IRA BLOG

ROTH CONVERSIONS AND INHERITED IRA RMDS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger
IRA Analyst
Follow Us on Twitter: @theslottreport

Question:

Late in December, 2021, a taxpayer (under age 59 ½) takes a distribution of his (traditional, not Roth) 401(k), and has 20% withheld for Federal tax. Early in January, 2022, the full 100% of the distribution is deposited in a Roth IRA. Does this avoid the 10% penalty for early distribution? Is this reportable as a Roth conversion in 2022 or 2021?

Answer:

The 10% early distribution penalty does not apply to Roth conversions. It’s not clear whether the taxpayer converted 80% of the distribution or came up with the funds out-of-pocket to make up the 20% withheld and convert the whole thing. If the taxpayer only converted 80%, then he would owe the 10% penalty on the 20% withheld. The 401(k) plan would report the distribution on a 2021 Form 1099-R, and the taxpayer would be taxed/penalized on the distribution in 2021 (even if the conversion is delayed until 2022). The IRA custodian would report the conversion on a 2022 Form 5498.

Question:

Hello,

I have done a lot of research on this and one’s head can spin as you read the different articles. Hoping you can clear up these two questions.

The Situation: Our 98-year-old mother passed in May, 2022. She had both a Roth IRA and a traditional IRA, and we (her children) were the primary beneficiaries of both IRAs. She passed before taking her 2022 traditional IRA RMD. The broker created inherited Roth and traditional IRAs for us and, during the process, sent us each a check that totaled Mom’s 2022 RMD amount so that her 2022 year-of-death RMD was satisfied.

On our inherited traditional IRAs, we understand that based on February 2022 IRS guidance we need to take annual RMDs from those accounts over 10 years and have the inherited traditional IRAs emptied by the end of the 10th year. With Mom’s 2022 RMD already having been satisfied, is our first RMD year 2022 or 2023? Our understanding is that there are no annual RMDs on our inherited Roth IRAs, but that we must have emptied them by the end of the 10th year. Is our understanding correct?

Thanks for fielding everyone’s questions and sharing your answers.  It is a great service!

Greg

Answer:

Hi Greg,

Appreciate the compliment, and sorry for your loss. These rules are complicated, but you have a good grasp of them. Since Mom died after her RMD required beginning date, the inherited traditional IRAs must be emptied by 12/31/32, and annual RMDs (based on the beneficiary’s single life expectancy) must be taken starting in 2023. The rules are different for the inherited Roth IRAs. Those accounts also must be emptied by 12/31/32, but annual RMDs are not required during the 10-year period because Roth IRA owners are always considered to have died before their required beginning date.

https://www.irahelp.com/slottreport/roth-conversions-and-inherited-ira-rmds-today%E2%80%99s-slott-report-mailbag

HOW ARE ROTH 401(K) DISTRIBUTIONS TAXED?

By Ian Berger, JD
IRA Analyst
Follow Us on Twitter: @theslottreport

More and more 401(k) plans now offer Roth contributions. At the same time, Americans are changing jobs and receiving 401(k) distributions in record numbers. So, it’s a good time to review the tax rules that apply to Roth 401(k) withdrawals. (The same rules also apply to Roth 403(b) and Roth 457(b) withdrawals.)

Roth 401(k) contributions are made with already-taxed compensation. So, if you are eligible for a distribution, you can withdraw the contributions themselves without paying taxes. (If you’re still working, you can’t withdraw Roth contributions before age 59 ½ except for hardship.) But earnings on Roth contributions only come out tax-free if the distribution is considered “qualified.”

To be qualified, a distribution must satisfy two requirements. First, you must be at least 59½ at the time of distribution (or the distribution must be on account of your disability or death). Second, you must have held the Roth 401(k) account for more than five years. This five-year holding period starts on January 1 of the first year you made a Roth contribution to the plan that the distribution is coming from. Periods during which you made Roth contributions to other 401(k) plans don’t count (unless you rolled over those contributions to your current employer’s plan). Any other non-Roth 401(k) contributions are also ignored.

Example 1: From 2012-2018, Denise worked for Alpha Company and made Roth contributions to the Alpha 401(k). In 2018, Denise left Alpha and began working for Beta Company. She made her first Roth 401(k) contribution to that plan on July 1, 2018. In 2022, at age 60, Denise wants to withdraw from her Beta Roth 401(k) account. If she does that, the earnings on account will be taxable since her distribution won’t be qualified. Although she is over 59 ½, her five-year holding period, which began January 1, 2018, won’t until December 31, 2022. Denise won’t get credit for her Alpha Roth 401(k) contributions unless she rolls over those funds to the Beta 401(k).

If your distribution is not qualified, a portion will be subject to tax under the pro-rata rule. To determine how much is taxable, following these steps:

  • Step 1 – Divide the amount of your Roth 401(k) contributions by your total Roth 401(k) account balance (contributions + earnings).
  • Step 2 – Multiply the Step 1 percentage by your total distribution amount.
  • Step 3 – Subtract the Step 2 amount from your total distribution amount.

Example 2: Denise (from Example 1) goes forward with a partial Roth 401(k) withdrawal of $20,000 from the Beta plan. She has made $35,000 of Beta Roth 401(k) deferrals, and her total Roth 401(k) account balance (contributions + earnings) is $50,000. The Step 1 fraction is 70% ($35,000 / $50,000), and the Step 2 amount is $14,000 ($20,000 x 70%). This means the Step 3 amount – the taxable portion of the $20,000 withdrawal – is $6,000 ($20,000 – $14,000). Denise can take the remaining $14,000 tax-free.

https://www.irahelp.com/slottreport/how-are-roth-401k-distributions-taxed

QCDS AND THE ABSOLUTE NECESSITY FOR A CWA

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Qualified Charitable Distributions (QCDs) are a common transaction these days, but all guidelines must be followed to ensure the QCD is valid. Recent court cases have exposed the absolute necessity to adhere to the rules…or the donation could be disallowed.

For IRA owners who are age 70 ½ and older, donations paid directly from an IRA to an eligible charity may be excluded from income. Using QCDs to offset all or a portion of a required minimum distribution (RMD) is incredibly popular. Up to $100,000 annually can be sent to charity via QCD, and this is in addition to the standard deduction. However, there can be no benefit back to the taxpayer. No goods or services, other than an intangible religious benefit, can be received in exchange for the contribution. This language is important.

Regarding itemized charitable deductions, historically taxpayers have been “a little loose” with their details. Overstatements and fabrications were (and are probably still) rampant. Deductions were taken for more than what was donated, and for donations that never even occurred. To curb abuse, Congress passed strict laws governing the reporting of charitable contributions. These rules cover both cash and non-cash donations. How much was given? What was the fair market value of the item? What was the taxpayer’s cost basis on that item? On and on the rules go.

Not surprisingly, most donations need to be documented with some sort of receipt. Officially, this is called a “contemporaneous written acknowledgement” (CWA), and it is applicable to all contributions of $250 or more. Ultimately, when a QCD is done, the necessary documentation needed for a tax return includes the amount of the donation, the date of the donation, the name of the charity, and whether the charity provided any goods or services for the donation. (Remember, no goods or services, other than an intangible religious benefit, can be received in exchange for the contribution.)

Since QCDs are typically sent directly from the custodian to the charity, verifying the date, amount and to whom the dollars were sent should be easy. The tricky part is getting the proper receipt from the charity. Even if no goods or services were received, the CWA cannot remain silent on this issue. It must state that nothing was transferred back to the donor. And if the language about “no goods or services being received” is missing, the entire donation could be disallowed.

In one particular court case, all parties agreed that a donation was made. However, the “no goods or services received” language was missing from the CWA. Despite the obvious donation, the judge’s hands were tied. Based on the strict laws, the charitable deduction was denied. Additionally, there is no retroactive fix. Why? Because the CWA must be obtained by the taxpayer on or before the earlier of the date on which the taxpayer files a return, or the due date (including extensions) for filing the return. Creating and sending the proper documentation after the fact is of no help. (Note that while this court case involved an itemized charitable deduction, the same CWA rules apply to QCDs.)

Please be careful. It is imperative that QCD and general charitable donation rules are acknowledged and firmly adhered to. Otherwise, simple acts of kindness and giving can be ruined and tax benefits lost.

https://www.irahelp.com/slottreport/qcds-and-absolute-necessity-cwa

REQUIRED MINIMUM DISTRIBUTIONS AND NET UNREALIZED APPRECIATION: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Question:

I turn 72 in 2023. If I wait to take my first RMD until 4/1/24, do I calculate it using my IRA balance on 12/31/23 or on 12/31/22? I think 12/31/22, but do not want to assume. I can’t find a clear answer in Pub 590-B.

Tim

Answer:

Tim,

Since you turn 72 next year (2023), that will be your first year to take a required minimum distribution (RMD). You are correct – the 2023 RMD is calculated using the 12/31/2022 IRA balance. Yes, you are allowed to delay your first RMD until April 1 of 2024. However, delaying the 2023 RMD does not change how it is calculated. You will still use the 12/31/2022 balance.

Question:

I have a client where we initiated a partial NUA (net unrealized appreciation) distribution of approximately $300K of stock with a basis of $113K into a nonqualified account. The remainder of stock ($200K and rest of 401(k) dollars) were to be rolled directly into an IRA. However, the 401(k) provider made a mistake and instead distributed the entire $500K of stock into the nonqualified account. After consulting with a CPA, he thinks we can use a 60-day rollover to fix this by taking the $200K of stock and rolling it back into IRA. Is this accurate?

Sincerely,

Collin

Answer:

Collin,

The CPA is correct. Assuming we are still within the 60-day window from when the stock was originally distributed from the plan, any shares that are subsequently rolled to an IRA will avoid taxation and will not be included in the NUA transaction. Incidentally, even if your client had done another 60-day rollover within the previous 12 months, the one-rollover-per-year rule is not an issue because plan-to-IRA rollovers don’t count. While the $200K in stock shares are moving through a non-qualified brokerage account, this is still considered a plan-to-IRA rollover.

https://www.irahelp.com/slottreport/required-minimum-distributions-and-net-unrealized-appreciation-todays-slott-report

3 IRA RULES TO KNOW BEFORE YOU WALK DOWN THE AISLE

By Sarah Brenner, JD
Director of Retirement Education
Follow Us on Twitter: @theslottreport

According to many recent surveys, the fall months of September and October are overtaking June as the most popular time of year to tie the knot. If your wedding is approaching in the next few months, the last thing you may be thinking about is your retirement account, but when it comes to IRA rules, marriage has its benefits. Here are three IRA rules you should know before you walk down the aisle:

1. You can make spousal IRA contributions: If you are not working you may think you are ineligible to make an IRA contribution. That might not be the case.  If you are married, you may be able to contribute to your IRA based on your spouse’s taxable compensation for the year. An individual could make spousal IRA contributions in some years and regular IRA contributions in others.

To make a spousal contribution for 2022, you must be legally married on December 31, 2022 and file a joint federal income tax return for 2022. If you are divorced or legally separated as of that date, neither spouse is eligible for a spousal contribution, even if they were married earlier in the year.

2. You are able to use the Joint Life Expectancy Table for Required Minimum Distributions (RMDS): When you reach age 72, you must start taking distribution annually, called required minimum distributions. These are calculated by using life expectancy tables provided by the IRS. IRA spouse beneficiaries who are more than ten years younger than the IRA owner may use the Joint Life Expectancy Table. This results in smaller RMDs versus using the Uniform Lifetime Table, which is required to be used to calculate lifetime RMDs for all other IRA owners.

3. You have special benefits as a spouse beneficiary. The benefits of being married continue even after the death of a spouse. Only a spouse beneficiary can roll over or transfer an inherited IRA from a deceased spouse into their own IRA. This is known as a spousal rollover. There is no deadline for a spousal rollover. Once the spousal rollover is done, the funds are treated like any other IRA funds you own. There are no RMDs if you are not yet age 72. Non-spouse beneficiaries do not have this option.

Not every spouse beneficiary will want to do a spousal rollover. Sometimes to avoid early distribution penalties it can make more sense to keep an inherited IRA. Under the SECURE Act, most beneficiaries will need to empty the inherited IRA by December 31 of the tenth year following the year of death. However, eligible designated beneficiaries (EDBs) will still be able to take RMDs from the inherited IRA based on their own life expectancy. A spouse is one of those EDBs.

As a spouse beneficiary you can take advantage of a rule unavailable to non-spouse beneficiaries. If you are the sole beneficiary, and if your spouse dies before their required beginning date (RBD) – when RNDs are to begin – you can delay RMDs from the inherited IRA until the year your spouse would have attained age 72. That can mean a delay of many years before RMDs from the inherited IRA must begin.

Even when spouse beneficiaries are subject to RMDs, they receive a special break when calculating that amount. Spouse beneficiaries have the advantage of being able to recalculate their life expectancy. Over time, this results in lower RMDs for spouse EDBs compared to non-spouse EDBs.

Best wishes to all the new brides and grooms!

https://www.irahelp.com/slottreport/3-ira-rules-know-you-walk-down-aisle

THE LIMITS OF ERISA SPOUSAL PROTECTION

By Ian Berger, JD
IRA Analyst
Follow Us on Twitter: @theslottreport

A recent federal court case from West Virginia illustrates that the spouse of a 401(k) participant usually has no right to prevent the plan from paying the participant a lump sum distribution.

In Gifford v. Burton, a Mr. Gifford (his first name is omitted in the decision) was an optician at Walmart and a participant in the Walmart 401(k) plan. He was married to Sara Gifford, who was his sole beneficiary under the plan. In February 2021, Mr. Gifford received a distribution of all of his 401(k) funds and deposited those funds into an IRA. He then designated his daughter, Emma Gifford, as 90% beneficiary of his IRA and wife Sara as 10% beneficiary.

Mr. Gifford didn’t obtain spousal consent from Sara before receiving the 401(k) distribution. Sara sued, arguing that ERISA required her to consent to the payout. She lost.

ERISA does ban certain retirement plans from paying lump sums to married participants without spousal consent. For those plans, married participants must have their distribution paid in the form of a “qualified joint and survivor annuity” (QJSA), unless the spouse gives consent to another form of payment such as a  lump sum. 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.

However, this spousal consent requirement does not apply to most 401(k) plans. It only applies if a 401(k) offers a lifetime annuity as an optional form of payment and a married participant elects the lifetime annuity. Most 401(k) plans don’t offer a lifetime annuity. Since the Walmart plan falls into that category, Mr. Gifford didn’t need Sara’s approval before electing a lump sum. Note that, unlike most 401(k) plans, the spousal consent rule does apply to all ERISA-covered defined benefit pension plans.

A second type of spousal consent does apply to all 401(k) plans subject to ERISA. (Most 401(k) plans are subject to ERISA. Exceptions include the federal Thrift Savings Plan and solo 401(k) plans.) This rule requires the spouse of a married employee to agree to the employee’s designation of someone other than the spouse as 401(k) beneficiary. So, if Mr. Gifford had attempted to name daughter Emma as his 401(k) beneficiary, wife Sara would have needed to consent to that designation.

This beneficiary rule does not apply to most IRAs, since IRAs aren’t subject to ERISA. So, in most states, a married IRA owner can name anyone he wants as beneficiary without first getting spousal consent. However, in community property states, spousal consent to a non-spouse beneficiary is required for IRAs opened during the marriage.

These rules are helpful to a married person (like Mr. Gifford) who wants to leave his retirement funds to someone besides his spouse. Once eligible, that married person can receive a lump sum 401(k) payment, roll over those funds to an IRA and designate anyone as beneficiary. In most cases, neither the 401(k) distribution nor the IRA beneficiary designation requires spousal consent.

https://www.irahelp.com/slottreport/limits-erisa-spousal-protection

REQUIRED MINIMUM DISTRIBUTIONS AND INHERITED IRAS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst
Follow Us on Twitter: 
@theslottreport
Question:

By law I must withdraw a certain percentage from my retirement accounts to meet the required RMD. And I will have to pay income taxes on that amount. The percentage amount I must withdraw is based on the value of the account as of December 31, 2021 at which time the market was very high. My stocks and mutual fund investments are now worth a lot less than they were in December 2021…at least 30% less! This means I will have to sell a lot more of my investments (and reduce my retirement nest egg) in order to meet the RMD percentage of value.

I know that if all my investments were in a Roth IRA, I would not have this problem. However, I cannot be alone in this and wonder if the feds have any plans to give some relief to us seniors?

Barbara

Answer:

Hi Barbara,

The volatile markets have left many retirement account owners in the same situation as you. Required minimum distributions (RMDs) for 2022 are calculated based on the December 31, 2021 balance. Many account owners have seen their accounts decline in value since then. Unfortunately, this time around there have been no signs that Congress will be providing any relief.

One possible strategy that may help is to take your RMD in kind. This is allowed. You can simply transfer the stock from your IRA to a non-retirement brokerage account. Your RMD will be taxable but in the future the stock may rebound, and you could reap the benefits outside your retirement account.

You mention Roth IRAs. Now, when account values are low, is a good time to consider converting. Turbulent markets are likely to be with us for a while. Converting funds to a Roth IRA would eliminate the worry of future RMDs for you.

Question:

I inherited an IRA from my father. I am interested in converting this IRA to a Roth IRA. How do I go about getting this done?

Thank you for your help.

Barry

Answer:

Hi Barry,

Unfortunately, you are not allowed to convert the IRA you inherited from your father to a Roth IRA. The rules do not allow nonspouse IRA beneficiaries to convert. This is a strange quirk in the tax code because nonspouse beneficiaries of employer plans are permitted to convert. Congress may change this rule some day but for now we are stuck with it.

https://www.irahelp.com/slottreport/required-minimum-distributions-and-inherited-iras-todays-slott-report-mailbag-0

ROTH IRA DISTRIBUTION ORDERING RULES

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

This may seem like a rudimentary topic, but it is the basics that are often so confusing. A fundamental understanding of Roth IRA distributions is essential for Roth IRA owners. In a blog post from June 8 (“One Roth IRA Bucket”), I created a scenario where a person had five Roth IRAs, a couple of traditional IRAs, and was doing Roth conversions. The point of that exercise was to demonstrate how the IRS knows what dollars within all of a person’s Roth IRAs are contributions, what are conversions, and what are earnings. Additionally, I stressed that the IRS treats the entirety of a person’s Roth IRAs, regardless of how many, as a single Roth IRA.

Why is it so important to know which dollars are which within a Roth IRA? Because Roth IRA distributions follow strict ordering rules. There is no such thing as FIFO (“first in, first out”) with a Roth IRA. LIFO (“last in, first out”) and pro rata also have zero bearing on Roth IRA withdrawals. In fact, there is a simple ordering procedure for Roth IRA distributions:

  • Contributions come out first. When they are depleted…
  • Converted dollars come next. When they are depleted…
  • Earnings come out last.

That’s it. Those are the ordering rules, and it does not matter from which Roth IRA you take a distribution. Remember, all the IRS sees when it looks at all of your Roth IRA accounts is one bucket of Roth IRA dollars, subdivided into contributions, conversions and earnings.

What about access to these dollars? A person can always withdraw Roth IRA funds, no questions asked. The issue is whether those dollars will be subject to the 10% early withdrawal penalty and/or taxes. This article will not get into the weeds of the Roth 5-year clocks, nor will it cover exceptions to the 10% penalty. Space is limited. However, below is an overview of the different types of Roth IRA dollars (contributions, conversions and earnings) and a brief explanation of when those funds are available.

Contributions. Roth IRA contributions are always available tax- and penalty-free. It does not matter how long the Roth IRA was opened or how old you are. If you made any contribution to a Roth IRA in any year, those dollars can be withdrawn at any time for any reason. Fortunately, based on the ordering rules, Roth IRA contributions come out first. Until you exceed the amount of contributions with your withdrawals, converted dollars and earnings will stay put.

Conversions. Conversions come out next. Since the tax was paid in the year of conversion, these dollars come out tax-free. Roth IRA converted dollars are penalty-free after 5 years OR age 59 ½. The word “or” is key. If either of these targets are hit, the converted dollars are available free and clear. There are no other variables. Did you hit your 5-year conversion clock on these specific converted dollars? OR, are you 59 ½ or older? If yes for either, then you have full access to the converted Roth IRA funds.

Earnings come out last. They are available tax- and penalty-free after 5 years AND 59 ½. The word “and” is crucial. BOTH must be satisfied. (Note that earnings are always penalty-free if you are over 59 ½.)  If you had any Roth IRA for 5 years AND meet the age limit, congratulations! All your Roth IRA dollars will forever be tax- and penalty-free.

https://www.irahelp.com/slottreport/roth-ira-distribution-ordering-rules

ROTH CONVERSIONS AND DESIGNATED BENEFICIARIES: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Question:

Hi Mr Slott,

I read somewhere but couldn’t remember where, if a person needs to withdraw an RMD but doesn’t need the money, can he convert this RMD to a Roth IRA?

Thanks in advance

Answer:

This is an area where there is a lot of confusion. An RMD cannot be converted to a Roth IRA. The reason for this is the tax rules are very clear that an RMD is not eligible for rollover, and a conversion is considered to be a type of rollover. The correct way to handle this situation is to take the RMD from the IRA and then convert the remainder of the IRA or any portion of it. The RMD cannot be deposited as part of the conversion.

Question:

My client passed away in 2021.  He had an IRA, for which he made his (at the time) revocable living trust the sole beneficiary.  He had one son who is the sole beneficiary of his estate.  As I read the regulations, I believe the son fits the fact pattern to be treated as a designated beneficiary since the son is the sole beneficiary of the trust and its assets.  As such, I have concluded that the son falls into the category of designated beneficiary (not an Eligible Designated Beneficiary) and therefore has 10 years to liquidate the IRA.  My client had already begun to take RMDs prior to his passing.   Based on the February proposed IRS regulations, will the son need to take “stretch RMDs” in years 1-9 and the balance in year 10?

Regards,

Jack

Answer:

Hi Jack,

We agree with your analysis. If the trust meets the look-through rules and the son is considered a designated beneficiary, the 10-year payout rule would apply to the trust. That would mean that the inherited IRA would need to be paid out to the trust by the end of the tenth year following the year of death. The new IRS proposed regulations do add an additional twist. Since the IRA owner died on or after his required beginning date, the trust does need to take RMDs based on the single life expectancy of the son during years one through nine of the 10-year period. If the IRA owner died in 2021, the first RMD based on this calculation would be due by the end of 2022.

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

YOUR AGE AND YOUR ROTH IRA CONVERSION

By Sarah Brenner, JD
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Questions on how age affects the decision to convert to a Roth IRA are common. What age is too old to convert? There is no easy answer to this question because there is no magic age when conversion makes the most sense or no longer makes sense at all. Conversion can be the right move at any age.

Younger Savers

Roth IRA conversions for younger people are a usually a smart strategy. This is no surprise. Younger people are generally in a lower tax bracket and have not yet accumulated large sums in their IRAs or 401(k)s. Also, time is on their side. They have a long timeline to save and accrue tax-free earnings in a Roth IRA.

Conversion comes with a tax bill. Any individual who converts should be reminded of that before moving ahead with the conversion. Younger people who may not have time to amass large amounts of savings should be prepared for the tax cost. Now that recharacterization is no longer available there is no way to undo a conversion to escape the tax hit.

Midlife Conversions

For those looking to convert in middle age, timing is critical. These individuals are likely to be in the peak earnings years and in the highest tax brackets. Conversion is best considered in a year when tax conditions are optimal, and when it can be done at a low tax rate or even at no tax cost at all with offsetting tax losses, deductions, or credits.

A tax year with a low tax bracket or with net operating losses from a business is good year for middle aged savers to consider conversion. Another strategy to investigate is doing a series of smaller annual Roth conversions over several years, to lessen the tax impact in each year.

Too Old to Convert? Think Again

There is no age when an individual is too old to convert. Older individuals may think that they do not have a long time to save, but that is overlooking the potential of conversion as an estate planning strategy.

For older individuals who do not need their retirement savings soon or at all, especially if they plan to pass these funds on to beneficiaries – the Roth conversion is an effective estate planning vehicle, and even more so now after the elimination of the stretch IRA under the SECURE Act. Most beneficiaries will be subject to the 10-year rule which can push the tax bill into a shorter time frame, leaving less for beneficiaries. A Roth conversion can eliminate the tax bill for beneficiaries, since the tax will be paid up front at conversion, possibly at lower tax rates available now.

Older individuals should also be advised that a Roth conversion does increase ordinary income for the year of the conversion – potentially causing the loss of valuable tax credits and deductions, taxation of Social Security, and increased premiums for Medicare Part B and Part D premiums. However, that additional income is only for one year, and the trade off is future tax-free earnings and tax-free distributions from the Roth IRA.

https://www.irahelp.com/slottreport/your-age-and-your-roth-ira-conversion

CAUGHT IN A TRAP: RMDS FROM 401(K) PLANS IN THE YEAR OF RETIREMENT

By Ian Berger, JD
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Here’s a common question: An employee retires in or after the year he turns 72 and wants to roll over his 401(k) funds to an IRA. Does an RMD have to be taken before the funds are rolled over?

What makes this tricky is that required minimum distributions (RMDs) normally don’t need to start until April 1 following the age 72 year (or April 1 following the year of retirement for someone using the “still-working exception”). That April 1 is considered the employee’s required beginning date (RBD).

If the 401(k)-to-IRA rollover takes place before the RBD, it would make sense that no RMD should be required before the rollover occurs. But, as is the case with many IRA and workplace plan rules, what makes sense isn’t always the correct answer. The correct answer is that a RMD from the 401(k) must be taken first, and only what’s left can be rolled over.

How can that be? Well, first, the IRS says that the first funds distributed in a year in which an RMD is required are considered part of the RMD (the “first-dollars-out rule”). Second, the first year in which an RMD is required is not the year of the RBD – it’s the year of retirement (that is, the year before the year of the RBD). Third, RMDs can never be rolled over. Putting all three rules together means that the first dollars received in the year of retirement on or after age 72 are part of the RMD and aren’t eligible for rollover.

If the RMD is rolled over, it is considered an excess contribution. To avoid penalty, excess contributions – along with earnings or losses attributable to the excess amount – must be returned by October 15 of the year following the year the contribution was made.

Example: Kaitlin works for Fourth Fifth National Bank and participates in its 401(k) plan. Kaitlin uses the still-working exception to delay plan RMDs beyond age 72. In 2022 at age 73, Kaitlin retires and elects to roll over her 401(k) balance of $400,000 to an IRA. She is aware that her RBD is not until April 1, 2023. For that reason, she rolls over the entire $400,000 (including her 2022 401(k) RMD, which we assume to be $15,000) to the IRA. Since the $15,000 was not eligible for rollover, it is now an excess contribution in the IRA. Kaitlin can fix the error without penalty by withdrawing $15,000, plus or minus earnings or losses on her IRA attributable to the $15,000, from the IRA by October 16, 2023.

