a new spousal IRA account this year?

Steve

Answer:

Hi Steve,

The SECURE Act does away with the age limit for IRA contributions for contributions made for 2020 or later. This would include spousal contributions. So, if you file jointly and your spouse has enough earned income to cover your contribution, you can make spousal contribution to your IRA for 2020 regardless of your age.

https://www.irahelp.com/slottreport/opening-ira-account-and-ira-rollovers-todays-slott-report-mailbag

TOP 12 RMD WAIVER QUESTIONS

By Andy Ives, CFP®, AIF®
IRA Analyst

As we have written on many occasions, the “Coronavirus Aid, Relief, and Economic Security Act” (CARES Act) waives required minimum distributions (RMDs) for 2020. This waiver applies to company savings plans and IRAs, including both inherited traditional and inherited Roth IRAs. While that sounds like a straightforward announcement, the RMD waiver has generated a landslide of inquiries and confusion since the CARES Act was passed in late March. Here are a dozen of the most popular and widely applicable Yes/No questions and answers:

1. My RMD is sent to me automatically on a monthly schedule. Even though I already took a portion of my 2020 RMD, can I stop the remaining monthly payments? YES

2. My 75-year-old father passed away in January without taking his 2020 RMD. Now my siblings and I are establishing inherited IRAs. Do we need to take his year-of-death RMD? NO

3. Can I still take my 2020 RMD if I want to? YES

4. Since RMDs are waived for 2020, if I decide to take it anyway, does that mean there is no tax due on that withdrawal? NO

5. If I received multiple 2020 RMD payments, can I roll them all back to my IRA? YES (as long as they are all returned by August 31, 2020).

6. I have an inherited IRA and already took my RMD. Can I roll it back/replace it? YES (as long as the inherited RMD is repaid to the same IRA by August 31, 2020).

7. Will I need to take both my 2020 and my 2021 RMD next year? NO

8. Since RMDs are waived, can I do a Roth conversion without taking my RMD first? YES

9. I turned 70½ last year and my first RMD was for 2019, but my required beginning date was April 1, 2020. I delayed taking this first RMD until 2020. Is that RMD waived under the CARES Act? YES

10. Can I now roll my 401(k) into an IRA without taking the 2020 RMD? YES

11. Can I still do a qualified charitable distribution (QCD) even though my RMD is waived? YES (as long as you are otherwise eligible).

12. Do I need to be  an “affected person” under the coronavirus rules for the RMD waiver to apply to me? NO

https://www.irahelp.com/slottreport/top-12-rmd-waiver-questions

A ROUNDUP OF RECENT DOL AND IRS RETIREMENT PLAN GUIDANCE

By Ian Beger, JD
IRA Analyst

There’s been a flurry of recent government regulation of company retirement plans. Here’s a quick summary:

Electronic Disclosure of Retirement Plan Documents

On May 27, 2020, the Department of Labor published a final regulation making it easier for employers to issue retirement plan notices to participants electronically. Notices can be posted on a website or mobile app or delivered via email. Employees who prefer hard copies can opt out of electronic delivery and receive paper disclosures instead. The DOL rule applies only to retirement plan notices required under ERISA (e.g., summary plan descriptions). It does not apply to notices required by the Internal Revenue Service or employer health plan communications.

Employers are not required to use the new regulation. They may instead rely on an existing DOL rule allowing electronic disclosure in limited situations. Or, they can furnish paper documents by hand-delivery or by regular mail. The new rule is effective July 27, 2020.

Private Equity Investments in 401(k) Plans

For the first time, the DOL has endorsed the use of private equity as an investment option in 401(k) plans. (In a nutshell, private equity is ownership of company shares that, unlike stocks, are not publicly traded.) For many years, defined benefit plan sponsors have invested plan assets in private equity. However, 401(k) plan sponsors have been reluctant to offer it as part of their investment menu because of ERISA liability concerns.

The DOL guidance, issued June 3, 2020, allows plan sponsors to make private equity available as one part of a 401(k) investment option that also offers other, more traditional, investments (for example, a target date fund that also offers stocks and bonds). Plan sponsors cannot offer direct investment in private equity. Proponents of the new rule say that it will open up these investments to rank-and-file employees who have been shut out of the opportunity. Critics say that its risk profile, high fees and lack of transparency make private equity an inappropriate investment for most employees.

ESG Investments

In recent years, defined benefit plan sponsors have been under increasing pressure to take into account ESG (environmental, social and governance) criteria when choosing appropriate investments for plan funds. On June 23, 2020, the DOL proposed a new rule warning that ERISA requires that economic considerations be the sole focus in selecting plan investments. ERISA fiduciaries may not invest in any investment vehicle that is more concerned with satisfying ESG criteria than making money.

The DOL guidance does allow more leeway for offering ESG funds as an investment option under a 401(k) plan.

The regulation is proposed and will not become final until after comments are received and considered by the DOL.

Suspending or Reducing 401(k) Safe Harbor Contributions

Many 401(k) plans offer “safe harbor” employer contributions as a way of automatically satisfying nondiscrimination tests. The contributions can be either matching contributions or across-the-board contributions. One condition for using the safe harbor is that contributions must normally remain in effect for the entire plan year.

In Notice 2020-52, issued June 29, 2020, the IRS allows employers to suspend or reduce safe harbor contributions after March 13, 2020 for the balance of the year, regardless of whether the employer is suffering an economic loss. However, to take advantage of this relief, the employer must adopt a plan amendment suspending or reducing the safe harbor contributions by August 31, 2020.

https://www.irahelp.com/slottreport/roundup-recent-dol-and-irs-retirement-plan-guidance

 

THE CARES ACT AND RMDS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

If someone took two IRA distributions earlier in 2020 that were considered RMDs, and now wishes to repay the cumulative amount back into the same IRA, are there any rules about the number of rollover deposits they can make in order to do so? Must it be done in 1 transaction, or 2, or could it be spread out across even more?

Thank you,

Adam

Answer:

Adam,

With IRS Notice 2020-51, released on June 21, the one-rollover-per-year rule and the 60-day rollover rule can both be bypassed for RMD payments that are returned by August 31, 2020. In your situation, one of the earlier RMD payments can go back as a rollover, and the other can be returned to the same IRA as a “repayment.” There is no limit on the number of “repayments” that can be done, as long as they are a return of RMD dollars and go back to the same IRA from which the RMD originated.

Question:

My custodian messed up my 2019 RMD (I’m in my 80s) and didn’t distribute it until January 10, 2020.  When I filed my 2019 taxes, I asked for a waiver of the 50% penalty on the missed 2019 RMD, armed with a letter from my custodian, and as expected, got it.

Now it’s June 2020 and RMDs for 2020 are fully waived. Is my January 10, 2020 distribution (taken to fulfill my 2019 RMD) considered a RMD for 2020 and therefore waived and eligible for rollover?

Also, a large part of the January 2020 distribution was for my 2019 withholding, which unfortunately went into 2020 rather than 2019.  ls there a way to reverse it or to apply 2020 tax payments to my 2019 taxes due July 15th?

Answer:

The CARES Act waived RMDs due in 2020. While it was taken in calendar year 2020, your distribution on January 10 was an RMD that was actually due in 2019. As an RMD due in 2019, it does not fall under the CARES Act waiver. As for the taxes withheld, since the distribution was actually taken in calendar year 2020, those dollars withheld will apply to 2020. Unfortunately, there is no way to reverse the withholding or to assign dollars withheld in 2020 to the previous year.

https://www.irahelp.com/slottreport/cares-act-and-rmds-todays-slott-report-mailbag

EXCEPTIONS TO THE 10% EARLY DISTRIBUTION PENALTY FOR IRAS

By Sarah Brenner, JD
IRA Analyst

IRAs are supposed to be for saving for retirement but in challenging economic times like these many individuals may be forced to take distributions before retirement age. Be careful! If you tap your IRA before reaching age 59 ½, the bad news is that you run the risk of being hit with the 10% early distribution penalty. The good news is that there are some exceptions to this penalty. You IRA distribution will still most likely be fully taxable, but you can spare yourself the additional 10% penalty if one of these exceptions apply to you.

Birth or Adoption

Beginning in 2020, the SECURE Act adds a new 10% penalty exception for births or adoptions.  It is limited to $5,000 for each birth or adoption. To qualify, the distribution must be taken within one year from the date of birth or when the adoption in finalized.

First Home Purchase

If an individual takes a distribution from their IRA and uses the funds to acquire a first home, the 10% early distribution penalty does not apply. The definition of first-time home buyer for purposes of this exception may not be what many expect. The definition of first-time home buyer is someone who has not owned a home for the past two years. The first-time home buyer may be the IRA owner but certain family members can qualify as well. A spouse, or a child, grandchild, parent or grandparent of the IRA owner or their spouse all qualify.

Higher Education

If an individual takes a distribution from their IRA for qualified higher education expenses, the 10% early distribution penalty does not apply. Such expenses include post-secondary tuition, fees, books, supplies and required equipment. The education expenses must occur in the same year as the IRA distribution.

Health Insurance for the Unemployed

If an individual takes a distribution from their IRA to pay for health insurance when unemployed, the 10% early distribution penalty does not apply. The insurance can be for the IRA owner, a spouse, or dependents.

Death

A distribution taken from an inherited IRA after the death of an IRA owner is never subject to the 10% penalty. It does not matter what the age of the IRA owner was or what the age of the beneficiary is.

Disability

If an individual takes a distribution from their IRA, the 10% penalty will not apply if they are disabled. The standard for disability for this purpose is a strict one and it is difficult to meet. The IRA owner must be unable to engage in any gainful activity because of a physical or mental condition. The condition must be expected to last a long or indefinite period of time or be expected to result in death. In other words, the disability must be total and permanent.

72(t) Payments

IRA owners may set up a series of payments from an IRA and avoid the early distribution penalty. These payments are sometimes called 72(t) or substantially equal periodic payments. To qualify, the payments must be calculated in a very specific way and must be taken at least annually. If there is a modification of the payments before the individual reaches age 59 ½ or before five year have passed, she will be hit with the 10% penalty on all distributions already taken prior to age 59 ½ under the payment plan.

Reservist Distributions

A reservist who is called to active duty after September 11, 2001 for more than 179 days or for an indefinite period of time may take penalty-free distributions from their IRA.  The distribution must be made no earlier than the date the reservist was called to active duty and no later than the end of the active duty period. Also, the IRA owner can repay part or all of these distributions to an IRA within a two-year period after the active duty period is over.

Deductible Medical Expenses

IRA distributions are not subject to the 10% penalty if the distribution does not exceed the IRA owner’s deductible medical expenses for the year. The medical expenses can be for the IRA owner, a spouse or a dependent. An individual is not required to itemize deductions on their tax return in order to be eligible for this exception.

Tax Levies

IRA funds paid due to a tax levy by the IRS are not subject to the early distribution penalty. This only applies when the IRA is actually levied by the IRS.

https://www.irahelp.com/slottreport/exceptions-10-early-distribution-penalty-iras

SIX MONTHS OF CRAZY – A SUMMARY OF RECENT RETIREMENT EVENTS

By Andy Ives, CFP®, AIF®
IRA Analyst

After a six-month sprint through a diabolical obstacle course of new laws, a pandemic, record unemployment, deaths, confusion and complete disruption of everyone’s professional and personal lives, this seems like a good time to recap the madness of the previous 180 days.

January 1, 2020 – The Setting Every Community Up for Retirement Enhancement (SECURE) Act became effective. Remember this law? Passed in late December, the SECURE Act upended the retirement world. Some of the SECURE Act’s more consequential changes include:

· RMD age raised to 72.

· Age limit eliminated for traditional IRA contributions.

· Annuities more readily available in employer plans.

· Stretch payments on inherited IRAs eliminated for all but an entirely new class of “Eligible Designated Beneficiaries.”

January/February 2020 – Rumblings in the news about a virus.

February 24 – 28 – Worldwide stock markets report largest one-week declines since the 2008.

March 13, 2020 – National emergency declared due to the coronavirus (COVID-19) outbreak. Schools and businesses shuttered. Some hospitals overrun with the sick and dying.

March 20, 2020 – In Notice 2020-18, the Treasury Department and IRS announce the federal income tax filing due date is extended from April 15 to July 15, 2020. This also extended the deadline for making prior-year contributions to Roth and Traditional IRAs.

March 23, 2020 – Dow Jones hits intraday low of 18,213.65.

March 27, 2020 – Coronavirus Aid, Relief and Economic Security (CARES) Act signed into law. In addition to being one of the largest economic stimulus bills in history at over $2 trillion, the CARES Act also impacted retirement accounts, as such:

· Required minimum distributions (RMDs) waived for 2020.

· Coronavirus-related distributions (CRDs) created as a means for eligible individuals to gain access to retirement dollars penalty-free.

· Company plan loan rules expanded.

June 19, 2020 – IRS releases Notice 2020-50 which includes additional information on CRDs. The new guidance makes more individuals eligible for tax-advantaged distributions permitted under the CARES Act.

June 21, 2020 – IRS releases Notice 2020-51. The rollover deadline for repaying unwanted 2020 RMDs is extended to August 31, 2020. Inherited IRA RMDs can be repaid, and the one-rollover-per-year rule is waived for those who took multiple RMD payments in 2020.

Six months of crazy. 180 days. Feels like forever…and I didn’t even mention all the historic events unrelated to retirement. While we are all still figuring things out, this bumpy ride is far from over. Hang on tight, and be safe.

https://www.irahelp.com/slottreport/six-months-crazy-%E2%80%93-summary-recent-retirement-events

CARES ACT COVID-19 DISTRIBUTIONS AND SECURE ACT BENEFICIARY PAYOUTS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Hi Ed,

If a person takes that 100k distribution, can they elect to split evenly in 2020-2022 as income? Or can they determine how to apply the income?

Shannon

Answer:

Hi Shannon,

Those persons who qualify for up to $100,000 of 2020 coronavirus-related distribution (not everyone does) can spread out income evenly over their 2020-2022 tax returns. Or, they can choose to have all of it treated as 2020 income. No other choices are available.

Question:

Under the SECURE Act, are children of the deceased required to change to the 10-year rule after reaching age of majority? I’m reading conflicting information on this. It was my understanding that because they are an eligible designated beneficiary (EDB), they get the benefit of lifetime RMDs.

Also, are Non-EDB’s required to take yearly RMD’s? If yes, how are these calculated since they are not using the Life Expectancy Table?

Thanks for the insight!

Brenda

Answer:

Hi Brenda,

Even though minor children are EDBs, they can use the stretch only until they reach the age of majority (or, until age 26 if still in school). At that point, they are no longer EDBs and must switch to the 10-year payment rule.

The 10-year rule is satisfied as long as Non-EDBs (e.g., adult children or grandchildren) receive the entire account by the December 31 of the tenth year following the year of the original owner’s death. No annual RMDs during the 10 years are required.

https://www.irahelp.com/slottreport/cares-act-covid-19-distributions-and-secure-act-beneficiary-payouts-today%E2%80%99s-slott-report

IRS EXTENDS ROLLOVER DEADLINE FOR 2020 RMDS

By Ian Berger, JD
IRA Analyst

The IRS has extended the rollover deadline for required minimum distributions (RMDs) taken from IRAs or company plans in 2020. In Notice 2020-51, released on June 23, the IRS said that any unwanted 2020 RMDs can be repaid via rollover to an IRA or company plan by August 31, 2020.

Normally, RMDs cannot be rolled over. However, the CARES Act waived 2020 RMDs (and first-time 2019 RMDs delayed until 2020) from IRAs and defined contribution plans. For this reason, amounts received in 2020 that would have been RMDs are eligible for rollover since they are technically not RMDs.

Many individuals had already received RMDs before the CARES Act was signed into law and wanted to repay those amounts to avoid paying taxes on the RMD. Earlier this year, the IRS extended the 60-day rollover deadline until July 15, 2020 for distributions made after January 31, 2020. Individuals receiving RMDs in January 2020 were out of luck. In addition, the once-per-year rollover rule prevented those receiving monthly RMDs from rolling over each RMD. (That rule prohibits an IRA owner from making more than one traditional IRA-to-traditional IRA or Roth IRA-to-Roth IRA rollover in any 12-month period.) Finally, non-spouse beneficiaries were unable to roll over RMDs from inherited IRAs since non-spouse beneficiaries can never do rollovers.

Notice 2020-51 extends the rollover deadline to August 31, 2020. The extended deadline covers RMDs taken any time in 2020 – including in January 2020. The IRS also says that RMD repayments will not count against the once-per-year rollover rule. This will allow all 2020 monthly RMDs to be repaid. The IRS also carved out an exception to allow non-spouse beneficiaries to repay inherited IRA RMDs.

Notice 2020-51 applies to RMD payments only. Withdrawals of non-RMD funds are still bound by the usual 60-day rollover deadline (or the July 15, 2020 deadline for distributions made after January 31, 2020). In addition, distributions of amounts other than RMDs are still subject to the once-per-year rollover rule.

https://www.irahelp.com/slottreport/irs-extends-rollover-deadline-2020-rmds

NEW SEC REG BI APPLIES TO ROLLOVER RECOMMENDATIONS – ARE YOU READY?

Are you acting in your clients’ best interest when it comes to rollovers? On June 30, the new SEC Regulation Best Interest (Reg BI) becomes effective. Reg BI establishes a “best interest” standard of conduct for broker-dealers when they make recommendations to clients of any securities transaction or investment strategy involving securities. Reg BI specifically covers proposals for rolling over funds from a workplace retirement plan account to an IRA.

Under the new standard, brokers must “exercise reasonable diligence, care and skill when making a recommendation to the client.” This requires the financial professional to understand the risks and rewards of the recommendation, as well as its costs, for each client.

Closer scrutiny of client rollover advice means that a comprehensive analysis, including a discussion with the client about rollover benefits and drawbacks, is an absolute must for any advisor. With that in mind, it is imperative for advisors to educate themselves and thoroughly understand all the options and rules governing company plan-to-IRA rollovers.

https://www.irahelp.com/slottreport/new-sec-reg-bi-applies-rollover-recommendations-are-you-ready

IRS EXPANDS ELIGIBILITY FOR CORONAVIRUS-RELATED DISTRIBUTIONS

By Sarah Brenner, JD
IRA Analyst

On June 19, the IRS released additional guidance on coronavirus-related distributions (CRDs) from retirement accounts. The new guidance will make many more individuals eligible for these tax-advantaged distributions allowed under the CARES Act.

What Is a CRD?

If you qualify as an “affected individual”, you can take up to $100,000 of distributions from your IRAs and employer plans in 2020. There is no 10% early distribution penalty if you are under age 59 ½, and you have an option to spread the federal tax on CRDs evenly over a three-year period beginning with the year 2020. You also have a three-year period to repay CRDs to an IRA or employer plan. Taxes can be refunded on the amounts repaid. Repayment does not have to be made to the same IRA or company plan from which the CRD was originally paid. While the 10% penalty is a non-issue you if you are over age 59 ½, you can still take advantage of the other two items of relief if you are eligible.

Increased CRD Eligibility

The new IRS guidance increases eligibility for CRDs by expanding the definition of an “affected individual” to include those who suffer financial hardship as result of having a reduction in pay or having job offer rescinded or delayed due to COVID-19.

Additionally, the new definition includes those who experience financial hardship due to the following new factors: a spouse or a member of the individual’s household being quarantined, furloughed or laid off or having work hours reduced due to COVID-19; being unable to work due to lack of childcare due to COVID-19; having a reduction in pay due to COVID-19; or having a job offer rescinded or start date for a job delayed due to COVID-19; or closing or reducing hours of a business owned or operated by the individual’s spouse or a member of the individual’s household due to COVID-19.

The complete guidance released by the IRS can be found here: https://www.irs.gov/pub/irs-drop/n-20-50.pdf

Good Advice is Essential

Do you have questions as to whether you fit the new expanded definition of “affected individual”? Or, are you unsure whether a CRD is the right move for you? In these turbulent times, good advice is more essential than ever. Be sure to discuss your situation with a qualified tax or financial advisor.

https://www.irahelp.com/slottreport/irs-expands-eligibility-coronavirus-related-distributions

60-DAY ROLLOVERS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

Thank you for all the great resources you provide. I have been looking for an answer to my specific situation and have not been able to find a clear answer to what I think is a pretty straight forward situation/fact pattern.

I take my RMDs spread over a monthly basis on the 6th of each month. (I have taken four in 2020 – Jan, Feb, Mar, Apr). Under the new legislation that extends the “60-day rollover window” for distributions taken on or after February 1, 2020 to July 15, 2020, am I able to roll back all three distributions (Feb, Mar and Apr) in one contribution (rollover) into my IRA, or am I limited to only being able to roll back one month’s worth of distributions?

Thanks for your help and all you do.

Dale

Answer: 

This is a question that we have been getting frequently in the wake of the CARES Act waiving RMDs for 2020. Many individuals have their RMDs set up to come out of their IRAs monthly. Unfortunately, the once-per-year rollover rule will limit you to rolling over only one of these distributions from your IRA. The news is better if your RMDs are being distributed monthly from an employer plan. In that case, all the distributions could be rolled over because the once-per-year rule does not apply to plan-to-IRA rollovers.

Question:

Hello,

Our company currently subscribes to your publications. We had question we were hoping you could help us with.

If someone were to take a $10,000 IRA distribution on November 15, 2020 and then decided to use a 60 – day rollover and redeposit the funds in 2021, would they be able to reduce their 2021 RMD because the 2020 year-end balance would be lower by the $10,000?

Also, what would be the tax impact for 2020 and 2021? Would they need to still pick up the $10,000 income in 2020 even though it was re-contributed in 2021? It is our understanding that the 2020 1099-R would report the $10,000 as a taxable distribution.

We would appreciate any insight. Thanks again.

Best,

Nick

Answer:

There is no loophole here allowing for a reduced RMD for the next year if funds are not part of the December 31 IRA balance. While normally an RMD is calculated using the December 31 prior-year balance, the rules require that the balance be adjusted for an outstanding rollover. In other words, using your example, the $10,000 that was distributed in 2020 but rolled over in 2021 would need to be added to the December 31, 2020 balance used to calculate the 2021 RMD.

The $10,000 distribution would be reported on a 2020 Form 1099-R. It would not be taxable, however, because it was rolled over. This is true even though the rollover happened in 2021.

https://www.irahelp.com/slottreport/60-day-rollovers-todays-slott-report-mailbag

FIX/NO FIX – CORRECTING RETIREMENT TRANSACTIONS, AND THOSE THAT ARE LOST

By Andy Ives, CFP®, AIF®
IRA Analyst

FIX: Rolling Over the Tax Withheld on a Distribution. Was the mandatory tax of 20% withheld on your work plan withdrawal even though you intended to roll over the entire account? Did you change your mind on an IRA withdrawal and now want to roll it back, but you elected to have taxes withheld on the initial distribution? If money was withheld for taxes on a distribution from a work plan or an IRA and you want to roll over the distribution plus taxes withheld, you can make up the difference “out-of-pocket.” The money withheld and sent to the IRS is gone, but you can replace that withholding with other dollars, roll over the full amount, and have a credit waiting for you for the amount withheld when you do your taxes next year.

NO FIX: No Rollover for Non-Spouse Beneficiary Inherited IRA. If you took a distribution from your inherited IRA with the idea of moving the account to another provider via a 60-day rollover, you made an egregious error. Non-spouse owners of inherited IRAs are not permitted to do 60-day rollovers, and there is no way to put the money back. The full distribution amount is now yours to keep…along with any taxes that might apply.

FIX: Missed RMD. Failure to take a required minimum distribution (RMD) is commonplace. Whether it is an RMD from your own IRA, the year-of-death RMD for a recently deceased account owner, or an RMD from an inherited IRA, they are frequently missed. While the penalty is 50% of the untaken RMD amount, there is a fix. Take the missed RMD. Properly complete tax Form 5329 (“Additional Taxes on Qualified Plans”). Fall on your sword in a letter to the IRS and say that it will never happen again. You should have a positive outcome.

NO FIX: Unwanted Roth Conversion. If you did a Roth conversion and decided later that you could not afford the tax bill, or maybe the Roth conversion disqualified you from financial aid, there is no going back. Roth conversions are permanent and cannot be recharacterized.

FIX: Changing a Roth Contribution to a Traditional IRA (or vice versa). While recharacterizing a Roth conversion is off the table, recharacterizing a Roth contribution is still an option. If you made a contribution to a Roth IRA and later learned that you did not qualify due to the income restrictions, or if you made a contribution to a traditional IRA and later learned that you could not deduct the contribution, both of those contributions can be recharacterized (changed) to the other type of IRA. It will be as if the original contribution was made to the proper IRA. The deadline for recharacterizing a contribution is October 15 of the year after the contribution. (Or you could simply withdraw the contribution by the same cut-off date.)

NO FIX: Botching a Net Unrealized Appreciation (NUA) Transaction. If you are eligible for NUA and fail to complete a lump sum distribution after a trigger event, or if you roll over your company stock to an IRA, there is no going back. The NUA opportunity is lost forever.

FIX: Excess IRA Contribution. Before the October 15 deadline? Remove the excess contribution plus all net income attributable (NIA). No tax forms due, no 6% penalty. After the deadline? Remove the excess, file Form 5329, and pay the 6% penalty. (Surprisingly, the NIA can remain in the account when the fix is addressed after the deadline.)

https://www.irahelp.com/slottreport/fixno-fix-%E2%80%93-correcting-retirement-transactions-and-those-are-lost

IRS ALLOWS REMOTE WITNESSING OF SPOUSAL WAIVERS

By Ian Berger, JD
IRA Analyst

In the wake of the coronavirus pandemic, the IRS has temporarily relaxed the rule that spousal consent to certain retirement plan distributions and loans must be witnessed personally by a notary public or a plan representative. In Notice 2020-42, issued June 3, 2020, the IRS says that remote witnessing can be used for 2020 spousal waivers.

This issue arises most frequently when a married participant in a private-sector defined benefit plan or money purchase pension plan elects a lump sum distribution (including a coronavirus-related distribution under the CARES Act) or a plan loan. The plan is not allowed to pay the lump sum or make the loan unless the participant’s spouse gives written consent. [This spousal consent rule does not apply to most 401(k) or 403(b) plans or any governmental or church-sponsored plans.] IRS rules require that spousal consent must be witnessed in the physical presence of a notary public or a plan representative.

Written spousal consent is also required when a married participant in any private-sector plan [including a 401(k) or 403(b) plan] chooses a beneficiary other than the spouse. Here again, a notary or a plan representative must personally witness the spouse’s consent.

Because of the social distancing and stay-at-home practices required during the coronavirus crisis, satisfying this physical presence requirement has been challenging. In light of this, the IRS has waived this requirement for any spousal consents made in 2020. The new rules are different depending on whether the consent is witnessed by a notary or by a plan representative.

Elections witnessed by a notary public can be made remotely through live audio-visual technology (such as a Zoom conference call), as long as the system complies with state notary requirements.

As an alternative to witnessing by a notary, many plans allow a plan representative to witness spousal waivers. During 2020, those elections can also be made remotely through live audio-visual technology, as long as the following requirements are satisfied:

· The spouse must show a valid photo ID to the representative during the conference call;

· The conference must allow for live interaction between the spouse and the plan representative;

· The spouse must fax or email a copy of the signed document to the representative on the same day it is signed; and

· After receiving the document, the representative must return the signed document back to the spouse with an acknowledgement that it was witnessed remotely.

These new rules should help resolve what had been a thorny plan administrative issue brought about by the public health crisis.

https://www.irahelp.com/slottreport/irs-allows-remote-witnessing-spousal-waivers

SPECIAL NEEDS TRUSTS AND CRDS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Under the SECURE Act, if we can assume a Special Needs Trust can qualify for the stretch via the disabled beneficiary, what happens when the special needs trust beneficiary passes? The next named beneficiary (remainder) is a brother and/or nephew under this trust. Yet it’s already an inherited IRA. Would that formula continue to the next remainder beneficiary in line, i.e., would the stretch continue?