Can Kaitlin avoid taking the 2022 RMD from her 401(k) in 2022? Yes, by delaying her 401(k) distribution/rollover until 2023. But then she would have to take two RMDs – the 2022 RMD and the 2023 RMD – before rolling over the rest of her funds.

https://www.irahelp.com/slottreport/caught-trap-rmds-401k-plans-year-retirement

60-DAY ROLLOVERS AND ELIGIBLE DESIGNATED BENEFICIARIES: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

QUESTION:

I have a client where we did a 60-day rollover this past January. The proceeds were put back into the account in less than 60 days. The client has asked me to rollover the 403(b) plan he’s had sitting with his former employer. Is this a second rollover violating the once-per-year rollover rule?

Thank you

Jay

ANSWER:

Jay,

You are wise to consider the one-rollover-per-year rule before completing any 60-day rollover. A person is only allowed one 60-day rollover per 365 days. However, the one-rollover-per-year rule is not applicable to plan-to-IRA rollovers. You can do as many of those as you wish. So, in your situation, the 403(b) asset can be rolled to an IRA without violating any rules. However, your client will need to wait until at least next January before he can do another IRA-to-IRA 60-day rollover.

QUESTION:

An eight-year-old daughter inherited her father’s 401(k) plan this year (2022). It was rolled into a traditional inherited IRA account. Does she have to take an RMD based on her life expectancy tables beginning in 2022, and then at age 18 deplete the balance over the next 10 years?

Steve

ANSWER:

As a minor child of the original account owner, the eight-year-old daughter qualifies as an eligible designated beneficiary (EDB) and is permitted to stretch RMD payments over her own single life expectancy. The first RMD will be in 2023 and she will use the factor from the Single Life Expectancy Table for age nine (75.9). For each year thereafter, she will subtract one from previous year’s factor. This will continue until she reaches the age of majority – 21. At that time the 10-year rule will apply. The daughter can continue the RMD payments for another 10 years, but the account must be emptied by the end of the 10th year.

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

ROTH CONVERSION – OOPS!

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

An advisor called to discuss Roth IRA conversions. His new client made some decisions before speaking with him, and he was trying to untangle her self-inflicted knot. She was 69 years old, a single tax filer, still employed, and had a $1 million traditional IRA. Based on advice from her brother (who is not a financial professional), she had already ripped through Roth conversions of $200,000 for both 2021 and 2022. The brother’s only consideration in making his recommendation was, “The market is down.”

Uh-oh. And now we face the consequences.

First and foremost, Roth conversions cannot be undone. There is no recharacterizing a Roth conversion. (Roth contributions can still be recharacterized, but that is a different topic.) So, these $200K conversion knots could not be untied. Regardless, we still needed to explain the ramifications of the transactions and how to approach things differently in the years to come.

Taxes. Assuming this person had no after-tax dollars (basis) in her traditional IRA, then the entire conversion would be taxable. This year she added $200K of ordinary income to her roughly $50,000 of expected earnings. For a single filer who took the standard deduction in 2021 and will do so again in 2022, these balloon conversions most likely vaulted her from the 12% tax bracket all the way up to the 35% bracket. Maybe, with some creative planning, we could finagle a way to get her down to the 32% bracket, but she is definitively facing higher taxes.

A better solution would have been to consider tax brackets before she locked in a Roth conversion. Yes, the markets may be down as her brother said, but the tax brackets are stable. More precise conversions could have limited her to the 22% bracket or, if she was willing, inched her into the 24% bracket. For taxpayers who think rates will increase in the near future, maybe filling up the 24% bracket now (or even the 32% bracket) makes sense.

IRMAA. While tax brackets are steps, Income Related Monthly Adjustment Amount (IRMAA) surcharges for Medicare are a cliff. One dollar over an IRMAA bracket level and you dive headfirst into the next pool. As a single filer with $50,000 of income, this woman was in the bottom IRMAA bracket. By adding a $200,000 Roth conversion in both 2021 and 2022, she jumped to one of the highest brackets and will significantly increase her monthly costs in 2023 and 2024. (IRMAA charges are based on modified AGI from two years previous.) Take note – it is not just income tax brackets that must be considered before a conversion, but “stealth taxes” like IRMAA surcharges must also be part of the equation.

RMDs. Required minimum distributions had not yet kicked in for this individual. She was only 69 and still had a few years to go. Yes, converting her entire traditional IRA before 72 would eliminate the need to take an RMD. But at what cost? For those already taking RMDs, be aware that an RMD cannot be converted. Once satisfied, anything above and beyond the RMD can then be converted.

Financial aid can also be impacted by a Roth conversion, as can other income-based programs and benefits. Before doing any Roth conversion, be sure to weigh all factors, not just market conditions. Every person is different, and we all have personal goals and opinions. An “oops” conversion for one individual could be a home run for another. Tread carefully.

https://www.irahelp.com/slottreport/roth-conversion-%E2%80%93-oops

HOW AN ESA CAN HELP WITH BACK-TO-SCHOOL EXPENSES

By Sarah Brenner, JD
Director of Retirement Education
Follow Us on Twitter: @theslottreport

August is winding down and September is just around the corner. That means that it is back to school time! Education can be expensive. This year, with inflation raging, that seems even more true than ever. If you have children looking to further their education, you will need to explore every possible option out there that can help you save. One savings tool that many parents overlook is the Coverdell Education Savings Account (ESA).

Getting Started with an ESA

How can you start an ESA? There is a lot of flexibility here. Unlike other types of tax advantaged savings plans, there is no need for any involvement from an employer. You may establish an ESA with the custodian of your choice. The paperwork you complete is very similar to the paperwork necessary to establish an IRA. When you establish the ESA, you will need to name a responsible individual. The responsible individual controls the ESA, including investment choices and when distributions are taken. Many custodians will allow you, as the contributor, to name yourself as the responsible individual.

Contributions are made to the account to help save for education expenses of a designated beneficiary. The designated beneficiary is a child under the age of 18. Contributions may be made for designated beneficiaries older than 18 if they have special needs. The maximum contribution amount is $2,000 per year for each designated beneficiary, but you may contribute that amount to ESAs for multiple beneficiaries. For example, if you have five grandchildren, you could contribute $2,000 each year to each of their ESAs.

There is no earned income or taxable compensation requirement to contribute to an ESA. There are no age limits either. There are income limits. If your income is above them, you might consider giving the funds to the child or another person with income under the limits and having them make the contribution to avoid those limits. If you are already funding a qualified tuition plan or 529 plan, you can fund an ESA as well. ESA funds are even eligible to be rolled over to qualified tuition plans.

The contribution deadline is generally the tax-filing deadline, April 15. Your ESA contribution is not deductible, but the earnings will be tax-free if the funds are used to pay for qualified education expenses.

Taking ESA Distributions

Qualified distributions from an ESA are tax-free. The definition of qualified education expenses is very broad for ESA purposes. Qualified education expenses include college tuition, room and board as well as required books and supplies. The student can be a full time or part time student. Vocational school or community college expenses are included as well. A student’s computer and internet expenses are also qualified education expenses.

An important benefit of an ESA is that qualified tax-free distributions may be taken for primary and secondary school expenses. You are not limited to expenses after high school graduation. Eligible expenses include tuition, fees, tutoring and special needs services and expenses incurred in connection with enrollment of the designated beneficiary at a public or private school.

If an ESA distribution is not used for education expenses, the earnings portion will be taxable to the designated beneficiary and may be subject to a 10% penalty unless an exception applies. Funds may be rolled over from an ESA to an ESA for a member of the designated beneficiary’s family who is under age 30.

https://www.irahelp.com/slottreport/how-esa-can-help-back-school-expenses

ELIGIBLE DESIGNATED BENEFICIARIES AND RMD AGGREGATION: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education
Follow Us on Twitter: 
@theslottreport

Question:

Hi,

My wife (68) inherited a traditional IRA and a Roth from her sister (71) in 2021. Both accounts have been moved to inherited IRAs.

I’m trying to do some tax planning. Can you please confirm the following from my confusing research?

As an “eligible designated beneficiary,” my wife can stretch distributions over her lifetime for both the traditional and Roth IRAs.  RMDs are required starting this year from BOTH inherited accounts using the Single Life Expectancy Table for inherited IRAs.

Yes?  Thanks very much!

Steve

Answer:

Hi Steve,

You are correct. Because your wife was not more than ten years younger than her sister, she is considered an eligible designated beneficiary (EDB). As an EDB, she has the ability to stretch distributions from both the traditional and Roth inherited IRAs over her life expectancy. The annual RMDs would be calculated using the Single Life Expectancy Table, and the first RMDs would need to be taken this year from each inherited IRA.

Question:

I have an IRA at Vanguard and one at American Funds.  Can I aggregate my RMD and take it from just one account even though they are at different companies?

Thanks

Sonny

Answer:

Hi Sonny,

We get a lot of questions on when RMDs can be aggregated and taken from one IRA. In your case, there is no problem. You can aggregate your RMDs and take the total amount due from one of your IRAs. The fact that the IRAs are with different companies does not matter.

https://www.irahelp.com/slottreport/eligible-designated-beneficiaries-and-rmd-aggregation-todays-slott-report-mailbag

A RETIREMENT ACCOUNT SCORECARD

By Ian Berger, JD
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Here’s a line from one of the manuals we use in our education seminars for advisors: “Missed stretch IRA RMD by an EDB, when the IRA owner dies before the RBD.

An old baseball expression says: “You can’t tell the players without a scoreboard.” In the world of retirement accounts, you can’t understand the rules without knowing the abbreviated terms. Here’s 18 common ones you should know:

AMBT = Applicable multi-beneficiary trust. A trust named as an IRA beneficiary that enables chronically-ill or disabled EDBs to stretch out RMDs even though there are NEDB trust beneficiaries.

DB = (i) Designated beneficiary. A beneficiary that is a living person. DBs can be either EDBs or NEDBs. (ii) Defined benefit plan. A tax-qualified employer plan in which participants receive a benefit based on the plan’s formula. Also known as a “pension plan.”

DC = Defined contribution plan. A tax-qualified employer plan, like a 401(k) or 403(b), in which participants receive a benefit based on the value of their individual account.

EDB = Eligible designated beneficiary. A DB that is a surviving spouse, a minor child, a chronically ill or disabled individual, or is no more than 10 years younger (or older) than the IRA owner. EDBs can stretch inherited IRAs over their lifetime.

ERISA = The Employee Retirement Income Security Act of 1974. A federal law that regulates certain workplace retirement plans and health plans. Sometimes referred to as “Every Ridiculous Idea Since Adam.”

IRA =  Individual retirement arrangement. (Bet you got this one wrong.) An IRA can be an individual retirement account or an individual retirement annuity.

IRD = Income in respect of the decedent. An income tax deduction available when a beneficiary receives income on an item owned by the decedent (such as an IRA) that is subject to both federal income and estate taxes.

NDB = Non-designated beneficiary. A beneficiary that is not a living person (e.g., a charity, estate or non-qualifying trust). An NDB must be paid out over five years if the IRA owner died before her RBD or over her remaining life expectancy (had she lived) if the owner died on or after her RBD.

NEDB = Non-eligible designated beneficiary. A DB that is not an EDB. NEDBs must be paid out within 10 years and sometimes must receive annual RMDs in years 1-9.

NIA = Net income attributable. Earnings or losses in an IRA attributable to an excess or recharacterized IRA contribution.

NUA = Net unrealized appreciation. A tax strategy for 401(k) or ESOP participants with highly-appreciated company stock to reduce taxes on sale of the stock.

PLR = Private letter ruling. A tax ruling made by the IRS issued upon request of a taxpayer.

QCD = Qualified charitable distribution. A tax-free transfer from an IRA to a charity.

QDRO = Qualified domestic relations order. A court order awarding an ex-spouse  part of an ERISA plan participant’s retirement benefit.

RBD = Required beginning date. The date by which IRA owners and company plan participants must start RMDs. For IRA owners, the RBD is April 1 of the year following the year of their age 72 birthday.

RMD = Required minimum distribution. The minimum distribution that account holders must start taking at their RBD.

SEP = Simplified Employee Pension. A retirement plan in which employers contribute to employees’ IRAs.

SIMPLE = Savings Incentive Match Plan for Employees. A retirement plan for small employers in which elective deferrals and employer contributions are made to employees’ IRAs.

https://www.irahelp.com/slottreport/retirement-account-scorecard

YEAR-OF-DEATH RMD

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Lifetime required minimum distributions (RMDs) start in the year when an IRA owner turns 72. (Technically, the “required beginning date” for RMDs is April 1 of the year after a person turns 72.) Once begun, RMDs must be withdrawn annually on a calendar year basis. If you miss an RMD, the penalty is steep – 50% of the amount not taken.

If a person dies before taking all or part of that year’s RMD, it still must be withdrawn. Death provides no waiver. The responsibility for taking the year-of-death RMD then falls to the beneficiary. It is not paid to the IRA owner’s estate (unless the estate is the named beneficiary) and it cannot be paid to the deceased IRA owner. It is paid, and is taxable, to the beneficiary. Think of it as the final IRA transaction for the deceased owner, and the beneficiary is simply carrying that ultimate matter over the finish line.

While it sounds relatively straightforward, the year-of-death RMD creates all kinds of confusion. Here are three key points to help beneficiaries understand this closing transaction:

1.  Custodians will typically open an inherited IRA for the beneficiary first, transfer all assets to the inherited IRA, and then pay out the year-of-death RMD from the inherited IRA. The Form 1099-R issued for that distribution will include the beneficiary’s social security or tax identification number and will be coded as a death distribution. This payout will be reported on the beneficiary’s personal tax return, NOT the estate’s tax return.

2. If there are multiple IRA beneficiaries, the IRS does not care WHO takes the year-of-death RMD, the IRS just wants it to be taken. If multiple beneficiaries elect to divide the year-of-death RMD equally, they can do so. If one beneficiary chooses a lump sum payout, that could satisfy the entire year-of death RMD (if the lump sum is large enough). Same deal with a charity beneficiary. Charities typically want a lump sum. If the amount is large enough, the payout to the charity can satisfy the full year-of death RMD.

3. The deadline for taking the year-of-death RMD is December 31 of the year of death. If the original IRA owner dies late in the year and had not yet taken his RMD, there is a good chance the year-of-death RMD gets missed. Such situations have been so prevalent that the IRS recently created an extension for missed year-of-death RMDs. There is now an automatic waiver of the 50% penalty if the year-of-death RMD is taken by the beneficiary’s tax filing deadline, including extensions.

Example: Grampa Richie, age 79, has a traditional IRA with his grandson Max, age 25, as beneficiary. Grampa Richie’s annual RMD is normally paid on December 15. However, he dies on December 10, 2022. Grandson Max is responsible for taking the 2022 year-of-death RMD, but in his grief and confusion he misses the year-end deadline. Max is eligible for an automatic waiver of the 50% penalty if he takes the 2022 year-of-death RMD by his 2022 tax filing deadline, plus extensions.

Death is already a difficult and stressful time. Try not to compound issues by mishandling the year-of-death RMD.

https://www.irahelp.com/slottreport/year-death-rmd

ROTH IRA CONVERSIONS AND ROTH 401(K)-TO-ROTH IRA ROLLOVERS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst
Follow Us on Twitter: @theslottreport

Question:

When converting an IRA to a Roth IRA, do the investments (stocks, bonds, ETFs, etc.) have to be sold or can they be transferred directly from the IRA into the new Roth account?

Answer:

There is no requirement that investments be sold before a Roth conversion. If the same custodian will be holding the converted funds, the custodian will simply retitle the existing traditional IRA account as a Roth IRA with the same investment portfolio. If it is a partial conversion, the custodian will transfer the appropriate number of shares from the traditional IRA to the Roth IRA. If a new custodian is used, the conversion can usually be done via a direct transfer (also known as a trustee-to-trustee transfer). However, if you hold certain unconventional investments, it’s possible the new custodian won’t accept them.

 

Question:

Hello,

Can someone, age 70, do a rollover of a 20-year old Roth 401(k) with a former employer to a new Roth IRA without having to start the 5-year clock all over again?

Thanks for any help you can provide.

Mike
Answer:

Dear Mike,

This is a complicated issue. The 5-year clock on the new Roth IRA does have to start over again, but only for determining whether earnings credited after the rollover can come out tax-free. The period that the funds were held in the 401(k) does not carry over to that 5-year clock, so it starts fresh on January 1 of the year the new Roth IRA is established. That’s why it’s important to fund a Roth IRA (even with a small contribution) as early as possible in order to get the Roth IRA clock started. The good news is that the rolled-over funds themselves (both Roth 401(k) contributions and earnings credited before the rollover) can be distributed tax-free at any time after the rollover. That’s because the Roth 401(k) owner in this case was at least 59 ½ at the time of the 401(k) distribution and held the Roth 401(k) for at least 5 years. All of the former Roth 401(k) dollars go into the Roth IRA as essentially one big contribution, and Roth IRA contributions are always immediately available tax- and penalty-free.

https://www.irahelp.com/slottreport/roth-ira-conversions-and-roth-401k-roth-ira-rollovers-today%E2%80%99s-slott-report-mailbag

WHAT YOU NEED TO KNOW ABOUT THE STILL-WORKING EXCEPTION

By Sarah Brenner, JD
Director of Retirement Education
Follow Us on Twitter: @theslottreport

Are you nearing retirement age and not looking forward to taking unwanted required minimum distributions (RMDs) from your retirement account? You may be looking for a strategy to delay those distributions. The “still working” exception allows RMDs to be delayed. Will this exception help you? Here is what you need to know.

The still-working exceptions has some limits. It does not apply to all retirement accounts.  It applies only to company plans. The still-working exception does not apply to IRAs (including SEP and SIMPLE IRAs). If you are still working, that can’t help you delay RMDs from your IRA.

Also, the exception is only available for the plan of the company for which you are still working. If you have other funds in other company plans, it won’t help you with those. Not all plans allow the still working exception. You can’t use the exception if your plan doesn’t allow it. What constitutes still working? Well, there is no official position from IRS on this. There is no requirement that you work 40 hours a week for the exception to apply. A part-time position could be considered still working for purposes of this exception.

You can’t use the exception if you own more than 5% of the company for which you are still working.  When it comes to determining if you are a more than a 5% owner, it’s a family affair. The analysis starts with your personal ownership in the business but does not end there. The Tax Code’s family attribution rules apply. Any ownership in the business by your spouse, child, or grandchild will be included as well when making the call as to whether you are a more than 5% owner.

When you use the still-working exception, RMDs begin in the year you separate from service – even if your last day of work is December 31 of that year. Your required beginning date (RBD) is April 1 of the year after separation from service.

Delaying your RMD using the still-working exception may sound like a good idea, but there are downsides you should consider. You may face restrictions in the plan that would not apply to an IRA. You will begin taking RMDs later, which means you will be taking larger RMDs (due to a higher life expectancy factor). Larger RMDs mean more income taxes, which can result in a tax hit. Your Social Security income could be taxed, and you could lose out on deductions, credits, exemptions and phase-outs.

When considering  the still-working exception, be sure to understand the details.

https://www.irahelp.com/slottreport/what-you-need-know-about-still-working-exception

THE UNPLEASANT SURPRISE OF THE ACCURACY-RELATED PENALTY

By Ian Berger, JD
IRA Analyst
Follow Us on Twitter: @theslottreport

If a retirement account transaction becomes a taxable distribution, you probably know you will owe taxes and possibly the 10% early distribution penalty (if under age 59 ½) on the distribution. But what you may not know is there might be an unexpected surprise. On top of the additional taxes and 10% penalty, you might also be liable for what’s called the “accuracy-related penalty.” Here’s what you need to know about this unpleasant revelation.

The penalty normally kicks in if you substantially underpay your federal income taxes. An underpayment is “substantial” if it is more than the greater of $5,000, or 10% of the tax that was required to be shown on your tax return. (You could also owe the accuracy-related penalty if, in preparing your tax return, you acted negligently or disregarded IRS rules or regulations.) The accuracy-related penalty is normally 20% of the underpayment.

The IRS will waive the penalty if you can show there was “reasonable cause” for the underpayment and that you acted in good faith. The IRS considers reasonable cause on a case-by-case basis, taking into account all pertinent facts and circumstances. However, the IRS says the most important reasonable cause factor is how much of an effort you made to determine your tax liability.

A recent Tax Court case, Lionel E. LaRochelle et al, v. Commissioner; T.C. Summ. Op. 2022-12, illustrates the accuracy-related penalty and the reasonable cause exception. In 2017, Mr. LaRochelle withdrew $238,000 from his IRA, but he and his wife did not show the distribution on their tax return. Since the couple had moved in 2016, Mr. LaRochelle claimed he never received a Form 1099-R from the IRA custodian.

The IRS picked up on his failure to report the $238,000 and assessed additional taxes and the accuracy-related penalty. The LaRochelles paid the taxes but asked the IRS to waive the penalty. After the IRS refused, the case went to the Tax Court.

The couple argued there was reasonable cause for their underpayment because they didn’t receive the 1099-R. But the Tax Court said that failing to receive a tax form reporting a distribution isn’t a good excuse if the taxpayer knew about the distribution anyway. That was the case here. Next, the LaRochelles claimed that they had relied on their tax preparer to produce an accurate tax return, but the court didn’t buy that one either. The court reasoned that, since the couple hadn’t informed the tax preparer about the IRA withdrawal, they could not have expected him to file an accurate return. The $9,075 penalty stood.

The threat of the accuracy-related penalty makes it even more important to know about, and accurately report, all taxable retirement account transactions.

https://www.irahelp.com/slottreport/unpleasant-surprise-accuracy-related-penalty

RMDS & ROTH CONVERSIONS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Question:

My husband is the sole beneficiary of a Traditional IRA owned by his cousin, who recently  passed away. From my research, I believe my husband fits the exception criteria of “eligible designated beneficiary” in that he is not more than 10 years younger than the deceased (he is 9 years younger…he is age 72 and the deceased was age 81). As such, from what I read, he does not have to empty the inherited IRA account within 10 years and can withdraw his RMDs using the stretch IRA method. Can you please confirm this?  (I know that for the year of his cousin’s death – 2022 – he needs to take whatever RMD she still needed to take…but after that, it looks like he can stretch his RMDs and does not have to empty the account within 10 years).

Thank you.

Chris

Answer:

Chris,

Excellent detective work! You are correct on all points. Since your husband is not more than 10 years younger than the original account owner (his cousin), then he qualifies as an eligible designated beneficiary and can stretch required minimum distributions (RMDs) over his own single life expectancy. Since the cousin died this year, then RMDs for your husband will begin in 2023 using his own age next year and the applicable factor from the IRS Single Life Expectancy Table. You are also correct that your husband is responsible for taking his cousin’s year-of-death RMD. That needs to be withdrawn before the end of this year.

Question:

Hi there,

Wondering if you have any formula or analysis of determining whether converting some or all of a traditional IRA to Roth is recommended?

Thanks!

Joel

Answer:

Joel,

There is no universal formula for determining whether, or how much, of an IRA should be converted to a Roth IRA. Every situation is different, and there are several factors to consider. For example, do you have available funds to pay the taxes on the conversion? (Preferably these funds would come from a source other than the IRA.) Who is the beneficiary? (If it is all going to charity, then don’t convert.) What do you think future tax rates will be? (If higher, then conversion could be a good idea.) Are you of RMD age? (The RMD must be taken before any conversion, so that will impact taxable income and how much to convert.) Are you subject to IRMAA surcharges? Do you have financial aid based on income? (Both items could be impacted by a conversion.) Before doing any conversion, an independent analysis of that specific situation must be completed before any decision can be made.

https://www.irahelp.com/slottreport/rmds-roth-conversions-todays-slott-report-mailbag-0

INHERITED IRA Q&AS

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: 
@theslottreport

Each week the Ed Slott team answers questions from financial advisors across the country. Sometimes we see a pattern in repeating questions, sometimes the questions are relatively basic, and sometimes they are real stumpers. We never know what the next phone call or email will bring. Recently, we’ve fielded a rash of inherited IRA inquiries. Here are a few:

Can a QCD (qualified charitable distribution) be done from an inherited IRA? For whatever reason, this question came up a few times over the last couple of weeks. The answer is: Yes, a QCD can be done from an inherited IRA. However, the standard QCD rules apply. Meaning, the current owner of the inherited account must be 70 ½ years old or older to qualify. It is not good enough that the previous owner of the IRA was beyond the QCD age. So, if Thomas is 75, dies, and leaves his IRA to his younger siblings Sally, age 73, and John, age 68, only Sally can do a QCD from her inherited IRA. John will have to wait until he is 70 ½.

Can an inherited IRA ever be moved into your own IRA? This is a bit of a trick question. A non-spouse IRA beneficiary can never transfer an inherited IRA into his own IRA. This is true for traditional IRAs and for Roth IRAs. Both must remain as inherited IRAs for non-spouse beneficiaries. However, a spouse beneficiary has more options. A spouse beneficiary CAN transfer an inherited IRA into her own IRA. But under what circumstances would this happen? Wouldn’t a spouse just do a spousal rollover from the very beginning and completely bypass an inherited IRA? Not necessarily. Younger surviving spouses – those under 59 ½ – should consider an inherited IRA before a spousal rollover. An inherited IRA allows the surviving spouse full access to the IRA dollars without the 10% early withdrawal penalty.

Additionally, a surviving spouse has the benefit of not having to take RMDs (required minimum distributions) on the inherited IRA until the deceased spouse would have been age 72. Note that a spousal rollover can be done at any time. So, when the surviving spouse reaches age 59 ½, regardless of how far into the future that is, the inherited IRA can then be moved into her own IRA via a spousal rollover.

Must I consider inherited IRAs for the pro-rata rule? No, inherited IRAs are disregarded for pro-rata. In this case, the account holder wanted to do a Roth conversion. However, he was over 72 and subject to RMDs. Before any conversion could be completed, the RMD had to be taken first. Once that was accomplished, he could proceed with the conversion. But he had after-tax dollars (basis) in his IRA, and the advisor knew that targeting only those after-tax dollars for conversion was not permitted. The pro-rata math had to be done to determine the ratio of after-tax dollars to pre-tax. When doing the calculation, inherited IRAs are always ignored.

If a charity beneficiary takes a lump sum payout, will that satisfy the year-of-death RMD for the remaining living beneficiaries? Yes, assuming the payout to the charity is enough to cover whatever remains of the year-of-death RMD. Ultimately, the IRS does not care which beneficiary takes the year-of-death RMD, it just wants it to be taken. If a payout to a charity beneficiary is enough, then the remaining living beneficiaries are off the hook for the year-of-death RMD and can proceed with their inherited IRAs unencumbered.

https://www.irahelp.com/slottreport/inherited-ira-qas

FOUR THINGS TO KNOW ABOUT YOUR PLAN ROLLOVER AND YOUR RMD

By Sarah Brenner, JD
Director of Retirement Education
Follow Us on Twitter: @theslottreport

Many Americans are still working long beyond what has traditionally been retirement age. This may be a choice or a necessity. If this is your situation, you may be keeping funds in your employer plan well into your seventies and maybe even later. This can bring big benefits. You can still make contributions to your retirement account, and you may even be able take advantage of the “still-working exception” that allows required minimum distributions (RMDs) to be delayed.

Eventually, however, the time will likely come when you will want to take some or all of the funds out of your plan. You may want to roll over those funds to an IRA. A large percentage of employer plan funds do end up in an IRA eventually. At that time, you will need to pay special attention to your RMD if you have one due for the year. Failing to follow the rules for your RMD can result in adverse tax consequences and penalties.

1. If you have an RMD from the plan for the year, you will need to take that RMD prior to the rollover. It is NOT eligible for rollover to an IRA. It cannot be converted to a Roth IRA. The bottom line is that there is no way around it, you must take it.

2. The first money out of your plan is your RMD if you have one for the year. This is called the “first-money-out-rule,” and many people run afoul of it. You cannot roll part of the funds over now to an IRA and take the RMD later from the plan. You cannot roll over your entire plan balance to your IRA and then take the RMD from the IRA later. If you do either of these, you will wind up with an excess contribution in your IRA. That can mean penalties if it is not corrected on time.

3. Your plan RMD cannot be aggregated with RMDs from your IRA. This means you cannot take it from your IRA. Also, qualified charitable distributions (QCDs) are not available from plans. They are only available from IRAs.

4. Once you have taken your RMD, you may roll over the remainder of your plan funds that are eligible. When the rolled-over funds are deposited to your IRA, they become IRA funds and will be subject to all the IRA rules. There will be no IRA RMD due for the funds rolled over to the IRA for the year of the rollover. However, in years going forward RMDs would be due on these funds, just like any other IRA funds.

Moving your retirement account funds can be tricky. This is especially true when there is an RMD involved. If you have questions about your own situation, your best bet to get it right and avoid costly mistakes is to consult with a financial or tax advisor who is knowledgeable in this specialized area.

https://www.irahelp.com/slottreport/four-things-know-about-your-plan-rollover-and-your-rmd

RMD AGGREGATION AND AGE REQUIREMENTS OF ROTH AND TRADITIONAL IRA ACCOUNTS

By Sarah Brenner, JD
Director of Retirement Education

Question:

Can an RMD from an inherited IRA be taken out of your own traditional IRA?

Jack

Answer:

Hi Jack,

Aggregation of required minimum distributions (RMDs) can be complicated and we get a lot of questions on this topic. You can aggregate RMDs and take the total amount from one IRA in some cases. For example, if you have more than one of your own IRAs, you can aggregate your RMDs from each and take the full amount from one IRA. However, you cannot aggregate RMDs from IRAs you inherit with RMDs from IRAs that are your own. You cannot take the RMD from the inherited IRA from your own IRA.

Question:

My wife and I are ages 71 and 69 respectively, retired and not working. Are we eligible to contribute to Roth or traditional IRAs?

Answer:

Age is never a barrier when it comes to IRA contributions. However, there is a requirement that you have taxable compensation or earned income to make an IRA contribution. If you and your spouse are both retired and are not working, you will not be able to make an IRA contribution.

https://www.irahelp.com/slottreport/rmd-aggregation-and-age-requirements-roth-and-traditional-ira-accounts

DIRECT TRANSFERS, DIRECT ROLLOVERS, AND 60-DAY ROLLOVERS

By Andy Ives, CFP®, AIF®
IRA Analyst

When moving retirement money from IRA to IRA, or from a workplace retirement plan like a 401(k) to an IRA, there are essentially three methods to relocate those dollars. Two of them are similar, and the third opens all kinds of potential problems. Knowing how to properly move retirement dollars is imperative to produce the desired outcome.

Direct Transfer. A direct transfer is the recommended way to move money from one IRA to another. With a direct transfer, (also called a “trustee-to-trustee” transfer), the funds go directly from one IRA custodian to another. Note that if a check is made payable to the new custodian “for the benefit of” (FBO) the account owner, but received by the IRA owner, that will still qualify as a direct transfer.

Example: John has an IRA with Custodian X. He wants to consolidate his accounts with Custodian Z. John requests a direct transfer of his IRA from Custodian X to Custodian Z. John is a bit of a control freak and wants to make sure the transfer is completed, so he asks for the transfer check be mailed to him. Custodian X issues a check made payable to “Custodian Z FBO John, IRA.” This qualifies as a direct transfer, and John hand-delivers the check to Custodian Z.

Direct transfers are not reportable to the IRS. As such, no 1099-R is created for the transaction. Additionally, if an IRA owner is subject to required minimum distributions (RMDs), the entire account, including the RMD, can be directly transferred. There is no need to take an RMD prior to a direct transfer (although it must still be taken by the normal deadline).

Direct Rollover. When retirement dollars move from a work plan like a 401(k) to an IRA, the best option is the direct rollover. (A “direct transfer” is not available with a plan-to-IRA transaction.) A direct rollover is similar to a direct transfer, but with a couple of differences. Primarily, a direct rollover is reportable to the IRS and will generate a 1099-R showing the distribution. When the direct rollover is received by the IRA custodian, the custodian will produce a 5498 confirming the rollover and eliminating any possible taxes due. In addition, if the plan participant is subject to RMDs, the RMD must be taken before the remaining funds are directly rolled over.

Direct rollovers also avoid mandatory 20% withholding if plan dollars were paid directly to a plan participant. Note that there is no mandatory withholding on IRA-to-IRA transactions.

60-Day Rollover. When an IRA owner or plan participant takes a distribution that is paid directly to him, he has 60 days to redeposit all or part of those dollars into the same or similar account. Funds can move from plan-to-IRA and from IRA-to-IRA via 60-day rollover. However, this type of transaction opens numerous opportunities for error. If the funds are not timely rolled over, they will be taxable (and subject to potential penalty). Such distributions from a plan require 20% withholding, and any RMDs included in the distribution cannot be redeposited. Also, a person is only permitted one IRA-to-IRA 60-day rollover per 365-day period. (Note that non-spouse beneficiaries cannot do a 60-day rollover with inherited accounts. Inherited IRAs and work plan assets must be moved by either direct transfer or direct rollover.)

Be sure to understand these methods before requesting any retirement account transaction.

https://www.irahelp.com/slottreport/direct-transfers-direct-rollovers-and-60-day-rollovers

BENEFICIARY RMD RULES AND 401(K) CONTRIBUTION LIMITS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I have just read as many questions and answers as I could on The Slott Report and am still very confused.  Simply put, I am over 80 years old, and I have had a Roth and a traditional IRA for many years.  My daughter is the sole beneficiary of those IRAs and is in her 50s. Will my daughter have to take an annual RMD from both my Roth and traditional IRA when she inherits, as well as emptying my accounts within the 10-year period?

Hope you can clear up my confusion.  Thanks.

Chris

Answer:

Hi Chris,

This is a confusing area. Your daughter will have to empty both the Roth and traditional IRAs by the end of the tenth year following your year of death. Under the rules issued by the IRS in February, annual RMDs for years 1-9 of that 10-year period are required if a traditional IRA owner dies on or after his “required beginning date” for RMDs. However, a Roth IRA owner is not subject to RMDs, so he is always considered to have died before his required beginning date. You have already reached your required beginning date. This means your daughter will have to take annual RMDs from your traditional IRA in years 1-9, but not from your Roth IRA.

Question:

Someone participates in a 401(k) through his regular employer and has a solo 401(k) for a side job (self-employed). That person maxed out his 401(k) pre-tax deferrals for 2021 through the regular 401(k) and utilized the remaining limit up to $58,000 for a Mega Backdoor Roth contribution via after-tax contributions. Is he eligible for any solo 401(k) contributions for 2021 (not catch-up eligible)? What am I missing here?

Thank you for any input. I love your newsletters and read them all.

Answer:

We appreciate the compliment! We put a lot of work into The Slott Report and the newsletters.

This person couldn’t make any elective deferrals to the solo 401(k). The elective deferral limit, which takes into account only pre-tax elective deferrals and Roth contributions, applies across both plans, and he already maxed out his deferrals in the regular 401(k). But there is another limit, known as the “annual additions limit” or the “section 415 limit,” that takes into account all employee contributions (including after-tax contributions) and employer contributions. That limit applies separately to each plan if the regular employer and the side business aren’t considered related under the tax rules. If the side business is unrelated to the regular employer, this person could make after-tax contributions (not Roth) or employer contributions to the solo 401(k) even though he has maxed out on his annual additions limit in the regular 401(k).

https://www.irahelp.com/slottreport/beneficiary-rmd-rules-and-401k-contribution-limits-today%E2%80%99s-slott-report-mailbag

REPAYING A CRD

By Sarah Brenner, JD
Director of Retirement Education

Back in 2020 when COVID first became our new reality, Congress enacted the CARES Act. The CARES Act allowed qualified individuals who were affected by COVID to take penalty-free distributions from their retirement accounts of up to $100,000. The taxation on these distributions could have been paid in 2020 or spread over three years.

These distributions are called Coronavirus Related Distributions (CRDs) and they were only allowed in 2020. However, CRDs can still be repaid to eligible retirement accounts. Recently, we have received some questions about how repayment of a CRD works. Here is what you should keep in mind if you are considering repaying a CRD.

If you took a CRD, you may repay the withdrawals within three years to a retirement account, tax-free. The three-year period begins on the day after the date the funds were received. You can make one or more repayments during the three years. Repayments cannot exceed the amount that was distributed.

The repayments can be made to any retirement plan to which the original distribution could have been rolled over. Repayment does not have to be made to the account from which the CRD originated. This is an important point to keep in mind because many individuals may no longer have the retirement account from which the CRD came. For example, they may have changed jobs and no longer participate in the plan from which they received the CRD.

The repayment will be considered a direct rollover between a plan and an IRA, and a trustee-to-trustee transfer between IRAs. As such, no taxable event is considered to have occurred when CRDs are repaid, and the once-per-year rollover rule will not apply.

If you recontribute a CRD, you are able to file an amended tax return to recover the taxes paid.

Example: Juan had COVID in 2020 and lost his job. He took a CRD of $100,000 on September 8, 2020, from his 401(k). He elected to pay taxes due on the CRD in 2020 instead of spreading the income over three years. In 2022, Juan has a new job. He decides to repay the CRD to his IRA. He will need to file an amended return to recover the taxes he paid in 2020.

https://www.irahelp.com/slottreport/repaying-crd

SIDESTEPPING THE NEW IRS PRIVATE LETTER RULING FEES

By Ian Berger, JD
IRA Analyst

Like most everything else these days, the price for receiving an IRS private letter ruling (PLR) has recently gone up.

A person will request a PLR to receive the IRS’s blessing that a specific tax transaction won’t violate the tax code or IRS regulations. A PLR is specific to the particular tax situation of the person requesting it. This means that PLRs shouldn’t be relied on by anyone other than that person. Practically, however, other taxpayers with similar circumstances often will rely on a published PLR.

There are three problems with requesting a PLR. First, it often takes the IRS a long time – sometimes nine months or longer – to issue a ruling. By that time, it may be too late for the PLR to provide any meaningful relief. Second, PLRs are expensive. As of July 1, 2022, the filing fee alone for requesting a PLR on IRA matters increased from $10,000 to $12,500. And, an attorney or tax expert will charge thousands of dollars more to do the actual filing for you. Lastly, there’s no guarantee that the IRS will rule in your favor.

So, unless you’re faced with a very large tax matter and have the funds to pay the cost, a PLR probably isn’t a good option. Fortunately, with some common retirement account transactions, there are ways to avoid having to go to the IRS for a PLR.

One way is to make sure your IRA or company plan distribution is moved via a direct rollover or transfer rather than a 60-day rollover. With a 60-day rollover, there is always the risk that the deadline will be missed.

If that happens, the IRS will sometimes forgive the violation, but you must request a PLR to get relief. Since 2016, the IRS has also offered self-certification as a free alternative to a PLR for fixing a late rollover. Self-certification only requires you to provide a letter to the receiving custodian indicating that you missed the 60-day deadline due to one of 12 specified reasons. Those reasons include errors by the custodian, losing a rollover check, postal error or serious illness of you or a family member. But self-certification won’t work if you don’t meet one of those 12 reasons. That’s why we always recommend a direct rollover or transfer instead of a 60-day rollover.

A second way to avoid a PLR is to name a person (rather than a trust or estate) as your IRA beneficiary directly on a beneficiary form. Although there are good reasons to name a trust as IRA beneficiary, oftentimes a trust is named without a legitimate purpose. When a trust or estate is designated, it often becomes necessary to request a PLR to allow a surviving spouse to roll over the account owner’s funds to her own IRA or to allow the funds to be transferred to inherited IRAs set up for non-spouse beneficiaries. The need for a PLR in either situation can be avoided by simply naming the beneficiary directly.

https://www.irahelp.com/slottreport/sidestepping-new-irs-private-letter-ruling-fees

SELF-DIRECTED IRAS AND THE BACKDOOR ROTH: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Is there a required minimum distribution (RMD) on a self-directed IRA?

Answer:

A “self-directed IRA” is nothing more than an IRA that invests in unconventional items that not all custodians will handle – like maybe crypto currency, real estate, or a hard-to-value assets. Otherwise, self-directed IRAs follow the same rules as every other IRA. As such, yes, self-directed IRAs do have RMDs. So, if you own a commercial property or some other illiquid asset in your self-directed IRA, be proactive and ensure you have some way to take the RMD.

Question:

Ed,

I have enjoyed for years your seminars and newsletter. Last year Congress proposed to end the “Backdoor” Roth strategy. My question on this strategy for this year is, do we implement this with our clients or not? Are you aware of any tax proposals that target eliminating the Backdoor Roth? Or does it look like a safe strategy to employ again in 2022?

Thanks,

Thomas

Answer:

Thomas,

The Backdoor Roth strategy for those who earn too much to contribute to a Roth IRA directly is alive and well in 2022. (The strategy involves contributing non-deductible dollars to a traditional IRA and then converting those dollars to a Roth.) While the Build Back Better bill specifically targeted the strategy, the proposed legislation never made it to law. Should any similar legislation be passed in the second half of this year, we don’t think it would be retroactive for 2022. While Congress did tip its hand and show it is considering elimination of the Backdoor Roth, it is still 100% available for 2022.

https://www.irahelp.com/slottreport/self-directed-iras-and-backdoor-roth-todays-slott-report-mailbag

CONDUIT IRA – IS IT REALLY NECESSARY?

By Andy Ives, CFP®, AIF®
IRA Analyst

Conduit IRAs, sometimes called “rollover IRAs,” typically contained only money rolled over from a company plan – and subsequent earnings on those dollars. But a 2001 tax law (Economic Growth and Tax Relief Reconciliation Act of 2001) opened all sorts of rollovers and plan portability. So, for the most part, a person could commingle his IRA contributions and rollovers from plans in the same IRA. The result was that, beginning in 2002, conduit IRAs were no longer necessary for most people rolling over plan funds. Yes, conduit IRAs were still necessary for anyone looking to preserve the extremely rare tax break for 10-year averaging, but essentially, conduit IRAs became superfluous.

Nevertheless, people continue to think that a conduit IRA will somehow allow them to dance around certain tax rules or save them when it comes to bankruptcy. Here are a handful of reasons why a conduit IRA is nothing more than an extra statement in the mail, and a couple of reasons why a conduit IRA could still provide some value.

Bankruptcy Protection. ERISA plans – like most 401(k)s – maintain unlimited bankruptcy protection. If you have $10 million in your 401(k) and file for bankruptcy, those plan assets are unavailable to your creditors. If you were to roll over those plan dollars to an IRA, the $10 million would maintain unlimited bankruptcy protection.

An IRA, on the other hand, has only an inflation adjusted cap of bankruptcy protection. This cap currently sits at $1,512,350 and covers your IRA contributions and earnings. Anything over this contributory cap could become available to your bankruptcy creditors. So, should you keep your $10 million rolled over from your 401(k) in a separate IRA – away from your contributory IRA dollars? Not necessary. Commingling is allowed and will not impact the unlimited bankruptcy protection you still have on the former plan dollars. Those former plan dollars remain fully protected, and the $1,512,350 cap is still fully available for your contributory dollars.

After-Tax IRA Dollars/Basis. The Backdoor Roth strategy is alive and well. You can make after-tax (non-deductible) contributions to an IRA and then convert those dollars tax-free to a Roth IRA. However, the pro-rata rule applies. If you have any IRA (or SEP or SIMPLE) with pre-tax dollars, you cannot cherry-pick the after-tax dollars and only covert those. A separate IRA – possibly a conduit IRA where you rolled over your after-tax dollars from a former 401(k) – will not help. Segregating the after-tax from the pre-tax dollars in a different IRA has no bearing on pro-rata, so you might as well commingle.

Reverse Rollovers. Occasionally, employees will leave a job, roll over former plan dollars to an IRA, and then want to roll over those former plan dollars to a new plan at their new job. There is no rule that dictates former plan dollars must be segregated into their own conduit IRA before being rolled back to a new plan. Commingling is perfectly acceptable under the tax code. Now, a specific plan document could have some strange language that dictates that it will only accept former plan dollars via a reverse rollover. In such a case a conduit IRA would be necessary, but this is rare. Additionally, a conduit IRA could help – from an administrative standpoint – so an IRA owner can keep his accounts straight. Regardless, before opening that conduit IRA, ask yourself – is it really necessary?

https://www.irahelp.com/slottreport/conduit-ira-%E2%80%93-it-really-necessary

4 QCD RULES THAT MAY SURPRISE YOU

By Sarah Brenner, JD
Director of Retirement Education

A Qualified Charitable Distribution (QCD) is a way for you to move funds out of your IRA to a qualifying charity income-tax free. If you are thinking this might be a good strategy for you, here are 4 QCD rules that may surprise you.

1. You must be age 70 ½ or older.

IRA owners who are age 70½ and over are eligible to do a QCD. Sounds easy, right? This is more complicated than it might sound. A QCD is only allowed if the distribution is made on or after the date the you actually attain age 70 ½. It is not enough that you will attain that age later in the year.

QCDs are not limited to IRA owners. If you are an IRA beneficiary, you may also do a QCD. All the same rules apply, including the requirement that you must be age 70 ½ or older at the time the QCD is done.

2. Not all retirement accounts funds are available for QCDs

You may take a QCD from your traditional IRAs or your Roth IRA. QCDs are also permitted from SEP and SIMPLE IRAs that are not ongoing. A SEP and SIMPLE plan is ongoing if an employer contribution is made for the plan year ending with or within the calendar year in which the charitable contributions would be made. You may not take a QCDs from your employer plan.

QCDs apply only to taxable amounts. You may not transfer your basis (nondeductible IRA contributions or after-tax rollover funds) to charity as a QCD. QCDs are an exception to the pro-rata rule which usually applies to IRA distributions.

3. There is an annual limit.

QCDs are capped at $100,000 per person, per year. If you are married, you and your spouse can each contribute up to $100,000 from your own IRAs.

If you withdraw more than $100,000 from your IRA to contribute to a charity, you may not carry over the excess to a future year. You can do a QCD with the first $100,000 of the distribution and the remaining amount will be treated as a taxable distribution. You can take a charitable deduction for the amount over $100,000, if you itemize deductions and otherwise qualify for the deduction.

4. A QCD must be done as a direct transfer.

If you want to do a QCD, you must make a direct IRA transfer from the IRA to the charity. You should instruct the IRA custodian to make the distribution check payable to the charity of your choice. If a check that is payable to a charity is sent to you for delivery to the charity, it will be treated as a direct payment. Be careful! If you receive a check payable to you from your IRA and then later give those funds to charity, that is not considered a QCD.

https://www.irahelp.com/slottreport/4-qcd-rules-may-surprise-you

SENATE COMMITTEES TAKE UP RETIREMENT SAVINGS PROPOSALS

By Ian Berger, JD
IRA Analyst

Proposals to boost IRA and workplace plan savings are advancing, but they are not law yet. Several actions must occur before the proposals become law.

On March 29, the House passed the “Securing a Strong Retirement Act of 2022.” Now, two different Senate committees are taking up the subject. On June 14, a Senate committee (Health, Education, Labor and Pensions) unanimously approved the “Retirement Improvement and Savings Enhancement to Supplement Health Investments for the Nest Egg Act” (the RISE & SHINE Act). The RISE & SHINE Act deals with company plans only.

Today (June 22), a separate Senate committee – the Senate Finance Committee – is taking up its own bill, called the “Enhancing American Retirement Now Act” (EARN Act). The EARN Act deals with both IRAs and company plans. It is similar to, but not the same as, the House-passed bill.

The Senate Finance Committee is expected to pass the EARN Act. If that happens, the EARN Act and the RISE & SHINE Act will likely be combined into one Senate bill. The combined bill will then be taken up by the full Senate. If passed by the full Senate, the Senate bill will have to be reconciled with the House bill and approved by both houses of Congress before being sent to the President.

These bills are often referred to as “SECURE 2.0” because they expand on the original SECURE Act from December 2019.

Here’s how the House-passed bill and the Senate EARN bill compare on several key changes:

  • Both bills would increase the age that traditional IRA required minimum distributions (RMDs) must start. Currently, the first RMD year is age 72. The House bill would delay the first RMD year to age 73 beginning in 2023, 74 in 2030 and 75 in 2033. The Senate EARN bill would change the first RMD year to age 75 without interim changes to ages 73 and 74. However, the change to age 75 would not be effective until 2032.
  • Both bills would allow higher catch-up contributions to company plans. The current catch-up limit for those age 50 or older is $6,500. Both bills would increase that limit to $10,000 beginning in 2024. The House bill would apply that limit only to those who are age 62, 63 or 64, but the Senate bill would apply it to those who are 60, 61, 62 or 63.
  • For IRAs, the current catch-up limit is frozen at $1,000. Both bills would allow that limit to increase based on the cost-of-living. The House bill would be effective in 2024; the Senate bill would be effective in the year following the year the bill is signed into law.
  • Both bills require that any plan catch up-contributions for those over age 50 would have to be made as Roth contributions beginning in 2023 (the House bill) or 2024 (the Senate bill). In addition, plans could allow employees to have employer matching contributions made as Roth contributions. (Currently, employer contributions are made pre-tax.) The House bill is effective after the date the bill is signed into law, while the Senate bill is effective in 2024. These changes are designed to help pay for other provisions of the bills.
  • In both bills, the limit on “qualified charitable distributions,” which are tax-free direct transfers from traditional IRAs to charities, would be indexed for inflation. That limit is currently $100,000 per person, per year. This provision would be effective in the year the bill is signed into law under the House bill, or the year after the bill is signed into law under the Senate bill.
  • Employers would be allowed to make matching contributions to company savings plans and SIMPLE IRAs on student loan payments beginning in 2023 under the House bill or 2024 under the Senate bill.
  • In both bills, the “Saver’s Credit,” a federal tax credit for mid- and low-income taxpayers who contribute to an IRA or company plan, would be expanded but not until 2027.
  • Both bills create a new exception to the 10% early distribution penalty for IRA and plan withdrawals by victims of domestic abuse. This would be effective immediately after the provision becomes law. The Senate bill (but not the House bill) would create another exception to the 10% penalty for emergency withdrawals beginning in 2024.

We will keep you informed on the progress of these proposals.

https://www.irahelp.com/slottreport/senate-committees-take-retirement-savings-proposals

INHERITED IRAS AND RMDS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Dear Sirs:

I inherited a regular IRA upon my mother’s death in 2015. I am now 75 years old and have been taking required distributions since then. She was taking distributions herself when she died.

My question is: may I close out this IRA now by taking out the entire balance and paying taxes on it? Thanks.

Patrick

Answer:

Hi Patrick,

You inherited your mother’s IRA prior to the SECURE Act so you can stretch RMDs from this account over your life expectancy by taking required minimum distributions (RMDs) each year. However, these distributions are only the minimum that needs to be taken out to avoid penalties. You can always take more. If you want to withdraw the entire balance and pay taxes on it this year, there is nothing that prevents this.

Question:

Does the unexpected position of the IRS in the new regulations that non-spouse beneficiaries must take RMDs rather than waiting until the end of the 10-year period to empty the account also apply to an inherited Roth IRA?

Thanks.

Answer:

In the recently released proposed regulations, the IRS took the surprising position that when an IRA owner dies after their required beginning date, annual required minimum distributions (RMDs) are required during the 10-year payout period under the SECURE Act. This rule does not affect Roth IRA beneficiaries who are subject to the 10-year rule because there is no required beginning date for Roth IRA owners. Roth IRA owners do not have to take RMDs during their lifetime, so they are always considered to have died before their required beginning date.

https://www.irahelp.com/slottreport/inherited-iras-and-rmds-todays-slott-report-mailbag-1

SHOULD I ACCEPT A LUMP SUM BUYOUT OFFER?

By Ian Berger, JD
Director of Retirement Education

Should I Accept a Lump Sum Buyout Offer?

With economic uncertainty increasing, more companies with defined benefit (DB) pension plans will likely attempt to improve their bottom line by offering lump sum buyouts. A lump sum buyout is a limited opportunity for DB plan participants to elect a one-time cash payment in exchange for giving up future periodic payments. Some buyouts are offered to participants who are near retirement age, while others target those already receiving benefits.

Deciding whether to accept a lump sum buyout is an important choice that you shouldn’t make without consulting with a knowledgeable financial advisor. Here are several factors you and your advisor should be looking at:

What is the effect of interest rates?

The lump sum amount is calculated by taking into account several factors, including an assumption about interest rates. The lower the interest rate assumption, the higher the lump sum. With interest rates rising fast, this may be a good time to seriously consider locking in a lump sum, instead of waiting for a later buyout window to open when rates may be even higher.

How is your health?

The amount of the lump sum is also based on average life expectancies. If you expect to live longer than an average person of your age, you may want to consider passing up the lump sum. However, if you are facing medical issues, taking the buyout offer may be the way to go.

How financially secure is your employer and your plan?

If your employer goes out of business with a pension plan that doesn’t have enough funds to pay benefits, your existing or future payments could be reduced. That would be a factor favoring a buyout. The Pension Benefit Guaranty Corporation (PBGC) does insure pension benefits up to a certain amount. However, even though the PBGC’s financial picture has improved somewhat, it might be risky to count on that lifeline.

Will your spouse agree?

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

How tempting will a lump sum be?

Be honest with yourself. You may be the type of person who wouldn’t be able to resist spending a large check instead of putting it away for retirement. If you are, taking a lump sum now may jeopardize your financial well-being in later years.

Know the tax rules

DB monthly payments are typically fully taxable in the year received, and you can’t roll them over. But a lump sum payment is eligible for rollover to an IRA. Once rolled over, your funds become subject to required minimum distribution (RMD) rules. But aside from that, you have lots of flexibility with IRA withdrawals.