Answer:

The SECURE Act left many questions unanswered, especially when it comes to trust beneficiaries, but your situation may have an answer. You are correct that, under the new law, there are special rules for a trust for disabled or chronically ill beneficiaries that allow RMDs to be paid from the IRA to the trust using the beneficiary’s life expectancy. For these beneficiaries, the SECURE Act includes a provision allowing for “applicable multi-beneficiary trusts.” One of the ways to qualify as an “applicable multi-beneficiary trust” is to provide that no beneficiary, other than an eligible designated beneficiary, has any right to the IRA funds until the death of the eligible designated beneficiary. In your situation, assuming none of the remainder beneficiaries are disabled or chronically ill, upon the death of the disabled beneficiary, the remainder beneficiaries will be subject to the 10-year payout rule. There is no continuation of the original stretch. However, if any of the remainder beneficiaries are disabled or chronically ill, the SECURE Act does not tell us how payouts will be treated. Future IRS guidance will be needed.

Question:

Hi Ed,

If a person takes a $100k distribution, can they elect to split it evenly in 2020-2022 as income? Or can they determine how to apply the income?

Shannon

Answer:

Shannon,

I believe you are referring to a Coronavirus-Related Distribution (CRD) created under the CARES Act. Assuming a person qualifies for a CRD and takes the maximum $100,000, the income from that distribution can all be applied to 2020, or it can be spread evenly over the three years (2020 – 2022). There is currently no option to divide up the income in any other manner.

https://www.irahelp.com/slottreport/special-needs-trusts-and-crds-todays-slott-report-mailbag

SECURE ACT’S 10-YEAR RULE BRINGS NEW PLANNING OPPORTUNITIES

By Sarah Brenner, JD
IRA Analyst

By now, most IRA owners have heard the bad news. The SECURE Act eliminates the stretch IRA for the majority of beneficiaries who inherit in 2020 or later. Instead, for most, a 10-year payout rule will apply. Here is how this new rule works and how, for some beneficiaries, there may be new planning opportunities available.

How It Works

This new 10-year rule works like the old 5-year rule worked. There are no annual RMDs. Instead, the entire account must be emptied by the 10th year after the year of death. In the 10th year following the year of death, any funds remaining in the inherited IRA would then become the required minimum distribution (RMD). If the funds are not taken by the deadline, a 50% penalty would be owed.

The Opportunities

While many IRA owners will miss the stretch IRA, for some, the 10-year rule may be beneficial. Even when the stretch IRA was available, not all beneficiaries used it. Not every beneficiary was interested in keeping an inherited IRA open for years and years. Some beneficiaries want the money faster. For them, the 10-year rule is a good fit.

Those beneficiaries that did take advantage of the stretch were locked into a rigid annual RMD schedule. The annual RMD had to be taken regardless of the beneficiary’s tax situation or there would be a 50% penalty. There were no other options.

What the new 10-year rule offers is flexibility. During the 10-year period, the beneficiary may choose to take nothing during a particular year or large distributions in others, as long as the account balance is emptied by the end of the 10-year term. This provides a tax planning opportunity. Distributions can be structured in such a way as to minimize the tax hit. There are no restrictions as long as the account is emptied by the end of the tenth year following the year of death.

The 10-year rule also provides a big opportunity for Roth IRA beneficiaries. Distributions from inherited Roth IRAs are almost always tax-free. A beneficiary could take no distribution until the tenth year, leaving all the earnings in the inherited Roth IRA to grow tax-free. The account could then be emptied in the tenth year after years of tax-free growth with no tax bill for the beneficiary.

Good Advice is Essential

Maybe you inherited an IRA in 2020 and are concerned about the 10-year rule. Or, maybe you are considering your estate plan and are thinking about how your beneficiaries will fare under the new rules. Now is a good time to consult with a knowledgeable tax or financial advisor. While the stretch IRA will be missed, the SECURE Act 10-year rule allows for new planning opportunities for those willing to think outside the box.

https://www.irahelp.com/slottreport/secure-act%E2%80%99s-10-year-rule-brings-new-planning-opportunities

ROTH CONVERSIONS: PAYING TAXES FROM ANOTHER SOURCE

By Andy Ives, CFP®, AIF®
IRA Analyst

The King of the Land wanted to send 100,000 of his greatest warriors off to battle. However, he was told that 20,000 of the warriors needed to remain behind to protect the castle. The King of the Land did not like this news. He wanted a full complement of soldiers in the fight. So, the King of the Land decided to send all 100,000 warriors off to battle, and he used an additional 20,000 warriors from another army to protect the castle.

The investor wanted to convert $200,000 of his traditional IRA to a Roth IRA. However, it was recommended that he withhold 24% for taxes. The investor did not want to send only $152,000 to his Roth. The investor wanted all $200,000 growing tax-free. So, the investor had 0% withheld, converted the full $200,000, and used $48,000 from a non-qualified savings account to pay the taxes due.

Roth conversions are a taxable event that add to ordinary income for the year of the conversion. While the tax is not due immediately upon conversion, it will be owed at tax time. To get ahead of a potentially large tax hit, one can have a certain amount withheld at the time of the conversion (i.e., sent to the IRS). Any amount can be withheld for taxes, and the choice is yours.

The drawback is that withheld taxes that could otherwise be moved to the Roth IRA get sent to the government. For some, withholding is their only option. They may not have another source of funds to pay the taxes. They have no other army to protect their castle. But for those that do have other means, it is suggested they be leveraged. This is especially true for anyone doing a Roth conversion under the age of 59 ½ for the reasons outlined here:

Example: Jonathan is 45 years old and handles all his financial affairs on-line with no professional guidance. After logging into his account, he converts $50,000 to a Roth IRA and elects to have 20% withheld for taxes. Jonathan’s conversion results in only $40,000 going to the Roth ($50,000 x 80% = $40,000). The 20% withheld for taxes ($10,000) never actually gets converted and is, technically, a withdrawal prior to the conversion. Since Jonathan is under 59 ½ and no other exception applies, there is a 10% early withdrawal penalty ($1,000) on the money that was sent to the IRS. In addition, the $50,000 counts as ordinary income for the year, which pushes Jonathan above the income threshold for the financial aid he was receiving for his daughter’s college education.

Be careful before diving headfirst into a Roth conversion. Evaluate your income for the year and determine how much wiggle room you have before potentially pushing into the next tax bracket. Remember that Roth conversions can impact financial aid, IRMAA surcharges and other items based on income. While tax-free earnings in a Roth are a great motivator, also understand that using IRA funds to pay taxes on a conversion will reduce the conversion amount, thereby potentially setting your retirement account back.

Not everyone has extra cash in a non-qualified account available to cover the taxes on a Roth conversion. For that reason alone, it is imperative to do your homework. Consult with a financial professional. Understand the math and if a Roth conversion makes sense for you. Be the King of Your Land and protect your financial castle.

https://www.irahelp.com/slottreport/roth-conversions-paying-taxes-another-source

2020 RMD WAIVERS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I understand that I don’t have to take any RMDs during 2020.  However, is the CARES Act rule that it is an-all-or-nothing for RMDs or can I take a portion of my RMD for 2020 but not all

John

Answer:

Hi John,

Since RMDs are waived this year, you have complete flexibility. In 2020 you can take none of what would have been your RMD, some of it, all of it, or even an amount greater than what would have been your RMD amount.

Question:

Hello,

Under the CARES Act, I understand that a beneficiary of an inherited IRA may not return/rollover any RMD already taken in 2020 back into the IRA. But what if the beneficiary just inherited the IRA in 2020?  It is actually the decedent’s RMD that the beneficiary removed prior to enactment of the CARES Act.  May the beneficiary roll the decedent’s RMD back in?  I would appreciate your guidance on this.

Veronica

Answer:

Hi Veronica,

Since RMDs are waived for 2020, the decedent did not have an RMD for this year. As such, there is no year-of-death RMD. But some RMDs were taken before the waiver was announced, which sounds like your situation. Immediately upon death, the account belongs to the beneficiary, and any distributions are the beneficiary’s, not the decedent’s. The beneficiary here is simply a victim of timing. Non-spouse beneficiaries may never do IRA rollovers, including “return” rollovers of subsequently-waived RMDs already taken in 2020.

https://www.irahelp.com/slottreport/2020-rmd-waivers-today%E2%80%99s-slott-report-mailbag

SHOULD I TAKE A LUMP SUM BUYOUT?

By Ian Berger, JD
IRA Analyst

As a result of the current economic downturn, we can expect more and more companies to offer lump sum buyouts to employees with defined benefit (DB) plan benefits. A lump sum buyout is a limited opportunity for DB plan participants to elect one lump sum distribution in exchange for giving up future periodic payments.

The decision of whether to accept a lump sum buyout is a difficult and important one. Because the stakes are so high, it is crucial that you consult with a financial advisor before making a final decision. Here are several factors that you and your advisor should consider:

· What are the terms of the buyout? The plan calculates your lump sum amount by determining the present value of future payments, using interest rate assumptions. The lower the interest rate assumption, the higher the lump sum. A lump sum offered in the current environment of very low interest rates is likely to be as high as it will ever be.

· How financially secure is the plan and the plan sponsor? If the DB plan sponsor goes out of business with an underfunded plan, your existing or future pension payments may be reduced. That would be a factor favoring a lump sum distribution. The Pension Benefit Guaranty Corporation (PBGC) insures pension benefits up to a certain amount. But, since the PBGC is experiencing severe financial difficulties, you probably shouldn’t count on the PBGC guarantee.

· How is your health? The lump sum offered you is calculated on the basis of average life expectancies. If you expect to outlive your life expectancy, then you may want to consider passing up the lump sum. However, if you are facing medical issues, taking the buyout offer might be the right decision.

· How much financial discipline do you have? It is extremely tempting to be offered an unexpected check for tens (or even hundreds) of thousands of dollars. Make sure you understand what you are giving up in exchange for that lump sum. If you spend the lump sum on a luxury item, it may be difficult to replace the lost monthly income.

· Understand the tax implications. DB plan monthly payments are typically fully taxable in the year received and cannot be rolled over. On the other hand, DB lump sum payments are eligible for rollover to an IRA. Once rolled over, your funds become subject to required minimum distribution (RMD) rules. But aside from that, IRA withdrawals are extremely flexible.

· Will your spouse consent?  If you are married, your spouse must consent before you can receive a lump sum.

These are just some of the factors that should be part of any consideration about accepting a lump sum buyout offer. Remember: Don’t make this crucial decision without getting help from an expert.

https://www.irahelp.com/slottreport/should-i-take-lump-sum-buyout

3 REASONS TO ROLL OVER YOUR RETIREMENT FUNDS TO AN IRA

By Sarah Brenner, JD
IRA Analyst

More than 40 million Americans have filed for unemployment since the Corona virus pandemic hit in in the middle of March. With job loss can come questions of what to do with retirement savings such as your 401(k) plan. A rollover to an IRA may be good move for you. Here are three reasons why:

1. You can continue your retirement savings. When you contributed to your employer’s plan you made the smart decision to save for retirement. Rolling those funds over to an IRA will allow you to preserve those dollars for your retirement and even add to them in the future. You could keep your funds in an IRA and make IRA contributions or you could move the funds over to a future employer’s plan. Either way your retirement savings will remain intact and potentially grow.

2. You can avoid a tax hit. Times are tough and it may be tempting to hold on to any funds distributed to you from your employer plan. If you do, there will likely be a tax bill. Most retirement plan funds are taxable when distributed. Even worse, if you are under age 59 ½ you will be hit with a 10% early distribution penalty, unless an exception applies.

3. You can choose investments that are right for you. Losing a job or changing jobs can be stressful and overwhelming. It may be tempting to just ignore your retirement savings and leave them in your former employer’s plan.  By taking this path of least resistance, you may be missing out. Your employer plan may offer some solid investment choices. However. by rolling over to an IRA you can take advantage of many more. The choices for IRA investments are almost limitless and you should be able to find some that most closely suit your needs.

Rolling over to an IRA can offer many advantages, but everyone’s situation is different. Think carefully and weigh your options. If you do decide a rollover is for you, consider doing a direct rollover to an IRA instead of 60-day rollover. With a direct rollover your retirement funds can go right to your IRA. You avoid concerns about missing the 60-day deadline and you can skip any withholding requirements.

Don’t hesitate to consult a knowledgeable financial or tax advisor if you have questions. Your retirements savings are on the line. If you decide an IRA rollover is the right move for you, you will want to be sure the transaction is done properly.

https://www.irahelp.com/slottreport/3-reasons-roll-over-your-retirement-funds-ira

THE SECURE & CARES ACTS IMPACT ON RETIREMENT: WHAT YOUR CLIENTS NEED TO KNOW NOW

The Setting Every Community Up for Retirement Enhancement (SECURE) Act single-handedly upended many long-standing retirement rules when it became effective on January 1, 2020. Shockingly, the SECURE Act was pushed to the back burner when all the world was impacted by the coronavirus pandemic. Only three months after SECURE was introduced to the American public, a second and equally enormous piece of legislation was passed – the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

How will history remember 2020? That is yet to be written and out of our control. How will your clients remember you and the actions you took during these trying times? It is said that crisis does not build character—it reveals it. Leading financial advisors, those who take the reins during one of the most uncertain and difficult periods in American history, need to be knowledgeable about both the SECURE and CARES Acts. As a leader, you must proactively communicate, educate and guide your clients through the morass. Here is what you need to know:

DOWNLOAD THE FULL REPORT HERE

https://www.irahelp.com/slottreport/secure-cares-acts-impact-retirement-what-your-clients-need-know-now

QCDS UNDER THE CARES ACT AND IRA CONTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

Since no RMD in 2020 is required, what will the tax treatment be for QCD checks to charities written before the CARES Act became effective? Will 1099-R dollar amounts be included in AGI and charitable contributions only deductible if taxpayer itemizes on Schedule A? Do you recommend against making further QCD checks in 2020?

Mike

Answer:

Qualified charitable distributions (QCDs) are alive and well in 2020. There is a good deal of confusion about this likely due to the fact that the CARES Act eliminated required minimum distributions (RMDs) for the year. The elimination of RMDs does not mean that QCDs are not available. QCDs still work the same way and are still a good strategy for charitably inclined IRA owners who are eligible. A QCD made earlier this year would still be excluded from your 2020 adjusted gross income (AGI).

Question:

Hi, I am retired and get Social Security. Can I still contribute to a regular IRA or Roth IRA?

Answer:

To contribute to an IRA, you must have earned income. This is generally a salary or other taxable compensation for work. Social Security income does not qualify, so if that is your only source of income you cannot contribute to an IRA. If you happen to be married, you can make contribution to your IRA based on your spouse’s earned income if your spouse has any.

https://www.irahelp.com/slottreport/qcds-under-cares-act-and-ira-contributions-todays-slott-report-mailbag

DOES MEMBERSHIP HAVE ITS PRIVILEGES? SPOUSE BENEFICIARIES & THE 10-YEAR PAYOUT

By Andy Ives, CFP®, AIF®
IRA Analyst

Gold members of a national hotel chain, big airline or just the local club expect lofty benefits for their dedicated patronage. Bronze members have access to A, B and C. Silver members have access to A, B, C, plus D, E and F. At the highest level, gold members earned not only A through F, but also whatever additional allowances their premium membership affords. Are gold members cut off from any exclusive discounts that a bronze or silver member receives? Not typically. Do bronze and silver-level members earn first-class seating or premium hotel rooms that honored gold members are barred from? Of course not. As the saying goes, “membership has its privileges,” and gold members at the top of the pyramid have it all.

Under the SECURE Act, the gold standard for IRA beneficiaries are Eligible Designated Beneficiaries (EDBs). This elite group of individuals are still allowed to stretch inherited IRA required minimum distributions (RMDs) over their own life expectancy. EDBs include spouses, minor children of the account owner, disabled individuals, chronically ill individuals, and beneficiaries not more than ten years younger than the deceased IRA owner.

Within this EDB group, it can be argued that spouses are the pinnacle. Spouses are the only EDB who can do a spousal rollover of an IRA into their own. Spouses are the only EDB who can choose an inherited IRA for a certain period (e.g., while they are under 59 ½), and then do a spousal rollover at any time in the future. Spouses also have the advantage of being able to recalculate their life expectancy when subject to RMDs on an inherited account, thereby lowering RMDs vs. non-spouse EDBs.

The surviving spouse: gold standard of the Eligible Designated Beneficiaries, top member of the EDB club. No other bronze or silver beneficiary – not another EDB, and certainly not a Non-Eligible Designated Beneficiary (NEDB) – should be able to do anything more flexible or tax efficient than the alpha EDB surviving spouse…or can they?

The SECURE Act created a 10-year payout rule for NEDBs. Not only is this class of beneficiary forbidden from stretching inherited IRA RMDs over their life expectancy, but they are forced to completely empty the inherited IRA by the end of the 10th year after the year of death of the original IRA owner. If an NEDB dies during this 10-year window, their successor beneficiary can only extend payments for the duration of that original 10-year timeframe.

Can a surviving spouse elect the 10-year payout? The SECURE Act is unclear, and the experts disagree. If a 75-year-old dies and leaves his IRA to his adult NEDB son, the son may use the flexible 10-year payout. If that same 75-year-old were to leave the IRA to his surviving spouse – a gold member of the EDB class – can she choose the 10-year payout?

The 10-year payout would allow her to avoid RMDs on the inherited IRA for a decade. It would also allow her to delay a spousal rollover, thereby preventing a combined RMD the following year. As a gold-member EDB, can she choose the 10-year option and do a spousal rollover right before the 10 years expire, thus avoiding the full 10-year payout requirement altogether?

Does membership have its privileges?

https://www.irahelp.com/slottreport/does-membership-have-its-privileges-spouse-beneficiaries-10-year-payout

ONE MORE CARES ACT MISCONCEPTION

By Ian Berger, JD
IRA Analyst

The Coronavirus Aid, Relief, and Economic Recovery (CARES) Act continues to cause confusion. In the April 22, 2020 Slott Report, we discussed four misconceptions surrounding the new law. In this article, we add one more: If your employer refuses to offer CRDs, you can’t qualify for the special CARES Act tax breaks.

This statement is false.

The CARES Act allows workplace retirement plans [e.g., 401(k), 403(b) and governmental 457(b) plans] to offer a new kind of distribution – a coronavirus-related distribution (CRD). CRDs offer several tax breaks. If you are under age 59 ½, you are exempt from the 10% early distribution penalty. You may also spread taxes on the CRD over three years and/or recoup any taxes paid by contributing the CRD back to your plan or to an IRA and filing amended tax returns.

CRDs are not available to everyone. Under current rules, you are eligible only if you are a “qualified individual” under the following definition:

  • you are diagnosed with the SARS-CoV-2 or COVID-19 virus by a test approved by the    CDC;
  •  your spouse or dependent is diagnosed; or
  •  you experience “adverse financial consequences” on account of:

    – being quarantined;

    – being furloughed or laid off or having work hours reduced;

    – being unable to work due to lack of child care; or

    – closing or reducing hours of a business you owned or operated.

The IRS has said that it may expand these categories, but that has not happened yet.

If a plan offers CRDs, they are available in addition to normal plan distributions, such as hardship withdrawals or age 59 ½ distributions. But plans are not required to offer this new distribution option, and some have chosen not to.

However, just because a plan does not offer CRDs doesn’t mean that you can’t treat a normal plan distribution as a CRD – as long as you are a “qualified individual.”  In other words, you are not necessarily bound by whether your employer plan treats a distribution as a CRD. If you meet the definition of a “qualified individual,” you can still use the special tax breaks for 2020 distributions of up to $100,000.

Example: Jasmine, age 50, participates in a 401(k) plan that allows hardship withdrawals. Her employer has decided not to offer CRDs. Jasmine is a “qualified individual” because her husband has been diagnosed with COVID-19. She qualifies for and takes a hardship withdrawal of $40,000 from the plan on July 1, 2020. Even though the plan does not offer CRDs, Jasmine can treat her hardship withdrawal as a CRD and qualify for the special tax relief. Therefore, Jasmine will not be subject to the 10% early distribution penalty. She can also spread taxation of the withdrawal equally over three years and repay it within three years.

Keep in mind that any CRDs from your IRA are aggregated with CRDs from company plans for purposes of the $100,000 limit.

https://www.irahelp.com/slottreport/one-more-cares-act-misconception

INHERITED IRAS AND RMDS UNDER THE CARES ACT: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi,

My question is:  Does the SECURE Act affect inheritors of a Roth IRA account?  If so, in what way, and why – since it is not a pre-tax account? I look forward to your reply.  Thanks.

Regards,

Vikram

Answer:

Vikram,

Yes, the SECURE Act does affect inherited Roth IRAs for those who inherit in 2020 or later. (Any Roth IRAs inherited prior to 2020 fall under the old rules.) Under the SECURE Act, only eligible designated beneficiaries (spouses, minor children of the account owner, disabled individuals, chronically ill individuals, and beneficiaries not more than ten years younger than the deceased IRA owner) can stretch RMD payments over their own life expectancy. The SECURE Act requires non-eligible designated beneficiaries to empty the inherited Roth IRA account by the end of the 10th year after the year of death. Why does the SECURE Act speed up RMD payments? Probably so that tax-free inherited Roth money that would just be sitting there and growing gets forced back into circulation sooner, thus generating more taxable expenditures.

Question:

A friend reached his 70 1/2 age last December 29, 2019.  His 2019 RMD 2019 on his IRA had a beginning withdrawal date of April 1, 2020. No actual withdrawal has been made. With the CARES Act, will the RMD withdrawal suspension in 2020 also applies to the RMD 2019 not yet taken by April 1, 2020? Does the 50% penalty apply to the RMD 2019 amount not withdrawn by April 1, 2020?

Thank you.

Rudy

Answer:

Rudy,

As you mentioned, only a person’s first RMD can be delayed until April 1 of the following year. The CARES Act waived all 2020 RMDs. This waiver also applies to first-time RMDs in 2019 that were not yet taken by the end of 2019. In a normal year, the 50% penalty would apply to any amount of a first RMD not taken by the April 1 cutoff. However, as this is not a normal year, and since your friend delayed his first RMD to 2020, there is no penalty because there is no RMD to take due to the CARES Act waiver.

https://www.irahelp.com/slottreport/inherited-iras-and-rmds-under-cares-act-todays-slott-report-mailbag

CONVERSION NIGHTMARES

By Sarah Brenner, JD
IRA Analyst

With markets down, many IRA owners are thinking this may be the time for a Roth IRA conversion. Converting when account values are down can be a good bargain. You pay a tax bill on a lower balance now in exchange for potential tax-free growth down the road when the markets bounce back.

This can be a great strategy, but you need to be careful in executing your conversion transaction. We have heard more than one horror story of IRA owners who have gotten into trouble trying to convert IRA funds online on a custodians’ website, sometimes accidentally pressing a wrong button or putting a decimal point in the wrong place. As result, these unfortunate IRA owners have ended up with a “conversion nightmare” sometimes mistakenly converting thousand more than what they wanted. (And in one conversion nightmare, millions more!)

The problem is that there are no “do-overs” for unwanted conversions. To raise revenue for other tax breaks, Congress eliminated the ability to recharacterize unwanted conversions in 2018 with the Tax Cuts and Jobs Act. Now there is no way in the existing IRA rules to undo an unwanted conversion, even one that was done purely by accident.

There are no good solutions here. An IRA owner may try to ask the custodian for mercy and help undoing the transaction, but there is no guarantee that the custodian will cooperate. Custodians may be hesitant to undo a transaction that Congress said clearly should not be undone. Perhaps a tax professional might be able to plead the case to the IRS to try to get some relief, but this would be expensive, time consuming, and a successful outcome is far from guaranteed.

The best bet, since many financial organization’s websites can be confusing and mistakes are not cheap, is to get professional advice when embarking on a Roth IRA conversion. Good advice from a knowledgeable tax or financial advisor is critical in the decision as to whether a conversion is the right move. It is also essential to be sure the transaction is done properly to avoid “conversion nightmares.”

https://www.irahelp.com/slottreport/conversion-nightmares

CRDS AND ROTH CONVERSIONS – ABUSE OF THE RULES?

By Andy Ives, CFP®, AIF®
IRA Analyst

The coronavirus-related distribution (CRD) rules for Roth conversions have a gaping hole.

An “affected person” (as we have defined in previous blogs), is entitled under the CARES Act to withdraw up to $100,000 from their IRA or workplace retirement plan. A CRD avoids the 10% early distribution penalty for those under 59 ½, can be repaid to a qualified retirement account within three years, and allows the account owner to spread the income (and subsequent taxes due) over a three-year period.

The coronavirus pandemic has decimated the world’s economy. In the United States, unemployment levels rival the Great Depression. Businesses are shuttered. Food banks are strained as desperate families wait patiently for a box of groceries. Hospital staffs are exhausted, and the number of dead increases daily. CRDs are designed to help those most in need by providing access to a source of last-resort, emergency funds. The 3-year repayment option allows profoundly “affected people” to make their account whole once the economy turns, and the 3-year tax spread helps soften the monetary pain of the withdrawal.

The CARES Act does not appear to preclude an affected person from taking a CRD and immediately rolling those dollars into a Roth as a conversion. The taxes can then be spread over the CRD-allowable 3-year period. Individuals who do not need the money from their retirement account due to a coronavirus emergency, but who can otherwise shoehorn themselves into the definition of an “affected person,” could abuse this loophole.

Does a CRD and immediate Roth conversion violate the “spirit” of the law? I certainly think so. Will I look sideways at those who maneuver their way into such a transaction? Absolutely. Will my disapproval make them lose any sleep at night? Probably not.

Be aware – this transaction is not without risk. The IRS or Congress could retroactively shut down the CRD/Roth conversion abuse. Until then, however, CRD exploitation will continue as people game the system.

Aren’t we better than that?

https://www.irahelp.com/slottreport/crds-and-roth-conversions-%E2%80%93-abuse-rules

CONVERTING WAIVED RMDS AND PAYING BACK CORONAVIRUS-RELATED DISTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Sir:

The CARES Act includes a waiver of RMDs for this year from company savings plans and IRAs.

I am in the minority of retirees that took my 2020 RMD in January 2020, withheld 20% for taxes and am now finding out that I “missed” the 60-day rollover window to put the money back into my IRA by no fault of mine. Since RMDs are essentially eliminated for 2020, why can’t I put the entire amount into my Roth IRA?

Assuming I can do that “conversion,” is there a time limit to do that?

Thank you for considering my dilemma.

Ram

Answer:

Hi Ram,

Unfortunately, conversions to a Roth IRA are subject to the same 60-day rollover rule that applies to rolling over waived RMDs back to an IRA. The IRS has extended that 60-day deadline (to July 15, 2020), but only for RMDs made in February 2020 or later.

However, all may not be lost. It is possible the IRS may expand its relief to cover distributions made in January 2020. Stay tuned.

Question:

I am over 65 and retired. Can I borrow up to the $100,000 from my Roth IRA and redeposit it within the next 3 years?  I know it wouldn’t be taxed because I’ve had it for more than 5 years and I’m of retirement age. I just need the money now, and I would be able to replace it if it’s allowed.

Thank you. I haven’t seen this issue addressed anywhere.

Answer:

Since you are over age 59 ½ and established a Roth account at least five years ago, you can always take a tax-free distribution from your Roth IRA. Your ability to repay the distribution within 3 years depends on whether you are a considered a “qualified individual” under the CARES Act.