These are some of the important issues 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-accept-lump-sum-buyout-offer

IRA BASIS AND ROTH CONVERSIONS IN AN RMD YEAR: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I am 66 and would like to convert one of my IRAs to a Roth, but I am not sure if any of my old IRA accounts have any after-tax contributions. I have no records, so I assume they are all pre-tax but I am not sure. If I convert and pay taxes, does the IRS contact me regarding after-tax contributions if I ever made them?

Thanks

Mary

Answer:

Hi Mary,

Unfortunately, the IRS will not tell you whether you have any basis on account of making after-tax contributions. Instead, it’s solely up to you to establish that. You indicate that you have no records, but we suggest double-checking to see if you have copies of Form 8606 you may have filed with the IRS to claim basis. Also, you may be able to track down Form 5498 (issued by the IRA custodian to show account contributions) and then match up prior tax returns to see if you took a deduction for the IRA contribution reported on the form. If you can’t prove you have basis, you’ll have to treat all of your IRAs as pre-tax.

Question:

Hello,

We have a client with an RMD of $100,000. We also believe they should do a Roth conversion of $200,000. If they are looking to execute their Roth conversion now while their portfolio is down, can they execute the $200,000 Roth conversion today, then wait to take their RMD of $100,000 in December of this year?

Thanks!

Best Regards,

Josh

Answer:

Hi Josh,

Sorry, that won’t work. When an RMD is due in a particular year, the first dollars distributed from an IRA in that year are treated as the RMD, and RMDs can’t be rolled over. When a person does a conversion, it’s considered both a distribution and a rollover. So, the RMD must be satisfied first. After that, any amount over and above the RMD can then be converted.

https://www.irahelp.com/slottreport/ira-basis-and-roth-conversions-rmd-year-today%E2%80%99s-slott-report-mailbag

DEATH OF A SPOUSE, DEATH OF DAD

By Andy Ives, CFP®, AIF®
IRA Analyst

Over the past couple of months I have been tasked with the unfortunate responsibility of helping my mother sort through her financial affairs after the death of her spouse. My dad passed in March, and it has been a steady stream of questions, conference calls with her financial advisor and one important decision after another. Of course, this doesn’t even scratch the surface of the emotional stress and strain on the family.

Thankfully, my parents were prepared. Wills were drafted years ago and recently reviewed with their attorney – a meeting I sat in on. Beneficiary forms were current. Long-term care policies were in place. Decisions had been made a decade earlier about cremation and even what vessel my dad’s ashes would be placed in. Yet despite all this planning, despite their son being a CFP® with 25 years of experience in the financial services industry, it was still a slog.

I explained to my mom how a spousal rollover worked with the IRA accounts. I inquired with the financial advisor about life insurance policies. Other issues included things like: Were my mom’s investment accounts allocated properly? How does Social Security work after the death of a spouse? What items were covered by Medicaid and the long-term care policy? What about my dad’s pension? Joint checking accounts? The final joint tax return? On and on and on.

We are at the three-month anniversary of my dad’s passing, and we are in good shape financially. But we have a village of helpers, a tight-knit family, and broad skillsets that collaborated to coordinate the details. Not everyone has such a safety net…

About a month after my dad died, my teenage son and I went to the local bank to open a checking/savings account for him. He needed a debit card and direct deposit account for his new lifeguard job. As we sat in the little cubicle with the banker clicking away on her computer, I spotted an elderly woman clutching a handful of papers. I watched her sit down with another banker at a neighboring cubicle, and I could hear their conversation over the wall. Her first words were, “My husband died a few months ago, and I don’t know what to do.”

The banker began a series of probing questions, but I could not help but feel a sense of dismay for the widow. She was alone with, apparently, little guidance. How in the world could anyone manage such a daunting task by themselves? And if you have no close friends, relatives or advocates to lean on, I cannot fathom the sickening feeling of helplessness.

I mentioned what I had overheard to the lady who was assisting me and my son. She said it is amazing how many people come into the bank after the death of a spouse who have never written a check, who have never done any planning, who have no idea where to turn. I thought of my mom’s situation and, while almost everything was in order, we still had a gauntlet to run.

What does this lead me to? Please, for the sake of your beneficiaries, get your financial affairs in order. It is never too early to start, and it is the responsible thing to do. Also, make an effort to learn the basics of banking, investing, and financial services in general. And be sure to work with trusted and knowledgeable financial and tax advisors. Even a CFP® like me appreciated the professional handholding while my world was trembling.

https://www.irahelp.com/slottreport/death-spouse-death-dad

TOO OLD TO CONVERT? THINK AGAIN

By Sarah Brenner
Director of Retirement Education

You may have heard how converting to a Roth IRA is a great move for younger people. This is no surprise. A younger person who converts has two big factors working in her favor. She may pay taxes on a smaller IRA balance, and she has many years to accrue tax-free earnings in her Roth IRA. But what about older people? It is a mistake to write off conversion just due to age. Older individuals should not overlook the potential tax benefits of converting later in life.

Converting Your Traditional IRA

When you convert your traditional IRA to a Roth IRA, your pre-tax traditional IRA funds will be included in your income in the year of the conversion. This will increase your income for the year of the conversion. That may, in turn, 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 to you. Not a bad deal!

Three Questions to Ask

Thinking conversion may be the right move for you? No matter how young or old you are, you should ask yourself three questions. First, when will you need the money? Do you need your IRA money immediately for living expenses? If so converting may not be for you. Second, what is your tax rate? If you are retired and your income is lower, that may favor conversion. The third question to ask yourself is whether you have the money to pay the tax on the conversion. It is best to pay the conversion tax from non-IRA funds.

Distributions from your Roth IRA

After you convert, your converted funds can always be distributed from your Roth IRA both tax-and penalty-free if you are over age 59 1/2. However, no matter what your age, you must wait five tax years from the year of your first Roth IRA conversion or contribution to any Roth IRA for a distribution of earnings from any Roth IRA to be tax-free. The good news is that earnings are considered the last funds distributed from your Roth IRA(s) and will never be subject to the 10% early distribution penalty if you are over age 59 ½.

Another plus of converting is the fact that you are not required to take required minimum distributions (RMDs) from your Roth IRA. If you convert your traditional IRA to a Roth IRA, you must take any RMD before converting. However, you will not have to take any more RMDs during your lifetime from your Roth IRA. For those with large IRAs and large RMDs, this could be a big tax savings.

Roth IRA Estate Planning Advantages

A Roth IRA can be a great estate planning tool. You may be thinking that converting is not for you because you don’t want to pay the tax. Don’t forget the big picture. In the short run there will be a tax, but in the long run, your beneficiaries will get the Roth IRA completely tax-free in most cases. Plus, because RMDs are not required during your lifetime, your Roth IRA can sit there growing tax-free for your beneficiaries who will inherit more because of this extra growth.

Roth IRA distributions to your beneficiaries are generally income tax-free, in contrast to traditional IRA distributions to beneficiaries, which are generally taxable. If your beneficiary takes a distribution from the inherited Roth IRA after five tax years from the year of your first Roth IRA conversion or contribution to any Roth IRA, the distribution will be completely income tax and penalty-free.

Should You Convert?

Should every older person with a traditional IRA convert? No, of course not. Conversion is not the best course of action for everyone. However, it should not automatically be off the table for older individuals. Age is just a number. Don’t let it prevent you from exploring if you could benefit from this valuable strategy. Are you a good candidate? The best way to find out is to discuss your situation with a knowledgeable financial or tax advisor.

https://www.irahelp.com/slottreport/too-old-convert-think-again

THE 5-YEAR RULE AND MULTIPLE BENEFICIARIES: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi Ed,

I’m 66 Years old. Less than a year ago I converted into my Roth from my traditional IRA with the intention of parking it there until I could finalize the details of a summer house purchase. I know I have taxes to pay on the conversion. However, now that I wish to use the money and remove it from the Roth, am I going to be subject to a penalty due to a 5-year rule? I was of the understanding that only “earnings” (which for me meant any money earned ON the money I had deposited into the Roth) had to stay in the Roth for 5 years. Does the 5-year rule actually apply to ALL the money I put into the Roth via conversion from the traditional IRA? I have spoken to a few different advisors and have gotten conflicting responses, so I’ve decided to go to the IRA Guru for an accurate, reliable answer.

Thanks Ed!

Sincerely,

Tom

Answer:

Tom,

Since you are over age 59 ½, you couldn’t get a 10% penalty on your IRA even if you wanted one. A person always has access to their Roth IRA contributions tax- and penalty-free, but since you are over age 59 ½, you also have immediate access to all of your Roth IRA conversion dollars tax- and penalty-free. Even if you tapped the earnings, there would not be a penalty. And if you had any Roth IRA for 5 years, those earnings would also be tax-free. If your Roth conversion less than a year ago was your first entry into a Roth IRA, you would have to wait 5 years for the earnings to be tax-free, but the 10% penalty is permanently off the table for you.

Question:

My question relates to multiple types of IRA beneficiaries. If we split the beneficiary designation between a person and a charity, would the person then be subject to the same payout rules as the charity? My understanding is a charity may be required to distribute the IRA within 5 years after the death of the IRA owner. If the other beneficiary is a person, would they also now be subject to the 5-year payout?

Brandon

Answer:

Brandon,

If the beneficiary designation on an IRA is split between a living person and a charity, regardless of the percentage split, the person could potentially be stuck with a shortened payout structure after the death of the IRA owner. However, this would only happen if there was a delay in processing the post-death accounts. After death, you have until December 31 of the year after death to split the account into inherited IRAs or, in this case, to cash out the charity. As long as the charity is timely cashed out after death and the remaining beneficiaries have individual inherited IRAs set up for them before the deadline, they will not be negatively impacted and can follow the payout rules applicable to living people.

https://www.irahelp.com/slottreport/5-year-rule-and-multiple-beneficiaries-todays-slott-report-mailbag

72(T) DON’TS

By Andy Ives, CFP®, AIF®
IRA Analyst

The 72(t) rules (”series of substantially equal periodic payments”) allow a person to tap retirement dollars before 59½ without a 10% early distribution penalty. However, to gain this early access, you must commit to a plan of withdrawals according to the strict guidelines set forth in the Tax Code. For example, some basic requirements dictate that:

  • 72(t) payments can begin from an IRA at any age, even if you are still working.
  • 72(t) payments from a company retirement plan are permitted only if the person has terminated employment with that company.
  • Must continue for at least five years or until age 59½, whichever period is longer.
  • Must be distributed at least annually.

If you get sideways with the rules, a 10% penalty will apply retroactively to all distributions taken before age 59 ½, sometimes referred to as the “recapture penalty.” To avoid this retroactive penalty, here are a handful of important “72(t) Don’ts” to consider:

Don’t roll new money into the IRA account with the 72(t), and don’t make any contributions to that IRA. Both actions will be deemed as a modification of the account and will trigger the recapture penalty. Think of the IRA with the 72(t) as a fragile antique bowl filled to the rim with a volatile and explosive liquid. Those who start a 72(t) must carry this delicate bowl with them until the 72(t) term expires. Handle it with extreme caution!

Don’t think you can withdraw more than what the 72(t) payment structure allows. Sure, the IRS would get their taxes quicker if you took larger distribution, but this is a deviation from the 72(t) term and will be a modification.

Don’t handcuff all your IRA money. If the desired annual payout can be achieved with a lower starting IRA value, it is highly recommended that you split the IRA. The strict 72(t) rules (the “handcuffs”) will only apply to the IRA being annuitized. The IRA without the 72(t) can still be used for contributions, Roth conversions, rollovers, additional withdrawals, etc.

Don’t alter the payment formula – stick to the script. While there is a one-time change allowed from the amortization and annuitization methods to the RMD method, be careful. Do not slosh the volatile 72(t) liquid around too much in the antique bowl.

Don’t stop the payments. Unless you die or become disabled, stopping the payments is a modification and will activate the recapture penalty.

Don’t shortchange yourself with a low interest rate. The IRS recently permitted the use of 5% for new 72(t) calculations if applicable rates are lower. However, in a rising interest rate environment, it is imperative to be aware of current rates so as to maximize new 72(t) schedules.

Don’t get loose with the 72(t) rules. Carry that fragile bowl carefully. Do not spill a drop of the volatile liquid. Any misstep or modification will trigger the recapture penalty…and the 72(t) will explode.

https://www.irahelp.com/slottreport/72t-don%E2%80%99ts

INHERITED IRAS AND QUALIFIED CHARITABLE DISTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner
Director of Retirement Education

Question:

Ed,

My mother passed away in May 2019, and I inherited her IRA.  She had not completed her RMD for 2019, so I did that. In 2020, I began my RMDs based on the Single Life Table for Inherited IRAs.

Since I inherited prior to January 1, 2020, does anything in the SECURE Act apply to my inherited IRA? Will I be able to continue the RMDs per the Table or will I need to make sure I empty it completely within 10 years of when I inherited it?

Thank you,

Dale

Answer:

Hi Dale,

Your inherited IRA is grandfathered because your mother passed away before the SECURE Act was effective. You can continue stretching RMDs over your life expectancy. However, any successor beneficiary that you name on the inherited IRA would be subject to the SECURE Act. Your successor beneficiary could not continue the stretch. The successor would instead be subject to the 10-year rule and would need to empty the account within 10 years of your death.

Question:

Hi,

My 72nd  birthday is 9/17/2022, and I would like to do a qualified charitable distribution (QCD) before that date to offset either all or most of my first RMD amount for the year. Do I need to wait until that date or later to do the QCD, or can I do the QCD earlier in the year before I turn 72?

Thanks

Answer:

The rules for qualified charitable distributions are confusing. When the age to start taking required minimum distributions was raised from 70 ½ to 72, the age requirement for a QCD remained at age 70 ½. The rules require you to actually be 70 ½ at the time the QCD is done. You cannot reach that age later in the year. Since you are already past age 70 ½, you are eligible for a QCD right now.

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

WHEN THE FIVE-YEAR RULE APPLIES

By Sarah Brenner
Director of Retirement Education

If you inherit an IRA, especially if it is a larger one, you may be afraid of being stuck with the five-year distribution rule. If this rule applies, your IRA must be entirely emptied in five years, which can be a serious tax hit.

Under the tax rules, if you are named as the beneficiary on the IRA beneficiary designation form, you will not be subject to the five-year rule. Instead, you will most likely be looking at a 10-year payout under the SECURE Act. If you qualify as an eligible designated beneficiary, you can even still stretch payments from the inherited IRA over your life expectancy. Eligible designated beneficiaries include spouses, disabled and chronically ill individuals, minor children of the IRA owner who are under age 21, and individuals who are not more than 10 years younger than the deceased IRA owner.

So, what are those rare times when the five-year rule does apply? Well, this can happen if you inherit IRA funds through an estate (as opposed to if you were named directly on the beneficiary designation form). If an estate is the beneficiary, there is no designated beneficiary. If the IRA owner dies before the required beginning date with his estate as beneficiary, that is the time under the tax rules when you will be stuck with the five-year rule. If the IRA owner dies on or after their required beginning date, you escape the five-year rule and can take distributions over the remaining life expectancy of the deceased IRA owner. Here is where the rules can be tricky. All Roth IRA owners are considered to have died before their required beginning date because required minimum distributions do not apply to Roth IRAs during the original owner’s lifetime. That means whenever you inherit a Roth IRA through an estate you will be hit with the five-year rule.

Example: Joseph, age 82, dies in 2022. His Roth IRA beneficiary is his estate. His daughter Missy is a beneficiary of the estate. Because the estate was the named beneficiary and not Missy, the inherited Roth IRA must be distributed in five years. If Missy had been named on the beneficiary form, she could have had 10 years to empty the inherited IRA.

It is important to keep in mind that while most IRA documents do not limit the options to a beneficiary that are otherwise available under tax law, a few do. It is possible that your inherited IRA might include language that would limit you to the five-year rule. In these cases, it is your IRA document and not the tax rules that is leaving you stuck with the five-year rule.

Professional Advice

The rules can be complex. When you inherit an IRA, be sure that everything is done the right way. To minimize the risk of unnecessary taxes and penalties, your best bet is to seek advice from a knowledgeable tax advisor.

https://www.irahelp.com/slottreport/when-five-year-rule-applies

ANNUITY ILLUSTRATIONS ARE COMING SOON TO YOUR 401(K) STATEMENT

By Ian Berger, JD
IRA Analyst

Those of you who participate in 401(k) plans or certain 403(b) plans should see something new on your next quarterly statement for the period ending June 30, 2022.

For the first time, the statements must include illustrations of the monthly payments you would receive if your current plan account balance was used to purchase an annuity. This new requirement is part of the SECURE Act passed by Congress in December 2019. Congress intended that employees will see the illustrations and realize that their lump sum account balance may not produce high enough monthly income to last their lifetime. This, in turn, will persuade workers to increase their retirement plan savings rate.

The illustrations are required for ERISA-covered 401(k) and 403(b) plans. Most 401(k) plans are covered by ERISA. Notable exceptions are the Thrift Savings Plan (for federal workers and the military) and solo 401(k)s. 403(b) plans offered by not-for-profit companies (such as hospitals) are also covered by ERISA if the company makes contributions to the plan.

The statement must show two kinds of annuity – a single life annuity (payments over your lifetime only) and a joint and survivor annuity (payments over the joint life expectancy of you and a hypothetical spouse with the same age). The illustrations on each statement will use your account balance as of the statement date. If you’re under age 67, the examples assume annuity payments will start at age 67; if you’re over age 67, it’s assumed payments will start right away. The illustrations do not assume that you will have any future contributions between your actual age and age 67. For that reason, if you’re much younger than age 67, the examples may seriously underestimate the annuity value of your 401(k) savings. The new illustrations also will not take into account Social Security benefits.

The Labor Department requires that the narrative explaining the illustrations be “written in a manner calculated to be understood by the average plan participant.” The DOL has produced model language that plans can use to satisfy this requirement. Some critics of the new requirement believe that the model language is too complicated for an “average” employee to understand and even those employees who read their account statements will simply gloss over the new illustrations.

https://www.irahelp.com/slottreport/annuity-illustrations-are-coming-soon-your-401k-statement

HOW THE SECURE ACT RMD RULES AND THE 5-YEAR HOLDING PERIOD WORK FOR INHERITED IRAS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Good Day,

I have a client (age 65) who inherited a traditional IRA from her mother in 2020. I know that she must empty the account by 12/31/30. She is not an eligible designated beneficiary (EDB). I’m trying to calculate the 2022 RMD. I have used several online calculators, and none calculates an RMD amount. They all say that no distributions are required as long as she withdraws the full amount by the end of the 10th year after death. How can I calculate the correct 2022 RMD amount? Thanks.

Sue

Answer:

Hi Sue,

Since the mother died in 2020 after reaching her RMD required beginning date, the daughter is required to take annual RMDs during the 10-year period under IRS regulations issued in February. That 10-year period began in 2021. However, the new regulations just made us aware of the need to take RMDs within the 10-year period in this situation. So, it’s not clear whether a 2021 RMD will be required. We are hoping the IRS will issue guidance on this issue later this year.

If required, the 2021 RMD would be the 12/31/20 account balance divided by 21.8 — the RMD factor for a 64-year old under the old IRS Single Life Expectancy Table. (We use age 64 because your client is 65 this year, but the RMD starting point was last year.) The 2022 RMD is based on the 12/31/21 account balance divided by the 2022 RMD factor. Since a new IRS Single Life Expectancy Table became effective in 2022, the 2022 RMD factor must be reset. We start with 23.7, the factor for a 64-year old under the new table, and then subtract one to get a 22.7 2022 RMD factor. Subtracting one from the preceding year’s factor will continue for years 3 – 9. For more details, check out the January 3, 2022 Slott Report.

Question:

Hello,

I have a question about the application of the 5-year rule for Roth IRA accounts and inherited Roth IRA accounts.

Scenario: An 80 year-old client converts $1,000,000 from a traditional IRA to a Roth IRA and pays the associated taxes. The client did not have a Roth IRA in place before making this first conversion in 2022. The client dies 6 months later, and the $1,000,000 is split into separate inherited Roth IRAs for the son and daughter as named beneficiaries of the account.

Questions:

1) Are the son and daughter able to take money from the inherited Roth IRA tax free despite the fact that the original owner did not establish the Roth more than 5 years ago?

2) If the answer to Question 1 is “no,” can they wait to distribute any withdrawal until after the 5-year window passes to avoid any taxation?

Any help is appreciated.

David

Answer:

Dear David,

1) Yes, the son and daughter can take tax-free money from the inherited Roth IRA immediately, but only up to the amount converted by the parent. Based on Roth IRA distribution ordering rules, contributions come out first, then conversion dollars, then earnings. The children can receive the converted dollars tax-free (since the parent already paid the tax on those dollars). However, they will have to wait until a 5-year holding period is satisfied before any earnings would be available tax-free. That holding period began on January 1, 2022. Therefore, the earnings will become available tax-free on January 1, 2027.

2) Yes, they can wait to distribute any withdrawals until after the 5-year window. This is because they are not required to take RMDs during the 10-year payout period. Since the parent had a Roth IRA, the parent is considered to have died before the RMD required beginning date. All that is required of the children is that they take out their entire inherited Roth IRA shares by December 31, 2032.

 

https://www.irahelp.com/slottreport/how-secure-act-rmd-rules-and-5-year-holding-period-work-inherited-iras-today%E2%80%99s-slott

ONE ROTH IRA BUCKET

By Andy Ives, CFP®, AIF®
IRA Analyst

SCENARIO: John owns multiple Roth IRAs. He believes it is necessary to maintain all these accounts to keep things properly organized and to track his 5-year conversion clocks. He has contributed to Roth IRA #1 for over a decade. He did a partial Roth conversion from a traditional IRA many years ago (to Roth IRA #2). Since that first conversion, John did two more conversions. These are Roth IRAs #3 and #4. Finally, John recently rolled over his 401(k) plan. The pre-tax dollars went into another traditional IRA (Traditional IRA #2), and the Roth 401(k) dollars went to Roth IRA #5. A summary of John’s IRA accounts looks like this:

 

  • Traditional IRA #1 – Used to make partial Roth conversions
  • Traditional IRA #2 – Includes only pre-tax rollover dollars from John’s 401(k)
  • Roth IRA #1 – Contributions and earnings
  • Roth IRA #2 – Created by the first traditional-to-Roth IRA conversion
  • Roth IRA #3 – Created by the second traditional-to-Roth IRA conversion
  • Roth IRA #4 – Created by the third traditional-to-Roth IRA conversion
  • Roth IRA #5 – Rollover Roth dollars from the 401(k)

 

What does the IRS see when it looks at all of John’s IRA accounts?

  • 1 bucket of Traditional IRA dollars
  • 1 bucket of Roth IRA dollars

But how does the IRS keep things straight? How do they know what is Roth contributions, what is conversions, and what is earnings? Tax forms. Form 1099-R and 5498 tell all. Through these tax forms, the IRS knows what went down, which means they know what’s up.

If John takes a distribution from ANY of his Roth IRAs, what will that distribution consist of? Based on strict ordering rules, the first dollars out will be contributions, then conversions, then earnings. Even if John does another conversion today (generating Roth IRA #6) and then takes a small distribution from that same account tomorrow, it will be considered a withdrawal of contributions.

But how is that possible? Once again, the IRS does not care how many Roth IRAs you maintain. They see only one bucket of Roth IRA dollars under your name, and that bucket is clearly separated into contributions, conversions, and earnings.

Assume John contributed a total of $50,000 to Roth IRA #1 over many years. This means that every year the custodian would generate a 5498 and report to the IRS in Box 10 – “Roth IRA Contributions.” The IRS adds up all those 5498’s and, logically, anything above $50,000 is earnings. What if John then did a total of $200,000 in Roth conversion? Those conversions would also be reported on a 5498, Box 3 – “Roth IRA conversion amount.” Additionally, each annual 5498 is essentially time stamped to track the 5-year clocks. Now, all within the same bucket of Roth IRA dollars, the IRS sees $50,000 of Roth contributions, $200,000 of Roth conversions, and when those transactions were completed. Anything above that is earnings.

One Roth IRA bucket. Clearly defined. Strict ordering rules. No need to maintain separate Roth IRA accounts like John if you don’t want to. The IRS sees all.

https://www.irahelp.com/slottreport/one-roth-ira-bucket

5 WAYS AN EXCESS IRA CONTRIBUTION CAN HAPPEN

By Sarah Brenner, JD
Director of Retirement Education

You can have too much of a good thing. While saving for retirement with an IRA is a good strategy, there are limits.  When a contribution is not permitted in an IRA, it is an excess contribution and needs to be fixed. Here are 5 ways an excess IRA contribution can happen to you:

1. Exceeding the Annual IRA Contribution Limit

You will have an excess IRA contribution if you contribute more than the annual limit to an IRA for the year. For 2022, the limit is $6,000 for those under age 50 and $7,000 for those who are age 50 or over.  This may seem like an easy rule to follow. You may wonder who is going around contributing tens of thousands of dollars to IRAs in violation of the contribution limits, especially since most IRA custodians will not accept contributions over the yearly limit. However, an individual with multiple IRAs with different custodians could exceed the limit by contributing to each of them.

2. Not Enough Earned Income

A more common occurrence is an IRA owner not having sufficient earned income or taxable compensation to fund an IRA contribution for the year. While you can use a spouse’s taxable compensation to fund your IRA, you may not use many other different income sources including Social Security, pension, rental, and investment income. You may have a high income, but not be eligible to fund an IRA. If you go ahead anyway, the result is an excess IRA contribution.

3. Too Much Income for a Roth IRA Contribution

A common cause of excess Roth IRA contributions is contributing in a year when income is too high. If your income fluctuates or you have unexpected income in the year, you are particularly vulnerable. Watch out for the annual income limits. For traditional IRAs, there are no income limits for eligibility to contribute, so this is never a problem.

4. Failed Attempts to Rollover

You may be surprised to know that a failed attempt to rollover can result in an excess contribution. How can this happen? Well, there are a variety of ways you can end up in this position. One possibility would be the violation of one of the rollover rules. If you mistakenly roll over after the 60-day rollover period has already expired or if you violate the once-per year rollover rule, you will end up with an excess contribution.

5. RMDs Not Eligible for Rollover

If you are older, you may be at greater risk of excess contribution due to rollover mistakes. This is because of the rule that says that the required minimum distribution (RMD) for the year cannot be rolled over. In fact, the RMD for an IRA must be taken before any of the funds in the IRA are eligible for rollover. For example, an RMD must be taken before doing a Roth IRA conversion. If you mistakenly roll over your RMD, you will end up with an excess contribution.

Fixing an Excess IRA Contribution

Now you know what can cause excess IRA contributions. That is the first step in avoiding them. If despite your best efforts, an excess contribution occurs, the bad news is that the problem will not go away or fix itself. An excess contribution will be subject to penalties each year it remains in the IRA. The good news is that excess contributions can be corrected and often without penalty. For the right fix for your situation, be sure to talk to a knowledgeable tax or financial advisor.

https://www.irahelp.com/slottreport/5-ways-excess-ira-contribution-can-happen

2022 RMDS AND AND THE REQUIRED BEGINNING DATE: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

As we did 2 years ago, will we be able to skip taking a 2022 required minimum distribution (RMD) without penalties?

Answer:

Sorry, but RMDs are in full effect for 2022. The CARES Act waived RMDs in 2020, but that was a one-time deal. RMDs were back in play for 2021, and are still required for 2022 as well.

Question:

Good afternoon! I really enjoy the content and clarification around IRAs and the tax code. Makes my job a little easier! I did have a question about the 10-year rule and RMDs after the Required Beginning Date (RBD). If a beneficiary inherits the IRA from the decedent, how is the RMD on the inherited IRA calculated? Is it based on the age of the deceased or the age of the beneficiary? Is it a simple 10% per year? Does the beneficiary take normal inherited RMDs in years 1-9 and then distribute the remaining balance in year 10? Any help would be appreciated because I am in this exact scenario. Thanks!

Answer:

Glad we can be of help! If a beneficiary is subject to the 10-year rule, RMDs will only apply in years 1-9 if the original IRA owner died on or after his required beginning date. (The RBD is April 1 of the year after a person turns 72.) If that is the case, the RMDs are calculated using the single life expectancy of the beneficiary. This factor is then reduced by 1 for the following years 2 – 9. Think of the RMDs in years 1 – 9 as if the beneficiary was getting a normal lifetime stretch. However, by the end of year 10, the entire account must be emptied.

https://www.irahelp.com/slottreport/2022-rmds-and-and-required-beginning-date-todays-slott-report-mailbag

WHEN A “REVERSE ROLLOVER” MAKES SENSE

By Ian Berger, JD
IRA Analyst

Usually, rollovers involving 401(k) accounts and IRAs involve moving dollars from a plan to an IRA. But sometimes it makes sense to instead do a “reverse rollover” – from an IRA to a 401(k).

Let’s get some bad news out of the way: Although 401(k)s (and other company plans) are required to allow rollovers out of the plan, they are not required to allow rollovers into the plan. So, before withdrawing your IRA, check with your plan administrator or HR to make sure you can do a reverse rollover. Also, the tax code only allows reverse rollovers of pre-tax (deductible) IRA funds. Roth IRA funds and after-tax (non-deductible) IRA accounts are not eligible.

So, why bother with a reverse rollover?

The main reason is to avoid getting hit by the pro-rata rule if you’re converting traditional after-tax IRA funds to a Roth IRA – a “backdoor” Roth IRA conversion. The pro-rata rule looks at all of your non-Roth IRA accounts (including SEP and SIMPLE IRAs) as of December 31 of the year of the conversion. If you have any pre-tax funds as of that date, a portion of your conversion will be taxable. But if you have rolled over your pre-tax IRAs to a 401(k) during that year, you’ll be left with only after-tax funds as of December 31, and the conversion will be potentially tax-free. And, you still can “reverse the reverse rollover,” by rolling the 401(k) funds back to the IRA in the next year.

There are other good reasons to move your IRA to your plan:

  • If you work past your “required beginning date” for RMDs (April 1 after the year you turn 72), RMDs may not be required from your 401(k) until you leave your job. But RMDs from your traditional IRAs must always be taken by your required beginning date.
  • If you leave your job at age 55 or older (50 or older for certain public safety employees), you can receive your 401(k) without worrying about the 10% penalty. With a traditional IRA, you usually must delay your distribution until 59 ½ to dodge the penalty.
  • If the plan allows, you can borrow from your 401(k) plan, but not from your IRA.
  • Depending on your state’s laws, your retirement savings may be better protected from creditors while in a 401(k) rather than in an IRA.
  • Administrative and investment 401(k) fees can be lower than IRA fees.

But, like with most retirement decisions, there’s another side of the coin. Here are good reasons to keep your money in the IRA:

  • You can access your IRA savings at any time, but 401(k) payouts are only available upon certain events, such as attaining age 59 ½, leaving your job or incurring a financial hardship.
  • Several of the exceptions to the 10% early withdrawal penalty for distributions under 59 ½ (e.g., for higher education expenses and first-time home purchases) are available only if the funds are paid from your IRA.
  • Your 401(k) investment choices are usually much more limited than IRA investment options.

Check with a knowledgeable financial advisor before finalizing a reverse rollover.

https://www.irahelp.com/slottreport/when-%E2%80%9Creverse-rollover%E2%80%9D-makes-sense-0

MOVING NON-IRA ACCOUNTS AND THE PROPOSED RMD REGULATIONS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

I am 79 and make SEP-IRA withdrawals annually as required.

I also have several regular (non-IRA) accounts. One fund I own throws off tremendous taxable capital gains every year. Is there any way I can move it into an IRA account without selling it first in a taxable transaction?

Thanks.

Answer:

There are several roadblocks to moving your non-IRA account to an IRA. The only way that funds can go into an IRA is if they are being rolled over from another IRA or from a qualified employer plan or if they are an IRA contribution. The account you are describing is not an IRA or a plan, so a rollover is off the table. IRA contributions must be based on earned income and must be made in cash. Therefore, even if you have earned income, you would not be able to contribute the non-IRA account, since it is considered property.

Question:

I heard Ed Slott speak a while ago at a webinar on the recent interpretation by the IRS of the 10-year rule, but wanted to make sure that I understood correctly as it pertains to a client of mine.

Client inherited a traditional IRA from his mother in 2020. She was already taking RMDs when she died in 2020 as she was in her 80’s.  My understanding is that our client needs to take ANNUAL RMDs since his mother had already started taking them.  In addition to the annual RMDs, he needs to make sure that the ENTIRE IRA is distributed by the end of the 10th year. Is this correct – annual RMDs required IN ADDITION TO complete distribution within ten years?

Also, assuming he does need to continue with her RMDs each year, which life expectancy table does he use to calculate his annual RMD each year?

Thank you in advance for any input you can provide on these questions.

Christie

Answer:

Hi Christie,

Your understanding is correct. The IRS really threw us a curveball here! Unexpectedly, the new proposed regulations are requiring annual required minimum distributions (RMDs) during the 10-year payout when the account owner dies after her required beginning date. The RMDs are calculated using the IRS Single Life Expectancy Table and are based on the beneficiary’s life expectancy.

https://www.irahelp.com/slottreport/moving-non-ira-accounts-and-proposed-rmd-regulations-todays-slott-report-mailbag

WATCH OUT FOR THE ONCE-PER-YEAR ROLLOVER RULE

By Sarah Brenner, JD
Director of Retirement Education

Why is it so important to know how the once-per-year rollover rule works? Well, that is because trouble with the once-per year rule is the kind of trouble no one wants! An IRA owner who violates this rule is looking at some serious tax consequences.

One Rollover a Year for an IRA owner

If an IRA owner for whatever reason elects not to do a direct transfer but instead chooses to move her money by a rollover, then there will usually no escaping the once-per-year rollover rule. The rule says that an IRA owner cannot roll over an IRA distribution that was received within 12 months of a prior IRA distribution that was rolled over.

Traditional and Roth IRAs are combined for purposes of the once-per-year rule. A distribution and subsequent rollover between your Roth IRAs will prevent another rollover of a traditional IRA received within one year from receipt of the Roth. The bottom line is that only one IRA-to-IRA (or Roth IRA-to-Roth IRA) 60-day rollover may be done if the distributions are received within 12 months of each other.

Fatal Error

A mistake with the once-per-year rollover rule can result in the loss of your retirement savings. It is a fatal error with no remedy.

If an IRA owner takes a distribution with the intent of rolling it over and discovers that she is ineligible to roll over the funds due to the rule, that distribution will be taxable to her. She will no longer have an IRA and will likely have a tax bill instead. The distribution will also be subject to the 10% early distribution penalty if the IRA owner is under age 59 ½. If she goes ahead and deposits the funds anyway, she will have an excess IRA contribution complete with all the penalties and headaches that go with it. What about the IRS? Well, the IRS will not be able to grant relief. This is because by law the IRS has no authority to waive this rule. The self-certification procedures which allow for relief when the 60-day rollover deadline is missed do not apply to violations of the once-per-year rollover rule. A private letter ruling (PLR) request won’t work either.

Direct Transfers Are the Way to Go

Why chance it? A good place to start is by avoiding 60-day day rollovers whenever possible. If there is no 60-day rollover, then there is no once-per year rollover rule to worry about. How then can you move your retirement funds? The best advice is to directly transfer the funds from one retirement account to another instead of taking a distribution payable to yourself and then rolling it over to another retirement account. You can do as many transfers between IRAs annually as you want. There are no limits to worry about.

https://www.irahelp.com/slottreport/watch-out-once-year-rollover-rule

THE RULE-OF-55 AND RMD CONVERSIONS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Hi,

I am age 50 and am targeting retirement at age 55. My current employer is selling the division I work for, and I see the potential that I could be laid off at, say, 52. If this were to happen, could I join a new employer with a 401(k) plan, roll my old 401(k) over to the new plan, and then take a distribution (both the rolled-over funds and the new 401(k) funds) under the rule of 55?  The statute suggests that I could do this, but I have seen comments that the rollover funds wouldn’t count.

Thanks,

Dave

Answer:

Hi Dave,

This will work, and is a good workaround. You want to make sure your new employer allows incoming rollovers (some don’t). And, you need to separate from service from your new employer in the year you turn age 55 or older. Finally, if you roll over your “rule-of-55” distribution to an IRA, you’ll have to wait until age 59 ½ to withdraw the IRA funds penalty-free. That’s because the age-55 exception does not apply to IRAs.

Question:

Hi Mr. Slott,

I read somewhere that if we need to withdraw a required minimum distribution (RMD) but don’t need the money, we can convert this RMD to a Roth IRA. Is this true?

Thanks in advance,

Puzzled

Answer:

Puzzled,

Sorry, but that won’t work. A conversion to a Roth IRA is actually a rollover, and RMDs can never be rolled over. However, once the RMD has been satisfied, any additional withdrawals could be converted to a Roth IRA.

https://www.irahelp.com/slottreport/rule-55-and-rmd-conversions-today%E2%80%99s-slott-report-mailbag

HOW THE VESTING RULES WORK FOR COMPANY RETIREMENT PLANS

By Ian Berger, JD
IRA Analyst

Employees leaving their jobs are often surprised to discover they aren’t entitled to the full balance of their company plan account. The reason is that some plans impose a vesting rule on certain types of contributions.

What do the vesting rules mean? They tell you how much of your plan benefit you actually own and cannot be taken away from you. If you’re fully vested, you’re entitled to your entire benefit. If partially vested, you only get a portion of your benefit. And, if you’re 0% vested, you receive no benefit at all. In the case of a partially-vested or 0%-vested benefit, the unvested portion of your benefit will be forfeited.

You receive vesting credit based on your service with your employer. Most plans award you with a year of vesting service for each 12-month period that you work at least 1,000 hours. Other plans measure vesting service based on the total period of your employment from date of hire to date of separation. Check the plan’s written summary or speak with the plan administrator or HR for more details.

In a defined contribution plan like a 401(k), 403(b) or 457(b), employee contributions (pre-tax deferrals, Roth contributions and after-tax contributions), and associated earnings, are immediately 100% vested. Employer matching or profit sharing contributions, and their earnings, may be immediately 100% vested or subject to a vesting schedule.

If your plan uses a vesting schedule, it can be either “cliff vesting” or “graded vesting,” as follows:

 

Years of Service                    Cliff Vesting                       Graded Vesting

1                                         0%                                        0%

2                                         0                                          20

3                                      100                                         40

4                                      100                                         60

5                                      100                                         80

6                                      100                                       100

Example: Terrance participates in a 401(k) plan with a graded vesting schedule for employer matching contributions. He leaves his job after three years of service with $40,000 in his pre-tax deferral account and $8,000 in his match account. Terrence can receive a total distribution of $43,200, which represents 100% of his deferral account ($40,000) and 40% of his match account ($3,200). The unvested part of his match account ($4,800) will be forfeited.

Most defined benefit pension plans use a 5-year cliff vesting schedule where benefits become 100% vested after five years of service.

By law, your benefit under any company plan must become 100% vested, regardless of years of service, when you reach the plan’s “normal retirement age” (typically age 65) or when the plan terminates. Many plans also provide for 100% vesting if you die or become disabled.

Vesting rules don’t apply to IRAs, including SEP or SIMPLE IRAs. You can receive the full value of your IRA account at all times.

If you’re thinking about leaving your job, make sure you know about the vesting schedule that applies to your plan. It may pay to stick it out a little longer to get additional vesting service. Otherwise, you may lose out on a valuable benefit.

https://www.irahelp.com/slottreport/how-vesting-rules-work-company-retirement-plans

ED SLOTT’S ELITE IRA ADVISOR GROUP℠ TOPICS OF CONVERSATION – KANSAS CITY

By Andy Ives, CFP®, AIF®
IRA Analyst

Last week in Kansas City, the Ed Slott team hosted our first in-person training program for members of our Elite Advisor Group since late 2019. While we managed to stay in contact with everyone via virtual meetings for the last two years, it was good to again see people face-to-face. The conversations were lively and interaction among the members during the breaks was spirited. Throughout the program, we focused on a number of current topics – like nuances of the 10-year rule for beneficiaries, common mistakes made when setting up inherited accounts, and the advantages of Roth IRAs and Roth 401(k) plans. Some of the questions and topics that bubbled up organically, across all retirement account subjects, included the following:

Can a spouse beneficiary do both a spousal rollover and an inherited IRA? Yes. It is recommended that a spouse who is under 59 ½ do an inherited IRA with the deceased spouse’s account. This way she can have full access to the funds without the 10% early withdrawal penalty. Once the surviving spouse reaches age 59 ½, she can then do a spousal rollover. However, if the surviving spouse wanted to do a spousal rollover with a portion of the inherited funds before 59 ½ and leave the rest as an inherited IRA, that is perfectly acceptable.

How does the stretch IRA work for an eligible designated beneficiary (EDB) child? The new regulations clearly define the age of majority (for IRA beneficiary purposes) as 21. Also, there is no longer an extended age for anyone still in school. That language has been removed. A minor child of an IRA owner, as an EDB, is permitted to stretch required minimum distribution (RMD) payments over the child’s own single life expectancy until the year she turns 21. After that final year, the 10-year rule springs forward.

Do former 401(k) plan dollars rolled into an IRA have to maintain the spouse as beneficiary? They do not. While ERISA rules dictate that a spouse must be the beneficiary of the 401(k) unless the spouse consents, there is no such spousal consent rule for IRAs.

When does the 10-year rule start, and is there still a year-of-death RMD? If the original IRA owner was subject to lifetime RMDs, and if that original owner had yet to take the final RMD, then the beneficiary is responsible for taking the year-of-death RMD. If the beneficiary is subject to the 10-year rule, the 10 years start with the year after death, so it is essentially a full 10-year term PLUS whatever time remains in the year of death. When trying to determine the final year in the 10-year term, start with the year after death, and count them out on your fingers. (There is no shame in that!)

Is a dependent child who has his own earned income potentially phased out for a Roth IRA by his parent’s income? No. If a dependent child has his own earned income from anything from lifeguarding to washing dishes to stocking shelves, and if that child files a tax return, Roth IRA eligibility is based on that child’s income, not the parents.

Conversations also included details about the new successor beneficiary rules, life expectancy tables, considerations when moving money from a Roth 401(k) to a Roth IRA, 72(t) schedules, trust beneficiary rules, and much more. It was a long and informative few days, and we look forward to our next member event in October in Las Vegas.

https://www.irahelp.com/slottreport/ed-slotts-elite-ira-advisor-group%E2%84%A0-topics-conversation-kansas-city

QUALIFIED CHARITABLE DISTRIBUTIONS & SPOUSAL BENEFICIARIES: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

I have a 401(k) that I’d like to use a portion for a QCD. I understand that QCD’s have to be from an IRA. Can I move a portion to an IRA for the QCD? How will this affect my RMD from my 401(k)? Federal tax implications? Thank you!

Answer:

You are correct that QCDs can only be done from an IRA, so you would have to roll over money from your 401(k) to an IRA to do a QCD. However, based on the “first-dollars-out rule,” the first distribution from your 401(k) will count toward the 401(k) RMD. Since these first dollars out are considered RMD dollars, they cannot be rolled over. Only after the plan RMD has been satisfied could you then roll additional 401(k) dollars to an IRA for a subsequent QCD. The plan RMD will be included in your income, while the QCD will not.

Question:

Dear Mr. Slott,

Before I was married, I opened several brokerage accounts and a Roth IRA in my name alone.  After marriage, I named my wife the beneficiary for these accounts.  I am wondering if we would be better off if I made her a co-owner.  What do you suggest?

Yours truly,

Mitchell

Answer:

Mitchell,

Regarding the non-IRA brokerage accounts, we suggest you speak to a financial advisor to discuss the pros and cons of making those joint account. As for the Roth IRA, that can only be held by one owner. You can name your wife as the beneficiary of the Roth IRA (as you did), but the account itself cannot be held jointly.

HOW YOUR IRA CAN HELP IF YOU ARE A FIRST-TIME HOME BUYER

By Sarah Brenner, JD
Director of Retirement Education

The real estate market is red hot right now. This can be especially challenging for first time home buyers. IRA savings are intended to be used for your retirement. However, if you are like many others, your IRA may be your biggest asset. You may need your IRA funds to make home ownership happen and there is a special break in the tax code that can help you.

Exception to the 10% Penalty

Usually, if you are under age 59 ½ and you take a distribution from your IRA, you will be hit with not only taxes but also a 10% early distribution penalty. However, there is an exception for those who are looking to take the leap and purchase their first home. The 10% penalty does not apply to your IRA distribution that you use to buy or build a principal residence if you are a first-time homebuyer. You can also use those funds to pay for the settlement fees, closing costs, and financing fees.

Qualifying as a First Time Home Buyer

Who is considered to be a first-time home buyer? The answer may surprise you. You qualify as a first-time homebuyer if you haven’t owned a house in the past two years. That’s right. Even if you had previously owned a home, but sold it five years ago and rented an apartment ever since, you would qualify. If you’re married, your spouse also cannot have owned a home in the past two years. You may use your IRA funds to help a family member with a home purchase if they meet the definition of a first-time buyer.

$10,000 Lifetime Limit

There’s a $10,000 lifetime limit on penalty-free distributions that you can use for a first-time home purchase. If you and your spouse each have your own IRAs and qualify as first-time homebuyers, each of you can take $10,000 for a total of $20,000 for the same home purchase. If you take more than $10,000 from your IRA, the amount above won’t be exempt from the 10% penalty. Once you use up your lifetime limit, it is gone forever

Use the Funds Within 120 Days

You must use the distribution within 120 days from the day it is received to buy your first home. If things don’t go as planned and the home purchase is delayed or cancelled, you may roll the funds back into an IRA. You have 120 days from the date of the distribution to do this rather than the 60-day period which is normally the deadline for rolling over IRA distributions.

How to Claim the Exception

Remember, your IRA distribution will still be taxable to you, unless you have basis included in the distribution. This tax break only gets you out of the 10% early distribution penalty. Your IRA custodian will likely report the distribution as an early distribution to both you and the IRS. You will want to claim the exception to the 10% early distribution penalty when you file your tax return for the year. As with all tax matters, you will want to keep good records in case the IRS decides to ask questions.

https://www.irahelp.com/slottreport/how-your-ira-can-help-if-you-are-first-time-home-buyer

IRS NEEDS TO CLARIFY ANNUAL RMD REQUIREMENT UNDER THE NEW REGULATIONS

By Ian Berger, JD
IRA Analyst

Just when we thought we understood the new IRS regulations on required minimum distributions (RMDs), here comes more uncertainty.

As we have reported, the IRS threw everyone a curveball with its interpretation of the 10-year payout rule under the SECURE Act in its proposed regulations issued on February 23. For most non-spouse beneficiaries, the SECURE Act replaced the life expectancy payout rule (also known as the “stretch IRA”) with a new 10-year rule. It is clear that the 10-year rule requires that the entire IRA account be emptied by December 31 of the 10th year following the year the IRA owner died. (However, eligible designated beneficiaries or “EDBs” — surviving spouses, children of the IRA owner under age 21, chronically-ill or disabled individuals, and beneficiaries no more than 10 years younger than the IRA owner – can continue to use the stretch.)

The IRS curveball was that, if the IRA owner died on or after his required beginning date (“RBD”), there is an additional RMD requirement for non-eligible designated beneficiaries. (The RBD for IRA owners born on or after July 1, 1949 is April 1 of the year following the year they turn age 72.) In that situation, the non-EDB must not only receive the entire account within 10 years, but also must take annual RMDs in years 1-9 of the 10-year period. (This annual RMD requirement never applies to Roth IRA beneficiaries.)

The IRS justified this result by citing the “at least as rapidly rule.” This rule says that once the IRA owner begins taking RMDs, RMDs must continue to be taken by a non-EDB after the owner’s death. This would seem to mean that if the IRA owner died before his RBD, the 10-year emptying rule still applies, but the annual RMD rule in years 1 – 9 does not apply. Well, maybe or maybe not.

An example tucked inside the regulations suggests there is one situation where both rules apply to a non-EDB even if the IRA owner died before his RBD. That would be if a child under 21 inherits an IRA. As an EDB, that child can stretch RMDs until she turns 21. At that point, the child becomes a non-EDB subject to the 10-year emptying rule. The example suggests that the child would also have to continue annual RMDs during the 10-year period. But how can that be if the IRA owner died before his RBD?

The apparent rationale for this is that the “at least as rapidly rule” requires the child to continue RMDs since she was already taking them through age 21. (The same rationale would apparently require annual RMDs for a beneficiary of an EDB — a “successor beneficiary” – when the original IRA owner died before his RBD.)

However, not everyone agrees with this interpretation of the regulations. We are hoping the IRS will clear up this ambiguity when it finalizes the RMD regulations.

https://www.irahelp.com/slottreport/irs-needs-clarify-annual-rmd-requirement-under-new-regulations

REQUIRED MINIMUM DISTRIBUTIONS (RMDS): TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

I am 75 years old and contributing to my company’s 401(K) plan. I have not taken an RMD from my 401(K) utilizing the “still-working exception.” I just retired on April 30, 2022. My question is: Do I have to take an RMD from my 401(K) for the current year 2022, or am I allowed to wait until next April 2023 to commence taking the first RMD from the 401(K) plan?

John

Answer:

Hi John,

Congratulations on your retirement! You will have an RMD for 2022 because you retired in 2022. However, because this is the first year for which you must take an RMD, you may delay taking that RMD until April 1, 2023. Keep in mind that if you do that, you will need to take two RMDs in 2023. The one for 2022 that you delayed and the one for 2023 which is due by December 31, 2023.

Question:

Hi – If my RMD from my IRAs is $20,000, but 5% of my contributions to the IRA were non-deductible contributions, does that mean I actually have to take more out that year to satisfy the RMD?

Thanks,

Margy

Answer:

Hi Margy,

Good news! Any funds in an IRA can satisfy an RMD. This includes nondeductible contributions. RMDs do not have to consist of only taxable funds. You will not need to take extra money out because a portion of your RMD is nontaxable.

https://www.irahelp.com/slottreport/required-minimum-distributions-rmds-todays-slott-report-mailbag

A DOZEN QCD FACTS

By Andy Ives, CFP®, AIF®
IRA Analyst

Qualified charitable distributions (QCDs) continue to gain popularity, and with that popularity comes more questions. Here are a dozen QCD facts that will keep you on the straight-and-narrow with your QCD transactions:

1. QCDs are capped at $100,000 per person per year, and they only apply to IRA owners (which includes inherited IRAs) if the IRA owner or inherited IRA owner is age 70½ or older. Note: you must actually be 70 ½, not just turning 70 ½ later in the year.

2. They can be done from IRAs, Roth IRAs and INACTIVE SEP and SIMPLE IRAs. (“Inactive” means no dollars went into the SEP or SIMPLE for the year.) QCDs cannot be done with distributions from employer plans like a 401(k).

3. QCDs must be a direct transfer to charity – NOT gifts made to private grant making foundations, donor advised funds or charitable gift annuities. (That’s right – no QCDs to DAFs.)

4. No split interest gifts of any type will qualify (meaning no part of the QCD can benefit the IRA owner personally).

5. The charitable donation from an IRA can satisfy a required minimum distribution (RMD), but the IRA distribution is not includable in income.

6. No deduction can be taken for the charitable contribution – that would be double dipping.

7. For a married couple where each spouse has their own IRA, each spouse can contribute up to $100,000 from their own IRA.

8. If more than $100,000 is withdrawn from the IRA and contributed to a charity, there is no carryover to a future year. The excess is taxable income. (However, a charitable deduction for the overage could be claimed if the taxpayer itemizes.)

9. There can be no benefit back to the taxpayer. No coffee mugs or tote bags or…and this was a real question…no quid pro quo to offer the grandchildren a private school scholarship.

10. The distribution from the IRA to a charity can satisfy an outstanding pledge to the charity without causing a prohibited transaction.

11. The charity must be a valid charity – no “Human Fund” donations allowed. (See: Seinfeld, Season 9, Episode 10, “The Strike.”)

12. QCDs apply only to taxable amounts. This is an exception to the pro-rata rule. Only taxable amounts in a Roth IRA will qualify…so don’t bother doing QCDs from a Roth IRA unless you want to have a potential administrative mess on your hands.

And a bonus QCD fact: There is no code on a 1099-R that indicates a QCD.

https://www.irahelp.com/slottreport/dozen-qcd-facts

INVESTING YOUR IRA IN CRYPTO

By Sarah Brenner, JD
Director of Retirement Education

Recently, Fidelity investments made headlines by announcing that it would allow retirement savers to put Bitcoin in their 401(k)s. Cryptocurrency has been all over the news, and you may be wondering if it would be a good investment for your IRA. Here is what you need to know.

What is crypto? A good place to start is by learning exactly what cryptocurrency is. Cryptocurrency is a digital currency that is typically not issued by any government. It is exclusively digital. There are no physical coins or notes. Bitcoin is probably the most well-known cryptocurrency, but there are thousands of others.

Can you invest your IRA in crypto? The answer is yes. When Fidelity announced that it would allow bitcoin investments in 401(k)s, that did not immediately make those types of investment available to all 401(k)participants. Instead, employers would need to decide to offer bitcoin as an investment choice to their employees who participate in the company’s 401(k) plan. Many are likely to be reluctant to do so due to concerns expressed by the Department of Labor and potential liability. IRAs, however, are different. With an IRA there is no such gatekeeper and aside from a short list of prohibited assets you can invest your IRA funds in whatever types of assets you choose. There is no rule against investing your IRA in Bitcoin or another cryptocurrency.

Should you invest your IRA in crypto? This is a tougher question. Just because an investment is allowed in an IRA does not mean that it is a good idea for retirement savings. It is easy to envision the potential upside of investing your IRA in crypto, especially if it is a Roth IRA. With Roth IRA, if the rules are followed, any earnings can be distributed tax-free. If a crypto investment brings the returns that its proponents claim it can, that could be a substantial tax-free windfall for your golden years.