Not everyone is a “qualified individual.” You meet that definition only if:
·      you have been diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the CDC;

·      your spouse or dependent has been diagnosed with the virus; or

·      you have suffered “adverse financial consequences” due to the virus as a result of:

Ø  being quarantined; being furloughed or laid off; or having work hours reduced;

Ø  being unable to work due to lack of child care; or

Ø  closing or reducing hours of a business you own or operate.

https://www.irahelp.com/slottreport/converting-waived-rmds-and-paying-back-coronavirus-related-distributions-today%E2%80%99s-slott

IRA PROTECTION AGAINST THE EVIL GENIE IN THE LAMP

By Andy Ives, CFP®, AIF®
IRA Analyst

The evil genie in the IRA lamp wants your money. He roars with laughter at the thought of you facing hard times. Given an opportunity, he will line the pockets of creditors with your IRA dollars, and he will serve your remaining non-qualified financial assets to the vultures, who will drag the accounts into the gutter and pick them clean.

The evil genie must be forced to remain inside the IRA lamp.

Fortunately, there are protections in place to keep creditors from rubbing the lamp and intentionally releasing the genie. These protections, which provide shields for bankruptcy and lawsuits, include the following:

  • The Bankruptcy Code protects contributory IRAs against bankruptcy claims of up to an inflation-adjusted cap of $1,362,800. Even if you maximized your contributions since the introduction of IRAs back in the mid 1970’s, you would be hard-pressed to be above the cap with just contributed dollars, plus earnings.
  • The Bankruptcy Code also fully protects (without a cap) IRA dollars that were rolled over from a company plan. This bankruptcy protection of rolled-over assets is in addition to the $1,362,800 cap referenced above.
  • A third protection against unwanted people rubbing the IRA lamp and releasing the genie is provided by state law. This IRA protection is for non-bankruptcy claims (like if you get sued). But be careful! State laws vary widely. Not all states are as good at “lamp safety.”

With all these external protections, there is no way for the evil genie to escape, right? Not so fast. There is another protective step to take. While we have successfully protected the outside of the IRA lamp from claims brought against the IRA owner, the evil genie could escape with inside assistance if a claim is brought against the IRA itself.

For example, Aladdin has a self-directed IRA worth $500,000 that invests entirely in a magic carpet rental company without using an LLC (limited liability company). Aladdin has other non-qualified personal assets worth $1.5 million. A magic carpet renter falls off a flying carpet and suffers a catastrophic injury. The renter wins a $2 million judgment against the IRA. This claim is from inside the IRA lamp…and is all the evil genie needs to escape.

All of Aladdin’s IRA assets could be reached because the claim arose from activities of the IRA investment. Aladdin’s personal assets could also be at risk. However, if Aladdin’s IRA had been invested in an IRA/LLC that owned the magic carpet rental company, the LLC structure would have protected both the IRA assets and his personal assets against the $2 million judgment.

It is imperative to keep your IRA lamp protected from both the outside and the inside. Outside protection is provided for you by law. Inside protection is your responsibility. For IRA investments such as rental property, working through the steps to establish an LLC – and incurring the costs – could prove to be the most important defense against the evil bankruptcy and creditor genie.

https://www.irahelp.com/slottreport/ira-protection-against-evil-genie-lamp

CARES ACT EXPANDS HSAS

By Sarah Brenner, JD
IRA Analyst

The recently passed CARES Act includes some changes that impact your HSA. These changes will allow you to access more medical services without worrying about your deductible, and also enable you to take more tax-free distributions from your HSA. Here’s what you need to know.

Telemedicine Without Meeting Deductible

HSAs are designed to work with a high-deductible plan. To be considered a high-deductible plan, a health plan must meet certain requirements. One of them is that the health plan cannot waive the deductible for medical expenses, unless they are considered preventative. The CARES Act creates a temporary exception to this rule. For plan years beginning on or before December 31, 2021, a health plan is permitted to provide coverage for telehealth and other remote care services without the deductible being met and still be considered a high-deductible plan for HSA purposes.

Qualified Medical Expenses Expanded

You can take tax-free distributions from your HSA to pay for “qualified medical expenses”. The definition of qualified medical expenses for HSA purposes is pretty specific. In 2010, the Patient Protection and Affordable Care Act (PPACA) limited the definition of qualified medical expenses for HSAs. The revised definition required that over-the-counter medicines (other than insulin) be prescribed by a physician in order for the medicine to qualify for a tax-free HSA distribution.

The CARES Act eliminates this restriction permanently. Distributions from an HSA that are qualified medical expenses are no longer limited only to those medicines and drugs that are prescribed. This means that you can take a tax-free distribution from your HSA for over-the counter medicines and drugs, such as nonprescription aspirin and other pain relievers, allergy medicine, or antacids. Additionally, the CARES Act expands the definition of qualified medical expenses to include amounts paid for menstrual care products. These provisions apply to distributions from HSAs for amounts paid after December 31, 2019.

https://www.irahelp.com/slottreport/cares-act-expands-hsas

CARES ACT RMDS, INHERITED IRAS AND IRA ROLLOVERS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

I have been taking my RMDs on a monthly basis in 2020. Since the Cares Act has suspended RMDs for 2020, I would like to rollover my past 2 distributions. I would like to aggregate those two distributions and roll them over. I have not performed any rollovers within the last 12 months.

This is where it gets hairy. Some people are telling me I cannot aggregate the past two months distributions and roll them over as ONE rollover. However, those people who have taken their entire RMD as one lump sum vs. monthly are allowed to rollover the entire amount, which doesn’t seem fair.

Thoughts?

Thank you,

Rick

Answer:

Hi Rick,

We have been getting a lot of questions on this! You are running into the once-per-year rule. That rule says you can only roll over one distribution from an IRA back to an IRA in a 365-day period. That means that only one of your monthly RMD distributions can be rolled over. I can completely understand why that does not seem fair, but unfortunately that is how this rule works. You might consider rolling the second distribution into your workplace plan if you are eligible, or converting to a Roth IRA. Neither of these transactions would be subject to the once-per-year rule.

Question:

Dear Sir or Madam –

Two questions:

Inherited IRA Question –

I inherited a Traditional IRA at my mother’s death in 2005 and have been taking annual required distributions based on my life expectancy at that time.  My wife is named as my primary beneficiary of the Inherited IRA.

Question – At the time of my death, what are my wife’s options under the SECURE Act with regard to my inherited IRA?  Must she exhaust the inherited IRA within 10 years?

Roth IRA Question –

My wife is the Primary Beneficiary under my Roth IRA.  (Last year I rolled $20,000 from my Traditional IRA to the Roth which had been in existence for many years).

Question – At the time of my death, what are her options with regard to the Roth IRA under the SECURE  Act?  Can she roll it over to her own Roth or must she exhaust the Roth within 10 years?

Your response is sincerely appreciated and will be appreciated by my wife after I have passed away.

Bruce

Answer:

Hi Bruce,

You are correct about the first question. If an original IRA beneficiary of an inherited IRA dies in 2020 or later, the successor beneficiary (the beneficiary of the beneficiary) will be subject to the 10-year payout rule under the SECURE Act. This is true even if it is a spouse successor beneficiary.

As for your Roth IRA, your wife can do a spousal rollover. The Roth IRA will then become her own Roth IRA. She will not be subject to the 10-year rule because she is a spouse beneficiary.

https://www.irahelp.com/slottreport/cares-act-rmds-inherited-iras-and-ira-rollovers-todays-slott-report-mailbag

IRS ISSUES Q&AS ON CORONAVIRUS-RELATED DISTRIBUTIONS

By Ian Berger, JD
IRA Analyst

Under the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), certain individuals can take up to $100,000 of distributions from IRAs and company plans during 2020 and receive special tax relief. Those distributions are known as coronavirus-related distributions (CRDs).

On May 4, the IRS released a set of Q&As pertaining to CRDs. The IRS did not address many of the questions about CRDs left unanswered in the CARES Act itself. However, the IRS did promise additional guidance “in the near future.”

Here are the highlights of the Q&As:

  • Not everyone is entitled to make CRDs or receive the CARES Act tax relief. Instead, you must be a “qualified individual.” You meet that definition if:

– you have been diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the CDC;

– your spouse or dependent has been diagnosed with the virus; or

– you have suffered “adverse financial consequences” due to the virus as a result of:

> being quarantined; being furloughed or laid off; or having work hours reduced;

> being unable to work due to lack of child care; or

> closing or reducing hours of a business you own or operate.

 

The CARES Act gives the IRS discretion to expand that definition. In the Q&As, the IRS strongly hinted that it would liberalize the definition when it issues its additional guidance.

  • In addition to allowing CRDs, the CARES Act provides tax relief for company plan loans. First, the dollar limit for loans taken by September 22, 2020 was increased to $100,000 (but no more than the vested account balance). Second, plan loan repayments scheduled to be made between March 27, 2020 and December 31, 2020 can be delayed for up to one year. The Q&As clarify that company plans are not required to offer CRDs or either of the plan loan provisions. So, if you are a “qualified individual,” you need to check with the plan administrator or your HR department to see if your company has adopted the CRD or loan provisions.

 

  • If you are a “qualified individual,” the CARES Act waives the 10% early distribution penalty on CRDs if you are under age 59 ½, allows you to spread taxes on CRDs over three years, and allows you to repay CRDs to an IRA or company plan within three years. The Q&As confirm that, even if your company plan does not offer CRDs, you can still use this special tax relief for up to $100,000 of withdrawals made in 2020 if you are a “qualified individual.”

 

  • For those that do take a CRD, the distribution should be reported on your 2020 federal income tax return. You must include the taxable portion of the distribution in income ratably over the 3-year period – 2020, 2021, and 2022 – unless you elect to include the entire amount in income in 2020. You would use IRS Form 8915-E (which is expected to be available before the end of 2020) to report any repayment of a CRD and to determine the amount of any CRD includible in income for a year.

 

  • Another important retirement-related provision of the CARES Act is the waiver of required minimum distributions (RMDs) for 2020.  The Q&As do not address the RMD waiver, but we expect guidance from the IRS on that issue as well.

https://www.irahelp.com/slottreport/irs-issues-qas-coronavirus-related-distributions

THE MEGA BACKDOOR ROTH IS USUALLY TOO GOOD TO BE TRUE

By Ian Berger, JD
IRA Analyst

For a number of years, the “mega backdoor Roth” strategy has been touted as a way for employees to convert large amounts of after-tax employee contributions to Roth IRAs. Unfortunately, in most cases the strategy won’t work. Here’s why.

First, a little background. The mega backdoor Roth is simply the company retirement plan version of the backdoor Roth IRA. The backdoor Roth IRA is designed for individuals whose income exceeds the IRS limit for making Roth IRA contributions directly. The backdoor strategy allows for higher income employees to make Roth contributions indirectly by making a traditional IRA contribution and subsequently converting it to a Roth IRA. Congress and the IRS have both specifically blessed the backdoor Roth strategy.

By contrast, the mega backdoor allows 401(k) [or 403(b)] after-tax monies to be distributed while the employees is still working and immediately converted to a Roth IRA on a virtually tax-free basis. Why is this advantageous? Well, after-tax contributions and Roth contributions are both made with after-tax salary. But the earnings on after-tax contributions are taxable, while Roth IRA distributions are tax-free if made in a qualified distribution.

The mega backdoor is potentially even more lucrative than the backdoor. That’s because the backdoor Roth IRA is limited to the amount of traditional IRA contributions that can be made each year ($6,000 for 2020 with a $1,000 catch-up). On the other hand, annual after-tax contributions can potentially be considerably higher than that – as high as $30,000 or even more depending on the terms of the 401(k) or 403(b) plan.

But before you get too excited, be aware that the mega backdoor Roth works in only very limited situations.

First, the plan must allow after-tax contributions. 401(k) or 403(b) plan sponsors are not required to offer after-tax contributions, and many don’t. That is especially the case recently when more and more plans are offering Roth contributions instead. Second, an individual wanting to take advantage of the mega backdoor strategy must have enough income to make large amounts of after-tax contributions. Third, the plan must allow for distributions of after-tax contributions while the employee is still working. Even if a plan offers after-tax contributions, it’s not required to allow in-service distributions.

But the biggest problem is that IRS nondiscrimination rules limit the amount of after-tax contributions that high-paid employees can make based on the amount made by lower-paid employees. (See the November 13, 2019 Slott Report for more details.) Since high-paid employees are often the only participants able to afford after-tax contributions, it is difficult for plans to pass the nondiscrimination test. That’s why many plans don’t offer after-tax contributions in the first place.

One kind of plan where the mega backdoor Roth strategy would work is in a solo 401(k) plan. A solo 401(k) is a plan for self-employed persons with no employees (other than the spouse). Solo 401(k)’s are not subject to IRS nondiscrimination rules.

https://www.irahelp.com/slottreport/mega-backdoor-roth-usually-too-good-be-true

IRA CONTRIBUTIONS AND RMD WITHDRAWALS UNDER THE CARES ACT: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Dear Mr. Slott,

I seem to have gotten myself into a jam with my 2020 RMD withdrawal and the CARES Act, as it stands now. Hoping you are able to help, or make a suggestion on how to proceed.

In January, over three withdrawals, I took my entire 2020 RMD from an IRA. Then the CARES Act seemed to forgive/not require distributions during 2020. I returned the money to my IRA. Now the law has made a determination that RMD withdrawals beginning February 1, 2020 through May 15, 2020 and placed back into IRA accounts are forgiven. Well, my January RMD withdrawal was not forgiven, but I had already placed it back into the IRA account. Do I wait to see if there might be an adjustment including January distributions? Should I take the money out of the IRA account again? Is that allowed? Do I have until December, 2020 to do that in hopes the law will be altered? Is it realistic to expect the law to change? I have read your previous commentary on the subject. Lastly, how is the IRS going to look at all this? I cannot make contact with them, have written nine letters, made many calls to various offices.

Any help or assistance will be greatly appreciated.

Thank you.

John

Answer:

John,

You are in the same confusing RMD boat as many others. The big problem I see in your situation is a violation of the one-rollover-per-year rule. You said you took your RMD in January over three installments. Assuming no other rollovers were done in the previous 365 days, only one of those three payments was eligible to be rolled back to your IRA within 60 days. Even if you acted within the 60-day window, the other two are considered “excess contributions” and will need to be properly removed along with the “net income attributable” on both. The deadline for removal is October 15, 2021 to avoid any penalty. You may want to seek assistance from a knowledgeable financial advisor to help complete these transactions.

While the current waiver period of the 60-day rollover period is clunky, we anticipate further guidance from the IRS expanding the 60-day rollover window. However, until the rules are actually updated, we are stuck with current guidelines. Also, will the IRS relax the one-rollover-per-year rule for 2020, which would erase your current excess contribution problem? Time will tell, and we may not get full clarification until later this year.

Question:

I have a couple of clients that make over a million dollars a year. Could they make non-deductible contributions to a Traditional IRA and then convert to a Roth IRA?

Thank you,

Jim

Answer:

Jim,

What you are describing is the Backdoor Roth strategy. Yes, individuals who make more than the Roth IRA contribution limits ($196,000 – $206,000 for a married couple filing jointly in 2020) can make non-deductible contributions to a traditional IRA and then immediately convert those dollars to a Roth IRA. However, and this is an important item to be aware of, the pro-rata rule must be considered. All IRA, SIMPLE and SEP accounts are aggregated for the pro-rata calculation to determine how much of the conversion is taxable. You cannot just carve out after-tax dollars and convert only those to a Roth while leaving the pre-tax dollars behind.

https://www.irahelp.com/slottreport/ira-contributions-and-rmd-withdrawals-under-cares-act-todays-slott-report-mailbag

TECHNOLOGY, ROTH CONVERSIONS AND A SQUIRMING SON

By Andy Ives, CFP®, AIF®
IRA Analyst

77 and sharp – that’s my dad. A voracious reader. Daily crossword puzzles. Curious. Engaged with the community. But he gets a little loose with technology. Comedic evidence suggests he is blissfully unaware if he is having a personal text conversation with me, or if the communication is part of a larger group text with his extended family.

He is also too trusting, which is a sad commentary on society in general. This can be perilous when combined with tech. For example, not long ago his computer was infected with malware (“malicious software”). The glowing blue screen offered a phone number and a quick fix. He dialed. When a voice on the other side said the problem could be corrected, my dad willfully shared his credit card information. (I cringed and squirmed like an octopus in my chair as he relayed this story. Fortunately, he cancelled the card in time – no harm done.)

In another example, just recently we discussed the benefits of IRA-to-Roth conversions. With a depressed market, now is a good time to consider such a move. He has never had a Roth before (unfortunately), so we walked through the 5-year clock rules, the benefits of no RMDs on a Roth IRA, tax-free earnings, and the very real possibility that taxes will go up in the future. We talked about “stealth taxes” and how Roth conversions can impact other income-based items like financial aid and IRMAA surcharges for Medicare Parts B & D. We touched on his current income, the “bracket bumping” Roth conversion strategy, and other personal financial numbers.

He scratched out copious notes in order to have an intelligent discussion with his trusted financial advisor. He included his 2019 income and from where those dollars originated, i.e., pensions, RMDs, capital gains, etc. I offered to review his work, so he promised to type up the information and send it to me for edit. At 9:30 that evening, I received a text: “Andy, I sent you an email with a draft of my Roth conversion notes. I sent it to XXXXXX. Is that right?”

My personal email address has remained unchanged for 15 years. “XXXXXX” was an email I did not recognize. It included the letters “A-n-d-y,” but was otherwise completely foreign. Where in the world had he sent his personal financial data? I was squirming again, but now I was angry. Confusion over group texts can be laughed off, but this was a potentially serious breach.

We dodged another bullet. The obscure email belonged to an old family friend, and my dad called her to clear up the confusion. We all took a deep breath.

The larger point being – this is not Pleasantville, 1950. You may live in Small Town, USA, but slithering internet tentacles reach into all of our homes. Scammers and bad actors lurk. I consistently hear from frustrated advisors about newly acquired accounts that have been churned and intentionally mismanaged. Elder abuse is pervasive. We must all be diligent with our personal information, and extra vigilant when those who are less tech savvy share financial data via electronic communication.

My dad has been reprimanded and he is apologetic…though I’m sure he will accidentally text my brother this evening when he intends to text me.

https://www.irahelp.com/slottreport/technology-roth-conversions-and-squirming-son

SECURE ACT 10-YEAR RULE AND CARES ACT RMD ROLLOVERS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Did the SECURE Act change the rules for designated non-spouse inheritors of a Roth IRA? I believe they used to be able to take distributions based on their life expectancy. Does the 10-year rule also apply to Roth IRAs?

Thanks,

Dave

Answer:

Hi Dave,

Yes, the SECURE Act did change the payout rules for most beneficiaries if the IRA owner dies in 2020 or later. With certain exceptions, most beneficiaries cannot stretch out required minimum distributions (RMDs) over their lifetime like before. Instead, they must receive the entire IRA by December 31 of the 10th year following the year of the IRA owner’s death.

However, the following beneficiaries can still use the stretch: surviving spouses; minor children (while they remain minors); disabled individuals; chronically-ill individuals; and individuals no more than 10 years younger than the IRA owner. The 10-year payout rule also applies to Roth IRA beneficiary distributions.

Question:

Hello,

In February, I took my RMD for 2020 from my traditional IRA. Then the CARES Act came along. Now I would like to make this same amount go into my Roth IRA instead, leaving the taxes paid exactly as is. Can I do this with my broker who holds all accounts? It is probably beyond the 60 days mentioned in the Act.

Thanks,

Tom H.

Answer:

Hi Tom,

You are in luck. RMDs usually cannot be rolled over or converted to a Roth IRA. However, the CARES Act waived 2020 RMDs. So, any RMD already taken in 2020 is not considered an RMD. This means your RMD can be rolled over (i.e., converted) to a Roth IRA – as long as it meets the usual rollover rules.

One of those rules requires that a rollover be done within 60 days of receipt of the distribution. But the IRS recently said that if you received a distribution between February 1, 2020 and May 15, 2020, you have extra time – until July 15, 2020 – to roll it over.

4 CARES ACT MISCONCEPTIONS

By Ian Berger, JD
IRA Analyst

The Coronavirus Aid, Relief and Economic Recovery Act (CARES Act), signed into law on March 27, includes several important retirement-related provisions. Because some of these provisions are confusing, several misconceptions about the new law have arisen. In this edition of the Slott Report, we will attempt to set the record straight.

Misconception #1: Everyone is eligible for a CRD. The CARES Act allows individuals to withdraw up to $100,000 of IRA and company plan funds during 2020 and receive special tax breaks. These withdrawals are called “coronavirus-related distributions” (CRDs). However, not everyone is eligible to take these withdrawals and qualify for the relief. Under current rules, you are eligible only if you are in one of these categories:

  •      you are diagnosed with the SARS-CoV-2 or COVID-19 virus by a test approved by the CDC;
  •      you or your spouse or dependent is diagnosed; or
  • you experience “adverse financial consequences” on account of:

    – being quarantined;

    – being furloughed or laid off or having work hours reduced;

    – being unable to work due to lack of child care; or

    – closing or reducing hours of a business you owned or operated.

The law gives the IRS the authority to expand these categories, but that has not happened yet.

Misconception #2: Company plans must allow CRDs. Although the CARES Act allows companies to allow CRDs, companies are not required to offer them – even if you are in one of the above categories. Many plans are offering CRDs, but check with your company HR Department or the plan administrator to make sure.

Misconception #3: CRDs are tax-free. If you are under age 59 ½, your CRD is exempt from the 10% early distribution penalty. However, the CRD is generally subject to federal taxes. One of the relief provisions does allow you to spread out federal income taxes over three years. In addition, you can avoid federal taxes altogether by paying back the CRD to an IRA or company plan within three years of receiving it.

Misconception #4: Any RMD received in 2020 can be paid back. Another provision of the CARES Act waives required minimum distributions (RMDs) for 2020. This includes 2020 RMDs and 2019 RMDs if you reached age 70 ½ in 2019 and delayed your 2019 RMD into 2020.

But what if you already took an RMD in 2020 and don’t need it?  Certain RMDs can be rolled back to an IRA or company plan, but not all of them. Rollovers normally must be done within 60 days. However, if you received (or will receive) an RMD between February 1 and May 15, 2020, you have until July 15, 2020 to roll it over. But you don’t qualify for an IRA rollover if you had another IRA rollover during the 12 months before receiving your RMD. You also don’t qualify if you are a non-spouse beneficiary who received an RMD from an inherited IRA.

You are currently out of luck if you received your RMD in January of this year. But it is possible the IRS will issue broader rollover relief, so keep checking the Slott Report.

https://www.irahelp.com/slottreport/4-cares-act-misconceptions

4 CARES ACT MISCONCEPTIONS

By Ian Berger, JD
IRA Analyst

The Coronavirus Aid, Relief and Economic Recovery Act (CARES Act), signed into law on March 27, includes several important retirement-related provisions. Because some of these provisions are confusing, several misconceptions about the new law have arisen. In this edition of the Slott Report, we will attempt to set the record straight.

Misconception #1: Everyone is eligible for a CRD. The CARES Act allows individuals to withdraw up to $100,000 of IRA and company plan funds during 2020 and receive special tax breaks. These withdrawals are called “coronavirus-related distributions” (CRDs). However, not everyone is eligible to take these withdrawals and qualify for the relief. Under current rules, you are eligible only if you are in one of these categories:

  •      you are diagnosed with the SARS-CoV-2 or COVID-19 virus by a test approved by the CDC;
  •      you or your spouse or dependent is diagnosed; or
  • you experience “adverse financial consequences” on account of:

    – being quarantined;

    – being furloughed or laid off or having work hours reduced;

    – being unable to work due to lack of child care; or

    – closing or reducing hours of a business you owned or operated.

The law gives the IRS the authority to expand these categories, but that has not happened yet.

Misconception #2: Company plans must allow CRDs. Although the CARES Act allows companies to allow CRDs, companies are not required to offer them – even if you are in one of the above categories. Many plans are offering CRDs, but check with your company HR Department or the plan administrator to make sure.

Misconception #3: CRDs are tax-free. If you are under age 59 ½, your CRD is exempt from the 10% early distribution penalty. However, the CRD is generally subject to federal taxes. One of the relief provisions does allow you to spread out federal income taxes over three years. In addition, you can avoid federal taxes altogether by paying back the CRD to an IRA or company plan within three years of receiving it.

Misconception #4: Any RMD received in 2020 can be paid back. Another provision of the CARES Act waives required minimum distributions (RMDs) for 2020. This includes 2020 RMDs and 2019 RMDs if you reached age 70 ½ in 2019 and delayed your 2019 RMD into 2020.

But what if you already took an RMD in 2020 and don’t need it?  Certain RMDs can be rolled back to an IRA or company plan, but not all of them. Rollovers normally must be done within 60 days. However, if you received (or will receive) an RMD between February 1 and May 15, 2020, you have until July 15, 2020 to roll it over. But you don’t qualify for an IRA rollover if you had another IRA rollover during the 12 months before receiving your RMD. You also don’t qualify if you are a non-spouse beneficiary who received an RMD from an inherited IRA.

You are currently out of luck if you received your RMD in January of this year. But it is possible the IRS will issue broader rollover relief, so keep checking the Slott Report.

https://www.irahelp.com/slottreport/4-cares-act-misconceptions

QCDS – STILL AVAILABLE IN 2020 AND STILL A GOOD STRATEGY

By Sarah Brenner, JD
IRA Analyst

As the coronavirus pandemic has raged on, we have seen devasting images of overwhelmed hospitals and long lines of cars at food banks. If you are fortunate enough to have money to spare, you might be thinking about how you can help. One option to consider is a qualified charitable distribution (QCD).

QCDs Still Available for 2020

In response to the pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed by Congress. Included in this giant relief package was a provision that waives required minimum distributions (RMDs) for 2020 from retirement accounts.

You may be wondering if you can still do a QCD for 2020 even though your RMD is waived. The answer is yes. QCDs can still be made even in years when no RMD is required. QCDs from IRAs are still available in 2020 and still offer tax benefits, even though RMDs are not required.

How a QCD Works

QCDs allow IRA owners who are age 70 ½ or older to directly transfer up to $100,000 annually from an IRA to charity, tax-free. If you are married, you and your spouse may both transfer $100,000 for a total of $200,000. QCDs are also available to IRA beneficiaries over age 70 ½, but are not available from company plans or active SEP or SIMPLE IRAs. QCDs are limited to pretax IRA funds. One key component of a QCD is that the funds must be paid directly from the IRA to the charity. You may not take a distribution from your IRA and then contribute it to a charity and consider that transaction a QCD. Also, you may not receive anything of value from the charity in exchange for making the QCD.

QCD Tax Benefits

After tax reform arrived in 2018, QCDs became more valuable than ever. Many taxpayers now take the standard deduction, eliminating the tax deduction for charitable gifts. QCDs add to the standard deduction by allowing the donations made from the IRA to be excluded from income. With a QCD, you get a tax break for your charitable contribution even if you are using the standard deduction.

Another benefit of a QCD is that the amount transferred from the IRA to the charity is not included in your adjusted gross income (AGI) for the year. By not including the distribution in AGI you can potentially avoid the loss of exemptions, deductions, credits and phase outs, AMT (alternative minimum tax), the 3.8% surtax on net investment income, and the increase in Social Security premiums for Medicare Part B and Part D.

While RMDs are waived for 2020, QCDs remain as a viable tax strategy and could be more valuable than ever to charities during these trying times.

https://www.irahelp.com/slottreport/qcds-%E2%80%93-still-available-2020-and-still-good-strategy

RMDS & ROTH IRAS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

I took 25% of my 2020 required minimum distribution (RMD) from an inherited IRA on March 15, 2020. Can that be “undone” in accordance with the CARES Act and if so, how?  Thanks.