However, there are serious concerns that must be addressed when it comes to investing your IRA in crypto. First, it must be done the right way. You cannot contribute crypto to an IRA. You must contribute cash (subject to the annual contribution limits) and then the crypto would be purchased in the IRA. Second, not every IRA custodian will allow cryptocurrency investments. You will need to find one who does.

In addition, investments in cryptocurrency face the same issues that other alternative IRA investments encounter. Fees can be higher than with more conventional investments. Valuation can be an issue as well. Annual valuation is required by the IRS. Alternative investments also require more detailed reporting by the IRA custodian to the IRS. Higher IRS scrutiny is likely to follow. Cryptocurrency is also uniquely challenging as an investment, even among unconventional investments, because it is so new and it’s rules and legal status are still evolving.

Ultimately, the biggest negative with investing your IRA in crypto is risk. If all goes well, there could be a great return but because this is a new type of investment there is no historical track record. The fact that the Department of Labor warned against employers adding a cryptocurrency investment to their 401(k) and the fact that many employers are holding off due to liability concerns should not be dismissed by IRA owners.

To add diversity to retirement savings, investing some IRA funds in crypto might be attractive. However, IRA owners need to know all the facts and proceed with caution so as not to jeopardize their retirement savings by going all in with a bad bet on cryptocurrency.

https://www.irahelp.com/slottreport/investing-your-ira-crypto

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

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

I’m 68 years old. I would like to start IRA withdrawals. What are the rules for withdrawing before my RMDs are required at age 72?

Thanks,

Bob

Answer:

Bob,

There are no limitations to withdrawing your IRA before RMDs begin. As a 68-year-old, you have full access to your IRA whenever you want it, penalty free. Assuming all the dollars in your IRA are pre-tax (some people do have after-tax dollars in their IRAs), then any distribution will be taxable as ordinary income. This also assumes your IRA isn’t invested in something where liquidity might be an issue. As long as you are aware of the tax implications of an IRA withdrawal (and the possibility that the increased income could impact other items, like IRMAA surcharges in a couple of years), then your assets are available for you to use as you wish. However, before making any quick decisions, it might be a good idea to speak with a financial advisor.

Question:

Does the 10-year rule apply to an IRA with a charity as beneficiary?

Eddie

Answer:

Eddie,

Charities do not get the 10-year rule. As non-designated beneficiaries under the SECURE Act, they would instead (depending on the age of the IRA owner at death) need to be paid out over either the 5-year rule or the remaining life expectancy of the deceased IRA owner. However, if a charity is named as the beneficiary of an IRA, the most likely occurrence is that the charity will request a lump sum distribution as soon as possible. If there are co-beneficiaries named on the account, as long as the charity beneficiary is paid their portion of the IRA before September 30 of the year after the year of death, the 10-year rule would then apply to the remaining IRA beneficiaries, or possibly the stretch if they are eligible designated beneficiaries.

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

401(K), 403(B), 457(B): DOES IT REALLY MATTER?

By Ian Berger, JD
IRA Analyst

There are three types of company savings plans:

  • 401(k) plans if you work for a for-profit company;
  • 403(b) plans if you work for a tax-exempt employer, a public school or a church; and
  • 457(b) plans if you work for a state or local government.

(This article doesn’t cover the Thrift Savings Plan for federal government workers and the military, or 457(b) “top-hat” plans for tax-exempt employers.)

If you’re saving through your work plan, you may not know – or care – which category your plan falls into. But should you care?

For the most part, it doesn’t matter which type of plan you’re in, since many features are exactly the same in all three. For example:

  • Each plan allows elective deferrals up to $20,500 for 2022, and employees who are age 50 or older can make an additional $6,500 of catch-up contributions.
  • All three can allow Roth contributions and plan loans.
  • Hardship withdrawals are usually available, although the 457(b) hardship standard is stricter than the 401(k)/403(b) standard.
  • Required minimum distributions (RMDs) are required, but the “still-working exception” may be used. If you don’t own more than 5% of the company, that exception allows you to defer RMDs until the year you retire or separate from service.
  • You must be allowed to directly roll over eligible distributions from all three plans to IRAs or other plans. However, your employer must withhold 20% for federal income taxes if you don’t directly roll over your payout.
  • All three can allow in-service distributions at age 59 ½.

But there are also some important differences among the plans that you should be aware of:

  • While 401(k) and 403(b) plans can offer after-tax contributions, 457(b) plans can’t.
  • In determining RMDs, 403(b) plans can be aggregated, but 401(k) and 457(b) plans can’t be aggregated.
  • A 10% early distribution penalty applies to 401(k) or 403(b) distributions made before age 59 ½. For some reason, the penalty doesn’t apply to 457(b) distributions – except for distribution of monies previously rolled over into the plan from non-457(b) plans or IRAs.
  • Only 403(b) plans allow for a special catch-up contribution if you have at least 15 years of service. Only 457(b) plans allow a special catch-up for the last three years before your retirement date.
  • Whether your plan dollars are protected from creditors depends on which plan you’re in. You enjoy complete protection under ERISA if you’re in a 401(k) plan (except the Thrift Savings Plan) or a 403(b) plan where your employer makes contributions. If you’re in a 403(b) plan where your employer doesn’t contribute (and isn’t administratively involved with the plan) or you’re in a 457(b), you only have whatever creditor protection is available under your state’s laws. That protection varies from state to state.

https://www.irahelp.com/slottreport/401k-403b-457b-does-it-really-matter

FIRST DOLLARS OUT RULE AND THE STILL-WORKING EXCEPTION

By Andy Ives, CFP®, AIF®
IRA Analyst

For those who have 401(k)s or other employee retirement plans (but not SEP or SIMPLE plans), the required beginning date (RBD) for when required minimum distributions (RMDs) are to begin is the same as for IRA owners – April 1 of the year after a person turns 72. However, if the plan allows for the “still-working exception,” the RBD can potentially be delayed if a worker is still working for the company where they have the plan. (Also, the worker cannot own more than 5% of the company in the year they reach age 72.)

If the worker qualifies and the plan permits, he can delay the RBD to April 1st of the year following the year he finally retires. This is sometimes called the “still-working” exception, but it only applies to RMDs from employer plans. It does NOT apply to IRAs. It also does not apply to employer plans if the worker is not currently working for that company. Note that this provision is optional – plans are not required to allow it.

What happens when a person over 72 is still working and has no plan RMD due to the still-working exception, but then get laid off, quits voluntarily, or some other circumstance forces the person to abruptly separate from service? Suddenly that former employee now has an RMD for the year. And what if that person had done a rollover from the plan to an IRA earlier in the year with the expectation that they would continue working through the whole year?

Well, based on the “first dollars out rule,” that person may have rolled over the RMD, which is not allowed. While the RMD did not apply at the time of the rollover because of the still-working exception, the subsequent separation from service within the same year would have ended the still-working benefit. Consequently, the normal RMD rules would spring into effect.

Example: John is a 75-year-old employee at Beachside Surf where he fabricates surfboards. John participates in the Beachside Surf 401(k) and uses the still-working exception to delay his plan RMDs. John intends to work for a few more years before he retires. In order to access a particular investment that he cannot purchase in the plan, John rolls over $20,000 to his IRA in March of 2022. He has not taken any other distributions.

In August of the same year, Beachside Surf is hit by a tsunami and the business is destroyed. The owners have no plans to rebuild, and all the employees are immediately laid off. Suddenly, John is no longer “still-working.” With this abrupt separation from service, John has a 401(k) RMD for 2022. Uh-oh. John rolled over $20,000 earlier in the year. Based on the first-dollars-out rule, in conjunction with his unexpected termination, the $20,000 retroactively includes John’s 2022 RMD. That RMD is now an excess contribution in the IRA and must be rectified.

This example may sound like a stretch, but similar circumstances cause people to run afoul of the regulations all the time. When it comes to the still-working exception and the first-dollars out rule, it is imperative to monitor your timing. Leaving your job just a day too early could result in unexpected RMD headaches when all the guidelines overlap.

https://www.irahelp.com/slottreport/first-dollars-out-rule-and-still-working-exception

401(K) PARTIAL ROTH CONVERSIONS AND USING QCDS TO OFFSET RMDS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Hello,

I’m learning a lot from Ed Slott’s latest book, “The New Retirement Savings Time Bomb,” but I do have a question on 401(k) Roth IRA conversions. I’m recently retired with a company 401(k). I’m leaning towards keeping the 401(k) (rather than rolling it into my IRA). Is it possible to do an annual direct conversion (partial) from my 401(k) to my Roth IRA, keep the remaining funds in the 401(k), and repeat the process every year until reaching RMD age?

Thank you,

Marc

Answer:

Hi Marc,

Glad you’re enjoying the book. You can do partial conversions of your 401(k) funds to a Roth IRA as long as the plan allows you to take partial distributions of your account balance. Some plans require participants to take out their entire balance or none at all. So, check with your plan administrator or HR. If you are allowed to do partial distributions, make sure to do a direct rollover, rather than a 60-day rollover, so you can avoid mandatory income tax withholding.

Question:

I am 78 and have been taking RMDs as required. For 2021 I took my RMD and a few weeks later did a partial Roth conversion. For 2022, I am considering doing a QCD for the full RMD required, then later, doing a partial Roth conversion (and paying taxes on the conversion.) I suspect this process is OK, the QCD meeting the RMD requirement. Correct?

Many thanks,

Gil

Answer:

Hi Gil,

That will work. If you are subject to RMDs, you must take the RMD first before doing a Roth conversion in the same year. But if you make a QCD that fully offsets your RMD, there’s no  RMD left to take before you subsequently do the conversion.

https://www.irahelp.com/slottreport/401k-partial-roth-conversions-and-using-qcds-offset-rmds-todays-slott-report-mailbag

UNDERSTANDING THE SAME PROPERTY RULE

By Sarah Brenner, JD
Director of Retirement Education

For IRA-to-IRA or Roth-to-Roth 60-day rollovers, the same property received is the property that must be rolled over. These rules also apply to SIMPLE and SEP IRAs. You cannot receive a distribution of cash and then roll over shares of stock purchased with the cash or shares that you currently own. If cash is distributed from an IRA, then cash must be rolled over within 60 days.

Example 1:

Jody takes a $60,000 distribution from her IRA. She cannot purchase stock with the $60,000 and roll over the stock to her IRA. Because cash was distributed, cash must be deposited as a rollover.

If you take an IRA distribution of property other than cash, the same property must be put back into a retirement account in a timely manner if you want to complete a valid rollover.

Example 2:

Juan takes a distribution of 100 shares of Disney stock from his IRA. He must roll over the same 100 shares of Disney stock within 60 days to complete the transaction regardless of whether the price of Disney shares have gone up, down or remained the same since the initial distribution. (Remember, it’s the same-property rule, not the same-value rule.)

Company Plan Exception

There is an exception to the same-property rule for rollovers distributed from a company retirement plan, such as a 401(k). In this case, recipients have a choice: They can either roll over the same property to an IRA or they can sell all or part of the property distributed from the plan and roll over the cash proceeds from the sale. This is true even if the sale proceeds are greater or less than the value of the property when it was initially distributed from the company plan.

You may not keep the property and substitute your own funds for property you received.

Example 3:

Loretta receives a total distribution from her employer’s plan consisting of $10,000 cash and $15,000 worth of Apple stock. She decides to keep the Apple stock. She can roll over to a traditional IRA the $10,000 cash received, but she can’t roll over an additional $15,000 representing the value of the property she chooses not to sell.

If you sell the distributed property and roll over all the proceeds into a traditional IRA, no gain or loss is recognized. The sale proceeds (including any increase in value) are treated as part of the distribution and aren’t included in your gross income.

https://www.irahelp.com/slottreport/understanding-same-property-rule

TAKE ADVANTAGE OF CATCH-UP CONTRIBUTIONS!

By Ian Berger, JD
IRA Analyst

Tax Day 2022 seems like an appropriate time to review a sometimes-overlooked way to get extra dollars into your IRA or company savings plan. Folks age 50 or older are allowed to make “catch-up” contributions with no strings attached. These extra contributions allow you to build up your savings while enjoying an immediate tax break (if making pre-tax contributions) or a tax break down the road (if making Roth contributions).

The catch-up limit for 2022 traditional or Roth IRA contributions is $1,000 if you’re age 50 or older by the end of the year. This means you can make a total 2022 IRA contribution of up to $7,000 – as long as you are otherwise eligible for the IRA. The IRA catch-up is frozen at $1,000, but Congress is considering legislation that would increase it based on inflation.

The catch-up limit for 2022 401(k) plan deferrals is $6,500 if you’re age 50 or older. This allows total 2022 plan deferrals (pre-tax and Roth) of up to $27,000. The plan catch-up limit is indexed periodically.

Despite their name, age 50 catch-up contributions are available even if you’ve contributed the maximum amount in all prior years. And, you can use the age 50 catch-up for both workplace plans and IRAs in the same year.

403(b) and 457(b) participants have even better catch-up opportunities. A 403(b) plan may allow employees with at least 15 years of service to make up to an additional $3,000 of annual catch-up contributions. There is no age requirement for this catch-up, and it can be used on top of the age 50 catch-up. However, there is a lifetime limit of $15,000.

If you’re in a governmental 457(b) plan, you can defer up to an additional $6,000 if you’re age 50 or older. But this catch-up is not available if you’re in a 457(b) plan sponsored by a tax-exempt employer like a hospital.

Both types of 457(b) plans may allow you to defer an even higher catch-up amount in your last three years before retirement. For those three years, your additional catch-up amount could be as high as the normal deferral limit. For example, you may be able to defer as much as $41,000 ($20,500 + $20,500 catch-up) in 2022 – a real windfall. However, this three-year catch-up really is a true “catch-up,” meaning that it only works if you haven’t contributed the maximum in prior years. Also, you can’t use both the three-year catch up and the age 50 catch-up in the same year.

https://www.irahelp.com/slottreport/take-advantage-catch-contributions

INHERITED IRAS AND EMPLOYER RETIREMENT PLANS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Hello,

Client (72) has recently inherited a “Beneficiary IRA” account. My question is for next year:  Can she use qualified charitable distributions for her beneficiary IRA?

Thank you,

Kathy

Answer:

Hi Kathy,

Yes, this would work. Beneficiaries can take qualified charitable distributions (QCDs) from inherited IRAs as long as they are over age 70 ½.

Question:

Dear Ed Slott Experts,

I changed my job in January 2022 and my new employer does not allow me to contribute to a 401(k) plan for a year. Other than an IRA, is there any other way to contribute to a 401(k) or some other kind of retirement pre-tax plan so it will help with my tax situation?

Thanks,

Umang

Answer:

Hi Umang,

Unfortunately, this is predicament that many workers find themselves in. If your employer does not offer a retirement plan, your options are limited. You must be an employer to be eligible to establish a qualified plan. If you have a side job, you may qualify as self-employed, in which case you could establish a plan for your business. If you do not, an IRA would be your only option. If neither you nor your spouse participates in a plan at work, your IRA contribution would be deductible and that could help with your tax situation.

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

LAST-MINUTE IRA TAX DEADLINES & RULES

By Andy Ives, CFP®, AIF®
IRA Analyst

The deadline for filing your 2021 tax return is this Monday, April 18. It is extended through the weekend because IRS offices in Washington DC are closed on Friday, April 15, in observance of the locally recognized Emancipation Day. As such, this buys all of us a couple of extra days to complete our returns. For procrastinators, or for those who simply had time get away from them, there is still sand in the hourglass to complete certain IRA transactions. However, not all options are available. Here are some important IRA deadlines and answers to common IRA tax-filing-deadline questions.

Prior-Year Traditional and Roth IRA Contributions. There is still time to make a traditional and/or Roth IRA contribution for 2021. The deadline is April 18. This deadline does NOT include extensions. So, even if you file for an extension, that does not allow prior-year IRA contributions beyond the 18th. Note that if you do make a timely prior-year Roth IRA contribution, and if that is your first foray into the world of Roth IRAs, congratulations! You just shaved 15 months off your Roth 5-year clock and earned a January 1, 2021 start date.

SEP Contributions. Business owners with a SEP IRA plan can make 2021 contributions up to the business’s tax filing deadline INCLUDING extensions. This runs counter to the IRA deadline mentioned above and is a source of some confusion.

Backdoor and “Regular” Roth IRA Conversions. While we know that Congress is targeting the Backdoor Roth IRA strategy, it is still alive and well as of this writing. For those taxpayers who cannot contribute directly to a Roth IRA due to the income limits, the Backdoor Roth strategy allows them to make a non-deductible traditional IRA contribution, and then (minding the pro-rata rule) immediately convert it to a Roth IRA. As mentioned, while a prior-year 2021 contribution can be made up to the tax filing deadline, any conversion done in 2022– either a Backdoor or “regular” conversion – will count for 2022. There is no such thing as a “prior-year conversion” – the deadline for a 2021 conversion was December 31 of last year.

Fixing an Excess IRA Contribution. Anyone who erroneously contributed to a traditional or Roth IRA in 2021 – either by contributing too much or maybe simply changing one’s mind – can still correct the situation. And you may have more time than you think. The deadline for correcting an excess, either by removal without the 6% penalty or recharacterization, is the extended tax filing deadline – whether you actually go on extension or not. So, for 2021, you still have the potential to make the fix until October 18, 2022.

QCDs (Qualified Charitable Distributions). QCDs allow IRA owners who are 70 ½ and older to send money directly from an IRA to a qualified charity. The donation is removed from income and is typically used to offset all or a portion of a required minimum distribution. The deadline for completing a 2021 QCD was December 31 of last year. As with Roth conversions, there is no such thing as a “prior-year QCD.” While your tax software may inquire about any charitable giving you did, know that any QCDs done during 2022 will only count for this calendar year.

As we race toward the tax finish line, be sure to understand which IRA transactions can still be done in the next few days (and possibly months), and recognize those that cannot.

https://www.irahelp.com/slottreport/last-minute-ira-tax-deadlines-rules

5 TAKEAWAYS FROM THE NEW SECURE ACT REGULATIONS

By Sarah Brenner, JD
Director of Retirement Education

The SECURE Act was signed into law in late December of 2019. This new law upended the rules for retirement accounts. With it came many questions, and IRS guidance was eagerly anticipated. Finally, on February 23, the IRS released new proposed regulations that incorporate all the changes brought about by the SECURE Act. Since then, we have been busy combing through 275 pages of complicated new rules. As the dust begins to settle, here are 5 of our takeaways from the new SECURE Act regulations.

1. The RMD rules are more complicated than ever. Under the SECURE Act, when it comes to required minimum distributions (RMDs) the rules have become more complicated, instead of less complicated! We have more kinds of beneficiaries and more distribution options than ever before. It is true that most retirement account beneficiaries are subject to the 10-year rule and are no longer eligible for the stretch. However, while this may seem to make the rules easier, it does not. What the IRS has done in the regulations is simply add the 10-year rule as yet another layer to already complicated rules.

2. What is old is new again. The required beginning date is when RMDs must begin during a retirement account owner’s lifetime. Prior to the SECURE Act, this date played a critical role in determining the options available to beneficiaries. With the SECURE Act, it was thought that this date would no longer matter for many beneficiaries. The new regulations resurrect the importance of this date by requiring annual RMDs be taken by beneficiaries during the SECURE Act’s 10-year period only when the account owner dies on or after the required beginning date.

3. Roth IRAs are even more attractive. Want to avoid the complication of annual RMDs during the 10-year period? The Roth IRA is the answer. Roth IRA beneficiaries are always considered to have died before their required beginning date and are never subject to annual RMDs during the 10-year payout period under the SECURE Act. What is not to like about inheriting a Roth IRA and letting it sit and grow tax free for 10 years? That is a huge advantage for Roth IRAs.

4. Think twice before naming a trust as an IRA beneficiary. The rules that apply when a trust is named as an IRA beneficiary have always been complicated. However, the ability to get the stretch was worth it for many. Now, the SECURE Act regulations make the rules even more complex, and many trusts will be subject to a 10-year payout anyway. This may mean you should think twice about naming a trust as beneficiary. While there are certainly good reasons for doing so, such as providing for a special needs beneficiary or a minor child, in many cases leaving an IRA to a trust may not be worth the cost and administrative headaches.

5. Good advice is essential. For many individuals, their retirement account is their biggest asset and the product of many years of hard work and careful savings. The new regulations make the rules for these accounts more complicated than ever. One wrong move can result in unnecessary taxes and penalties. To protect your legacy, be sure to consult with a knowledgeable advisor who is up to date on the new rules. Find an Advisor | Ed Slott and Company, LLC (irahelp.com)

https://www.irahelp.com/slottreport/5-takeaways-new-secure-act-regulations

INHERITED IRAS AND SEP ACCOUNTS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

I have a non-spousal inherited IRA account.  Once I take out my RMD for the year, am I able to take out excess funds and roll those into a Roth account?

Thank you.

Answer:

Inherited IRA accounts do not follow all the same rules nor do they have all the same benefits as your own IRA. For one, inherited IRA dollars are not permitted to be converted to a Roth IRA. This is true even if you have satisfied your RMD for the year on that inherited IRA account. You could use a withdrawal from the inherited IRA to make a contribution to a Roth IRA – assuming you are otherwise eligible to contribute to a Roth – but a conversion is not allowed.

Question:

Hi there! Can someone possibly clear up a very confusing Form 5498 issue for a SEP accounts? I understand the 5498 reports the contributions when they are actually received between Jan 1st through December 31st of any given tax year. This is regardless of the year for which the contribution is intended for. In short, for a SEP, the plan trustee ignores the whole current year/prior-year coding – for 5498 reporting purposes. So, here’s the uncertainty that results: does the IRS compare the taxpayers claim (on their tax return) of their deductible contribution against the trustee’s reported 5498 (which again ignores the intended year on contribution)?

Thank you so much!

Mike

Answer:

Mike,

This is a common question. The concern stems from the fact that, because the IRA custodian reports SEP contributions on a calendar year basis and the employer can designate a SEP contribution for a prior year, confusion will happen. This is not a problem. The IRS eventually sees Form 5498 which the custodian files for each calendar year and sees the total SEP contributions made by the employer as reported on the tax return. To ensure accuracy, the IRS will overlay what the tax filing claims vs. the 5498 Forms year after year.

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

HOUSE PASSES SECURE 2.0 BILL, BUT IT’S NOT LAW YET

By Ian Berger, JD
IRA Analyst

A bill designed to increase savings in IRAs and company plans has passed the House of Representatives, but it’s not yet law.

The bill is officially called the “Securing a Strong Retirement Act of 2022,” but many are calling it “SECURE 2.0” since it’s seen as an expansion  of the original SECURE Act from 2019. On March 29, the House passed the bill by a near-unanimous 414-5 vote. The action now moves to the Senate where several committees are working on their own retirement bills. If a consensus Senate bill emerges, it will have to be reconciled with the House bill before it goes to the president. All of this may take some time.

Here are the important pieces of the House bill:

  • There would be a gradual increase in the age that traditional IRA required minimum distributions (RMDs) must start. Currently, the first RMD year is the age 72 year. The bill would delay the first RMD year to age 73 starting in 2023, 74 in 2030 and 75 in 2033. You would be subject to the age 73 RMD age if you were born on or after January 1, 1951 and before January 1, 1957.
  • Some of you would be able to make higher catch-up contributions to your company plan or IRA beginning in 2024. For plans, the current catch-up limit for those age 50 or older is $6,500. That limit would increase to $10,000, but only if you are age 62, 63 and 64. For IRAs, the current catch-up limit is frozen at $1,000. The bill would allow that limit to increase based on the cost-of-living.
  • Any catch up-contributions to plans for those over age 50 would have to be made as Roth contributions starting in 2023. In addition, as soon as the bill becomes law, your employer could allow you to have employer matching contributions made as Roth contributions. (Currently, employer contributions are made pre-tax.) These changes were proposed to help pay for other provisions of the bill.
  • The limit on “qualified charitable distributions,” which are tax-free direct transfers from traditional IRAs to charities, would also be indexed for inflation as soon as the bill becomes law. That limit is currently $100,000 per person, per year.
  • Starting in 2024, employers with more than 10 employees who establish a new 401(k) or 403(b) plan would have to provide automatic enrollment. This means that employees would be forced to contribute to the plan unless they opt out.
  • Employers would be allowed to make matching contributions to company savings plans and SIMPLE IRAs on student loan payments beginning next year.
  • The “Saver’s Credit,” a federal tax credit for mid- and low-income taxpayers who contribute to an IRA or company plan, would be expanded, but not until 2027.
  • As soon as the bill becomes law, there would be a new exception to the 10% early distribution penalty for IRA and plan withdrawals by victims of domestic abuse.

It’s important to emphasize that this bill is not yet law and has a ways to go before it becomes law. We will keep you informed.

https://www.irahelp.com/slottreport/house-passes-secure-20-bill-it%E2%80%99s-not-law-yet

“MISSED” 2021 RMD WITHIN THE 10-YEAR RULE? OUR ADVICE ON HOW TO PROCEED

By Andy Ives, CFP®, AIF®
IRA Analyst

The new SECURE Act regulations, released in late February, created a firestorm of confusion and complexity. We have addressed concerns in recent Slott Report articles and will continue to do so as issues arise. However, as of now, one question has emerged as the most popular: How do beneficiaries handle “missed” 2021 RMDs within the 10-year payout rule?

My teammate Ian Berger touched on this in his March 7 Slott Report entry, “The Most Controversial Part of the New Regulations.” Yet, this question persists. Since so many accounts are impacted, we thought it best to address this topic again and offer our opinion on how to proceed.

Background: Eligible designated beneficiaries (EDBs) are permitted to stretch inherited IRA payments over their own single life expectancy. As such, required minimum distributions (RMDs) must be taken from the account annually. (EDBs include surviving spouses; children of the IRA owner who are under age 21; disabled or chronically ill individuals; and anyone not more than 10 years younger than the IRA owner.) But many beneficiaries do not qualify as EDBs. Most of these other beneficiaries use the 10-year payout rule.

Under the 10-year rule, the entire inherited account must be emptied by the end of the 10th year after the year of death. For the past 2+ years, industry experts believed there were no annual RMDs within the 10-year window. Nevertheless, the new regulations tell us otherwise. If the original IRA owner died on or after his required beginning date (when lifetime RMDs begin), then any subsequent 10-year period for a beneficiary or successor beneficiary will require RMDs within the 10-year window.

This leads us to what has become the question du jour (and since there is a 50% penalty for missed RMDs, it is understandable why this inquiry is so prevalent): “If a beneficiary inherited in 2020 and was subject to the 10-year rule, do we have a missed 2021 RMD?”

Answer: Nobody knows.

Until the IRS provides clear guidance, what is the best way forward?

Our advice is to sit tight, for a couple of reasons. First, no one knew there were RMDs within the 10-year period, so the IRS could conceivably waive the 2021 RMD on inherited IRAs. Or, the IRS could say the 2021 RMD must be taken, and they will issue a blanket penalty waiver. (Hopefully the IRS won’t make everyone take their 2021 RMD and then also apply for an individual penalty waiver.) Second, regardless of when a person takes the 2021 RMD this year, there are no accruing daily penalties. Whether it is taken today or in December is irrelevant from a penalty perspective. If it turns out the 2021 RMD is required, withdrawing it early vs. later this year will have the same result.

So, we suggest patience for now in the hopes that the IRS will give us some guidance on how to handle ‘missed’ 2021 inherited IRA RMDs within the 10-year period.

https://www.irahelp.com/slottreport/%E2%80%9Cmissed%E2%80%9D-2021-rmd-within-10-year-rule-our-advice-how-proceed

ONCE-PER-YEAR ROLLOVER RULE AND INCOME FOR ROTH IRA CONTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Hi,

I have a client that needs funds for a short period of time, so he plans to use the 60-day rollover rule to borrow money from his IRA and return it within 60 days. He has a Traditional IRA and a Roth IRA. He is under the impression he can do a 60-day rollover for each account. My understanding is that he can only do one 60-day rollover regardless of account type during any 365-day period, so he can only take funds from his IRA or Roth, but not both. Am I correct?

Answer:

You are correct. Traditional IRA-to-traditional IRA rollovers and Roth IRA-to-Roth IRA rollovers are aggregated for purposes of the once-per-year rollover rule.

Question:

Hello Ed Slott Team,

Do dollars that hit the 1040 from a Roth conversion get discounted when calculating MAGI for a Roth contribution? Have a great day!

Answer:

Yes. Modified adjusted gross income (MAGI) is used to determine eligibility for Roth IRA contributions. MAGI is a person’s federal adjusted gross income, with certain adjustments. One of those adjustments is a subtraction of income generated by a Roth conversion. For a full list of adjustments, see “Modified Adjusted Gross Income for Roth IRA Purposes” in IRS Publication 590-A.

https://www.irahelp.com/slottreport/once-year-rollover-rule-and-income-roth-ira-contributions-today%E2%80%99s-slott-report-mailbag

THE 3 EXCEPTIONS TO THE PRO-RATA RULE THAT YOU NEED TO KNOW

By Sarah Brenner, JD
Director of Retirement Education

Most IRA distributions will be taxable. However, if you have ever made nondeductible contributions to your IRA or rolled over after-tax funds from your company plan to your IRA, then the rules can get a little bit tricky. You will need to understand the pro-rata rule.

The pro-rate rule is a rule that almost always determines the taxation of an IRA distribution when the IRA owner has any IRA containing after-tax amounts. However, some IRA distributions are not subject to the pro-rata rule. These exceptions may provide an opportunity for you to lower the tax bill that comes with an IRA distribution or conversion.

The Pro-Rata Formula

You may have more than one IRA. For example, you may have an IRA that was rolled over from a former employer, a SIMPLE IRA with your current employer, an IRA where you make annual deductible contributions, and a IRA where a long time ago you made some contributions for which you did not take a deduction. Usually, when you take an IRA distribution, all of your IRAs (except Roth IRAs) are considered one big IRA.

With the pro-rata formula, you take the total year-end balance of all your IRAs and divide that into the total balance of all after-tax amounts in all your IRAs. The resulting percentage is then applied to the distribution to determine the tax-free portion of your distribution. The remaining part of the distribution is taxable. You cannot separate out any one part of your IRAs and select only that part to be your distribution. You cannot take out or convert only the after-tax funds in your IRAs. You must use the pro-rate formula. The pro rata formula is determined using IRS Form 8606.

Exceptions to the Pro-Rata Rule

While most IRA distributions are subject to the pro-rata rule, you should know that there are some exceptions. Three distributions that are not subject to the pro-rata rule include:

1. Rollovers to Company Plans – You may rollover your taxable IRA funds to your company plan if the plan allows.

2. Qualified Charitable Distributions (QCDs) – Each year if you are age 70 ½ or older, you can transfer up to $100,000 from your IRA to a charity tax-free.

3. Qualified HSA Funding Distributions (QHFDs) – You are permitted to do a QHFD once in your lifetime. This is a tax-free transfer from your IRA to you HSA. The amount that can be transferred cannot exceed the amount you are eligible to contribute to your HSA for the year.

You can only fund each of these distribution with the taxable part of your IRA. The pro-rata rule will not apply. Instead, the distribution will consist only of taxable IRA funds.

Strategy to Reduce Taxes

If you are eligible, using one of these three exceptions is strategy that can pay off when it comes how your IRA distributions are taxed. Each strategy allows you to move only your taxable IRA funds out of your IRA. This means that a greater percentage of what is left behind will be after-tax funds. When you convert or take a distribution, this means that less will be taxable. A smaller tax bill is good news for you. Want to learn more and find out if this is a good strategy for you? A good move is to discuss your situation with a tax or financial advisor who is knowledgeable about the IRA rules.

https://www.irahelp.com/slottreport/3-exceptions-pro-rata-rule-you-need-know

$1,512,350 IS THE NEW $1,362,800

By Ian Berger, JD
IRA Analyst

When you file for bankruptcy, one thing you usually don’t have to worry about is protecting your IRA funds from creditors.

That’s because, in just about every case, all of your IRA (and Roth IRA) monies are off limits. Under the federal bankruptcy law, IRA assets up to a certain dollar limit cannot be reached by creditors. That dollar limit is indexed every three years based on the cost-of-living. The current dollar limit is currently $1,362,800, but on April 1 it goes up to $1,512,350 until March 31, 2025.

That limit is especially generous because it doesn’t take into account rollovers from employer plans like 401(k) plans. (Those rolled-over dollars are always fully protected.) So, only IRA contributions themselves, and earnings on those contributions, are taken into account. Since IRAs did not become available until 1975, it would be a rare case for someone to have amassed over $1.5 million from IRA contributions and earnings alone.

Of course, the $5 billion Roth IRA owned by Peter Thiel, a cofounder of PayPal, is a notorious exception to that rule. If you’re also an IRA owner lucky enough to have contributory IRAs worth more than the federal dollar limit, you may have two other ways to shield your entire IRA portfolio in bankruptcy.

First, you may live in a state that has its own state bankruptcy laws protecting all of your IRA funds in bankruptcy – no matter how large (in other words, without the $1,512,350 cap).

The second way is if you live in a state with an anti-garnishment law. That’s a law that says your IRAs can’t be reached to pay off a non-bankruptcy legal judgment (for example, when you must pay lawsuit damages). In the recent case of Hoffman v. Signature Bank of Georgia, No. 20-12823 (11th Cir. 2022), January 24, 2022, a Georgia resident filed for bankruptcy. Georgia is a state that completely protects IRAs from garnishment. The Eleventh Circuit Court of Appeals ruled that the existence of the Georgia anti-garnishment law, a non-bankruptcy law, fully protects a resident’s IRA dollars in bankruptcy. (Don’t ask me to explain; it’s complicated.) That would be the case even if the IRA assets exceed the $1.5 million cap.

A couple of points about the Hoffman decision. First, it technically only affects you if you live in the Eleventh Circuit – Alabama, Florida and Georgia. Second, it would never apply if you live in a state that doesn’t have an anti-garnishment law like Georgia’s.

But, remember, even if your state doesn’t have its own laws to protect your IRAs, you can always rely on the federal protection up to $1,512,350 (come April 1). For most people, that should be more than enough.

https://www.irahelp.com/slottreport/1512350-new-1362800

ROTH IRA DISTRIBUTIONS AND IRA ROLLOVERS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question: I established a Roth IRA in 2011 and needed to withdraw $ 30,000 in 2021 to pay for my daughter’s first year of college tuition. I am under 59 1/12 and the 1099-R has a code of J meaning early distribution and no known exception. Will my distribution, therefore, be fully taxable and will I have to pay the 10% early withdrawal penalty? I was told by the Company holding my Roth IRA that it would be a fully NON-taxable distribution and no penalty as it was used for educational purposes. Please advise. Thank you

Answer: Determining the taxation of a Roth IRA distribution can be confusing. You must apply the Roth IRA ordering rules. Any contributions you have made over the years come out first. Those are always tax and penalty free. Your conversion dollars come out of the Roth IRA next and are always tax-free but can be subject to penalty if you are under age 59 ½. However, an exception does apply if you use the funds for higher education.

The last money out of a Roth IRA would be any accumulated earnings. Unfortunately, a distribution of earnings taken when you are under age 59 ½ that is used to pay for higher education would be taxable, although it would not be subject to penalty. All of your Roth IRAs are aggregated when applying the Roth IRA ordering rules, and you can use Form 8606 to determine the taxation of your distribution.

Question: Can I do a nondeductible contribution and conversion before having any pre-tax rollover contributions and after converting it to the Roth IRA, roll over my pre-tax 401k into an empty IRA a month later, without triggering the pro rata rule since at the time of the backdoor conversion there was no pre-tax monies in any IRA?

Answer: Unfortunately, that timing would not avoid the pro rata formula. That is because any funds that are rolled into the IRA later in the year are included when applying the formula. The balance at the end of the year, with some adjustments, is what is used on Form 8606 when determining the taxation of a conversion.

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

SUCCESSOR BENEFICIARIES – “YOU HAVE GOT TO BE KIDDING ME”

By Andy Ives, CFP®, AIF®
IRA Analyst

Here we go again. In my March 14 Slott Report entry (“Monitoring Concurrent Life Expectancies? – SMH”), I railed against the IRS for a seemingly pointless rule in the new SECURE Act regulations directed at elderly IRA beneficiaries. (Subsequently, I saw other commentary criticizing that same rule as “nasty” and “mean spirited.”) In today’s article, I am back on my soapbox calling out more baffling guidelines.

I will preface these comments with a direct quote from a financial advisor on Friday, March 18, after I explained the possible options to his successor beneficiary question: “Give me a break. You have got to be kidding me.

Nope, not kidding.

A successor beneficiary is the beneficiary of a beneficiary. As a successor, there is definitive guidance when it comes to handling the payouts from an inherited IRA. Successor beneficiaries are strictly bound by the 10-year payout rule. If the previous beneficiary was using the 10-year rule, the successor can only continue that same 10-year window. If, however, the previous beneficiary was stretching required minimum distribution (RMD) payments over his own single life expectancy, upon the death of that first beneficiary, the successor is permitted to start his own 10-year payout period. All good so far.

Now, the concern. For the past two-plus years the industry has been operating under the impression that there were no RMDs within the 10-year period. However, the new SECURE Act regulations dictate that there may or may not be annual RMDs within the 10-year period for successor beneficiaries. Whether or not RMDs apply within the 10 years is predicated on how old the original IRA owner was in relation to the required beginning date (RBD). If the original IRA owner died on or after the RBD (April 1 of the year after a person turns 70 ½ or 72), then the successor will have to take RMDs within the 10-year period. If the original IRA owner died before the RBD, then no RMDs are required within the 10-year period for the successor. (How to calculate those RMDs is another story.)

And that is why the financial advisor was so incredulous. His client was the first beneficiary who inherited the IRA more than a dozen years earlier. His client had been properly stretching the inherited account RMD payments over her own single life expectancy, but she just passed away. As the first beneficiary, upon her death, her successor now has the 10-year rule. When I asked the advisor if he had any idea who the original IRA owner was 12+ years ago or how old that person was at death, he replied with what became the title of this article.

The account had changed custodians a couple of times, information was lost, and the advisor acquired the client and inherited IRA only a few years earlier. He had three options: 1) Research the details of the age of the original IRA owner; 2) Hope the successor beneficiary knew definitively how old the original IRA owner was at death; or 3) Take a conservative approach and require the successor beneficiary to take annual RMDs within the 10-year period.

How many beneficiary IRAs exist that were inherited prior to the SECURE Act in 2020? Hundreds of thousands? A million? Every single one that is left to a successor beneficiary will have to go through this exercise. “You have got to be kidding me” – the appropriate response.

https://www.irahelp.com/slottreport/successor-beneficiaries-%E2%80%93-%E2%80%9Cyou-have-got-be-kidding-me%E2%80%9D

NOW IS THE TIME TO MAKE YOUR 2021 IRA CONTRIBUTION

By Sarah Brenner, JD
Director of Retirement Education

It may be hard to believe it but the countdown to the 2021 tax filing deadline is on. The deadline is April 18, 2022, for most filers. That is really only a few weeks away. Time is running out. Is your IRA ready?

Making a 2021 IRA Contribution

April 18, 2022 is the deadline for making a 2021 IRA contribution. This is true even if you have an extension to file your tax return. That does NOT give you extra time to make a traditional or Roth IRA contribution. So, if you are thinking about making that contribution you will need to move quickly.

The rules do allow IRA custodians to accept prior year 2021 contributions after the tax-filing deadline if they are mailed with a postmark of April 18 or earlier. This is true even if the contribution does not reach the custodian until after the deadline has passed. Be sure to follow your custodian’s procedures for making an IRA contribution and clearly indicate that your contribution is for the prior year (2021). If you fail to indicate that it is a prior year contribution, the custodian may report it for the current year (2022). That can cause a tax mess for you.

If you are making a 2021 traditional IRA contribution that is deductible, you will want to be sure to report it on your tax return to claim that deduction. If you are making a nondeductible contribution, be sure to file IRS Form 8606 with your tax return. That is how you will claim your basis in your IRA. This will be important down the road when you take distributions from your IRA to avoid taxation on your nondeductible contributions. What about your Roth IRA contribution? Well, Roth IRA contributions do not show up anywhere on your tax return, but you will want to track them yourself to avoid complications with future Roth IRA distributions.

Still Time

Time is not running out for all 2021 IRA transactions. After April 18, 2022, there are a few transactions that can still be done.

  • If you are looking to make a SEP IRA contribution, you may have more time. The deadline is different than it is for traditional or Roth IRA contributions. The deadline to establish and fund a SEP for 2021 is the business’ tax-filing deadline, including extensions.
  • There is still time as well to remove an unwanted contribution. For example, if you made a contribution to your traditional IRA and later discovered it was nondeductible, you can remove it, plus earnings attributable, by October 15, 2022.
  • October 15, 2022 is also the deadline to remove true excess IRA contributions and avoid the 6% excess contribution penalty. If you miss this deadline, you will be stuck paying the penalty and it will continue to accrue for each year the excess remains in the IRA.

Don’t Delay

If you are considering making a 2021 IRA contribution, do not delay. Waiting until the last minute is not a good plan. Mistakes can happen and life can get in the way. Get that 2021 IRA contribution done sooner rather than later!

https://www.irahelp.com/slottreport/now-time-make-your-2021-ira-contribution

ROTH CONTRIBUTIONS AND ROLLOVERS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hey Ed-

Long time reader and listener of yours…and have bought a few copies of your latest book to share with clients! Prior to us being involved, my client made a Backdoor Roth contribution in 2021. He did this despite his income being below the threshold limits. Also, he had existing IRA balances. Is there anything he can do? Are the 2018 recharacterization rules such that he is stuck with any tax implications?

THANK YOU!!

Graham

Answer:

Graham,

There is still time for a possible fix. Can your client deduct the 2021 contribution he made to the traditional IRA? If so, take the deduction for that contribution and do not claim the basis. (Do not file Form 8606.) Then, the “Backdoor Roth” conversion he did will just be a regular taxable conversion. Assuming he has no other basis (after-tax) dollars in his IRA, he will not have to worry about the pro-rata rule.

As for recharacterization, that is no longer available for conversions. It cannot be undone. Also, since the conversion is complete, he will not be able to recharacterize the original contribution. If he is NOT eligible to deduct the 2021 contribution, then he should file Form 8606 to claim the basis. Now we have the pro-rata rule to think about to determine how much of the conversion is taxable. By not paying attention to the Roth phase-out limits, he has certainly created some complications.

Question:

Hello there! I’ve come across your website while searching for support on a very specific problem I’m encountering. In January 2021 I left my previous employer and since I didn’t have a new 401(k) established at my new job, I asked my 401(k) provider to initiate a rollover. My 401(k) consisted of both pre-tax and Roth funds, but I only had a Roth IRA at the time.

Long story short, despite me asking the IRA custodian to facilitate a conversion of the pre-tax funds so they could go into my Roth IRA, the custodian deposited both amounts directly into the Roth IRA (rather than opening up a traditional IRA then doing the conversion). It is only now while preparing my tax return that I realize they have done this incorrectly, and again “long story short,” they are refusing to accept ownership of the error or help to resolve it, beyond saying the only mitigation I can take is to file an ‘IRA Recharacterization’.

This form looks fairly complicated since the funds have been in positions since they were deposited at the start of last year. I’m also concerned by some statements in the Tax Cuts and Jobs Act, and I’m concerned some rollover dates may be violated as a result of performing a fix.

I’ve reached out to a few CPAs online but I’m struggling to find any who specializes in this issue just yet. I’m hopeful you might be able to support me in rectifying this issue.

Kind regards

Jonathan

Answer:

Well, Jonathan, that is a long story long! Good news is that there is no problem with the transaction you outlined. Former pre-tax 401(k) dollars are allowed to be rolled over directly to a Roth IRA. This is a valid conversion. The funds do NOT have to be routed through a traditional IRA first. No need to reverse any transactions, no need to try to recharacterize anything, no need to push back on the custodian. No errors were made. Enjoy tax-free earnings in your Roth IRA, and congrats on a proper conversion from your 401(k)!

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

DECIPHERING YOUR 401(K) STATEMENT

By Ian Berger, JD
IRA Analyst

With many 401(k) (and 403(b) and 457(b) plans) offering multiple participant accounts, your plan statement is probably more complicated than ever. Here’s a brief primer to help you understand what each account represents:

Pre-tax deferral account. All retirement savings plans allow for pre-tax deferrals. You make these contributions from before-tax pay. Both the contributions and earnings are taxable when paid out.

Roth contribution account. Roth contributions are optional, but are becoming more and more popular. Contributions are made on an after-tax basis. When funds from this account are distributed, they will either be “qualified” or “non-qualified.” If qualified (meaning you have turned age 59 ½, become disabled or died, and the account has been held for at least five years), contributions and earnings are non-taxable. If non-qualified, the distribution is partially taxable based on the pro-rata rule. The taxable portion is calculated by dividing the amount of earnings by your total Roth account balance and then multiplying that ratio by the amount of your distribution.

After-tax contribution account. Traditional after-tax (non-Roth) employee contributions are allowed in 401(k) and 403(b) plans, but not in 457(b) governmental plans. Contributions come from already-taxed pay. Earnings on after-tax contributions will be taxable. A partial distribution from that account will be partly taxable based on the pro-tata rule as applied just to that account.

Pre-87 after-tax account. If you made after-tax contributions before 1987, you can withdraw those contributions separately from their earnings. The pro-rata rule doesn’t apply.

Rollover account. Your plan may accept rollovers into the plan of deductible IRA funds or pre-tax funds from other plans you participated in. These rollover funds and associated earnings are taxable when distributed to you.

Employer matching/profit sharing contribution account. Employer matching or profit sharing contributions are common in 401(k) plans, less common in 403(b) plans, and rare in 457(b) governmental plans. These contributions are pre-tax funds.

Matching contributions are typically made on both your pre-tax deferrals and Roth plan contributions. (Even if made on Roth contributions, matching contributions are still allocated to this pre-tax account.) Profit sharing contributions are usually expressed as a flat percentage of your compensation (for example, 3% of annual pay) – whether you make contributions or not. Your plan can impose a service requirements before you are vested in (i.e., you own) employer contributions made on your behalf. However, if your company makes “safe harbor” contributions to avoid IRS nondiscrimination testing, those contributions must be 100% vested right away.

https://www.irahelp.com/slottreport/deciphering-your-401k-statement

“MONITORING CONCURRENT LIFE EXPECTANCIES?” – SMH

By Andy Ives, CFP®, AIF®
IRA Analyst

I am usually patient with the IRS. I understand the massive workload they have, and there are tax cheats lurking around every corner. The IRS does its best to ensure no loopholes exist for bad actors to circumvent tax laws to avoid paying their fair share. However, when it comes to some of the guidance in the recently released SECURE Act regulations, my patience has run out.

There are a number of items in the proposed regulations that make me SMH – shake my head. But I will focus on one egregious case of ridiculous government oversight: monitoring concurrent life expectancies. This rule is so complex and misguided that there is little chance it will ever be properly followed.

Example: Robert dies at age 74, which is after his required beginning date (RBD) dictating when RMDs begin. Robert’s beneficiary is his older sister Sally, age 80. Since Sally is not more than 10 years younger than Robert, she can stretch RMD payments. However, since Robert died after his RBD and Sally is older that Robert, Sally is permitted to use Robert’s single life expectancy to calculate her RMDs. Robert’s life expectancy in the year of death is 15.6 years for a 74-year-old. For subsequent years, Sally subtracts 1 each year. As such, the IRA should last for 15 years until Sally is age 95.

And here is where things go off the rails. From the Explanation of Provisions of the proposed regulations:

…these proposed regulations require a full distribution of the employee’s remaining interest in the plan in the calendar year in which the [life expectancy factor] would have been less than or equal to one if it were determined using the beneficiary’s remaining life expectancy (even though the [life expectancy factor] for determining the required minimum distribution is based on the remaining life expectancy of the employee).

Translation: Even though Sally is using Robert’s life expectancy factor (15.6) to calculate her annual RMDs, she must also monitor her OWN life expectancy factor to determine when she must empty the account. Had Sally used her own life expectancy to calculate RMDs, she would have started with 10.5 (the factor for Sally’s age in the year after Robert’s death – age 81*). Eleven years later, Sally’s own life expectancy factor would have been down to 0.5. Since 0.5 is less than one, Sally is required to empty the inherited IRA at age 91. This is true even though Robert’s life expectancy still had four years remaining and was the life expectancy Sally had been properly using to calculate her RMDs from age 81 to 91.

C’mon, man. Give me a break. Why focus on something as miniscule as this? Aren’t there bigger fish to fry? We have to make a rule for the rare occurrence when this happens, just to fractionally accelerate RMD payments to generate pennies more in tax revenue? Good luck explaining this rule to the general public. Good luck actually implementing it and enforcing it.

Some things deserve to be lambasted. “Monitoring concurrent life expectancies?” SMH.

*Note: While the example in the regulations uses the life expectancy of 11.2 in the year of death, we chose to use the life expectancy in the year after death for our example.

https://www.irahelp.com/slottreport/%E2%80%9Cmonitoring-concurrent-life-expectancies%E2%80%9D-smh

NEW IRS SECURE ACT REGULATIONS AND MISSED RMDS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Ed,

I read your 2/28/22 Slott Report on the updated SECURE Act information for non-eligible designated beneficiaries (non-EDBs) that requires annual RMDs to continue if the original owner was taking them prior to his death and also requires the account to be emptied by the end of year 10.

Since the Roth IRA does not have RMDs, is it correct to assume that the non-EDB of an inherited Roth IRA would also not be required to take RMDs and only be subjected to the 10-year rule?

Thank you.

Answer:

You are correct. The new IRS regulations specifically say that Roth IRA owners are considered to have died before their RMD required beginning date (RBD). Since the new annual RMD requirement applies only when an IRA owner dies on or after his RBD, beneficiaries of inherited Roth IRAs are spared from this rule. However, those beneficiaries still have to empty the account by December 31 of the 10th year following death.

Question:

I will try to be brief.

I do taxes for an 80+ year old lady with an IRA. She said she never received a letter from the company she has her IRA with to let her know she needed to take a withdrawal for 2021. The company, of course, says they did.

I am trying to find a way to rectify this situation. She is filling out the paperwork for the 2021 RMD, but because she is two months past the due date, technically she owes the penalty. Should we file her taxes for 2021 and just wait for the IRS to catch up with this?

Thank you,

Chuck

Answer:

Hi Chuck,

There is a 50% excise tax for missing an RMD. However, the IRS will usually waive that penalty if the IRA owner takes the RMD and files Form 5329 with the IRS. The Form 5329 should include an attachment explaining why your client did not take the 2021 RMD. She does not need to pay the excise tax unless the IRS comes back and assesses it (which is unlikely).

https://www.irahelp.com/slottreport/new-irs-secure-act-regulations-and-missed-rmds-today%E2%80%99s-slott-report-mailbag

SECURE ACT REGS BRING NEW ROTH IRA ADVANTAGE

By Sarah Brenner, JD
Director of Retirement Education

Roth IRAs have always been a great retirement savings tool. While pre-tax retirement accounts allow tax deferred savings, a Roth IRA promises tax-free benefits. They allow you to receive years of earnings in retirement without tax consequences. Those tax-free distributions also have the side benefit of not increasing stealth taxes such as IRMAA surcharges and taxation of Social Security benefits. Add in the fact that a Roth IRA does not require RMDs during the owner’s lifetime (unlike qualified plans and traditional IRAs), and it is easy to see the Roth advantage. The newly released SECURE Act regulations have added another benefit to the Roth IRA tax break list with their unexpected interpretation of the 10-year payment rule.

In the new regulations, the IRS has taken the position that when an IRA owner dies on or after their required beginning date and the 10-year rule applies, the account is also subject to annual RMDs. This surprising interpretation of the SECURE Act will affect a lot of IRA beneficiaries because most IRA beneficiaries will be subject to the 10-year rule under the SECURE Act and many IRA owners die when they are older and beyond their required beginning date. Now these beneficiaries are subject to the hassle of having to calculate annual RMDs during years one to nine of the 10-year period using tricky rules. They must take taxable distributions to avoid a hefty 50% penalty for missed RMDs.

Good news for Roth IRA beneficiaries! The IRS confirms in the regulations that all Roth IRA owners are considered to have died before their required beginning date. This means no annual RMDs from inherited Roth IRAs are required for beneficiaries subject to the 10-year rule. An inherited Roth IRA offers complete flexibility within the 10-year period and completely avoids the complicated RMD rules. And, best of all, the Roth IRA can grow tax-free for ten years before any distributions are required.

Example: Rodney, age 75, dies in 2022. The beneficiary of his Roth IRA is his daughter, Rhianna, age 50. Rhianna will be subject to the 10-year rule, but she does not have to take annual RMDs. She can let the Roth IRA grow and accumulate tax-free earnings for ten years. The entire inherited Roth IRA must still be distributed by December 31, 2032, but it will be a tax-free distribution.

https://www.irahelp.com/slottreport/secure-act-regs-bring-new-roth-ira-advantage

THE MOST CONTROVERSIAL PART OF THE NEW IRS REGULATIONS

By Ian Berger, JD
IRA Analyst

The part of the new IRS SECURE Act regulations causing the most reaction is the one requiring annual required minimum distributions (RMDs) for some IRA or workplace plan beneficiaries subject to the 10-year payment rule.

Under the SECURE Act, IRA or plan beneficiaries who are not “eligible designated beneficiaries” (EDBs) are subject to the 10-year rule. (EDBs are surviving spouses; children of the IRA owner or plan participant who are under age 21; disabled or chronically ill individuals; and anyone not more than 10 years younger than the owner/participant.) Non-EDBs must empty the IRA or plan account by the end of the 10th year following the year the owner or participant died. On the other hand, EDBs are allowed to stretch required minimum distributions (RMDs) over their life expectancy.