Audrey

Answer:

Hi Audrey,

The CARES Act waives RMDs for 2020. The waiver does include inherited IRAs. However, any amounts already taken from an inherited IRA by a nonspouse beneficiary cannot be rolled over. That is because the regular rollover rules still apply, and those rules do not allow a nonspouse beneficiary to do rollovers. If you are a spouse beneficiary, the rules are different. A spouse beneficiary can roll over distributions from an inherited IRA.

Question:

I have always had a traditional IRA. I plan to start a Roth IRA for the tax year 2019. Do I have until July 15, 2020 to make my first $7,000 contribution?

Answer:

Yes. The IRS has confirmed that the deadline for making both traditional and Roth IRA contributions for 2019 is delayed until July 15, 2020.

https://www.irahelp.com/slottreport/rmds-roth-iras-todays-slott-report-mailbag

ROLLING OVER AN RMD, PART 2 – “JUST WAIT A MINUTE”

By Andy Ives, CFP®, AIF®
IRA Analyst

I grew up in the northeast, where snow squalls sweep across Lake Ontario and cede to blue skies, where 85-degree summer days change to a biting rain at a moment’s notice. The folksy phrase around town was, “If you don’t like the weather, just wait a minute.”

Only nine days ago I wrote in the Slott Report about rolling over required minimum distributions (RMDs). Since the “Coronavirus Aid, Relief, and Economic Security Act,” (CARES Act) waived 2020 RMDs (and first-time 2019 RMDs not withdrawn by April 1), my article addressed how many of these RMDs, if already taken, can now be rolled over – as long as the account owner follows the normal rollover rules. For example, the distribution must be received within 60 days to be eligible for rollover, and there is only one IRA-to-IRA rollover allowed per year.

I closed my April 6th article with the following: “Be sure that all rules are followed before haphazardly rolling over an RMD. Yes, these are crazy times, but they are also fluid times. Changes come quickly. Further guidance from the IRS could potentially expand RMD rollover capabilities. As of this writing, RMDs that meet the standard rollover requirements can be rolled back to where they originated or to another qualified account.”

Well, “further guidance” has presented itself like a pop-up thunderstorm. Late last week the IRS released Notice 2020-23. Caught in this swirling vortex of tax filing deadline extensions and postponements was one particularly inconspicuous item. While this little section was not the primary target of the Notice, it was captured in the wind, nevertheless. Based on Notice 2020-23, if an RMD was/is taken between February 1 and May 15, and if that RMD is rolled over by July 15, 2020, then the 60-day rollover rule is waived. RMDs taken in January do not qualify for this relief, nor do any RMDs taken after May 15. In addition, despite this relief, the one-per-year rule still applies to all rollover situations, and inherited IRA RMDs cannot be rolled over.

If these dates seem random and convoluted, then we agree. As the rains come down, the IRS is plugging holes in the dyke as fast as it can. The last time RMDs were waived – back in 2009 – the IRS didn’t grant broad 60-day rollover relief until late in the year. Will they get around to it this year? I certainly hope so. If they do decide to grant additional relief, will they be more direct with their guidance than in Notice 2020-23? That would be much appreciated. Will the one-rollover-per-year rule be addressed? Maybe.

Best bet is to sit tight, inhale deeply, and see what new guidance, regulations and waivers come down the pike. Take your finger off the panic button. There are many months between now and the end of the year and, unfortunately, plenty of more dire issues to concern oneself with. Hopefully, the IRS will assess people’s RMD rollover anxieties and adjust accordingly. “Yes, these are crazy times, but they are also fluid times. Changes come quickly.”

If you don’t like the weather, just wait a minute.

https://www.irahelp.com/slottreport/rolling-over-rmd-part-2-%E2%80%93-%E2%80%9Cjust-wait-minute%E2%80%9D

ROLLING OVER AN RMD, PART 2 – “JUST WAIT A MINUTE”

By Andy Ives, CFP®, AIF®
IRA Analyst

I grew up in the northeast, where snow squalls sweep across Lake Ontario and cede to blue skies, where 85-degree summer days change to a biting rain at a moment’s notice. The folksy phrase around town was, “If you don’t like the weather, just wait a minute.”

Only nine days ago I wrote in the Slott Report about rolling over required minimum distributions (RMDs). Since the “Coronavirus Aid, Relief, and Economic Security Act,” (CARES Act) waived 2020 RMDs (and first-time 2019 RMDs not withdrawn by April 1), my article addressed how many of these RMDs, if already taken, can now be rolled over – as long as the account owner follows the normal rollover rules. For example, the distribution must be received within 60 days to be eligible for rollover, and there is only one IRA-to-IRA rollover allowed per year.

I closed my April 6th article with the following: “Be sure that all rules are followed before haphazardly rolling over an RMD. Yes, these are crazy times, but they are also fluid times. Changes come quickly. Further guidance from the IRS could potentially expand RMD rollover capabilities. As of this writing, RMDs that meet the standard rollover requirements can be rolled back to where they originated or to another qualified account.”

Well, “further guidance” has presented itself like a pop-up thunderstorm. Late last week the IRS released Notice 2020-23. Caught in this swirling vortex of tax filing deadline extensions and postponements was one particularly inconspicuous item. While this little section was not the primary target of the Notice, it was captured in the wind, nevertheless. Based on Notice 2020-23, if an RMD was/is taken between February 1 and May 15, and if that RMD is rolled over by July 15, 2020, then the 60-day rollover rule is waived. RMDs taken in January do not qualify for this relief, nor do any RMDs taken after May 15. In addition, despite this relief, the one-per-year rule still applies to all rollover situations, and inherited IRA RMDs cannot be rolled over.

If these dates seem random and convoluted, then we agree. As the rains come down, the IRS is plugging holes in the dyke as fast as it can. The last time RMDs were waived – back in 2009 – the IRS didn’t grant broad 60-day rollover relief until late in the year. Will they get around to it this year? I certainly hope so. If they do decide to grant additional relief, will they be more direct with their guidance than in Notice 2020-23? That would be much appreciated. Will the one-rollover-per-year rule be addressed? Maybe.

Best bet is to sit tight, inhale deeply, and see what new guidance, regulations and waivers come down the pike. Take your finger off the panic button. There are many months between now and the end of the year and, unfortunately, plenty of more dire issues to concern oneself with. Hopefully, the IRS will assess people’s RMD rollover anxieties and adjust accordingly. “Yes, these are crazy times, but they are also fluid times. Changes come quickly.”

If you don’t like the weather, just wait a minute.

https://www.irahelp.com/slottreport/rolling-over-rmd-part-2-%E2%80%93-%E2%80%9Cjust-wait-minute%E2%80%9D

TAPPING INTO RETIREMENT ACCOUNTS IF NOT DIRECTLY IMPACTED BY COVID-19

By Ian Berger, JD
IRA Analyst

The recently-enacted Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed by President Trump on March 27, 2020, allows “qualified individuals” to take up to $100,000 of penalty-free IRA and company plan withdrawals during 2020. “Qualified individuals” include those who are (or whose family members are) sickened by the virus or who have virus-related adverse financial consequences.

But what if you are lucky enough not to be a “qualified individual,” but still have extraordinary bills to pay? You should always look first to other non-retirement plan savings to pay your expenses. Any IRA or company plan savings you tap into will mean less available funds at retirement. The next source of savings should be your IRAs. IRA withdrawals are easier and faster than company plan distributions.

The last resort should be your company plan accounts. If your plan offers loans, you may want to consider that option. You can borrow up to 50% of your account balance, but no more than $50,000 (minus any outstanding loans). Plan loans don’t require a credit check, and the application process is normally simple and quick. In addition, a plan loan isn’t a taxable distribution, and repayments are made back to your account – not to a bank.

However, borrowing against your account reduces the tax-deferred savings that you may need for retirement. And, if you terminate employment with an outstanding loan, you may be taxed on the entire outstanding loan balance.

If your plan doesn’t offer loans or you don’t want to take on more debt, you should check to see if your plan offers in-service withdrawals. Many plans offer withdrawals for any reason at age 59 ½ and hardship withdrawals at any age.

Generally, hardship withdrawals are allowed if you can satisfy one of the IRS “safe harbor” criteria. These include medical expenses, educational expenses, payments necessary to prevent eviction or mortgage foreclosure, and burial or funeral expenses. Also included are expenses and losses (including the loss of income) incurred on account of a disaster if you live or work in a FEMA-designated disaster area. Every state has now been designated a disaster area because of the coronavirus. So, you should be eligible for a disaster hardship withdrawal if your plan allows them. However, keep in mind that any hardship withdrawal cannot be more than is necessary to pay your financial expense.

Any withdrawal of pre-tax accounts will be taxable and, if you are under age 59 ½, will normally be subject to the 10% early distribution penalty.

As with loans, if considering a withdrawal, you must carefully weigh the need for these funds against the loss of tax-deferred growth in your savings plan account.

https://www.irahelp.com/slottreport/tapping-retirement-accounts-if-not-directly-impacted-covid-19

QCDS AND ROTH CONVERSIONS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi. What are the rules for QCDs now that required minimum distributions (RMDs) have been cancelled for 2020?

Thanks for your help.

Jerry

Answer:

Jerry,

Qualified charitable distributions (QCDs) are unaffected by the CARES Act. Even though RMDs are waived for 2020, you can still do a QCD if you otherwise qualify. While QCDs are a popular way to offset the income from an RMD, they are not required to coincide with an RMD. “Voluntary” withdrawals can just as easily be removed from income by a QCD.

Question:

In January 2020 I converted money from my traditional IRA to a Roth IRA.  Can I undo the conversion?  If so, is there a time limit to do this by and are there any stipulations?

Thank you,

Mike

Answer:

While Roth contributions can still be recharacterized, conversions such as yours cannot. Roth conversion recharacterization was eliminated a couple of years ago by the Tax Cuts and Jobs Act. It may be wishful thinking but, with the recent market collapse and all the financial support offered in the CARES Act, the IRS could decide to temporarily allow conversion recharacterizations. However, I am sorry to say that, as of now, there is no going back on your Roth conversion.

https://www.irahelp.com/slottreport/qcds-and-roth-conversions-todays-slott-report-mailbag-1

NO “FIRST MONEY OUT” RULE FOR 2020

By Sarah Brenner, JD
IRA Analyst

On March 27, the massive “Coronavirus Aid, Relief, and Economic Security Act,” or the “CARES Act,” was signed into law. The CARES Act includes a waiver of required minimum distributions (RMDs) for 2020. This waiver applies to company savings plans and IRAs, including both traditional and Roth inherited IRAs.

The waiver of RMDs for 2020 has raised many questions. One question that we have been hearing a lot is: What is the effect of the waiver on the “first money out” rule?

How the First Money Out Rule Works

The first money out rule says that the first money you take out of your IRA or plan in a year when you have to take an RMD is considered to be your RMD for the year. An RMD cannot be rolled over or converted. So, if you want to roll over your employer plan to an IRA or convert your traditional IRA to a Roth IRA, you need to take your RMD first. It can’t be rolled over or converted.

No First Money Out Rule for 2020

The 2020 RMD waiver means that we get a year off from this problematic rule. Since RMDs are waived, you can go ahead with a rollover or conversion without any concern about taking your 2020 RMD first, because there is no RMD to take.

This is really good news. The first money out rule is always confusing people. We have a lot of other problems right now, but this pesky rule is not one of them!

The elimination of the first money out rule means that there are no worries this year about rolling over your entire plan distribution to an IRA.

This is also a great opportunity for a Roth conversion. In 2020, you can convert your entire IRA to a Roth IRA without having to take the RMD first. Now all that money (which would be taxed anyway) is available for conversion.

If you do not need your 2020 RMD, you may still want to take it anyway and convert it to a Roth IRA. Sure, there will be a tax bill now, but the trade-off is tax-free earnings when the market recovers.

https://www.irahelp.com/slottreport/no-%E2%80%9Cfirst-money-out%E2%80%9D-rule-2020

ROLLING OVER AN RMD

By Andy Ives, CFP®, AIF®
IRA Analyst

Like most people’s lives, the retirement world is upside down. This is made evident by a single statement: “Required minimum distributions (RMDs) can be rolled over.”

Yes, that is the new normal – at least for this year. RMDs are considered the first money out of an IRA and workplace plan. Typically, these dollars are ineligible to be rolled over to either another plan or IRA. The RMD always had to be taken first. If an RMD was erroneously rolled over, it was an excess contribution and the appropriate fix-it steps had to be followed.

But those hard-and-fast rules are no more for 2020. As we have written in the Slott Report, the “Coronavirus Aid, Relief, and Economic Security Act,” or the “CARES Act,” was signed into law on March 27. The Act includes a waiver of RMDs for this year from company savings plans and IRAs. In addition, the CARES Act impacts 2019 RMDs for those who reached age 70 ½ in 2019 and have a required beginning date of April 1, 2020. Any 2019 RMD amount remaining and not already withdrawn by January 1, 2020 is waived.

But what about RMD payments that were withdrawn between January 1, 2020 and March 27, when the Act was signed? Those account owners had no way of knowing that RMDs would be waived. And what about RMDs that were withdrawn subsequent to the passing of the CARES Act? After all, many RMDs are paid out automatically.

There is relief. Since RMDs are essentially eliminated for 2020, any withdrawal of what would have been an RMD is now considered a normal withdrawal. There is no “first money out” rule to be concerned with. Normal (voluntary) withdrawals are eligible for rollover, so some or all of the money may be able to be returned to the account. I say “may” because the CARES Act does not grant a free rollover to everyone for every RMD dollar. There are rules that must be followed, including:
1. The 60-day rollover rule still applies. The distribution must have been received within 60 days to be eligible for rollover.

 

2. The one-per-year rollover rule still applies. If another 60-day rollover was done within the previous 365 days, then the RMD cannot be put back. This means that if a person received monthly RMD payments, only one can be rolled over. (Note: Rollovers from employer plans to IRAs and vice versa do not count toward the one-per-year rule.)
3. Non-spouse inherited IRA RMDs cannot be rolled over. While the CARES Act waived RMDs from both inherited traditional IRAs and inherited Roth IRAs, payments already received cannot be returned. Even though the character of the inherited IRA RMD was changed to a normal withdrawal, no type of withdrawal from an inherited IRA can ever be rolled over.

Be sure that all rules are followed before haphazardly rolling over an RMD. Yes, these are crazy times, but they are also fluid times. Changes come quickly. Further guidance from the IRS could potentially expand RMD rollover capabilities. As of this writing, RMDs that meet the standard rollover requirements can be rolled back to where they originated or to another qualified account.

https://www.irahelp.com/slottreport/rolling-over-rmd

THE CARES ACT 2020 RMD WAIVER: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

The virus pandemic has prompted legislation that has eliminated the requirement for me to take a required minimum distribution (RMD) from my IRA for the year 2020. Am I therefore allowed to do a partial Roth IRA conversion in 2020 without having to take 2020 RMD first?

Answer:

Yes. The CARES Act RMD waiver for 2020 means you are not required to receive your RMD before doing a Roth IRA conversion in 2020 – or at any time. The same rule applies to any 2020 IRA rollover for anyone who would normally have an RMD due.

Question:

I took my 2020 RMD in full about 6 weeks ago. I’m wondering if the RMD waiver for 2020 can be applied retroactively, allowing me to roll back or otherwise undo this unfortunate distribution. My 60-day rollout clock (if it applies) is ticking!

Answer:

We have gotten this question a lot!

Because of the CARES Act RMD waiver, the RMD you already received was not technically an RMD. This means the RMD can be rolled over as long as two conditions are met. The first is that the rollover must occur within 60 days of the day you received the RMD. The second is that you must not have received another distribution during the 12 months prior to receipt of the RMD that you rolled over the same way as the rollover you wish to do (traditional IRA-to-traditional IRA or Roth IRA-to-Roth IRA). If both of these conditions are met, you should be able to do the rollover.

https://www.irahelp.com/slottreport/cares-act-2020-rmd-waiver-today%E2%80%99s-slott-report-mailbag

CARES ACT RELIEF FOR RETIREMENT DISTRIBUTIONS AND PLAN LOANS

By Ian Berger, JD
IRA Analyst

The recently-enacted “Coronavirus Aid, Relief, and Economic Security Act,” or CARES Act, includes special tax relief for IRA and company plan withdrawals made in 2020 and for company plan loans.

Who gets relief? Both the distribution and plan loan relief apply only to “qualified individuals.” Not everyone meets this definition. The definition includes:

· individuals diagnosed with the SARS-CoV-2 or COVID-19 virus by a test approved by

the CDC;

· individuals whose spouse or dependent is diagnosed;

· individuals who experience “adverse financial consequences” on account of:

>  being quarantined;

>  being furloughed or laid off or having work hours reduced;

>  being unable to work due to lack of child care; or

>  closing or reducing hours of a business owned or operated by the individual.

The law gives the Secretary of the Treasury the authority to expand this definition.

Which distributions get relief?  If you are a “qualified individual,” up to $100,000 of distributions from IRAs and company savings plan made in 2020 are eligible for relief. IRA and company plan distributions are aggregated for this purpose.

What are the relief provisions for withdrawals? There are three withdrawal-related relief provisions. The first waives the 10% early distribution penalty. That penalty normally applies to IRA or company plan withdrawals if you are under age 59 ½, unless an exception applies. The CARES Act adds a new exception to that penalty but only if you are a “qualified individual.”

The second provision provides relief if your financial situation improves and you no longer need the withdrawn funds. “Qualified individuals” can repay, tax-free, 2020 withdrawals to an IRA or company plan. Repayment must be made within three years of the date the money was received. If you have already paid taxes on a withdrawal that you later decide to repay, you can file an amended tax return to recover the taxes.

In most cases, your withdrawal will be taxable. To cushion the blow of getting hit with the entire tax in the year of distribution, the CARES Act permits you to spread any federal income tax over three years.

What are the relief provisions for loans? If you participate in a company plan that allows loans, the CARES Act increases the maximum amount of any new loan taken by September 23, 2020. If you are a “qualified individual,” you can borrow up to 100% of your account balance – but no more than $100,000 (reduced by the amount of any outstanding loans). In addition, you can get a break on repaying existing loans. For repayments normally due between March 27, 2020 and December 31, 2020, you can delay repayment for a year.

It appears that these tax relief provisions are available from your plan only if your employer allows it. We expect that most companies will.

https://www.irahelp.com/slottreport/cares-act-relief-retirement-distributions-and-plan-loans

CORONAVIRUS RELIEF FOR RETIREMENT ACCOUNTS

By Sarah Brenner, JD
IRA Analyst

As the coronavirus pandemic has spread, many Americans have been hit hard. Their retirement accounts have also taken a serious blow as markets have plummeted. In these tough times, there is a bit of good news as the government has come through with some relief for retirement savers.

IRA Deadline Extended until July 15

The IRS has extended the tax-filing deadline for 2019 federal income tax returns from April 15 to July 15. The extension of the tax-filing deadline also postpones the deadline for making 2019 prior-year contributions to traditional and Roth IRAs from April 15 to July 15. This is good news for retirement savers, giving them a little more time to get their prior-year contributions done. To avoid confusion, anyone taking advantage of this postponed deadline should be sure to clearly indicate to the IRA custodian that the amounts contributed are 2019 prior-year contributions.

2020 RMD Waiver

On March 27, the massive “Coronavirus Aid, Relief, and Economic Security Act,” or the “CARES Act,” was signed into law. The CARES Act includes a waiver of required minimum distributions (RMDs) for 2020. This waiver applies to company savings plans and IRAs, including both traditional and Roth inherited IRAs.

In addition, the CARES Act impacts 2019 RMDs for those who reached age 70 ½ in 2019 and have a required beginning date of April 1, 2020. Any 2019 RMD amount remaining and not already withdrawn by January 1, 2020 is waived.

The RMD waiver can help you if you would have had to take an RMD this year based on much higher end-of-2019 account values. Now you can avoid the tax bill altogether.

Other Relief

The CARES Act also waives the 10% early distribution on distribution of up $100,000 from IRAs and plans for individuals who meet the requirements of being affected by the coronavirus. The tax would still be due on pre-tax distributions, but could be spread evenly over three years, and the funds could be repaid anytime during the three years.

 

Rules for plan loans are relaxed for those who meet the definition of being affected by the coronavirus with loan limits increased and repayments postponed.

https://www.irahelp.com/slottreport/coronavirus-relief-retirement-accounts

THE TAX FILING DEADLINE AND CHILDREN UNDER THE SECURE ACT: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

With the COVID-19 changes to push the tax filing back to July 31st, can someone still make a 2019 contribution until that date or do all contributions need to be made by the usual April 15th deadline this year?

Jerry

Answer:

Hi Jerry,

This is a question we have been getting a lot!

The IRS has confirmed that the deadline for making both traditional and Roth IRA prior year contributions has been delayed to July 15, along with the tax-filing deadline. If you are making a prior year contribution after April 15, be sure that it is clearly designated as such to ensure proper handling by the IRA custodian.

Question:

Hello. Love the newsletter.

Under the SECURE act (boo!) what is the definition of a “minor” child?  I’m assuming it’s age dependent. Thank you.

Tom G.

Answer:

Hi Tom,

Thanks for reading the newsletter – we are happy you find it helpful!

A minor child of the account owner (but not a grandchild) qualifies under the SECURE Act as an eligible designated beneficiary and can stretch IRA payments until the age of majority or up to age 26 if still in school. The age of majority is determined by state law and is age 18 in most states.

https://www.irahelp.com/slottreport/tax-filing-deadline-and-children-under-secure-act-todays-slott-report-mailbag

BUILDING A SAFETY NET – SMALL BUSINESSES RETIREMENT PLANS

By Andy Ives, CFP®, AIF®
IRA Analyst

By their nature, small businesses struggle in the shallows. Now they face a tsunami. However, when the shutters are removed and customers return and the employees are back on the payroll, normal day-to-day concerns will be a welcome relief. My guess is that many small business owners will create improvements, look to reward dedicated employees, and try to build a better safety net for themselves and their teams should another calamity strike. We could see this materialize in the establishment of more retirement plans.

A recent editorial suggested that plan participants be allowed to invade their workplace retirement accounts – without penalty – as a financial crutch during the coronavirus shutdown. Time will tell if this comes to fruition. While it is a creative idea, not all businesses offer a plan. Many small business owners don’t have two nickels to rub together. Regardless, the conversation around budgeting for and implementing a retirement plan – a safety net – must be held.

Obviously, no two businesses are exactly alike. Every employer has different goals, and every employee has different needs. Does a restaurant in the Florida Panhandle with young seasonal employees and high turnover require the same plan as the mature architectural firm in Uptown Charlotte? Doubtful. Will a start-up law office and a start-up landscape company require the same plan design features? Probably not. Fortunately, there are options.

But where to begin? How do you carve a path through a dense jungle? Proper questions are a machete. Ultimately, the advisor and business owner should hack their way through the overgrowth of the unknown together. Some questions to consider are: Why do you want to implement a plan? What has been your experience with plans? Have you ever participated in a plan? As the conversation evolves, points of pain and items of need will manifest on their own.

Additional questions might include: What are your goals? Are you looking to attract and retain the best talent? Is this plan for you, so you can sink as much money as possible into your own retirement, or is it for your employees? (If the business owner will not be participating, there could be concerns about the viability of the plan. Energy and enthusiasm start at the top and trickle down. Without true buy-in from ownership, workplace plans often die on the vine.) Be forewarned, “greed” can drive some small business owners to exclude as many employees as possible by adopting strict plan eligibility rules. “Need” oftentimes results in a workplace plan that employees will proudly brag about to their friends.

More detailed questions will become relevant. How much do you personally intend to contribute to the plan? Who will be the plan administrator? Liability concerns? Is creditor protection important? Would you like to allow both employer and employee contributions? Will there be a matching component? Does a profit share feature interest you? Roth? Loans?

Through the Q&A process, the most appropriate type of plan will reveal itself. Maybe a SIMPLE is best, maybe a SEP. Possibly a 401(k) is a better fit. The retirement plan jungle is thick, but you can get through it. I suggest a small business owner seek out and partner with a knowledgeable advisor, who can in turn introduce a helpful TPA and a trusted record keeper. Ask questions, keep an open mind, and start the search for the best plan for your small business!

https://www.irahelp.com/slottreport/building-safety-net-%E2%80%93-small-businesses-retirement-plans

SPLITTING IRAS AFTER THE SECURE ACT

By Ian Berger, JD
IRA Analyst

It’s common for IRA owners to leave their assets to multiple beneficiaries – for example, their children. Before the SECURE Act, it usually made sense to split the IRA into separate accounts either before or after death. That’s because beneficiaries could stretch payment of their shares over their life expectancy. But, if there were multiple beneficiaries and the account was not split, each beneficiary was required to use the life expectancy of the oldest beneficiary – the one with the shortest life expectancy. Splitting accounts allowed each beneficiary to use her own life expectancy.

Under the SECURE Act, most non-spouse beneficiaries must use the 10-year payout rule, which requires the entire IRA to be emptied by December 31 of the tenth year following the owner’s death. No annual distributions are required. Life expectancy is no longer used to calculate payouts for beneficiaries subject to the 10-year rule.

So, does this mean that splitting IRAs is no longer a worthwhile strategy? Not at all. Here are several good reasons why it still makes sense to create separate accounts:

When a spouse is co-beneficiary. Surviving spouses can take advantage of special IRA distribution rules that no other beneficiaries can use. For example, a surviving spouse can roll over inherited IRAs to her own IRA. However, those special rules are available only if the spouse is a sole IRA beneficiary. So, if a spouse is an IRA co-beneficiary, look to create a separate account for her to make sure she can use the special payout rules.

When an eligible designated beneficiary is co-beneficiary. Under the SECURE Act, certain individuals, called eligible designated beneficiaries (“EDBs”), can still use the stretch. These are: surviving spouses; minor children of the account owner; disabled individuals; chronically ill individuals; and individuals no more than 10 years younger than the owner. But, if one beneficiary is an EDB and the others are not (for example, one beneficiary is a minor child and one is an adult child), the EDB can only use the stretch if a separate account has been established for the EDB.

When a co-beneficiary is a non-living beneficiary. Sometimes, an IRA owner will leave part of the IRA to a charity (or another non-living beneficiary) and the remainder to one or more individuals. Non-living beneficiaries must use the least favorable IRA distribution rules (which could result in a payout period of less than 10 years). So, unless the IRA is timely split, the individual co-beneficiaries will also be stuck with those restrictive payout rules.

Practical reasons. There are also practical reasons why splitting IRAs while still alive is wise. It allows the owner to invest each account in a way that is best suited for each beneficiary. And, following the owner’s death, each beneficiary is guaranteed to have the freedom to decide whether to accelerate IRA payouts during the 10-year period or wait until the end.

Remember that if the IRA owner doesn’t split the account during his lifetime, the beneficiaries can still do it after his death. But there is a deadline for splitting: December 31 of the year after the year of the original owner’s death.

https://www.irahelp.com/slottreport/splitting-iras-after-secure-act

INHERITED IRAS AND QCDS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

A daughter who has been diagnosed with rheumatoid arthritis is listed as the beneficiary on her father’s Roth IRA.  Does this disease qualify as a “chronic illness” for purposes of the exception to the 10-year rule? Is there a definition that the IRS uses for chronic illness? If she doesn’t take the inherited IRA after 10 years but withdraws it based on her life expectancy, will the IRS send a letter to her where she has to prove chronic illness?  If the IRS doesn’t agree, what will they assess her since the amount is not taxable?

Answer:

There is no list of illnesses that qualify as “chronically ill.” Instead, to meet the criteria as a chronically ill individual under the SECURE Act, the daughter must be certified (by a licensed health care practitioner) to be unable to perform at least 2 activities of daily living for at least 90 days, or require “substantial supervision” due to a severe “cognitive impairment.” It is incumbent upon her to proactively prove she is chronically ill if she intends to stretch inherited IRA payments over her life expectancy. If the IRS rejects her claim of chronically ill and the inherited IRA is not emptied after 10 years, there will be a 50% penalty on any dollars remaining in the account, despite the fact that this is an inherited Roth IRA.

Question:

When I move my 401(k) to an IRA, I understand that I have to take the RMD first. Can I use that RMD as a QCD?

Thank you

Answer:

You are correct that you must take your RMD from the 401(k) prior to rolling over any balance to an IRA. That is because RMDs are considered “first dollars out,” and because RMDs are ineligible for rollover. Since the RMD is applicable to the 401(k) plan, it cannot be offset with a QCD. Only RMDs from IRAs qualify for a QCD.

https://www.irahelp.com/slottreport/inherited-iras-and-qcds-todays-slott-report-mailbag

RETIREMENT SAVINGS IN A VOLATILE MARKET – IS NOW THE TIME FOR A ROTH IRA CONVERSION?

By Sarah Brenner, JD
IRA Analyst

The coronavirus has been wreaking havoc on markets and millions of retirement account balances have suffered significant losses. This has left many IRA owners looking at lower account balances after several years of gains and wondering what the next step should be. One strategy to consider in a market downturn is a Roth IRA conversion.

Why Convert Now?

When you convert your traditional IRA to a Roth IRA, your pretax traditional IRA funds will be included in your income in the year of the conversion.  This increased income may impact deductions, credits, exemptions, phase-outs, the taxation of your social security benefits and Medicare Part B and Part D premiums; in other words, anything on your tax return impacted by an increase in your income.

That is a tax hit, for sure, but keep it in perspective. Remember, the extra income is only for the year of the conversion. The trade-off is the big tax benefit down the road. If you follow the rules for qualified Roth IRA distributions, all your Roth IRA funds, including the earnings, will be tax-free when distributed. Not a bad deal!

A Roth IRA conversion done when the market is down is a bargain. Remember, your tax bill is based on the value of the traditional IRA assets at the time they are converted to a Roth IRA. Convert now when values are low and reap the benefits of tax-free earnings later when the market bounces back.

Beyond the volatile markets there are other good reasons to convert now. Tax reform has lowered tax rates for many and scaled back the AMT. These historically low tax rates will not be here forever. There is a window of opportunity to take advantage of them. Like many of the changes under tax reform, they are scheduled to sunset in a few years. No one knows for sure what the future will bring, but with large deficits a likely possibility, many see future tax rates as moving much higher. Converting now is a way to lock in today’s low rates and avoid worries about the uncertainty of future taxes.

Thinking conversion may be the right move? Ask yourself three questions. First, when will the money be needed? If you need your IRA money immediately for living expenses, converting may not be for you. Second, what is your tax rate? If your income is lower, that may favor conversion. Third, do you have the money to pay the tax on the conversion? It is best to pay the conversion tax from non-IRA funds.

Not sure about converting? The good news is that conversion is not an all-or-nothing decision. You can always hedge your bets and do a partial conversion of your traditional IRA.

Is Conversion Right for You?

Should everybody convert? No, of course not. Conversion is not one size fits all. Also, remember that conversions are now irrevocable. There is no more recharacterization or the ability to undo a conversion. This means you must be very sure before you go ahead with the transaction. Are you a good candidate? Is now the time for your conversion? Professional advice is more valuable than ever. The best way to find out what is right for you is to discuss conversion options with a knowledgeable financial or tax advisor.

https://www.irahelp.com/slottreport/retirement-savings-volatile-market-now-time-roth-ira-conversion

SELF-CERTIFICATION FOR MISSED 60-DAY ROLLOVERS

By Andy Ives, CFP®, AIF®
IRA Analyst

When a person takes a distribution from his IRA or workplace plan, he has 60 days from the day of receipt to redeposit (i.e., roll over) those dollars into another qualified account. This assumes no other disqualifying rollovers have been done in the past 12 months and these dollars are otherwise eligible to be rolled over. If he fails to redeposit all or a portion of the withdrawal within the 60-day window, whatever amount remains outside of the IRA or workplace plan will potentially be subject to tax and potential penalties.

How common are 60-day-rollover fails? Very. Unfortunately, people take withdrawals from retirement plans all the time, fully intent on rolling the money back. However, the reality is that many miss the deadline. But what if there were extenuating circumstances as to why the dollars were not rolled over within the 60-day period? After all, sometimes life gets in the way of the best intentions. In the past, there was no possible fix other than to petition the IRS via an expensive private letter ruling (PLR). PLRs are time consuming, costly, and there is no guarantee the decision will go your way.

Enter “self-certification.” Facing so many requests for an extension of the 60-day rollover window, in 2016 the IRS unveiled a no-cost alternative to a PLR. But tread lightly, self-certification is not a “get-out-jail-free” card. It is not a full waiver of liability, and it is not a second chance for rollovers previously denied. Also, it appears that the money out on rollover cannot have been used during the 60-day window. For example, was your rollover really just a short-term loan? Did you put a down payment on a new house with your rollover but didn’t sell your old house quickly enough to replace the rollover funds? It’s likely that self-certification won’t work because you used the money.

The IRS outlined 11 valid reasons for missing the 60-day deadline. These range from errors by a financial institution to simply misplacing a check. If you were seriously ill or incarcerated – those are also acceptable. Was there a postal error? Was the check lost and never cashed? Was your principal residence severely damaged? All are life events and rollover miscues potentially remedied with self-certification.

In fact, the IRS went so far as to create a model self-certification form letter for you to give to the IRA custodian or plan administrator. (Don’t send it to the IRS.)  Listed on this letter are the 11 allowable reasons for the late contribution. Just don’t mail the letter. Do the rollover as soon as possible and keep all documentation on file. If the rollover is questioned in the future, present your evidence and the form letter. While the IRS has full authority to disallow the rollover, you will have at least made a legitimate effort to rectify the situation.

Self-certification is a valuable tool that can delay or avoid potentially thousands of dollars in taxes, penalties and fees. While it can save an otherwise failed rollover, be sure to seek competent tax and financial advice before proceeding. Also, confirm that your situation fits one of the 11 permissible reasons…and maybe consider avoiding 60-day rollovers altogether.

https://www.irahelp.com/slottreport/self-certification-missed-60-day-rollovers

10% PENALTY ON ROTH CONVERSION DISTRIBUTIONS AND FORM 8606: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Hi Ed,

First of all, I’m a big fan.  Now here’s my question:

If I do a backdoor Roth conversion with exclusively nondeductible IRA contributions, is there a 5-year clock on withdrawing the converted dollars without penalty?  In this case there are no other outstanding IRA dollars. I know there’s a 5-year clock on conversions of deductible contributions. I wouldn’t think there would be a 5-year clock on withdrawing converted nondeductible IRA contributions, but I couldn’t find anything definitive saying that it was okay.  What say you?

Thanks!

Chris

Answer:

Hi Chris,

Thanks for the nice compliment! The 10% early distribution penalty typically applies to distributions of converted amounts if you’re under age 59 ½ and the conversion was less than five years ago. However, the penalty applies only to amounts that were taxable when the conversion was done. Since you had no deductible IRA funds, no part of your conversion was taxable. So, you don’t have to wait five years to withdraw the principal penalty-free. If you’re over 59 ½ (or some other exception, e.g., disability, applies), there is no penalty.

Question:

I have a quick question about 60 day Roth conversion rollovers.  If someone takes a distribution from their traditional IRA in December of 2019, but then within 60 days rolls it over to a Roth in 2020, is Form 8606 required to be filed for tax year 2019 or 2020?

Thanks for your help.

Bill

Answer:

If the Roth conversion took place in 2020, you will file Form 8606 for 2020.

https://www.irahelp.com/slottreport/10-penalty-roth-conversion-distributions-and-form-8606-today%E2%80%99s-slott-report-mailbag

APRIL 15 DEADLINE LOOMS TO CORRECT 2019 EXCESS PLAN DEFERRALS

By Ian Berger, JD
IRA Analyst

The amount of annual elective deferrals you can make to a 401(k) or 403(b) plan is limited by the tax code. If you discover that you’ve over-contributed in 2019, time is of the essence to correct the error. If you don’t act quickly, the tax consequences are serious.

What is the limit?  For 2019, you were limited to $19,000 in elective deferrals (plus an additional $6,000 if you were at least age 50 at the end of the year). It’s important to remember your deferrals to each company savings plan are normally aggregated for purposes of this limit. (There is an exception if you participate in both a 457(b) plan and a 403(b) plan.)

How do you know whether you’ve exceeded the limit?  Most plans have mechanisms in place to prevent you from exceeding the deferral limit in that plan. The problem normally arises if you participated in two different plans during the year (for example, you changed jobs). The W-2 you received from each employer should indicate the amount of elective deferrals in Box 12. Or, you can check your plan statement.

What do I do if I’ve exceeded the limit?  Don’t panic, but contact your plan administrator as soon as possible. To avoid double taxation (see below), the plan must correct the excess amount by April 15, 2020. Since correction may take some time, it’s important that you do this quickly. If you don’t know how to reach the plan administrator, contact your company’s HR department.

What happens next? The plan must make a “corrective distribution” of the excess amount – adjusted for earnings or losses on the excess. The earnings or losses cover the period between the date the excess deferral was made and December 31, 2019. You will receive a corrected W-2 that adds back the excess deferrals to your 2019 taxable wages. Earnings on the excess are taxable to you in 2020.

Example: Hannah, age 40, made pre-tax elective deferrals of $10,000 to Company A’s 401(k) plan before she left Company A to join Company B on July 1, 2019. Hannah then made another $10,000 of pre-tax deferrals to Company B’s 401(k) between July 1 and December 31, 2019. She has exceeded the 2019 deferral limit by $1,000. The excess $1,000 of deferrals earned $75. Hannah becomes aware of this problem and immediately contacts the administrator of Company B’s plan.

Before April 15, 2020, the plan makes a corrective distribution of $1,075 to Hannah. Company B also sends Hannah a corrected 2019 W-2 showing an additional $1,000 of 2019 taxable income. She must include the $75 as taxable income for 2020.

What if the April 15 deadline is missed? This definitely creates double trouble. The excess deferrals are taxed to you both in the year they are contributed and in the year they are eventually paid out.

What if I make excess deferrals in a 457(b) plan?  The rules for correcting 457(b) excess deferrals are different than those described in this article. Contact your plan administrator for more details.

https://www.irahelp.com/slottreport/april-15-deadline-looms-correct-2019-excess-plan-deferrals

 

HOW THE NEW SECURE RULE ELIMINATING THE AGE RESTRICTION ON TRADITIONAL IRAS WORKS

By Sarah Brenner, JD
IRA Analyst

The SECURE Act eliminated the age restriction on contributions to traditional IRAs. The rule outlawing contributions for those 70 ½ or older is no more. This is good news for older IRA owners who are still working or have a spouse who is. Now, traditional IRAs have joined Roth IRAs as available options for eligible savers of all ages. This new rule may seem straightforward, but we have been getting some questions about who is eligible and when it is effective.

Making Contributions and Taking RMDs

One area of confusion for some IRA owners is how the new rule eliminating the age limit for traditional IRA contributions works with another new rule in the SECURE Act, the rule raising the RMD age to 72. IRA owners who reached age 70 ½ in 2019 cannot take advantage of the new ruling delaying RMDs until age 72. They must still take an RMD for 2019 by April 1, 2020 and another RMD for 2020 by December 31, 2020. However, even though they lose out on the new delayed RMD rule, they can still take advantage of the new rule eliminating the age restriction for traditional IRAs.

This will create a situation similar to what has always been the case for SEP and SIMPLE IRAs. Contributions may be coming in for those who are eligible as RMDs are being paid out.

Example 1: Grace is a pre-school teacher. She reached age 70 ½ in 2019. She must take an RMD for 2019 by April 1, 2020 and an RMD for 2020 by December 31, 2020. She can also make a 2020 traditional IRA contribution.

SECURE Act Does Not Apply to 2019 Prior Year Contributions

Another area of confusion is when the rule eliminating the age 70 ½ limit for traditional IRA contributions is effective. This rule is effective for contributions for tax years 2020 and later. It is NOT effective for 2019 contributions. This is true even for prior year 2019 contributions made in 2020. The old pre-SECURE rules apply to 2019 contributions, and those rules do not allow contributions for years in which an individual is age 70 ½ or older.

Example 2: Gabe, 77, works part time at a local hardware store. He would like to contribute to a traditional IRA. Gabe may make a contribution for 2020 to his traditional IRA. However, he cannot make a prior year contribution in 2020 for 2019.

https://www.irahelp.com/slottreport/how-new-secure-rule-eliminating-age-restriction-traditional-iras-works

QCDS AND THE 10-YEAR RULE: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

My dad was 86 when he died and I inherited half of his IRA, which I elected to stretch.  Am I correct in thinking that since I am not yet 70 ½, I am not allowed to direct qualified charitable distributions (QCDs) from this IRA?  Please advise.

Thanks, Ron.

Answer:

Hi Ron,

You are correct. Beneficiaries can do QCDs, but to be eligible the beneficiary must be age 70 ½. If you have not yet reached that age, you may not do a QCD.

Question:

We have not been able to find a clear answer on this…

If a non-spouse beneficiary inherits an IRA and is bound by the new 10-year rule and passes away within the 10 years, is the successor beneficiary bound by the original 10-year timeframe?  Does the account still need to be emptied by the end of the 10th year of the original owner’s death?

Mike

Answer:

Hi Mike,

The SECURE Act is only a little over two months old and there are still a lot of questions about the details. We will need guidance from the IRS to clarify some of these issues. While it is not completely clear, an analysis of the SECURE Act provisions leads us to believe that if a beneficiary dies within the 10-year payout period, a successor beneficiary would not get an additional 10-year period. Instead, the account would need to be emptied within whatever time remains of the original beneficiary’s 10-year period.

https://www.irahelp.com/slottreport/qcds-and-10-year-rule-todays-slott-report-mailbag

RMD TRIVIA

By Andy Ives, CFP®, AIF®
IRA Analyst

True or False?  “It is mathematically impossible for an IRA account owner to have his first required minimum distribution (RMD) be due for the year 2020.”

Here’s why this statement is true.

First, we are not talking about inherited IRAs. If the account owner died in 2019, then the first RMD for the beneficiary needs to be taken by December 31, 2020. Inherited IRAs do not fit this statement.

Next, we are not talking about workplace retirement plans – like a 401(k). The reason this statement does not apply to a 401(k) is because of the pesky “still-working” exception. If a plan has the still-working exception feature and an older employee separates from service in calendar year 2020, then the first RMD will also be due for 2020.

The reasons why it is mathematically impossible for an IRA account owner to have his first RMD be due for the year 2020 are as follows.

1. Anyone who turned 70 ½ in 2019 would be required to take their first RMD for 2019. Granted, the first RMD may be delayed until April 1 of the following year (2020), but this RMD would still be considered a 2019 RMD. Those who turned 70 ½ before 2019 are already on to their second-or-more RMD in 2020.

2. Didn’t the SECURE Act change the RMD to age 72? It did, but a person who turns 72 in 2020 – whether his 72nd birthday is January 1 or December 31, 2020 – is already taking RMDs and would fall into category 1 above. Any RMD taken in 2020 would not be the first RMD.

3. Anyone born on or after July 1, 1949 will turn 70 ½ in 2020 or later. These individuals qualify under the SECURE Act and can delay their first RMD until age 72. If you were born exactly on July 1, 1949, you would have turned 70 ½ on January 1, 2020. Your 72nd birthday will be July 1, 2021, and your first RMD will be for calendar year 2021. While that first RMD can be delayed until April 1, 2022, it will still be labeled as your 2021 RMD. Regardless, neither of these years are 2020.

So, the year 2020 is unique. Legislation and the calendar dictate that it is, in fact, mathematically impossible for an IRA account owner to have his very first RMD be due for this year.

Bonus RMD Trivia: Name a year where a 70 ½ year-old IRA account owner’s very first RMD could have been completely skipped?

Answer: 2009. The Worker, Retiree, and Employer Recovery Act of 2008 waived all 2009 RMD requirements for IRAs and workplace plans due to the 2008 stock market crash.

https://www.irahelp.com/slottreport/rmd-trivia

SEVEN Q&AS ABOUT COMPANY PLAN LOANS

By Ian Berger, JD
IRA Analyst

Who can offer them? Most company retirement savings plans, such as 401(k), 403(b) and 457(b) plans, are allowed to (but not required to) offer plan loans. Loans are not allowed from IRAs or SEP and SIMPLE-IRA plans.

What is the maximum amount I can borrow? Plan loans are generally limited to the lesser of 50% of your vested account balance, or $50,000. Your employer can allow an exception to this rule: If 50% of your vested account balance is less than $10,000, you can still borrow up to $10,000.

Example 1: Justin participates in a 401(k) plan that allows plan loans. Justin’s vested account balance is $16,000. If his plan doesn’t allow the exception, the most Justin can borrow is $8,000. If the plan allows the exception, he can borrow up to $10,000.

Can I have more than one loan at a time? Yes, but any new loan, when aggregated with the outstanding balance of the existing loan, can’t exceed the plan’s maximum limit.

How long do I have to repay the loan? Generally, you must repay a plan loan within 5 years. But a loan used to purchase your principal residence can have a longer repayment.

How are loan repayments made? Loans must be repaid in substantially equal amounts made at least quarterly. Most plans require repayment through payroll deduction.

What are some advantages of taking a plan loan?

· Plan loans don’t require a credit check, and the application process is simple and quick.

· As long as the loan satisfies the above rules, it isn’t a taxable distribution.

· Plan loans usually offer better interest rates than commercial loans. Also, repayments are made back to your account – not to a bank.

What are some disadvantages of taking a plan loan?

· By borrowing against your account, you are reducing the tax-deferred savings that you may need for retirement.

· If your loan violates one of the plan loan rules, your entire outstanding balance will be taxable income to you and can’t be rolled over.

· If you terminate employment with an outstanding loan balance and can’t pay off your balance, your account will be offset by the loan balance. That balance is considered a distribution subject to tax and penalty. You can avoid the tax hit if you can come up with the funds to roll over the unpaid balance to an IRA. The rollover deadline is April 15 of the year following the year the offset occurs (or October 15 if you file for a tax return extension).

Example 2: Elena, age 45, terminates employment on February 15, 2020 with a $50,000 401(k) account balance and a $20,000 loan balance. Elena does not have the funds to repay the loan balance. On March 10, 2020, the plan offsets her $50,000 account balance by the $20,000 loan balance and distributes $30,000 to her. Elena has until April 15, 2021 (or October 15, 2021 if she files for an extension of her 2020 tax return) to find other sources to replace the full $20,000 so she can complete a full rollover. Otherwise, she would owe taxes on the $20,000 and a 10% early withdrawal penalty of $2,000.

https://www.irahelp.com/slottreport/seven-qas-about-company-plan-loans

INHERITED IRAS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Looking for your help. Husband has an inherited IRA (from his dad prior to the SECURE Act) and was taking RMDs using the single life table. Husband passes away in 2020 and leaves the inherited IRA to his wife who is age 65. What are the wife’s options for distribution?

Thanks,

Travis

Answer:

Travis,

Under the SECURE Act, if a beneficiary owner of an inherited IRA dies in 2020 (or later), the next beneficiary in line (the successor beneficiary) is bound by the 10-year payout rule. Even if the successor beneficiary would otherwise be allowed to stretch payments as an eligible designated beneficiary (i.e., spouse, disabled individual, etc.), that person is still saddled with the 10-year rule. There are no annual RMDs over the 10 years, but the wife must empty the account  by the end of the 10th year after the year of her husband’s death.

Question:

Hello. I recently inherited an annuity from my father. His advisor advised me to take a lump sum distribution from the annuity and deposit into my inherited IRA. I subsequently received the check for the lump sum distribution and handed it over to her for deposit into my inherited IRA.  She stated that as long as I did not cash the check, I would not be taxed until the funds were eventually withdrawn from the inherited IRA. However, I now have received a 1099-R for the funds. The original annuity company stated that we should have completed a non-taxable transfer. What is the best way to clear up this situation with the IRS?

Thank you very much for your time!

Margaret

Answer:

Margaret,

After reading the first few lines of your question, I thought, “Oh, no.” Unfortunately, you were given bad information from both your father’s advisor and the custodian where the check was deposited. Non-spouse beneficiaries cannot do 60-day rollovers with inherited money. Only spouses can. The original annuity company is correct in saying the money should have been moved via a non-taxable transfer.

My “oh no” reaction was because this mistake cannot be reversed. The full amount of the distribution from the IRA annuity will be taxable (hence, your receipt of the 1099-R). In addition, you will need to remove the amount rolled into the inherited IRA. Since the annuity money was not eligible for rollover, it is technically an excess contribution in the inherited IRA and subject to a potential penalty.

https://www.irahelp.com/slottreport/inherited-iras-todays-slott-report-mailbag

10 THINGS TO KNOW ABOUT THE SECURE ACT’S 10-YEAR RULE

By Sarah Brenner, JD
IRA Analyst

The SECURE Act overhauled the rules for beneficiaries of retirement accounts. One significant change it brought is the new 10-year payout rule. Here are ten things you need to know about the new 10-year rule.

1. The 10-year rule applies to most nonspouse beneficiaries when the account owner dies in 2020 or later. The bottom line with the SECURE Act is that very few nonspouse beneficiaries will escape the 10-year rule. While the new law does carve out some exceptions such as disabled or chronically ill individuals, most beneficiaries who used to be able to stretch out distributions over their lifetime will end up with the 10-year rule.

2. Spouse beneficiaries are not subject to the 10-year rule. Many people name a spouse as the beneficiary of their retirement account. Spouse beneficiaries escape the 10-year rule and can continue to use the stretch.

3. The account must be emptied by December 31 of the tenth year following the year of death. We expect the 10-year rule to work like the old 5-year rule with an end-of-year deadline.

4. The 10-year rule applies to successor beneficiaries. The rules have changed for successor beneficiaries. They must empty the account within ten years instead of continuing the stretch over the original beneficiary’s life expectancy.

5. There are no annual RMDs during the ten years. Nothing needs to be taken out of the inherited account until the end of the tenth year following the year of death.

6. Minor children will ultimately be subject to the 10-year rule. While minor children of the account owner can get the stretch, this won’t last forever. Once they reach the age of majority under state law or finish school (but no later than age 26), the 10-year rule will kick in.

7. Most trusts will be subject to the 10-year rule. Most trusts, like other nonspouse beneficiaries, will be subject to the 10-year rule.

8. Grandchildren who are retirement account beneficiaries will mostly be subject to the 10-year rule. Under the old rules, many retirement account owners would name a grandchild as an IRA beneficiary to get the maximum stretch. This will not work anymore. Unless a grandchild is chronically ill or disabled, the 10-year rule will apply.

9. Roth IRA beneficiaries are also subject to the 10-year rule. The SECURE Act requires Roth IRA beneficiaries to use the same set of rules as traditional IRA beneficiaries, resulting in the 10-year rule applying to most Roth IRA beneficiaries.

10. Failure to comply with the 10-year rule results in a big penalty. If a beneficiary does not empty the account by the end of the tenth year following the year of death, there is a serious penalty. A 50% penalty will apply to any amount not taken from the inherited account.

https://www.irahelp.com/slottreport/10-things-know-about-secure-act%E2%80%99s-10-year-rule

CAREFUL CONSIDERATIONS: SPOUSAL ROLLOVER OR INHERITED IRA?

By Andy Ives, CFP®, AIF®
IRA Analyst

A spouse beneficiary of an IRA faces many decisions. There is great flexibility and many items to consider. For example, how old was my spouse when he or she passed and what impact will that have on my available choices? Do I need money now? How can I minimize my tax burden? Will penalties apply if I withdraw from the account? By systematically considering each question and leveraging the rules, a spouse beneficiary can create a unique plan that fits his or her needs. After all, with the loss of a spouse, the last thing anyone wants to deal with is money problems derived from poor planning.

Example 1: Married couple John and Janet are both 55 years old. John dies and leaves his traditional IRA to Janet. Janet will need immediate access to the account to cover living expenses. Based on these facts, the decision is clear. Janet should establish an inherited IRA. By choosing this route, she will have full access to the account penalty-free. Of course, taxes will still be due, but at least Janet can avoid the under-age 59 ½ 10% early withdrawal penalty.

By choosing an inherited IRA, Janet will accomplish several goals. Since John died before his required beginning date, Janet can delay any required minimum distributions (RMDs) from the account until John would have been age 72. Then, when Janet is actually 59 ½, she can do a spousal rollover and move the remaining balance of the inherited IRA into her own IRA. At that point, when she is over 59 ½, there is no more 10% penalty to be concerned with, so consolidating accounts makes sense. There is no time limit for when a person must complete a spousal rollover.

Oftentimes a surviving spouse, based on misinformation, will jump to an erroneous decision. There are numerous real-life examples where poor planning and a general misunderstanding of the spousal inheritance rules lead to disaster. In one case, a young widow elected a spousal rollover of a $2.6 million IRA. She then took a $997,000 distribution. Since she was under 59 ½, a 10% penalty of $97,000 applied.

Example 2: Ed (age 73) and Edna (age 65) are a married couple. Edna dies and leaves her IRA to her husband Ed. Ed has plenty of money and is trying to reduce income to minimize taxes. Ed and his financial advisor evaluate the options. If Ed does a spousal rollover, all of Edna’s IRA money will immediately be moved into Ed’s IRA. Since Ed is already taking RMDs, this new influx of cash will increase his IRA balance, thereby increasing his future RMDs and tax burden.

However, as a spouse beneficiary, Ed has other options. Another possibility is to establish an inherited IRA. Since Edna died before her required beginning date, RMDs from this inherited account can be delayed until December 31 of the year that Edna would have turned age 72. Once again, the decision is clear. Based on Ed’s primary goal of reducing income and taxes, an inherited IRA is the way to go. Ed can delay any RMDs from Edna’s account for another 7 years. If Ed’s goals change, there is nothing stopping him from withdrawing more from the inherited IRA or consolidating accounts via a spousal rollover at any time in the future.

Every scenario is different, and every person has their own set of objectives. A spousal rollover is not always the perfect fit. It is imperative to be aware of all options available. There is no need to rush into a decision. Systematically work through the alternatives and carefully consider all possibilities.

https://www.irahelp.com/slottreport/careful-considerations-spousal-rollover-or-inherited-ira

TAX RULES FOR DIFFERENT TYPES OF WORKPLACE PLANS

By Ian Berger, JD
IRA Analyst

Most workplace retirement plans allowing elective deferrals fall into one of these varieties:

  • 401(k) plans for employees of private sector companies.
  • 403(b) plans for employees of tax-exempt employers, public schools and churches.
  • 457(b) plans for employees of state and local governments.

Although many of the tax rules governing these types of plans are the same, there are some important differences. (This article doesn’t cover the Thrift Savings Plan, for federal government workers and the military, or 457(b) “top-hat” plans for employees of tax-exempt employers.)

What’s the same?  These tax rules apply to all three types of plans:

  • Elective deferrals are limited (to $19,500 for 2020), but employees who are age 50 or older at the end of the year can make catch-up contributions (up to $6,500 for 2020).
  • Roth contributions may be offered.
  • Plan loans may be offered.
  • Hardship withdrawals may be offered (although the 457(b) hardship standards are stricter than the 401(k) and 403(b) standards).
  • Required minimum distributions (RMDs) are required, but the “still-working exception” may be used. That exception allows employees who do not own more than 5% of the company (after applying family aggregation rules) to defer RMDs until the year they separate from service or retire.
  • Rollovers of eligible distributions to IRAs or other plans must be offered. In addition, 20% of the distribution must be withheld for federal income taxes (and possibly an additional amount for state income taxes) for eligible distributions that are not directly rolled over.
  • Rollovers of eligible distributions from IRAs or other plans are permitted. However, 457(b) plans allowing incoming rollovers from IRAs or non-457(b) plans must hold them in separate accounts.
  • 401(k) and 403(b) plans have always been able to offer in-service distributions at age 59 ½ or older. Following a change made by a 2019 law, governmental 457(b) plans can now also offer age 59 ½ or older in-service distributions.

What’s different?  These tax rules apply differently:

  • While 401(k) and 403(b) plans can offer after-tax contributions, 457(b) plans cannot.
  • In determining RMDs, 403(b) plans can be aggregated, but 401(k) and 457(b) cannot be. RMDs for pre-1987 403(b) accounts can be delayed until age 75.
  • A 10% early distribution penalty applies to certain 401(k) or 403(b) distributions made before age 59 ½. The penalty does not apply to 457(b) distributions – except for certain distributions of non-457(b) plan rollovers.
  • Only 403(b) plans allow for a special catch-up contribution for employees with 15 or more years of service. Only 457(b) plans allow a special catch-up for the last three years before an employee’s normal retirement age.
  • https://www.irahelp.com/slottreport/tax-rules-different-types-workplace-plans

BACK DOOR CONVERSIONS AND GRANDCHILDREN UNDER THE SECURE ACT: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

For the last three years, I have done a back door Roth conversion. I do the conversion in January.

I am 68 years old and I am rolling over my 457(b) New York City deferred compensation plan funds to a rollover IRA with Vanguard. They will get the money around April 1, 2020. Will there be a tax penalty for the 2020 Roth conversion?

Answer:

When you do a back door Roth conversion, the pro-rata rule applies if you have pre-tax funds in any of your IRAs. In that case, a portion of your conversion will be considered taxable based on the ratio of your pre-tax IRA funds to the sum of all of your IRA funds.

The pro-rata calculation is not based on the balances in your IRAs on the date of the conversion. The account balance used is the end of the year of the transaction.

So, if you are rolling your New York City account into a traditional IRA, you will have pre-tax IRA funds as of December 31, 2020. That means a portion of your 2020 back door Roth conversion will be taxable.

Question:

In looking at information regarding the exceptions for inherited IRAs under the SECURE Act, Financial-Planning.com cited your company as a source to say “minors-but not grandchildren” are part of the exception.  However, I cannot find on the IRS site or any other for that matter that says grandchildren who are minors are NOT excluded.  Can you please provide the source for this?  Our firm would like to make all staff and advisors aware of this.

Thank you in advance for your time and assistance with this matter.

Best regards,

Brenda

Answer:

Hi Brenda,

You will find the reference to minor children in section 401(a)(2) of the SECURE Act. That section lists the categories of persons considered “eligible designated beneficiaries.” Eligible designated beneficiaries can continue to stretch out distributions over their life expectancy – even after the SECURE Act.

Besides minor children, other categories include: surviving spouses; disabled individuals; chronically ill individuals; and individuals no more than 10 years younger than the IRA owner. That section makes no mention of grandchildren – whether minor or not. This means grandchildren cannot use the stretch and instead are subject to the new 10-year payout rule.

https://www.irahelp.com/slottreport/back-door-conversions-and-grandchildren-under-secure-act-today%E2%80%99s-slott-report-mailbag

SECURE ACT REQUIRES ACTION IF A TRUST IS YOUR IRA BENEFICIARY

By Sarah Brenner, JD
IRA Analyst

Many IRA owners have named trusts as their IRA beneficiaries. You may be one. Trusts offer control from the grave and can be a smart choice, especially to protect beneficiaries who may be minors, have special needs or simply are not good with money. Naming a trust as an IRA beneficiary has always had its problems. The rules are complicated and having a trust drafted and administered can come with a hefty price tag. The ability to stretch RMDs over a trust beneficiary’s lifetime, however, was often enough to outweigh the negatives. The SECURE Act changes this equation.

Enter the SECURE Act

Under the SECURE Act, most beneficiaries will no longer get the stretch. Instead, most beneficiaries, including trusts, will be subject to a 10-year payout rule. That means all the funds in the inherited IRA must be paid out either to the trust or the trust beneficiaries within 10-years. Keeping the inherited IRA intact and using the stretch to pay annual RMDs to a trust is now a relic of the past.

Because trusts were often drafted with the goal of using the stretch in mind, under the SECURE Act many trusts will no longer work as planned. Many include language that will result in faster than expected payouts or larger than expected tax bills.

Is Your Trust Still the Right Beneficiary?

Every IRA owner who has named a trust as their IRA beneficiary should rethink that decision and reevaluate if a trust is still the way to go. The answer may still be yes for some, but for many others it will be no. If a trust is your IRA beneficiary, you should contact your financial advisor to discuss your specific situation. You may need to confer with the attorney who drafted it and decide whether the trust is still the right beneficiary. It may need to be revised or maybe scrapped altogether. This is something you should take care of sooner rather than later. If careful planning is not done, the SECURE Act could mean that your hard-earned savings may end up going to Uncle Sam instead of to your heirs. That is an outcome no IRA owner would want.

https://www.irahelp.com/slottreport/secure-act-requires-action-if-trust-your-ira-beneficiary

QCDS AND INHERITED ROTH IRAS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

Can a QCD be used to pay dues to a charitable organization?

Answer:

This is an area where we receive a lot of questions. To qualify as a QCD, there cannot be any benefit back to you from the funds that go from your IRA to the charity. Paying dues required for membership would be a benefit back to you and as such would not qualify as a QCD.

Question:

My brother and I are both recently retired. Our father is 90 years old. Dad has listed my brother and me as co-beneficiaries (each entitled to 50%) of his Roth IRA account upon his passing.

Do you believe this is the best/correct form of beneficiary title for my brother and me? If not, please detail what specifically you would recommend. What if my bother wants to cash out his 50% of the Roth account in the same year Dad passes, and I want to retain my 50% of for up to 10 years and then cash it out? Do we need to address this possibility with modified beneficiary title/instructions in advance?

Thank you,

Greg

Answer:

Hi Greg,

Your father’s plan to name both you and your brother as equal beneficiaries directly on his Roth IRA beneficiary form is a good one. By your father indicating on the beneficiary designation form exactly who is entitled to the IRA funds after his death and exactly how much each beneficiary will get, many of the issues and complications that can arise after the death of an IRA owner will be avoided

After your father’s death, separate inherited Roth IRAs should be established for both you and your brother. Each of you can do what you like with your share. If your brother wants to take an immediate distribution of his share and you choose to maximize the time allowed by the 10-year rule, that is not a problem. There is no need for any additional instructions to be added to the beneficiary form to address this situation.

https://www.irahelp.com/slottreport/qcds-and-inherited-roth-iras-todays-slott-report-mailbag

INDIANA JONES AND THE 72(T) IDOL

By Andy Ives, CFP®, AIF®
IRA Analyst

Do you want to access your IRA funds penalty-free, even though you are under age 59 ½ and no exception fits your situation? It can be done. Starting a new business and need capital from your IRA, but don’t want to pay the 10% early withdrawal penalty? There is a workaround. Lost your job and require funds to cover your mortgage and cell phone bill, but the only bucket of cash you have is your IRA? There is a pathway to the gold, but it is fraught with danger.

Like Indiana Jones sprinting through spiderwebs and dodging poison-tipped darts while leaping bottomless pits, the giant 72(t) boulder will roll fast at your heels. One misstep could result in crushing disaster. However, if it is the golden idol in the rear of the IRA cave you seek, there is a way.

The general idea of a 72(t) schedule (or a “series of substantially equal periodic payments”) is to open the door to an IRA before 59½ without a 10% penalty. However, you must commit to a plan of withdrawals according to the rules set out in Section 72(t) of the Internal Revenue Code. For example, you can begin the payment schedule from an IRA at any age, but it is required to continue for at least five years or until age 59½, whichever period is longer. (Start at age 42, and your daring cave escape must last 17+ years.)

The payments cannot be stopped during the term, unless the account owner becomes disabled, dies, or the account is decimated (say, from poor investment decisions). The IRA account to which the 72(t) schedule applies cannot have dollars added to it via contributions or rollovers. As such, consider splitting the IRA account prior to entering the 72(t) cave – the restrictions will only apply to the IRA being annuitized.

If you think you can avoid the thundering boulder by rolling over any unneeded 72(t) payments to a different IRA, that dead end will send you straight into the spears of the IRS. 72(t) payments are not eligible for rollover. Also, if the agreed upon schedule is modified, or if the balance in the IRA changes from anything other than normal gains and losses, then the 10% penalty will apply retroactively to all distributions taken prior to age 59 ½. More spears.

So how does one calculate the amount of the 72(t) payment? The IRS describes three primary allowable methods: Minimum Distribution, Amortization, and Annuity Factor. The Minimum Distribution method is essentially calculated in the same manner as RMDs when a person reaches his required beginning date. This method will generally produce the lowest annual payment, and it will fluctuate as the account balance and age factor change from year to year.

The Amortization and Annuity Factor Methods will produce higher annual withdrawals. Both methods allow you to use a “reasonable” interest rate to calculate the payment schedule. The IRS describes a reasonable interest rate as, “any interest rate that is not more than 120 percent of the federal mid-term rate…for either of the two months immediately preceding the month in which the distribution begins.”

Be wary. This is only a brief overview of the 72(t) process. Understanding the danger zones is paramount to survival. Read the cave map carefully, know the risks, and stay out of the light. By following the rules, you may get some spiderwebs stuck to your arms, but at least you can walk away with your golden 72(t) idol in hand.

https://www.irahelp.com/slottreport/indiana-jones-and-72t-idol

SPOUSAL PROTECTION IN COMPANY RETIREMENT PLANS

Ian Berger
IRA Analyst

One important difference between IRAs and company retirement plans is spousal protection. Except for community property states, spouses of IRA owners do not have any rights to the account. By contrast, many workplace plans must provide spouses at least some financial protection.

In the world of company plans, spouses have potentially two types of protection, depending on the type of plan.

Spousal Consent to Plan Distributions. The first type of protection requires certain plans to pay a married participant’s benefit as a specific type of annuity – unless the participant elects another form of payment and the spouse consents. The required annuity type is called a “qualified joint and survivor annuity” (QJSA). A QJSA pays a monthly benefit over the participant’s lifetime and, if the spouse outlives the participant, pays the spouse a monthly benefit over the spouse’s remaining lifetime. This rule applies to all plans covered by ERISA, with one important exception. It does not apply to ERISA-covered 401(k) and 403(b) plans – unless the plan offers an annuity as an optional form of payment and the participant elects the annuity. Since most 401(k) plans offer only a lump sum form of payment, most 401(k) plans are exempt from the QJSA requirement. However, the QJSA rules always apply to ERISA-covered defined benefit pension plans.

Example 1: Jerry participates in is an ERISA-covered pension plan. Jerry is married when he retires, and he wants to elect an annuity that pays him a benefit over his lifetime only (with no spousal benefit after he dies). The plan can pay Jerry that type of annuity only if his wife consents. If his wife doesn’t consent, the plan must pay him a QJSA.

Spouse as Beneficiary. The second type of protection requires certain company plans to automatically treat a married participant’s spouse as his beneficiary – unless the participant designates another beneficiary and the spouse consents. This rule applies to all ERISA plans – ERISA-covered 401(k) and 403(b) plans do not get a free pass.

An offshoot of this rule is the requirement that, without spousal consent, death benefits for beneficiaries of married participants who die before retirement must be paid in the form of a “qualified pre-retirement survivor annuity.” A QPSA pays a monthly benefit to a spousal beneficiary over the beneficiary’s lifetime. The QPSA rule does not apply to 401(k) or 403(b) plans that do not offer an annuity as an optional payment form. But, again, even those 401(k) or 403(b) plans must require a married participant’s spouse to be the beneficiary – unless the spouse consents to another beneficiary.

Example 2: Elaine participates in a 401(k) plan that does not offer an annuity as a payment option. Elaine has designated her brother Keith as her 401(k) plan beneficiary, but her husband David did not consent to that designation. While participating in the plan and still married to David, Elaine dies. The plan must pay the death benefit to husband David. However, the death benefit does not have to be in the form of a QPSA.

https://www.irahelp.com/slottreport/spousal-protection-company-retirement-plans

ROTH CONVERSIONS AND QUALIFIED CHARITABLE DISTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

An initial ROTH conversion was completed in 2018 for tax year 2018. A second conversion was completed in 2019 for tax year 2019. There was no ROTH IRA account prior to 2018 and the account owner is over 59 ½. The 5-year holding period will be satisfied on 1/1/2023. Does each ROTH conversion transaction have a separate 5-year clock to determine whether earnings are tax free or is it just the initial transaction? Thank you in advance for your assistance.

Dan

Answer:

Dan,

For those under the age of 59 ½, yes, each Roth conversion has its own 5-year clock. However, the account holder you are inquiring about is already over 59 ½. As such (and since this is his very first Roth IRA account), he only has to concern himself with the 5-year clock on the 2018 conversion. Since a person who is over 59 ½ already has full access to his traditional IRA before a conversion, he will still have full access to the account immediately after the conversion. It is the tax on the earnings that we are concerned about. On 1/1/2023, he will have satisfied the 5-year clock for tax-free earnings on the 2018 conversion. Also on 1/1/2023, he will have satisfied a second requirement – what I call the “5-year forever” Roth clock – which means the 2019 conversion clock becomes irrelevant. Going forward, his Roth IRA will provide immediate tax- and penalty-free earnings for the rest of his life, regardless of how or when new Roth money is added to it. There will be no more clocks to worry about.

Question:

Mr. Slott,

I understand that you can make up to a $100,000 withdrawal from my IRA for a qualified charity. Does the withdrawal for the charity have to be a once-per-year event, or can it be monthly, quarterly, etc., so long as the total does not exceed $100,000?

Wayne

Answer:

Wayne,

Yes, qualified charitable distributions (QCDs) are capped at $100,000 annually, per person. You must be at least age 70 ½ to do a QCD, and the payment must be directly transferred to the eligible charity. (Don’t make the mistake of withdrawing the money yourself.) QCDs can be done as often as you wish – there is no limit on the number of QCDs, only on the total amount. If you do go over the $100,000 limit, the overage will not be excluded from income and cannot be carried forward to the next year.

https://www.irahelp.com/slottreport/roth-conversions-and-qualified-charitable-distributions-todays-slott-report-mailbag

MOVING YOUR IRA FUNDS WHILE TAKING RMDS? PROCEED WITH CAUTION

By Sarah Brenner, JD
IRA Analyst

Are you looking for a better investment for your IRA? Are you thinking about making the move to another IRA custodian or financial advisor? You do have this opportunity. The IRA rules are set up to allow portability. However, if you are taking required minimum distributions (RMDs) from your IRA, you can still move your money, but things are a little more complicated and you will want to be especially cautious.

One way to move your IRA funds is to do a rollover. You will take a distribution of the funds in your IRA. The way the rules work is that the first money distributed from your IRA in a year when you are required to take an RMD will automatically be considered your RMD. With a rollover, there is no ability to take the RMD later. This rule is sometimes called the “first money out rule.” The RMD cannot be rolled over. If you do deposit the RMD to another IRA, it will be considered an excess contribution and need to be corrected following the IRS correction procedures. Otherwise, an excess contribution penalty of 6% will apply each year the funds remain in the IRA. So, take your RMD and then go ahead and move your IRA funds by rolling over the rest of the distribution within 60 days. A final note about rollovers:  you can only do one 60-day IRA-to-IRA or Roth IRA-to-Roth IRA rollover in any 12 month period.

Does a rollover sound complicated? It can be and there are lots of possibilities for error. A better choice for moving IRA funds is to do a transfer. With a transfer, your IRA funds will not be distributed from your IRA. You will not receive a check payable to you. Instead, the custodian will move the money directly from your existing IRA to the new IRA. The funds will be payable to the new custodian for the benefit of your IRA. Transfers between IRAs are not limited in frequency and are not subject to the 60-day rule. More good news is that you can transfer your RMD and take it later in the year from your new IRA. You are not required to take the RMD prior to the transfer. Do not forget to remove it by the deadline (usually December 31). If you do not take your RMD from the new IRA, you will be hit with a 50% penalty. Your new custodian will not be able to remind you to take the RMD because it will have no way of knowing if you already took it with the previous custodian.

Your IRA is portable. You can move to a better investment or a different custodian. Just proceed with caution if you are taking RMDs. There are some special additional rules you must know. Consider a transfer, rather than rollover, for maximum flexibility in when you must take your RMD and always consult with a knowledgeable financial advisor if you have questions about what is the best move for you.

https://www.irahelp.com/slottreport/moving-your-ira-funds-while-taking-rmds-proceed-caution

EDBS IN DETAIL: MINORS, DISABLED AND CHRONICALLY ILL

By Andy Ives, CFP®, AIF®
IRA Analyst

For those who inherit IRA accounts in 2020 or later, the SECURE Act permits five groups of people to stretch required minimum distribution (RMD) payments over their life expectancy. As I touched on in a recent Slott Report article (“The Stretch on a Stretcher,” Jan. 13), these five groups fall under the new term “Eligible Designated Beneficiaries,” or EDBs. Two of the five EDBs are self-explanatory:

1.) Spouses.

2.) Those not more than 10 years younger than the deceased account owner. These people do not need to be related to the deceased account owner.

The third group requires a little more detail.

3.) Minor children of the account owner. The minor child cannot be a grandchild of the account owner and qualify for the stretch. He or she cannot be the minor child of the neighbor, and cannot be a niece or nephew and qualify. The minor must be the deceased account owner’s child. Even then, the stretch is only allowed until the minor child reaches the age of majority or is still in school, up to age 26.

The last two groups of EDBs generate the most questions.

4.) Disabled. As we have written in the past, this is very high hurdle to get over. The tax code’s definition of a disabled person is incredibly limiting. Simply “retiring on disability” or collecting a disability pension does not necessarily mean you qualify as a disabled person eligible to stretch inherited IRA RMD payments.

From Tax Code Section 72(m)(7), the meaning of disabled is described as such: “For purposes of this section, an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require.”

5.) Chronically ill. This final sub-group of EDBs generates the most confusion. Fortunately, the IRS does provide detailed guidance as to the qualifications necessary to be considered “chronically ill.” Under the SECURE Act, a chronically ill individual is a based on the definition under the tax rules for defining long-term care services under long-term care insurance policies.

From Tax Code Section 7702B(c)(2) and under the SECURE Act, to qualify as a chronically ill individual the person would have to be certified (by a licensed health care practitioner) to be unable to perform at least two activities of daily living for at least 90 days, or require “substantial supervision” due to a severe “cognitive impairment.”

The SECURE Act has drastically limited the number of people who can stretch IRA payments. Going forward, designated beneficiaries that do not fall into one of the five EDB categories listed above will be forced to empty the inherited IRA by the end of the 10th year after death.

https://www.irahelp.com/slottreport/edbs-detail-minors-disabled-and-chronically-ill

THE SECURE ACT AND RMDS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Hi Ed,

Question on the new SECURE Act: Do you know if there were any changes to the payout period if an estate is the beneficiary of an IRA. Is it still a 5-year payout? Or is it now 10?

Thanks, appreciate your help.

Janet

Answer:

Dear Janet,

The SECURE Act made lots of changes to the IRA rules. But one change it did not make is to the payout rules when the estate — or any other non-individual (except for certain trusts) – is the IRA beneficiary.

As was the case before the SECURE Act, the required distribution depends on whether the owner dies before the owner’s “required beginning date.” That date is April 1 of the year after the year in which the owner attains age 72. If the owner dies before the required beginning date, the entire account must be paid out by December 31 of the fifth year following death.  If the owner dies on or after that date, annual required distributions must be made over the remaining life expectancy of the owner (had he lived) under the IRS Single Life Expectancy Table.

These accelerated payout rules are one reason why it’s usually better to designate an individual as IRA beneficiary rather than the estate.

Question:

Please help. I am confused by the new rules. My birthday is July 16, 1949. When must I start receiving required minimum distributions (RMDs)? Do I need to take it this year?

Thank you.

Answer:

Don’t feel bad. Lots of folks are confused about the new SECURE Act rules.

And consider yourself lucky. Since you were born on or after July 1, 1949, you get to take advantage of the new RMD rules that delay the first RMD year to age 72.  So, you don’t have an RMD in 2020. Your first RMD will be for 2021 (the year you turn age 72). If you want, you can delay that RMD until April 1, 2022, but that would mean that you would have two taxable RMDs for 2022 – the 2021 RMD due by April 1, 2022 and the 2022 RMD due by December 31, 2022.

If you were born before July 1, 1949, you would get no benefit from the new rules. Your RMDs would need to be started or continued under the old rules.

https://www.irahelp.com/slottreport/secure-act-and-rmds-todays-slott-report-mailbag

SECURE ACT GIVES 401(K) RELIEF TO PART-TIMERS

By Ian Berger, JD
IRA Analyst

Part-time employees in companies with 401(k) plans won a big victory when the SECURE Act was signed into law on December 20, 2019.

Before the SECURE Act, 401(k) plans could exclude employees if they did not work at least 1,000 hours of service in a 12-month period or were under age 21. These rules have prevented many long-term part-time employees from the chance to save in 401(k) plans.

The SECURE Act provides relief beginning with the first plan year after December 31, 2020 (for most plans, January 1, 2021). Any employee who has worked at least 500 hours in three consecutive years and is age 21 or older by the end of the three-year period must be allowed to start making elective deferrals. However, years beginning before January 1, 2021 do not have to be counted for purposes of meeting the three-consecutive-year rule.

Example: Assume Zoe starts part-time employment with Company A on January 1, 2019, when she is age 18. Company A has a 401(k) plan with a calendar year plan year. Before the SECURE Act, Company A required employees to attain age 21 and complete at least 1,000 hours in a 12-month period before becoming eligible to make elective deferrals. Zoe’s hours with Company A are as follows:

 

Year                             Age                                   Hours

2019                              18                                     750

2020                              19                                     850

2021                              20                                     800

2022                              21                                     925

2023                              22                                     550

Because of the new law, Zoe must be allowed to start making elective deferrals under Company A’s plan on January 1, 2024. That’s because she will have three consecutive years (2021, 2022 and 2023) with at least 500 hours of service and will be age 21 or older by December 31, 2023. Her service in 2019 and 2020 is not taken into account.

The new rule only applies for purposes of eligibility for elective deferrals. It does not require employers to make matching contributions or other employer contributions for part-timers who become eligible via the 500-hour rule.

Of course, employers are free to apply more liberal eligibility rules for their 401(k) plan. The new 500-hour rule is only a minimum eligibility rule. Also, keep in mind that the new rule doesn’t replace the pre-SECURE Act 1,000-hour/age 21 rule if that rule allows an employee to participate earlier than under the new rule.

Example: Assume that, in the above example, Zoe was age 21 when she began employment with Company A and had 1,100 hours of service (instead of 800) in 2021. Under the pre-SECURE Act eligibility rules that are still in effect, she must be allowed to start making elective deferrals on January 1, 2022.

The SECURE Act 500-hour rule does not apply to collectively-bargained 401(k) plans.

https://www.irahelp.com/slottreport/secure-act-gives-401k-relief-part-timers

IRA ROLLOVERS AND INHERITED IRAS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

According to the IRS website: Beginning in 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own (Announcement  2014-15 and Announcement 2014-32). The limit will apply by aggregating all of an individual’s IRAs. Trustee-to-trustee transfers between IRAs are not limited. Rollovers from traditional to Roth IRAs (“conversions”) are not limited.

If I am reading this correctly, we can “roll over” (hand carry checks) for multiple IRA accounts, as long as we are rolling over funds to a Roth IRA. Is that correct?

Thank you,

Shirley

Answer:

Hi Shirley,

The once-per-year rollover rule causes a lot of confusion. You can only do one 60-day rollover between IRAs of the same type in a 365-day period. This rule applies to your traditional and Roth IRAs in the aggregate. So, if you roll over a distribution from your traditional IRA, you cannot roll over another distribution from any of your IRAs, including your Roth IRAs, for 365 days. Conversions do not count for purposes of this rule. The best advice is not to do 60-day rollovers at all, and instead do direct transfers. This avoids all the complications of the once-per-year rollover rule.

Question:

If my son inherits my Roth IRA, I understand he now needs to withdraw the full amount over a 10 year period.

It also appears that any withdrawal by him – whether in year 1, equally over the 10 years, or all in year 10 – is tax free.

What if he decides to take nothing out the first 9 years, and then takes out the full original inherited amount in year 10?  If during those 10 years the account increased, can he keep the gains from the Roth IRA, as long as he withdraws the original amount he inherited?

Thanks,

Dennis

Answer:

Hi Dennis,

The SECURE Act has raised a lot questions on how distributions to beneficiaries will work going forward. You are correct that you son, if he is not a minor, will be subject to the 10-year rule when he inherits your Roth IRA. You are also right that the 10-year rule does not require annual required minimum distributions (RMDs). If tax-free Roth IRA funds are inherited, it is a good strategy to delay distributions as long as possible and then empty the account in the tenth year following the year of death. The rules, however, are clear. The whole account, including earnings after the Roth IRA owner’s death, and not just the original amount inherited, would need to be distributed by December 31 of the tenth year following the year of death. If this is not done, a 50% penalty would apply to any amount that is not distributed because it would be considered an RMD that was not taken.

https://www.irahelp.com/slottreport/ira-rollovers-and-inherited-iras-todays-slott-report-mailbag

THE SECURE ACT RUINS A PERFECTLY GOOD QCD

By Andy Ives, CFP®, AIF®
IRA Analyst

As we gradually peel back the layers of this legislative onion called the SECURE Act, more and more discoveries come to light. One revelation is how qualified charitable distributions (QCDs) are potentially affected. Could a QCD become, effectively, a taxable distribution? A looming cloud could soon peer over the shoulders of otherwise generous and giving individuals.

As a reminder, QCDs can be done by IRA owners (and inherited IRA owners) who are age 70½ or older. (The SECURE Act raised the age of RMDs to 72. However, the Act did not increase the age for QCDs – 70½ is the status quo.) IRA assets are transferred directly from an IRA to an eligible charity, and the dollar amount of the QCD is excluded from the account owner’s taxable income up to a maximum of $100,000 annually. Oftentimes, QCDs are leveraged to offset all or portion of a person’s required minimum distribution.

Yes, QCDs are a great planning tool…but the next layer of this onion stinks.

The SECURE Act also eliminated the 70½ age restriction for making deductible contributions to an IRA. Starting January 1, 2020, anyone with earned income, regardless of age, can contribute to a traditional IRA. That, in and of itself, is not bad. But what happens when a person over age 70½ combines a deductible IRA contribution with a QCD? Lousy things.

For example, Richard is 76 and still works part time. Since the SECURE Act eliminated the age restriction on traditional IRA contributions, Richard decides to make a deductible contribution of $7,000 to his IRA. Richard is also a charitable person and, in the same year as his contribution, he does a QCD for $10,000. The IRS views this as double-dipping. Richard cannot combine both the $7,000 deductible contribution and the $10,000 tax-free QCD. His otherwise tax-free QCD is reduced by the contribution amount, essentially causing $7,000 of his $10,000 QCD to be taxable.

Disregard the complicated formula provided by the SECURE Act in these situations. Just know that every post-70½ deductible IRA contribution is remembered by the IRS. These annual post-70½ contributions are tallied and totaled. The aggregate follows the IRA owner, ready to spring from the shadows and cancel the tax benefits of a future QCD.

In another example, Molly is 72 and works part-time as an organist at the local church. She makes a newly permitted $5,000 deductible contribution to her traditional IRA. Molly repeats this same transaction every year until she is 80 when she officially retires. Eight annual post-70½ deductible contributions of $5,000 have gone into her IRA totaling $40,000.

Molly has never done a QCD. When she is 85, she decides it is time to give back and requests a $50,000 QCD be directed to her church. There is a rumbling in the dark. Molly’s previous deductible contributions of $40,000, preserved by the IRS and lying dormant in a carry-forward bucket, spring forward and consume an equal amount of the QCD. In the end, $40,000 of Molly’s $50,000 QCD becomes taxable, and only $10,000 is excluded from her income for the year.

Those who itemize their taxes may find a fix. But if you take the standard deduction, is there a workaround? Not within a traditional IRA there isn’t – but other options exist. Avoid this rotten post-70½ onion altogether and simply contribute to a Roth.

https://www.irahelp.com/slottreport/secure-act-ruins-perfectly-good-qcd

SECURE ACT ATTEMPTS TO ADVANCE ANNUITIES IN COMPANY SAVINGS PLANS – PART 2: PORTABILITY AND BENEFIT STATEMENT ILLUSTRATIONS

By Ian Berger, JD
IRA Analyst

The new SECURE Act contains three provisions that are designed to promote annuities in company savings plans. The January 8, 2020 Slott Report described the first of these three changes – new protection for companies if the insurance company selected by the plan to provide annuities later runs into financial difficulties and cannot make payments. Today, we will discuss the other two new provisions.

Congress believed that plan sponsors were reluctant to offer annuity products in savings plans not only because of potential liability, but also because of uncertainty over whether the company could later eliminate that option. The second change addresses what happens if a plan begins to offer annuities as an investment option but for whatever reason decides to drop that option. In the past, participants who had invested in annuities would be stuck with termination penalties, surrender charges or other fees when the annuity was liquidated. To make matters worse, they would be unable to receive a distribution of the annuity contract because of restrictions on in-service withdrawals.

The new law provides two ways for participants to keep their annuity investments if the annuity option is dropped from the plan: (1) making a direct trustee-to-trustee transfer to an IRA or another company plan that accepts transfers; or (2) receiving an in-kind distribution of the annuity contract. Both must occur within 90 days before the annuity option is eliminated.

This change applies to 401(k), 403(b) and 457(b) plans. Withdrawals for this reason would be considered permissible in-service withdrawals.

The new provision is effective for plan years beginning after December 31, 2019 (January 1, 2020 for most plans).

The third change requires companies to begin including annuity illustrations in the benefit statements they are required to provide to participants. Although these statements must be given out quarterly, the new illustrations are only required annually. The illustrations must show the amount of monthly payments a participant would receive if the participant’s account balance was used to buy an annuity. The assumption is that plan participants, after seeing these illustrations, will lobby their employer to begin offering annuities.

These annuity illustrations are not required until after the Department of Labor gives guidance on the new rule.

https://www.irahelp.com/slottreport/secure-act-attempts-advance-annuities-company-savings-plans-%E2%80%93-part-2-portability-and

2020 LIFE TABLES AND RMDS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hoping you might be able to offer some guidance. We have a client who has two IRA accounts.  The client is 80 years of age. He wants to convert the full amount in one of his IRA accounts to a Roth. The IRS says that distributions from IRA accounts are treated as satisfying the RMD first, so we need to take the RMD before we process the conversion. My questions are: 1.) The client has plenty of money in IRA #2 to satisfy the RMD for both IRA accounts. I presume that doesn’t matter and we still need to take the RMD before we convert? 2.) Is the RMD that must be satisfied ONLY the RMD for IRA #1 that we plan to convert to a Roth, or is the RMD that must be satisfied the aggregate of both IRA accounts that must be met before we convert IRA #1 to a Roth?

Thank you.

Jamie

Answer:

Jamie,

Nice work recognizing that RMDs can’t be converted. RMDs are considered to be the first money distributed from an IRA and are not eligible for rollover or for conversion to a Roth IRA. Your presumption is correct.

The RMD that must be satisfied is only from the specific IRA being converted. You do not have to take the RMD from the other IRA that is not being converted and can wait to take that “second” RMD later in the year.

Question:

When do the Updated Uniform Lifetime Table & Single Life Table under 401(a)(9) go into effect for 2020?

Charles

Answer:

Charles,

Updates to the life expectancy tables are only proposed. If they are officially adopted, they will not go into effect until January 1, 2021.

https://www.irahelp.com/slottreport/2020-life-tables-and-rmds-todays-slott-report-mailbag

TOP 10 THINGS YOU NEED TO KNOW ABOUT THE NEW SECURE ACT AND YOUR RETIREMENT ACCOUNT

By Sarah Brenner, JD
IRA Analyst

On December 20, 2019 the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. This new law includes some big changes for your retirement account. Here are the top 10 things you need to know:

  1. No more age limits for traditional IRA contributions. Beginning in 2020, the new law eliminates the age limit for traditional IRA contributions (formerly 70 ½).

 

  1. Required minimum distributions (RMDs) can start a little later. The new law raises the age for beginning RMDs to 72 for all retirement accounts subject to RMDs. IRA owners age 70 ½ in 2020 catch a break and will not have to take their first RMD for 2020.

 

 

  1. The age for qualified charitable distributions (QCDs) remains the same. QCDs can still be done at age 70 ½ despite the new rule delaying RMDs until age 72.

 

  1. New help for new parents. Beginning in 2020, the SECURE Act adds a new 10% penalty exception for births or adoptions. The exception applies to both IRAs and employer plans.  It is limited to $5,000 for each birth or adoption.

 

  1. More opportunities for IRA contributions. The definition of “compensation” for IRA contribution purposes is expanded to include taxable fellowships and stipends for graduate or postdoctoral students. Also, foster care workers who exclude from taxable income certain “difficulty-of-care” payments from their employer can now use those funds to make IRA contributions.

 

  1. More annuity choices coming to your employer plan. There are several provisions of the SECURE Act designed to make it easier for employer plans to offer annuities to participants.

 

  1. Good bye, stretch IRA. Beginning for deaths after December 31, 2019, the stretch IRA is replaced with a 10-year rule for the vast majority of beneficiaries. For deaths in 2019 or prior years, the old rules remain in place.

 

  1. Hello eligible designated beneficiaries. There are five classes of “eligible designated beneficiaries” who are exempt from the 10-year post-death payout rule and can still stretch RMDs over life expectancy. These include surviving spouses, minor children (but not grandchildren), disabled individuals, the chronically ill, and beneficiaries not more than ten years younger than the IRA owner.

 

  1. Time to review your IRA trust. Many trusts will no longer work as planned under the new rules. If you named a trust as your IRA beneficiary, your plan needs an immediate review and probable overhaul.

 

  1. Good advice is more important than ever. The SECURE Act has changed the game when it comes to retirement and estate planning. A qualified financial advisor can help guide you through all the new rules and ensure you are best positioned to take advantage of the breaks while avoiding the pitfalls.

https://www.irahelp.com/slottreport/top-10-things-you-need-know-about-new-secure-act-and-your-retirement-account

THE STRETCH ON A STRETCHER

By Andy Ives, CFP®, AIF®
IRA Analyst

The stretch IRA is on a stretcher and paramedics just loaded it into an ambulance. It is on life support. Prognosis: negative. For most new beneficiaries, the stretch will not survive. The SECURE Act is the perpetrator, and it gives no quarter. The Act stood defiantly over the stretch after inflicting its damage and made no effort to run when the sirens wailed.

But all is not lost. Despite its injuries and overall dire shape, prone in a hospital bed, the stretch may still help some needy heirs.

Preceding this assault, essentially two classes of beneficiaries existed. There was the all-encompassing “Beneficiary” term that comprised everyone and everything. Charities, spouses, grandkids, estates, nieces, nephews, trusts, etcetera all fell under this enormous umbrella. Additionally, there was a further subdivision dubbed “Designated Beneficiaries.” This group included living, breathing people with life expectancies – no estates and no charities. Prior to the SECURE Act, only these designated beneficiaries could stretch IRA required minimum distributions (RMDs) over their life expectancy. (Makes sense, since neither charities nor estates have a heartbeat.)

The SECURE Act further slashed the number of people allowed to stretch IRA RMD payments. A new subclass of beneficiaries was christened: “Eligible Designated Beneficiaries,” or EDBs. Beginning for deaths on or after January 1, 2020, only EDBs can maximize the stretch. This includes:

 

  • Surviving spouses
  • Minor children of the account owner until age of majority – but not grandchildren
  • Disabled individuals
  • Chronically ill individuals
  • Beneficiaries not more than ten years younger than the IRA owner

 

If a beneficiary is not on this list, they are stuck with the new SECURE Act provision requiring the inherited IRA be emptied by December 31 of the tenth year after the year of death, i.e. the 10-year rule. Of course, there are nuances and curveballs. There are outliers and there are circumstances when a person is an EDB but then is not an EDB and the 10-year payout springs forward. (Think a minor child who is no longer a minor.)

Regardless, the once powerful stretch, in its wounded state, is now severely limited. As it is, the five groups listed above (along with grandfathered heirs who inherited prior to 2020) are the only people who can stretch IRA RMDs over their life expectancy.

Did you name a trust as your IRA beneficiary prior to the SECURE Act? Better review that trust to see if it still meets your wishes. Did you name your grandchild as a beneficiary in hopes of allowing the little tyke to stretch IRA payments over the next 70 years? You may want to reconsider. In fact, every beneficiary form should be reevaluated, because the ambulance just sped away, and the feeble stretch can only help so many.

https://www.irahelp.com/slottreport/stretch-stretcher-0

THE SECURE ACT’S IMPACT ON QUALIFIED CHARITABLE DISTRIBUTIONS AND REQUIRED MINIMUM DISTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I turn 70 1/2 in 2020. Since I do not have to take a required minimum distribution (RMD), how much can I do in a qualified charitable distribution (QCD) this year?

Ronnie

Answer:

Hi Ronnie,

Even though you won’t have an RMD for 2020, that doesn’t affect your ability to take a QCD at age 70 ½. One of the benefits of taking a QCD is to have it count towards the RMD. However, QCDs can be taken in amounts in excess of the RMD (up to the $100,000 annual limit) and can even be taken in years (such as 2020 in your case) when there is no RMD. Just be sure not to initiate the QCD before you are actually 70 ½.

Question:

Hello Mr. Slott:

I just read your article regarding the new SECURE Act, Good-bye Stretch IRA.  I have one question.  With the age limit for making IRA contributions lifted for as long as you work, if you are still working at the new RMD age of 72, will you also have to begin taking the required minimum distributions while still making IRA contributions?  That’s one area that wasn’t specifically addressed in your article.

Thank you,

Terry

Answer:

Hi Terry.

This is one of the strange consequences of the new SECURE Act rule that lifted the age 70 ½ limit for traditional IRA contributions. You will still be required to take RMDs on your IRAs beginning for the year you turn 72 – even if you are still making new IRA contributions. This “in-and-out” of contributions and RMDs, which has been typical of SEP and SIMPLE plans, now also applies to traditional IRAs.

https://www.irahelp.com/slottreport/secure-act%E2%80%99s-impact-qualified-charitable-distributions-and-required-minimum

SECURE ACT ATTEMPTS TO ADVANCE ANNUITIES IN COMPANY SAVINGS PLANS – PART 1: PROTECTION FOR PLAN SPONSORS

By Ian Berger, JD
IRA Analyst

There are three new provisions in the recently enacted SECURE Act designed to promote annuities in company savings plans. That explains why insurance companies lobbied so hard for passage of the legislation. The three provisions are:

  • New protection for plan sponsors who want to start offering annuities.
  • New options for participants to keep their plan annuity investments if the plan stops offering annuities.
  • A new requirement that benefit statements show annuity illustrations.

Today, we’ll discuss the first of these three changes. A future Slott Report will tackle the other two.

According to the Plan Sponsor Council of America, less than 10% of 401(k) plans now offer annuities. The reason often cited for this is that companies are afraid of being sued. Plan sponsors are considered fiduciaries under ERISA and must act “prudently.” Suppose a plan fiduciary chooses an insurance company to provide 401(k) annuities and that carrier subsequently goes belly-up and can no longer make annuity payments?  In that case, the unhappy annuitants could sue the plan sponsor under ERISA.

At the same time, too few workers have enough income to last their retirement. Instead, many participants squander their savings as soon as they leave the plan (or even earlier if the plan allows in-service withdrawals). And, since most workers these days aren’t covered by traditional pension plans, they cannot rely on the retirement income those plans provide.

The new law creates a new ERISA standard that protects companies from liability if the annuity provider is unable to meet its obligations. When selecting an annuity provider, plan sponsors must conduct “an objective, thorough and analytical search” of potential annuity providers taking into account (1) the financial capability of the candidates and (2) the cost of the contracts offered.

But this standard should be easy to meet since companies only need to get written representations from insurance companies that they are in good standing with state regulators. The plan sponsor is not required to do its own investigation. The SECURE Act also says that companies are not necessarily required to select the lowest cost contract offered.

Because of this change, any problems employees have with their annuity payments will now have to be taken up with the insurance company – not the employer.

This provision was effective December 20, 2019, the date the SECURE Act was signed into law.

https://www.irahelp.com/slottreport/secure-act-attempts-advance-annuities-company-savings-plans-%E2%80%93-part-1-protection-plan

NO RMD RELIEF FOR THOSE 70 ½ IN 2019 UNDER THE SECURE ACT

Sarah Brenner, JD
IRA Analyst

The SECURE Act is here! Most of new law’s provisions kicked in on January 1, 2020, overhauling many of the rules for retirement accounts that have been with us for decades. One significant change the SECURE Act brings us is the delay in the age at which RMDs must start from 70 ½ to 72.

This new rule has raised questions as to how those who reached age 70 ½ in 2019 are affected. Some had already taken 2019 RMDs. Others were waiting to take their first RMD until closer to their required beginning date of April 1, 2020. What happens now to those who reached 70 ½ in 2019? Do they still need to take an RMD for 2019? Can they then stop RMDs until they reach age 72? Would they have a new required beginning date?

The SECURE Act provides some disappointing answers to these questions to those who were hoping to get a reprieve from starting RMDs. The ability to delay RMDs that is available under the new law is only available to those who reach age 70 ½ after December 31, 2019. Those who reach age 70 ½ in 2019 are subject to the old rules. This means that they must take an RMD for 2019 and for each year thereafter. Only those who reach age 70 ½ in 2020 or later will be able to delay RMDs until April 1 of the year following the year they reach age 72.

Example: Kate celebrated her 70th birthday on January 20, 2019. She then reached age 70 ½ in July of 2019. She decided to delay taking her 2019 RMD until spring of 2020. With the passage of the SECURE Act, the rules for Kate have not changed. She still must take her 2019 RMD by April 1, 2020 and her RMD for 2020 by December 31, 2020.

Example: Gerry celebrated his 70th birthday on August 5, 2019. He will be 70 ½ in February of 2020. The SECURE Act allows Gerry to delay taking his first RMD until April 1 of the year following the year he reaches age 72. Jerry will need to take an RMD for 2021. His deadline for taking his 2021 RMD would be April 1, 2022. He would need to take his RMD for 2022 by December 31, 2022.

https://www.irahelp.com/slottreport/no-rmd-relief-those-70-%C2%BD-2019-under-secure-act

THE SECURE ACT AND INHERITED RETIREMENT ACCOUNTS: TODAY’S SLOTT REPORT MAILBAG

Sarah Brenner
IRA Analyst

Question:

With the SECURE Act, can a person who is older than 70 ½ fund a 2019 Traditional IRA?  The SECURE Act goes live on 1/1/2020, and an IRA can be funded up to 4/15/2020 for the previous year.  Any reason they cannot?

Answer:

Unfortunately, the answer is no. The new rule eliminating the age limit for traditional IRA contributions is effective January 1, 2020. Prior year contributions for 2019 would be subject to the old rules, including the age limit. The bad news is that a 2019 contribution would not be allowed. The good news is that for 2020 and later years, the age limit is gone.

Question:

Good Day,

We unfortunately lost a special family member at the end of October. Her employer sponsored savings plan was to be inherited primarily by her two adult daughters. but the paperwork from Vanguard has yet to be distributed to all beneficiaries. Do you know if the SECURE Act will be enforced for those accounts established after January 1, 2020, or if it will be driven by the date of death of the original account holder?

Getting this passed this late is going to cause major work for the brokerage and investment houses over the last week of 2019.

Thanks in advance for your time and consideration.

Kindly,

Art

Answer:

Hi Art,

Sorry for your loss. Because your friend passed away in 2019, she is subject to the old rules and the stretch would be available to her beneficiaries. This is true regardless of when the paperwork is processed. The new SECURE Act rules limiting the stretch will only apply to beneficiaries of IRA owners who die after December 31, 2019.

https://www.irahelp.com/slottreport/secure-act-and-inherited-retirement-accounts-todays-slott-report-mailbag

HAPPY NEW YEAR

Ian Berger, JD
IRA Analyst

The clock is winding down to the ball-dropping in Times Square that will usher in a new year – and a new decade. The Ed Slott and Company team wishes to thank you for supporting The Slott Report and responding to our articles with such insightful comments and questions.

2020 promises to be an exciting year in the IRA and savings plan worlds, as the full ramifications of the new SECURE Act begin to take shape. Beyond that, the IRS will likely finalize the new life expectancy tables expected to become effective in 2021.  And who knows what other IRS guidance and momentous court decisions will be coming our way?

No matter what happens, our resolution is to continue to keep you informed with “20/20” clarity.

Best wishes for a Happy and Healthy New Year!!

https://www.irahelp.com/slottreport/happy-new-year

ROTH CONTRIBUTIONS AND RMDS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi Ed,

Hope all is well.  I have a client that received the HEART benefit as her spouse passed away a few years ago.  We immediately moved those dollars into a Roth for her.  My question is, as we are doing some year-end planning, can I add to this Roth by doing a conversion, or do I need to open up a separate Roth for her?

Answer:

The HEART Act allows a beneficiary of military death gratuities to contribute those funds to a Roth IRA. The Roth contribution can be made without regard to the annual contribution or income limits. The contribution must be done within one year from the date of receipt of the death benefit, and HEART Roth IRA funds do not need to be kept separate. Future contributions and/or conversions can be added to this same Roth IRA.

Question:

Can you please confirm which RMD table should be used for a client who husband was taking RMD’s and passed away 10 years ago; as the surviving spouse and within 10 years of his age and the only beneficiary; she rolled the IRA into her name. Can you please clarify what table should be used for her RMD’s?

Thank You

Sean

Answer:

Sean,

Since the surviving spouse did a spousal rollover, the assets are treated as if they were always in her name. As such, she would use the Uniform Lifetime Table to calculate her RMDs based on her own age and life expectancy.

https://www.irahelp.com/slottreport/roth-contributions-and-rmds-todays-slott-report-mailbag

8 DAYS FOR 6 YEAR-END TRANSACTIONS

By Andy Ives, CFP®, AIF®
IRA Analyst

As of the writing of this Slott Report submission, it is Monday, December 23, 2019. T-minus 8 days before the end of the year, which means IRA owners have a tight window to complete any year-end transactions. Once the calendar turns, if not finalized in time, some items will be forever lost. Here are six transactions that absolutely must be completed within the next 8 days to avoid penalty and/or a lost opportunity:

Over 70 ½ RMDs. While the first RMD for the year a person turns 70 ½ can be delayed until April 1 of the next year, all future RMDs must be taken before the end of the calendar year. There is no wiggle room. There is no “still working exception” on IRAs. Failure to take an RMD by the end-of-year deadline will result in a 50% penalty of the amount not withdrawn. Yes, there are ways to go about making your case to the IRS as to why you missed the RMD and get the penalty waived, but that extra work can be avoided by simply taking the RMD on time.

QCDs. Qualified charitable distributions must also be completed and recognized by the custodian by December 31. There is no going back. There is no such thing as a “prior year QCD.” I say “recognized by the custodian” because some people have IRA checkbook accounts. Writing a check to an eligible charitable organization before the end of the year will not meet QCD criteria. It must be cashed and debited from the IRA account before the end of the year.

Account splitting for those who passed away in 2018. IRS regulations require that IRAs inherited by more than one beneficiary must be timely split for the individual beneficiaries to use their own life expectancy to stretch RMD payouts. “Timely split” means by December 31st of the year following the year of the IRA owner’s death. Even if the original IRA owner died on the first day of 2018, the beneficiaries still have until the end of 2019 to split the account. Guess what deadline is 8 days away? Missing the deadline will force the beneficiaries to use the age of the oldest beneficiary for RMD stretch calculations.

Inherited IRA RMDs. You split the inherited account on time? Nice work, but there is another task at hand. No matter your age, if you have an inherited RMD from a person who passed away in 2018 (or earlier), current rules dictate the beneficiary’s RMD from the inherited IRA must be withdrawn by December 31, 2019. If you miss the 2019 cut-off for those who passed away in 2018 or earlier, there is a 50% penalty, just like with the over-70 ½ RMD.

Roth Conversions. Roth contributions can be made up to the tax filing deadline, NOT including extensions. However, to have a 2019 Roth IRA conversion, the funds must be distributed from the traditional IRA by year end.  But don’t be too hasty. Consider your strategy carefully. Roth conversions cannot be recharacterized. Once you convert, there is no going back, and all the tax and income ramifications of that conversion are officially yours to keep. (Roth contributions can be recharacterized. Be sure not to confuse the two.)

NUA Lump Sum Distributions. While this is more of a workplace retirement plan deadline, it is still hard and fast. To qualify for the net unrealized appreciation (NUA) tax benefit, a lump-sum distribution means that ALL the company plan funds must be distributed in one tax year. If there is any balance in the plan at the end of the year, the NUA tax break is blown. If your goal was to complete an NUA transaction in 2019, be sure the NUA stock has been delivered in-kind and all other assets have been either paid out or rolled over to an IRA.

T-minus 8 days! Tick…tick…tick.

https://www.irahelp.com/slottreport/8-days-6-year-end-transactions

ROLLING OVER MULTIPLE CHECKS AND BACKDOOR ROTH IRAS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

My husband has taken two different qualified distributions from his Roth IRA within the last 60 days.  We would like to “pay those back.” It looks like we can put money back into the Roth IRA as a rollover.

My question is:  Can we put the total amount of the two distributions back into the same IRA, or are we limited to “paying back” just one of those distributions

Thanks,

Laura

Answer:

Hi Laura,

Redepositing the funds back into the Roth IRA is considered a rollover. Unfortunately, only one of your husband’s withdrawals can be rolled back into his Roth IRA. He is not permitted to combine them and then roll the combined amount back.

The rollover must be done within 60 days of receipt of the distribution that is being returned. However, you can’t do this rollover if you have done another IRA rollover within the last 12 months. (Company plan-to-IRA rollovers, IRA-to-company plan rollovers and Roth conversions don’t count for purposes of the once-per-year rule.)

Question:

I would appreciate your guidance regarding a backdoor Roth question.

My client participates in an employer 401(k) plan.  The client also has $50k in a traditional IRA which includes $20k in after-tax contributions that have been reported on Form 8606 over the years.  We are able to roll over his IRA balance to his 401(k) and would like to do so in order to complete backdoor Roth contributions in the future.  It is my understanding that he should transfer only the pre-tax funds to the 401(k) that is $30k.  This would leave $20k in after-tax contributions only in the IRA (which I presume we could convert to the Roth IRA next year).

Please confirm if this understanding is accurate.

Regards,

Jennifer

Answer: 

Hi Jennifer,

Your understanding is correct. The backdoor Roth strategy allows an individual to make an “indirect” Roth IRA contribution if the person’s income is too high to make a direct Roth contribution. This is accomplished by first making a non-deductible contribution to a Traditional IRA and subsequently converting the Traditional IRA to a Roth IRA.

However, you have added another layer to this scenario. Only traditional pre-tax IRAs can be rolled over to company plans that allow IRA-to-plan rollovers. Rolling over pre-tax IRA funds into a company plan will help your client take full advantage of the backdoor Roth strategy. If no pre-tax funds remain in the IRA when the traditional IRA contribution is converted to a Roth IRA, the converted amount (except for any investment gain from date of contribution to date of conversion) is tax-free. If any pre-tax funds do remain, the conversion can still be done – but a portion of the converted amount will be considered taxable under the IRS pro-rata rule.

https://www.irahelp.com/slottreport/rolling-over-multiple-checks-and-backdoor-roth-iras-today%E2%80%99s-slott-report-mailbag

HELLO SECURE ACT, GOOD BYE STRETCH IRA

By Sarah Brenner, JD
IRA Analyst

With the clock ticking down on 2019, Congress is expected to enact a $1.4 trillion year-end spending bill to keep the government running. Tucked away inside this mammoth piece of legislation is the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act is set to become effective January 1, 2020.

This new law includes significant changes to retirement accounts, including:

Age Limit Eliminated for Traditional IRA Contributions

Beginning in 2020, the new law eliminates the age limit for traditional IRA contributions (formerly 70 ½). Now, those who are still working can continue to contribute to a traditional IRA, regardless of their age.

RMD Age Raised to 72

The SECURE Act also raises the age for beginning RMDs to 72 for all retirement accounts subject to RMDs. IRA owners reaching age 70 ½ in 2020 catch a break and will not have to take their first RMD next year now that the RMD deadline has been extended to age 72.

New Exception to the 10% Penalty for Birth or Adoption

The SECURE Act adds a new 10% penalty exception for birth or adoption, but the distribution is still subject to tax. It is limited to $5,000 over a lifetime. The birth or adoption distribution amount can be repaid at any future time (re-contributed back to any retirement account).

IRA Contributions with Fellowship and Stipend Payments

Additionally, the new law allows taxable non-tuition fellowship and stipend payments to be treated as compensation to qualify for an IRA (or Roth IRA) contribution.

Employer Liability Protection for Annuities in Plans

The SECURE Act provides a safe harbor for employer liability protection for offering annuities in an employer plan. This is expected to open the door for more annuity products to be available as investment choices in employer plans.

Good Bye, Stretch IRA

Beginning for deaths after December 31, 2019, the stretch IRA will be replaced with a ten year rule for the vast majority of beneficiaries. The rule will require accounts to be emptied by the end of the tenth year following the year of death. There will be no annual RMDs. Instead, the only RMD on an inherited IRA would be the balance at the end of the 10 years after death. For deaths in 2019 or prior years, the old rules would remain in place.

There are five classes of “eligible designated beneficiaries” who are exempt from the 10-year post-death payout rule and can still stretch RMDs over life expectancy. These include surviving spouses, minor children, disabled individuals, the chronically ill, and beneficiaries not more than ten years younger than the IRA owner.

The new rules will mean a new landscape when it comes to retirement and estate planning.  How will they affect you? You may have some new opportunities to make IRA contributions or be able to access your retirement funds without penalty. You may be able to delay taking RMDs a little bit longer. You will also want to give some serious consideration to how the elimination of the stretch will impact you. Reviewing your beneficiary designation form is a good place to start.

https://www.irahelp.com/slottreport/hello-secure-act-good-bye-stretch-ira

Weekly Market Commentary

December 10th, 2019

Chadd Mason, CEO The Cabana Group

Yet Again, the Market Focuses on What Matters – Interest Rates and Earnings

After a rocky start to last week, U.S. equity markets rebounded and finished higher, led by Friday’s 1% bounce in the S&P 500. The employment number reported on Friday was exceptionally strong and is further evidence that economic growth can continue. This is frankly not surprising in that the stock rally over the past six weeks has been telegraphing the same thing.

High beta risk assets are outperforming, and interest rates appear to have bottomed. We are now right back at all-time highs in the major indices, after a brief pullback on overbought conditions. Dips are being bought at every opportunity and that is a good sign as we close out the year. Commodities, like copper, are also rallying. Copper is up nearly 5% in the last week. Copper is often called “Dr. Copper” because it is a great indication of the world’s economic health. Copper is used throughout the supply chain in manufacturing and transportation. Rising interest rates are ultimately caused by commodity inflation, which is caused by demand outstripping supply. Interest rates having bottomed is also consistent with buying in commodities.

If China can begin to catch up with the developed markets, either as a result of resolving the trade issues with the U.S. or as a result of improving general economic conditions, look for commodities of all types to move higher (along with interest rates).

December is always volatile due to light trading, end of year tax harvesting and window dressing by professional investors as they try to make their portfolios close the year as strong as possible. Even so, it appears we have a good shot of closing at all-time highs across the board. After all the worrying, complaining and talks of imminent recession this year, the market always focuses on what matters – interest rates and earnings. Price aggregates such information and predicts, but it never guesses!

At Cabana we remain moderately bullish.

IMPORTANT DISCLAIMERS

This material is prepared by Cabana LLC, dba Cabana Asset Management and/or its affiliates (together “Cabana”) for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed reflect the judgement of the author, are as of the date of its publication and may change as subsequent conditions vary. The information and opinions contained in this material are derived from  proprietary and nonproprietary sources deemed by Cabana to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Cabana, its officers, employees or agents.

This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. All investment strategies have the potential for profit or loss. All strategies have different degrees of risk. There is no guarantee that any specific investment or strategy will be suitable or profitable for a particular client. The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal.

Cabana LLC, dba Cabana Asset Management (“Cabana”), is an SEC registered investment adviser with offices in Fayetteville, AR and Plano, TX. The firm only transacts business in states where it is properly registered or is exempted from registration requirements. Registration as an investment adviser is not an endorsement of the firm by securities regulators and does not mean the adviser has achieved a specific level of skill or ability. Additional information regarding Cabana, including its fees, can be found in Cabana’s Form ADV, Part 2. A copy of which is    available upon request or online at www.adviserinfo.sec.gov/.

The Financial Advisor Magazine 2018 Top 50 Fastest-Growing Firms ranking is not indicative of Cabana’s future performance and may not be   representative of actual client experiences. Cabana did not pay a fee to participate in the ranking and survey and is not affiliated with Financial Advisor magazine. RIAs were ranked based on percentage growth in year-end 2017 AUM over year-end 2016 AUM with a minimum AUM of $250 million, assets per client, and growth in percentage assets per client. Visit www.fa-mag.com for more information regarding the ranking.

The Financial Advisor Magazine 2019 Top 50 Fastest-Growing Firms ranking is not indicative of Cabana’s future performance and may not be representative of actual client experiences. Cabana did not pay a fee to participate in the ranking and survey and is not affiliated with Financial Advisor Magazine. Working with a highly-rated advisor also does not ensure that a client or prospective client will experience a higher level of performance. These ratings should not be viewed as an endorsement of the advisor by any client and do not represent any specific client’s evaluation. RIAs were based on number of clients in 2018, percentage growth in total percentage assets under management from year end 2017 to 2018, and growth in percentage growth in assets per client during the same time period.  Visit www.fa-mag.com for more information regarding the ranking.

Cabana claims compliance with the Global Investment Performance Standards (GIPS®). In addition to the firm’s third-party verification, six of Cabana’s core portfolios have been performance examined consistent with GIPS® standards. The Global Investment Performance Standards are a trademark of the CFA Institute. The CFA Institute has not been involved in the preparation or review of this report/advertisement. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS® standards. Verification does not ensure the  accuracy of any specific composite presentation unless an independent performance examination has been conducted for a specific time period. Past performance is not indicative of future results. Due to various factors, including changing market conditions, the portfolios may no longer be reflective of current positions.

No client should assume that the future performance of any specific investment or strategy will be profitable or equal to past performance. All investment strategies have the potential for profit or loss. All strategies have different degrees of risk. There is no guarantee that any specific investment or strategy will be suitable or profitable for any investor. Asset allocation and diversification will not necessarily improve an investor’s returns and cannot eliminate the risk of investment losses. While loss tolerance and targeted “drawdown” are identified on the front end for each portfolio, Cabana’s algorithm does not take any one client’s situation into account. It is the responsibility of the advisor to determine what is suitable for the client. An advisor should not simply rely on the name of any portfolio to determine what is suitable. Cabana manages assets on multiple custodial platforms. Performance results for specific investors may vary based upon differences in associated costs and asset availability.

HOW THE TOP-HEAVY RULES FOR 401(K) PLANS WORK

By Ian Berger, JD
IRA Analyst

Just like eating too much pumpkin pie with whipped cream isn’t good for your waistline, being a “top-heavy” retirement plan also may not be healthy.

Sponsors of certain retirement savings plans must have their plan tested each year to determine if it is “top-heavy.” The top-heavy test is designed to make sure that lower-paid employees receive at least a minimum benefit if most plan assets are held for higher-paid employees.

Section 401(k) plans are subject to top-heavy testing, unless the plan uses a “safe harbor” contribution formula. SEP-IRAs are also subject to testing, but most will automatically comply. Section 403(b) and 457 plans and SIMPLE IRAs are exempt from the top-heavy test.

A plan is considered top-heavy for a particular year if the total value of the plan accounts of “key employees” is more than 60% of the total value of all accounts. This calculation is done as of the last day of the previous year (usually December 31).

A key employee is:

  • An officer making over a certain dollar limit ($185,000 for 2020 and $180,000 for 2019);
  • A more-than-5% owner of the company; or
  • A more-than-1%-owner who also earns over $150,000 for the plan year.

Ownership is determined using family aggregation rules.

If a plan is top-heavy, the employer must usually make a contribution of at least 3% of pay for all non-key employee participants still employed on the last day of the plan year. (However, in the unlikely event that the largest contribution of pay percentage – taking into account both employer contributions and elective deferrals – for any key employee is less than 3%, only that smaller contribution percentage needs to be made for non-key employees). The minimum contribution can be subject to a vesting schedule.

Example: Company A sponsors Plan A, a 401(k) plan. As of December 31, 2019, the account balances of the key employees was $200,000, and the total account balances was $300,000. The plan is top-heavy for 2020 because the total value of the plan accounts of key employees as of December 31, 2019 was 66.67 % of the value of all accounts.

For 2020, the largest contribution of pay percentage, taking into account both employer contributions and elective deferrals, for any key employee is more than 3%. Therefore, Company A must make an employer contribution of at least 3% of pay for all participants employed on December 31, 2020 who are non-key employees.

Don’t confuse the top-heavy rules with two other nondiscrimination rules that many 401(k) plans must satisfy each year. The first of those tests, the ADP test, compares the elective deferrals made by high-paid employees to deferrals made by other employees. The second test, the ACP test, compares matching contributions and after-tax contributions for the two groups. Sponsors of 401(k) plans can use a “safe harbor” contribution formula to avoid these tests – as well as the top-heavy test.

https://www.irahelp.com/slottreport/how-top-heavy-rules-401k-plans-work

THANKSGIVING PARADE

By Andy Ives, CFP®, AIF®
IRA Analyst

The Macy’s Thanksgiving Day Parade is a river of sights and colors and sound. A snappy marching band flows to an army of volunteers clutching the ropes of a six-story inflatable SpongeBob, swaying in the wind. Flag bearers and cheerleaders give way to a giant turkey in a Pilgrim hat being towed by a pick-up truck. Singers and dancers stream past and stilt walkers in Nutcracker outfits move with gaping steps. More towering balloons and more trumpets and more characters follow while the crowd oohs and ahs.

Like a parade, each calendar year glides by – a procession of days and months and seasons. Ensnared in the hoopla, our lives march down the road. Thanksgiving allows a moment of pause, a time to reflect on our personal parades and to applaud the participants.

The Ed Slott team is thankful to work with a passionate staff who strive to educate and help. We are thankful to partner with enthusiastic advisors eager to properly steer their clients through the parade route, and we are appreciative of the support and continued interest from the public at large. Eventually we will all return to our individual parades – to RMDs and QCDs and IRAs – and we will cling to the guide ropes of our enormous wind-swept life balloons soon enough.

But until then…HAPPY THANKSGIVING!

https://www.irahelp.com/slottreport/thanksgiving-parade

ACTIVE PARTICIPATION

By Andy Ives, CFP®, AIF®
IRA Analyst

Jenny earns a salary of $1,000,000. She is single and is not an active participant in a company retirement plan. Jenny can contribute $6,000 to a traditional IRA and deduct the full amount on her taxes. Benny, also unmarried, has a modified adjusted gross income of $76,000. He participates in a 401(k) at work. Benny can make a $6,000 contribution to a traditional IRA, but he is not allowed to deduct it. What gives? A person making a million can deduct an IRA contribution, but the person with a MAGI of $76,000 cannot? Is this another example of the rich getting richer?

No, not really. The key factor driving eligibility for a deduction of a traditional IRA contribution is not salary or MAGI, but participation (or lack thereof) in a company retirement plan. When a person or their spouse is an “active participant” in a company retirement plan for any part of the plan year, his ability to deduct an IRA contribution is then contingent upon phase-out ranges. In 2019, these ranges are $64,000 – $74,000 for single or head of household, $103,000 – $123,000 for those married filing joint, and $193,000 – $203,000 for an IRA contributor who is not an active participant but is married to someone who is. (These numbers will increase in 2020 to $65,000 – $75,000, $104,000 – $124,000, and $196,000 – $206,000, respectively.)

But what are the finer details of “active participation”?

Plan Type. Active participation in a 401(k), 403(b), SEP or SIMPLE plan affects deductibility. Profit sharing, stock bonus and Keogh plans also impact deductibility, as do governmental plans established by the U.S. Government (i.e. Federal TSP) or by a state government (including county, parish, city, town, etc.). Note: Section 457 deferred compensation plans do not impact IRA deductibility.

DB vs. DC Plans. Individuals who work for a company that maintains a defined benefit plan are considered “active participants” unless the individual is specifically excluded under the plan’s eligibility provisions. For defined contribution plans [i.e. 401(k), profit sharing, money purchase plans], a person is an active participant if contributions or forfeitures are allocated to his or her account for the year.

SEPs and Discretionary Profit Sharing Plans. A person is an “active participant” when an employer contribution or forfeiture is allocated to his balance. This applies to the year in which the contribution is made.

SIMPLE and 403(b) Plans. One is an “active participant” if he makes salary deferrals.

Even if a person only participated in the above plans for a short period of time, or even if he only contributed a small amount, he is considered an “active participant” for that entire year. Whether or not the participant’s benefits are vested is irrelevant.

Who is not considered an active participant? Individuals who are eligible to make salary deferrals but decline (and do not receive other contributions or forfeitures) are not considered “active participants.” Those covered under social security or railroad retirement, individuals who receive benefits from a prior employer’s plan, and those who only receive earnings in their account are not active participants. As mentioned, those participating in 457(b) deferred compensation plans are not “active participants” nor are members of the Armed Forces Reserve units based on reserve duty, unless serving more than 90 days of active duty during the year (not including training).

Are you an active participant or not? It can be confusing, but there is a “cheat code” to confirm. Generally, active participation in an employer plan is reflected by a check mark in the “Retirement Plan” box on a person’s W-2.

https://www.irahelp.com/slottreport/active-participation

WHY YOU SHOULD NOT CARE ABOUT THE ROTH IRA FIVE-YEAR RULES

By Sarah Brenner, JD
IRA Analyst

Roth IRAs first arrived over twenty years ago. A lot has changed since 1998. That was the year that Google was founded and an electronic pet called a Furby was one of the most popular Christmas gifts. However, some things haven’t changed so much. Impeachment is once again all over the news and here at the Slott Report we are still being asked many questions about how the five-year rules for Roth IRA distributions work. We probably get more questions on this topic than just about any other.

How the Rules Work

A good deal of the confusion about the Roth IRA distribution five-year rules stems from that fact that there are two separate rules that each work differently.

There is one for penalty-free distributions. It applies only if you are under 59½ years old and only to conversions. This five-year holding period will restart with every conversion you do.

The other five-year rule is used to determine if a Roth distribution of earnings is a qualified distribution and income tax-free. This five-year holding period starts when your first Roth IRA account is established. It does not restart for each Roth IRA contribution or conversion.

Why You Should NOT Care

Are you a little confused? Don’t worry about it. Think of the big picture. It is, of course, always helpful to be educated about the retirement account rules and understand what you are getting into when you take a distribution. However, if you are using your Roth IRA as intended with the goal of putting money away for future retirement, none of these complicated rules should affect you at all. If you keep your Roth IRA intact over the long term and until you reach retirement age, the rules could not be easier. All your distributions are completely tax and penalty-free! Nothing to it!

If you are thinking of converting, but are very concerned about failing to meet the Roth IRA five-year holding periods, this may be a warning sign that maybe a Roth IRA conversion is not for you.  To get the most bang for your buck with a Roth IRA, you need time. You should be in it for the long haul. Not only are the rules less complicated this way, but it is the only way you can really maximize the big tax benefit of the Roth IRA: long term accrual of tax-free earnings.

https://www.irahelp.com/slottreport/why-you-should-not-care-about-roth-ira-five-year-rules

AGGREGATING IRAS AND RMD CALCULATIONS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I am over 71 and have 2 IRAs, one in my name, the other is inherited.

Can I take one RMD from the inherited IRA to satisfy both?

Or must I treat them separately and do 2 separate RMDs?

Thank you!

Tyler

Answer:

Hi Tyler,

You must treat the IRAs separately and take two separate RMDs.

If you own more than one IRA (not inherited), you can aggregate them and take the RMD from any one (or more) of them. The same is true for inherited IRAs that came from the same original IRA owner and are of the same type (e.g., Traditional vs. Roth). But you cannot aggregate IRAs that you own and IRAs that you inherit.

Question:

Hello,

I am hoping that you can help me out with one question or otherwise direct me to another format to solicit the correct answer.

Mr. Smith turns 81 on December 1, 2019. To calculate his current RMD using his 12-31-18 balances, which age factor should be used: 80 or 81?

Thank you,

Mark

Answer:

Hi Mark,

The RMD calculations can be tricky.

To calculate an RMD for a particular year, you always use the factor corresponding to the individual’s age as of December 31 of that year. So, in your example, you would use the age 81 factor for Mr. Smith’s 2019 RMD (which is 17.9 from the Uniform Lifetime Table).

https://www.irahelp.com/slottreport/aggregating-iras-and-rmd-calculations-today%E2%80%99s-slott-report-mailbag

TEN QCD RULES FOR 2019 YOU NEED TO KNOW

By Sarah Brenner, JD
IRA Analyst

If you are charitably inclined and have an IRA, you might want to consider doing a Qualified Charitable Distribution (QCD) for 2019. The deadline for a 2019 QCD is fast approaching. It is December 31, 2019 and many custodians have even earlier cutoffs. Don’t miss out on this valuable tax break. Here are ten QCD rules you need to know.

1. Must be Age 70 ½

IRA owners who are age 70½ and over are eligible to do a QCD. This is more complicated than it might sound. A QCD is only allowed if the distribution is made on or after the date you actually attain age 70 ½. It is not sufficient that you will turn 70 ½ later in the year.

2. Beneficiaries Can Do QCDs

QCDs are not limited to IRA owners. An IRA beneficiary may also do a QCD. All the same rules apply, including the requirement that the beneficiary must be age 70 ½ or older at the time the QCD is done.

3. Eligible Retirement Accounts

You may take QCDs from your taxable IRAs funds. QCDs are also permitted from SEP and SIMPLE IRAs that are not ongoing. An ongoing SEP and SIMPLE plan is defined as one where an employer contribution is made for the plan year ending with or within the IRA owner’s tax year in which the charitable contributions would be made. QCDs are not available from an employer plan.

4. $100,000 Annual Limit

QCDs are capped at $100,000 per person, per year. For a married couple where each spouse has their own IRA, each spouse can contribute up to $100,000 from their own account.

5. RMD Can Be Satisfied

A QCD can satisfy your required minimum distribution (RMD) for the year. A QCD can exceed the RMD amount for the year as long as it does not exceed the $100,000 annual limit.

6. Only Taxable Amounts

QCDs apply only to taxable amounts. No basis (nondeductible IRA contributions or after-tax rollover funds) can be transferred to charity as a QCD. QCDs are an exception to the pro-rata rule which usually applies to IRA distributions.

7. Direct Transfer is a Must

If you want to do a QCD, you must make a direct IRA transfer from the IRA to the charity. If a check that is payable to a charity is sent to you for delivery to the charity, it will qualify as a direct payment.

8. Charitable Contribution Requirements

A QCD can only be made to a charity which is eligible to receive tax-deductible charitable contributions under IRS rules. The QCD rules are not available for gifts made to grant-making foundations, donor advised funds or charitable gift annuities. The contribution to the charity would have had to be entirely deductible if it were not made from an IRA. A taxpayer does not have to itemize deductions, but the gift to the charity still has to meet all of the deductibility rules.

9. Charitable Substantiation Requirements Apply

You should have documentation to substantiate the donation (something in writing from the charity showing the date and amount of the contribution).

10. Reporting on the Tax Return

The IRA custodian will not be separately reporting the QCD. There is no code or box on the 1099-R to identify the QCD. It will be up to you to let the IRS know about the contribution by including certain information on your tax return.

https://www.irahelp.com/slottreport/ten-qcd-rules-2019-you-need-know

QCDS AT THE STATE LEVEL

By Andy Ives, CFP®, AIF®
IRA Analyst

Earlier this month, a tax notification service released information declaring that “North Carolina Governor Roy Cooper signed legislation allowing an income exclusion for distributions from individual retirement accounts (IRAs) to charities by taxpayers age 70½ or older. Beginning with the 2019 tax year, North Carolina conforms to the federal income exclusion from personal income tax for a qualified charitable distribution from an individual retirement plan by a person who has attained the age of 70½.”

Were individuals living in North Carolina ineligible to do QCDs prior to the governor signing this legislation? No – QCDs were certainly allowed in North Carolina. Every IRA owner who is otherwise eligible to do a QCD can do so. What this announcement was referring to is the impact QCDs have on state taxes.

The most significant benefit of a qualified charitable distribution is realized at the federal level where QCDs are not counted toward AGI or taxable income. To report a QCD, you basically subtract from your total IRA distributions the amount you gave to charity and write “QCD” in the margin.

However, each state operates independently and taxes income differently. Not all states conform to federal law with respect to QCDs. Some states require a donor to add back the entire QCD amount and include it as income, thus allowing zero QCD deductions at the state level (i.e., New Jersey, which uses a gross income tax). At the opposite end of the spectrum, some states allow a full charitable deduction, and seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) have no personal income tax at all. The remaining states fall somewhere in the middle.

Some states have partial exclusions for retirement income. Others exempt retirement income altogether. Here, a QCD adds no benefit at the state level since any IRA distribution is already exempt from state tax. Pennsylvania is a good illustration. It does not tax any retirement distributions. For those in the Keystone State, there is no state tax on Roth conversions or RMDs.

When determining taxes due, some states begin with the federal adjusted gross income, which means they indirectly allow QCDs. New York State falls into this category. Before the new legislation, North Carolina also started with AGI from the taxpayer’s federal return, but it forced state taxpayers to add back the QCD exclusion. The new law eliminates that adjustment and allows QCDs from the federal return in the Tar Heel State.

The state tax savings on a QCD is only a small percentage of the overall benefit. It is at the federal level where QCDs are most valuable. That’s where the big tax savings reside since federal rates are typically much higher than state tax rates. However, state tax savings can also be beneficial. Regardless of where you live, recognize that state tax rules vary widely. Donors using QCDs should consult a tax advisor to fully understand the impact on their state tax liabilities.

https://www.irahelp.com/slottreport/qcds-state-level

ROTH CONVERSIONS AND THE 60-DAY ROLLOVER RULE: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

Hello Ed,

I have received differing views on making a 401(k) conversion to a Roth IRA.  I’m a 64 year old retired federal employee and plan to transfer all my funds from the TSP to my traditional IRA.  From there I plan to make annual conversions to my long established Roth IRA.  Is there an issue with the five-year rule that would prevent me from being able to make withdrawals from the Roth during the next few years?  Thanks for your help.

Dan

Answer:

Hi Dan,

Your plan works! You can roll over your TSP to a traditional IRA and make series of conversions to a Roth IRA without worries about taxes and penalties on any Roth distributions. How is this possible? Well, all your converted funds can be accessed tax and penalty free because you are over age 59 ½. There is no five-year holding period to be concerned about. Assuming your “long established” Roth IRA was established by a conversion or contribution more than five years ago, your earnings will also be tax and penalty free. This is because you are over age 59 ½ and your Roth IRA has satisfied the five-year holding period for qualified earnings. This five-year period never restarts.

Question:

Ed:

I’ve read your articles for years.  Thank you for being a great resource to our industry!

I have a couple of questions:

  • You’ve written on the once-a-365-day-year indirect IRA rollover rule.  How is this applied?  Does the 365-day year start on the day that the distribution is paid from the distributing IRA, or on the day the funds are actually redeposited in the receiving rollover IRA?
  • If funds are distributed from an IRA, you have 60 days to indirectly roll them to another IRA to avoid making those funds taxable.  RMDs are based on prior-year-end value of an IRA.  Why couldn’t an IRA owner withdraw the funds in his IRA on December 1, then redeposit them to another IRA on January 15, making the December 31 value = $0, and negate any RMD for that year?

 

Thank you!

Evan

Answer:

Hi Evan,

Those are both great questions and we get them all the time.

In response to your first question, the 365-day period for purposes of the once-per-year rollover rule starts with the date the distribution from the IRA is received. If that distribution is rolled over, no other distribution from any of that IRA owner’s IRA can be rolled over during that 365-day period. (IRA to plan rollovers and IRA to Roth IRA conversions are exempt from this rule.)

As far as your second question goes, the IRS is one step ahead of you. There is a special rule that requires adjustment of the December 31 balance when calculating RMDs. Any outstanding rollovers or transfers must be added back in to the balance. This prevent IRA owners from withdrawing their entire IRA balance in one year and redepositing it back in the following year to avoid RMDs.

https://www.irahelp.com/slottreport/roth-conversions-and-60-day-rollover-rule-todays-slott-report-mailbag

HOW THE 401(K) NONDISCRIMINATION RULES WORK – PART 2

By Ian Berger, JD
IRA Analyst

Many 401(k) plans must pass two annual nondiscrimination tests: the ADP test and the ACP test. The November 11 Slott Report discusses the ADP test. This Slott Report tackles the ACP test and the options available to 401(k) plans that fail one or both tests.

ACP test. While the ADP test takes into account pre-tax deferrals and Roth contributions, the ACP test considers after-tax contributions and employer matching contributions.

First, the plan must calculate a contribution percentage for each employee. Your contribution percentage is the sum of your after-tax contributions and employer matching contributions, divided by your pay for the year. (If you are eligible but don’t make any after-tax contributions and don’t receive any matching contributions, your ACP percentage is 0 %.)

Second, the plan must calculate an average contribution percentage for all of the non-highly compensated employees (NHCEs) and an average for all highly compensated employees (HCEs).

The ACP test works the same way as the ADP test:

  • If the NHCE average is 2% or less, the HCE average can’t exceed twice the NHCE average.
  • If the NHCE average is between 2% and 8%, the HCE average can’t exceed the NHCE average plus 2%.
  • If the NHCE average is more than 8%, the HCE average can’t exceed the NHCE average times 1.25.

Example: Company B has 3 NHCEs and 2 HCEs eligible for its 401(k) plan in 2019. Company B performs the ACP test based on the following data:

Employee           After-tax contributions + Match            Pay            Contribution Percentage

NHCE1                       $       0                                      $50,000                        0%

NHCE2                         6,000                                        60,000                    10.0

NHCE3                         7,200                                        90,000                      8.0

HCE1                            7,500                                      150,000                      5.0

HCE2                          19,000                                      190,000                    10.0

Here, the NHCE average contribution percentage is 6.0% [(0% + 10.0% + 8.0% /3]. Therefore, to pass the ACP test, the HCE average percentage can’t be more than 8.0%. Since the HCE average percentage is 7.5% [(5.0% + 10.0%)/2], the plan passes the ACP test for 2019. The plan must also pass the ADP test for 2019.

Remedies. If the plan fails the ADP or ACP test (or both), the employer must remedy the violation. Available remedies include:

  • Distributing excess contribution to HCEs;
  • Requiring HCEs to limit their deferrals and/or after-tax contributions; or
  • Making special contributions for NHCEs.

Safe harbor contributions.  Performing the ADP and ACP tests each year can be an administrative burden. Meanwhile, the available remedies aren’t ideal because they either prevent HCEs from maximizing deferrals or are too costly (or both). Fortunately, plan sponsors can avoid testing entirely by adopting one of the following “safe harbor” contribution formulas:

  • The company contributes 3% of each employee’s pay, whether or not the employee makes deferrals.
  • The company matches 100% of employee deferrals made up to 3% of pay and matches 50% of deferrals made on the next 2% of pay.
  • The company matches 100% of employee deferrals made up to 4% of pay.

All safe harbor contributions must be immediately 100% vested. This makes those contributions expensive compared to other employer contributions, which can be subject to a vesting schedule.

https://www.irahelp.com/slottreport/how-401k-nondiscrimination-rules-work-part-2

By Ian Berger, JD
IRA Analyst

If you participate in a 401(k) plan, you probably know about the annual limit on the amount of your deferrals (for 2019, $19,000, or $25,000 if over age 50). But if you are a high-paid employee, another limit may apply.

Welcome to the IRS nondiscrimination rules! These rules are designed to ensure that retirement plans don’t favor “highly compensated employees” (HCEs) at the expense of other employees. In the 401(k) context, the rules limit the amount of deferrals that HCEs can make, depending on the level of deferrals all other employees make. (The nondiscrimination rules don’t apply to solo 401(k) plans.)

HCE’s. You’re an HCE for a particular year if:

  • you, or certain family members, own more than 5% of the plan sponsor during that year or the prior year; or
  • for the prior year, you received pay of more than an indexed dollar limit ($120,000, if the prior year is 2018).  (Your employer may choose to limit HCEs to employees who are also in the top 20% of employees ranked by pay.)

If you’re not an HCE, you’re considered a non-highly compensated employee (NHCE).

ADP test. There are two 401(k) nondiscrimination tests: the ADP test and the ACP test. Both must be passed annually.

For the ADP test, the plan must first calculate a deferral percentage for each employee. Your deferral percentage is the amount of pre-tax and Roth deferrals (but not age 50 catch-up contributions) you make, divided by your pay for the year. (If you are eligible but don’t defer, your deferral percentage is 0 %.)

Then, the plan must calculate an average deferral percentage for all of the NHCEs and an average for all of the HCEs.

The ADP test works this way:

  • If the NHCE average is 2% or less, the HCE average can’t exceed twice the NHCE average.
  • If the NHCE average is between 2% and 8%, the HCE average can’t exceed the NHCE average plus 2%.
  • If the NHCE average is more than 8%, the HCE average can’t exceed the NHCE average times 1.25.

Example: Company A has 4 NHCEs and 2 HCEs eligible for its 401(k) plan in 2019. Company A performs the ADP test based on the following data:
Employee                           Elective deferrals                      Pay              Deferral Percentage

NHCE1                                    $       0                              $40,000                        0%

NHCE2                                      3,000                                60,000                      5.0

NHCE3                                      4,800                                80,000                      6.0

NHCE4                                      9,000                              100,000                      9.0

HCE1                                       14,000                              140,000                     10.0

HCE2                                       19,000                              158,333                     12.0

In this example, the NHCE average deferral percentage is 5.0% [(0% + 5.0% + 6.0% + 9.0%)/4]. Therefore, to pass the ADP test, the HCE average percentage can’t be more than 7.0%. Since the HCE average percentage is 11.0% [(10.0% + 12.0%)/2], the plan fails the ADP test for 2019.

The November 13 Slott Report will discuss the other nondiscrimination test – the ACP test – as well as ways a plan sponsor can remedy an ADP or ACP test failure.

https://www.irahelp.com/slottreport/how-401k-nondiscrimination-rules-work-part-1