Prior to the issuance of the new regulations, most commentators believed the 10-year rule never required annual RMDs for years 1-9 of the 10-year period. In the past, the IRS has given out mixed signals on this issue. However, in the new regulations, the IRS very clearly says that certain non-EDBs are subject to both the 10-year payment rule and a requirement to take annual RMDs in years 1-9 of that 10-year period.

Only non-EDBs who inherit on or after the owner or participant’s required beginning date (RBD) are subject to the annual RMD requirement. Non-EDBs who inherit before the decedent’s RBD can take as little or as much as they want over the 10-year period. But the rule requiring distribution of the entire account by the end of the 10-year period still applies.

So, what is the RBD? It’s the date by which the first RMD is due. For an IRA owner born before July 1, 1949, it’s April 1 of the year following the year she turned age 70 ½. For an IRA owner born on or after July 1, 1949, it’s April 1 of the year following the year she turns 72. For plan participants who don’t own more than 5% of the company sponsoring the plan, the RBD can be delayed until April 1 of the year following the year of retirement.

What if you are a non-EDB who inherited in 2020 after the owner/participant’s RBD and you didn’t receive your 2021 RMD (because you didn’t know it was required)? Should you take the missed RMD now? Keep in mind it’s possible that 2021 annual RMDs in this situation were not required based on the fact the new regulations technically weren’t effective last year. (This is a murky legal question.) It’s also possible the IRS will issue relief for missed 2021 RMDs later this year. Holding off taking your 10-year-rule 2021 RMD until later in 2022 won’t subject you to any higher penalty than if you take it now. So, if you are in the affected category of non-EDBs, you may want to delay your “missed” 2021 RMD until later in 2022 when we may know more. Talk this over with a knowledgeable financial advisor.

Meanwhile, we’ll let you know about any further guidance from the IRS on this issue.

https://www.irahelp.com/slottreport/most-controversial-part-new-irs-regulations

REQUIRED MINIMUM DISTRIBUTIONS AND INHERITED IRAS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Hello. I was reading the 2/28/22 edition of the Slott Report and noticed the section titled “Beneficiaries Hit w/Annual RMDs and the 10-Year Rule.” It was my understanding that starting 1/1/20, most non-spouse beneficiaries would have 10 years from the year of death to distribute the IRA, with no RMDs required.

Will adult individuals who inherit a traditional IRA from an 80-year-old parent in 2020, for example, now have to start taking annual RMDs, with the remaining balance withdrawn in the 10th year?

Thank you!

Answer:

This is a great question. The IRS just recently released proposed SECURE Act regulations. In the regulations, they do take the position that, if the IRA owner died on or after his required beginning date, then annual RMDs would be required, as well as the SECURE Act’s 10-year rule. In your example, an adult child, who inherits a traditional IRA from a parent who dies at age 80, would need to take annual RMDs from the inherited IRA (for years 1-9 after the year of death) and also empty the account by the tenth year following the year of death. If the IRA owner dies before his required beginning date, then no annual RMDs would be required during the 10-year payout period.

Question:

If a Roth IRA was inherited before 2019 and the non-spouse beneficiary is taking RMDs under the old stretch lifetime rules, will the new changes to the IRS life expectancy table apply to that inherited Roth IRA staring in 2022?

And, if yes, will the IRA custodian automatically make the changes (apply the new factors), or does the beneficiary have to do something?

Thank you.

Answer:

All beneficiaries who are required to take annual RMDs from inherited IRA can use the new life expectancy tables issued by the IRS starting for 2022 RMDs. For a non-spouse beneficiary, this may mean resetting her factor by finding her age in the year following the Roth IRA owner’s death on the new table and then subtracting one for each year that has passed through 2022. Custodians are likely to make the changes automatically, but if you have any questions you should contact them or reach out to a knowledgeable tax or financial advisor.

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

AGE OF MAJORITY AND THE NEW SECURE ACT REGULATIONS

By Andy Ives, CFP®, AIF®
IRA Analyst

The 275 pages of proposed SECURE Act regulations, released by the IRS on February 23, are chock full of little details. Each of these tidbits will have some impact on particular IRA owners and retirement account participants.

One such new rule pertains to the age of majority. When is a minor child recognized as an adult? Existing IRS guidance deferred to the age of majority under state law. This created some confusion as most states said age 18, a couple said 19, and Mississippi said 21. Why is this important? The age of majority dovetails with the opportunity a minor beneficiary has to stretch inherited IRA account assets.

The new regulations draw a universal line in the sand. The age of majority is now recognized as 21.

The minor child of an IRA account owner is considered an eligible designated beneficiary (EDB). As an EDB, that minor child is allowed to use her own single life expectancy to calculate an annual required minimum distribution (RMD). This will allow the child to stretch IRA payments until she is 21. At that time, the 10-year payout rule will apply, and the now-adult child will have another 10 years to maintain the inherited IRA. (Future Slott Report entries will discuss the new guidelines governing the 10-year rule.)

Example: Meredith dies at age 48. She had an IRA, and her only daughter Sally, age 10, was listed as the beneficiary. Sally is an EDB, so she is permitted to stretch IRA payments over her own life expectancy. (When RMDs start in the year after death, when Sally is 11, she will use the single life expectancy factor of 73.9.) Sally can take annual RMD payments until she is 21. At that point, the 10-year rule will apply. Sally must then empty the account by December 31 of the tenth year following the year she turns 21.

Additionally, the new SECURE Act regulations changed a provision which allowed minor children who were still in school to extend the age of majority to as late as age 26. This is no longer an option and, as such, should minimize confusion. The “still-in-school” language is no more. The age of majority, as recognized by the SECURE Act regulations, is fixed at 21.

Stay tuned for more summaries of the SECURE Act regulations in the coming days and weeks. There is lot to dig through in those 275 pages, and we will do our best to bring you the pertinent highlights…and lowlights.

https://www.irahelp.com/slottreport/age-majority-and-new-secure-act-regulations

SECURE ACT REGULATIONS ARE HERE

By Sarah Brenner, JD
Director of Retirement Education

On February 23, 2022, the IRS released the long-awaited proposed SECURE Act regulations. The new regulations clock in at 275 pages and offer guidance on many SECURE Act rules. They also include a few surprises. Here are some highlights.

Eligible Designated Beneficiaries

The SECURE Act did away with the stretch IRA for most beneficiaries, but those who are considered an eligible designated beneficiary (EDB) can still take advantage of it. The regulations clarify exactly who is an EDB. They specify that a minor child of an IRA owner is considered an EDB until his 21st birthday. The regulations also provide guidance on determining who qualifies as disabled, particularly for beneficiaries under age 18.  Also, a new documentation requirement is imposed on chronically ill and disabled EDBs to qualify for the stretch.

Trusts

The SECURE Act upended the rules for trusts as beneficiaries of IRAs, and guidance addressing the outstanding issues were sorely needed. The newly released regulations keep many of the rules that existed for trust beneficiaries prior to the SECURE Act such as the rules for look-through trusts. If a trust satisfies the look-through rules, then the beneficiaries of the trust are considered designated beneficiaries.

The regulations also attempt to answer some of the many issues with trusts that were raised in private letter rulings over the years. This includes when beneficiaries can be disregarded for purposes of identifying RMD payments, the impact of powers of appointments, and state laws that permit the terms of a trust to be modified after death.

The SECURE Act carved out special rules for trusts with disabled or chronically ill individuals allowing the stretch even if the trust has other beneficiaries. The new regulations provide guidance on these trusts and also add minor children of the IRA owner as another category of EDB that can still qualify for the stretch even if there are other non-EDB trust beneficiaries.

Beneficiaries Hit with Annual RMDs and the 10-Year Rule

The IRS has taken a somewhat surprising position on the new 10-year rule imposed by the SECURE Act. If the account owner dies before her required beginning date, the 10-year rule only requires that the entire account be emptied by December 31 of the tenth year following the year of death. There are no annual RMDs. However, the new regulations say that if the IRA owner dies after her required beginning date, then not only does the 10-year rule apply, but also annual RMDs are required in years one through nine.

Spousal Rollovers

The regulations include a new rule for spousal rollovers that seems to be intended to prevent spouse beneficiaries from using the new 10-year rule to delay RMDs. The rule requires “hypothetical missed RMDs” to be taken when a spousal rollover is done in some circumstances.

50% Penalty Relief

If the IRA owner was required to take an RMD in the year of their death, the rules require the beneficiary to take that RMD if the IRA owner did not do so prior to death. This rule can be hard on beneficiaries when the IRA owner dies late in the year. The new regulations provide some relief in these situations by providing an automatic waiver of the 50% penalty that usually applies when an RMD is missed. This waiver is available as long as the beneficiary takes the year of death RMD by her tax-filing deadline, including extensions.

Stay Tuned

The new regulations are proposed to apply for determining RMDs for 2022 and later. Public comments are being accepted and a hearing is scheduled in Washington for June 15, 2022. The IRS will then issue final regulations at some point in the future. That could take some time. Stay tuned to the Slott Report for more information on the new SECURE Act regulations!

https://www.irahelp.com/slottreport/secure-act-regulations-are-here

ROTH CONVERSIONS AND SPOUSAL IRAS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

If an 80-year-old converts his IRA to a Roth account and dies the following year, when can the beneficiaries begin withdrawing money tax-free from the Roth?  Do the beneficiaries have to wait for the expiration of the 5-year period following the conversion?

Thank you for your response.

George

Answer:

George,

Since the IRA owner already paid taxes on the converted dollars, any converted funds will be immediately available to a beneficiary tax-free. When it comes to earnings in that same Roth IRA, it is a little trickier. Regarding the earnings, it depends if the 80-year-old ever had a Roth IRA before. If the conversion (when he was 80) is his first exposure to a Roth IRA, then the beneficiaries will have to wait the full 5 years from January 1 of the year of conversion before the earnings will be tax-free. (It does not matter if a beneficiary has his own IRA.) If the 80-year-old already had a Roth IRA for 5 years, the earnings will be immediately available tax-free to his beneficiaries.

Question:

I enjoy reading the Slott Report mailbag articles, and I’ve learned a lot. Thanks! Your recent post on spousal IRA’s was timely and did prompt a couple follow-up questions:

1.  Is the spousal IRA contribution limit $7,000 (for a couple aged 61)?

2.  Can a spousal IRA contribution for a prior year be made until April 15th?

3.  Can a spousal IRA contribution be made into a Roth account?

Thanks,

Greg

Answer:

Greg,

Thanks for reading! Yes, a spousal IRA contribution is limited to $7,000 ($14,000 combined) assuming both spouses are age 50 or over and the working spouse has enough earned income to make the contributions. It can be made up to April 15 for the prior year (April 18 for 2021). And yes, a spousal contribution can be made to a Roth IRA. Just be aware of the income phase-out limits for Roth IRA contribution eligibility.

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

ACT NOW TO CLEAN UP 2021 EXCESS 401(K) DEFERRALS

By Ian Berger, JD
IRA Analyst

The amount of annual pre-tax deferrals and Roth contributions you can make to a 401(k) plan is limited by the tax code. If you exceeded that limit in 2021, time is of the essence to correct the error. If you don’t act quickly, the tax consequences can be serious.

For 2021, you were limited to $19,500 in pre-tax deferrals and Roth contributions (plus an additional $6,000 if you were at least age 50 at the end of the year). It’s important to remember that 2021 pre-tax deferrals and Roth contributions made to ALL plans are combined when applying this limit. (There is an exception if you participate in both a 401(k) plan and 457(b) plan.)

Most plans have mechanisms in place to prevent you from exceeding the deferral limit in that plan. If the plan mistakenly allows you to overcontribute, it is up to the plan to fix the problem.

It’s a different matter if you participated in two different plans during the year (because you had two jobs at the same time or changed jobs). One plan had no way of knowing how much you contributed to the other plan. So, it’s up to you to keep track. Your W-2 from each employer indicates the amount of pre-tax deferrals and Roth contributions in Box 12. Or, you can check your plan account statements.

If you’ve overcontributed, contact the administrator of one of the plans and make them aware of the problem. To avoid double taxation (see below), the error must be fixed by April 18, 2022. But act quickly to give the plan enough time to correct the error by that deadline.

The plan fixes the problem by making  a “corrective distribution” to you. That is the excess amount, adjusted for earnings or losses on the excess. You’ll receive a corrected W-2 that adds back the excess deferrals to your 2021 taxable income. Earnings on the excess are taxable to you in 2022.

Example: Ray, age 40, had two jobs in 2021 and participated in each company’s 401(k). He made $10,000 of Roth contributions to the Alpha Company plan before leaving Alpha on June 30, 2021 to work for Beta Company. Ray did not keep track of his total 2021 contributions and made another $12,000 to the Beta 401(k) for a total 2021 contribution of $22,000. He has exceeded the 2021 deferral limit by $2,500 ($22,000 – $19,500). The excess deferrals earned $200. Ray becomes aware of this problem and contacts the administrator of Beta’s plan. On March 31, 2022, the Beta plan makes a corrective distribution of $2,700 ($2,500 + $200) to Ray. Beta also sends Ray a corrected 2021 W-2 showing an additional $2,500 of 2021 taxable income. He must include the $200 as taxable income for 2022.

If the corrective distribution is not made by April 18, 2022, you’ll face double trouble. The excess deferrals cannot be paid to you until you are otherwise able to receive a distribution from the plan. Nonetheless, they are taxed to you in the year they were contributed. And the excess, along with related earnings, is taxable a second time in the year it is eventually distributed to you.

https://www.irahelp.com/slottreport/act-now-clean-2021-excess-401k-deferrals

WHAT PROTECTION DO SPOUSES GET IN COMPANY PLANS?

By Ian Berger, JD
IRA Analyst

The federal ERISA law gives spouses of plan participants in ERISA-covered plans certain rights to the participant’s account. There are two types of ERISA financial protection for spouses. Spouses of IRA owners usually don’t have similar rights.

The first type of protection applies to all ERISA plans. Those plans must automatically treat a married participant’s spouse as his beneficiary – unless the participant designates another beneficiary and the spouse gives written consent. (Spouses in community property states also receive this protection for IRAs established during marriage.)

An offshoot of this rule is the requirement that, without spousal consent, a surviving spouse of a married participant who dies before retirement must be paid in the form of a lifetime annuity. However, this annuity requirement doesn’t apply to 401(k) plans that don’t offer an annuity as an optional form of payment.

Example 1: Martina participates in a 401(k) plan that does not offer an annuity as a payment option. She has designated her brother Nicolas as her 401(k) beneficiary, but her husband Daniel has never consented to that designation. While participating in the plan and still married to Daniel, Martina dies. The plan must pay the death benefit to husband Daniel – not to Nicholas. However, the benefit to Daniel does not have to be paid in the form of a lifetime annuity. So, he can elect a lump sum payment.

The second type of spousal protection requires certain plans to pay a married participant’s benefit in the form of a specific type of annuity – unless the participant elects another form of payment and the spouse consents. The required annuity pays a monthly benefit over the participant’s lifetime and, if the surviving spouse outlives the participant, pays the spouse a monthly benefit over the spouse’s remaining lifetime. The spousal benefit must be at least 50% of the participant’s benefit.

This rule applies to all plans covered by ERISA, except for most ERISA-covered 401(k) plans. (It does apply if those plans offer an annuity as an optional form of payment, and the participant elects the annuity.)

Example 2: Michael is in an ERISA-covered pension plan. He is married to Hannah when he retires. He wants to receive an annuity from the plan that will pay him over his lifetime only, with no spousal benefit after he dies. The plan can only pay Michael this type of annuity if Hannah consents. If she doesn’t consent, he can still receive an annuity over his lifetime. But if Hannah survives him, she must receive an annuity payment over her lifetime that is at least 50% of Michael’s payment. Because of that spousal benefit, Michael’s lifetime payment will be smaller than it would have been if there were no spousal benefit.

https://www.irahelp.com/slottreport/what-protection-do-spouses-get-company-plans

DIRECT ROTH CONVERSIONS AND QCDS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I am 66 years old and live on Social Security and other retirement income. Additionally, I have about a half million dollars in pre-tax 457(b) funds that I do not need for current expenses. Are these funds in the pre-tax retirement accounts eligible for Roth conversion? Can I withdraw funds from the 457(b) account and deposit them in a Roth IRA? Must I have current compensation to do a Roth conversion?

Jane

Answer:

Assuming you are eligible to take a distribution from your 457(b), those funds can be directly converted to a Roth IRA. You do not need to have current compensation to do a Roth conversion. Of course, you will need to pay taxes on the amount that you convert.

Question:

Hello,

Can a QCD be made from a SEP or SIMPLE IRA if the employer/participant does NOT make a deductible contribution to the SEP or SIMPLE IRA during the tax year in which the QCD is made? Alternatively, can a traditional IRA account be established as a receptacle for a trustee-to-trustee transfer of funds from the SEP or SIMPLE IRA followed by a QCD from the “new” traditional IRA account?  Would the IRS successfully argue step transaction to prevent this planning strategy?

Thank you.

Answer:

Yes, you can do a QCD from a SEP IRA for a particular year, but only if you do not receive a contribution from the SEP for that year. (This would be considered an “inactive SEP.”) Even if you receive a SEP contribution, you could roll over or transfer SEP funds to a traditional IRA and then do a QCD from that IRA. This is a perfectly acceptable workaround and not considered a step transaction.

The same rule applies to SIMPLE IRAs. However, you can only do a rollover or transfer from a SIMPLE to an IRA if you have participated in the SIMPLE for at least two years.

https://www.irahelp.com/slottreport/direct-roth-conversions-and-qcds-today%E2%80%99s-slott-report-mailbag

MAKING A SPOUSAL IRA CONTRIBUTION

By Sarah Brenner, JD
Director of Retirement Education

The pandemic has upended the workforce. Many workers lost jobs. Some workers resigned by choice. Others were forced to leave jobs due to childcare issues. If you are not working outside the home, you may believe you are ineligible to make an IRA contribution. You may think that because IRA contributions are based on taxable compensation, if you personally have not been working, you are out of luck. Good news! If you are married but not working, you may be able to make a contribution to your IRA based on your spouse’s taxable compensation for the year. These IRA contributions are called “spousal IRA contributions.” Spousal IRA contributions can be a valuable tool if you are out of the workforce and are concerned about the impact this may have on your retirement savings.

To do a spousal contribution, you make a contribution to your IRA based on your spouse’s compensation. Your spouse can still contribute to an IRA too, as long as he or she has enough earned income or taxable compensation to fund both contributions. Keep in mind that other IRA contribution rules still apply. There are income limits for Roth IRA contributions and, if your spouse is an active participant in a retirement plan, that can affect your ability to deduct your traditional IRA contribution.

You may make spousal IRA contributions in some years and regular IRA contributions in others. For example, if you were a stay-at-home parent in 2021 and the only income was generated by your spouse, you may make a spousal contribution for 2021. If you go back to work in 2022 and have taxable compensation, you could then make a regular contribution for 2022. Your 2021 spousal IRA contribution and your 2022 regular IRA contribution may both be made to the same IRA. There is no need to keep regular and spousal contributions in separate IRAs. You do not have to inform the IRA custodian that you are making a spousal contribution instead of a regular contribution because there is no special reporting required by the IRS. You are not required to contribute to the same type of IRA as your spouse. For example, you may choose to contribute to a traditional IRA and your spouse may contribute to a Roth IRA. You are also not required to make your contributions at the same time or with the same IRA custodian.

To make a spousal contribution for the year, you must be legally married on December 31 of that year. If you are divorced or legally separated as of that date, you are not eligible even if you may have been married earlier in the year. You must also file a joint federal income tax return for the year.

https://www.irahelp.com/slottreport/making-spousal-ira-contribution

HOW DOES THE IRS COMPENSATION LIMIT WORK?

By Ian Berger, JD
IRA Analyst

Towards the end of each year, the IRS announces cost-of-living increases for several retirement-related dollar limits that will become effective for the next year. For example, last November, the IRS said that the limit on employee pre-tax deferrals and Roth contributions in company plans would increase to $20,500 for 2022. You may have also seen that the IRS compensation limit also increased for 2022 to $305,000. What is this limit all about?

The compensation limit is a cap on the amount of pay that can be considered when determining the amount of employer contributions that highly-paid participants receive in a company plan, including SEP and SIMPLE IRAs. It’s also used in performing nondiscrimination testing for 401(k) and 403(b) plans.

With a compensation limit of $305,000 for 2022, most employees will never be affected. And if your pay does exceed the cap, it doesn’t mean you can’t receive a contribution. It just means your pay in excess of $305,000 can’t be used in calculating the company contribution made on your behalf.

Company contributions are made in most 401(k) plans and in some 403(b) plans. Those contributions are of two types: either a matching contribution (only for employees making deferrals), or a flat contribution for all eligible employees (regardless of whether they make deferrals). In both cases, the compensation limit applies.

Example 1: Catherine, age 55, is CEO of Acme Industries and participates in its 401(k). Acme matches 50% of each employee’s elective deferrals up to 5% of compensation. Catherine defers $27,000 in 2022 and earns $400,000 this year. The plan can only recognize $305,000 of Catherine’s compensation. This limits her match to $7,625 [50% x (5% x $305,000)]. Without the $305,000 maximum, her match would have been $10,000 [50% x (5% x $400,000)].

Example 2: Andre is CFO of General Hospital and will make $350,000 in 2022. He chooses not to make elective deferrals to the hospital’s 403(b) plan, which provides a flat 3%-of-pay employer contribution. Even though Andre does not make elective deferrals, he can still receive a contribution from the hospital. But that contribution will be limited to $9,150 (3% x $305,000).

The compensation limit also applies to SEP IRA contributions. However, it does not always apply to SIMPLE IRAs. SIMPLE IRAs can have either a matching employer contribution or a flat contribution. If a flat contribution is made, the pay cap does apply. But if a matching contribution is made, the cap does not apply and all compensation can be taken into account.

https://www.irahelp.com/slottreport/how-does-irs-compensation-limit-work

ROTH CONVERSIONS & RMDS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

I turn 72 this year.

I am getting notices from my many IRA custodians that they want a waiver on file if I am NOT using my account for the RMD (i.e., I am taking it somewhere else). They make it sound like if I do not contact them, that they will automatically cut me a check for the required RMD amount.

How can that be?  Don’t custodians have to have permission or instructions to make such distributions?

Bob

Answer:

Hi Bob,

You are correct in that it is possible to aggregate your RMDs from your many IRAs and take the total amount from one.

Many custodians will require you to sign a waiver to have on file if you do not want to take your RMD from the IRA at their institution. Without a such a waiver, they will automatically pay out the RMD. This is a common practice and is intended as a customer service to help ensure that RMDs are taken, even though ultimately the IRS views taking the RMD as the responsibility of the IRA owner.

 

Question:

Hi,

I am trying to confirm that clients can do a Roth conversion before completing an RMD as long as we complete the full RMD later in the tax calendar year. The Slott website says that RMDs must be done first, but I have CPAs saying that’s not true as long as you meet the full RMD amount determined on the prior 12/31 valuation. Please help.

Jack

Answer:

Hi Jack,

This is an area where we get a lot of questions, but the rules are very clear. RMDs can never be rolled over or converted. Further, the “first money out” rule says that the first funds distributed from an IRA in a calendar year when an RMD is due are considered the RMD. Because a conversion is a distribution and RMDs cannot be converted, the RMD must be taken prior to the conversion. It is not possible to convert an IRA and then take the RMD later.

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

10% PENALTY EXCEPTIONS

By Andy Ives, CFP®, AIF®
IRA Analyst

For IRA owners and retirement plan participants who are under age 59 ½, taking a distribution from a retirement account is typically off limits. The distribution will most likely be taxable, and there is a good chance that a 10% penalty will also apply. However, sometimes life gets in the way and a withdrawal needs to be made.

Before shaking out your retirement piggy bank, know the rules. There is a possibility that the 10% penalty can be avoided. The IRS provides some exceptions, but be careful. Some of the exception apply only to IRAs, some apply only to plans, and some apply to both.

Exceptions Applicable to Both IRAs and Plans (Including SEP and SIMPLE IRAs)

  • Death
  • Disability
  • 72(t) “substantially equal periodic payments”
  • Medical expenses (over 7.5% of AGI)
  • IRS levy
  • Active reservists
  • Birth or adoption

Exceptions Applicable to IRAs Only (Including SEP and SIMPLE IRAs)

  • Higher education expenses
  • First-time home buyer
  • Health insurance if you are unemployed

Exceptions Applicable to Plans Only (Excluding SEP and SIMPLE IRAs)

  • Age 55
  • Age 50 for public safety employees
  • Section 457(b) (governmental) plans
  • Divorce (QDRO – qualified domestic relations order)
  • Phased retirement distributions from federal plans

Additionally, some of the exceptions apply only to the account owner. For example, the disability exception can only be used if the IRA or retirement plan participant is the one who is disabled. If an under-59 ½ spouse were to take an IRA distribution from his own account under the impression that he could claim the disability exception based on his wife’s disability, he would be mistaken. The 10% penalty would apply.

On the flip side, some exceptions are available to the account owner as well as certain family members. The higher education exception is a good example. As long as the higher education expenses are for the IRA owner, the IRA owner’s spouse, or any child or grandchild of the IRA owner or the IRA owner’s spouse, then the 10% penalty exception will work.

There is definitive nuance to each of the 10% penalty exceptions. The timing of the distribution vs. when bills are paid can be critical. Some exceptions allow for repayment, others do not. Regardless of which exception is applicable to your situation, be sure to know the rules before taking any plan or IRA distribution.

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

WATCH OUT FOR THE FIVE-YEAR RULE ON CONVERTED ROTH FUNDS

By Sarah Brenner, JD
Director of Retirement Education

If you are under age 59 ½ and you converted your traditional IRA to a Roth IRA, you will need to watch out for the five-year rule for penalty-free distributions of converted funds. Not understanding how the rule works can result in unexpected penalties when you withdraw your Roth IRA funds.

If you make annual tax year contributions to your Roth IRA, you can always access those funds tax- and penalty-free. That is pretty easy to understand. However, when it comes to converted funds, it gets a little more complicated. You can always access your converted funds tax-free – even if you are under age 59 ½. That makes sense because you already paid the tax bill when you did the conversion.

It’s a different story when it comes to the 10% early distribution penalty. If you are under age 59 ½, you must satisfy a five-year holding period on funds that were taxable when converted before you can access those funds penalty-free.

The five-year holding period will restart for each conversion and is effective as of January 1 of the year of conversion. If the conversion was done any time in 2022, the holding period for this five-year rule begins on January 1, 2022.

The best way to understand this five-year rule for penalty-free distributions of converted funds is to know exactly what it is set up to prevent. When you take a distribution from your traditional IRA and convert it to a Roth IRA, that distribution is taxable but not subject to the 10% early distribution penalty. This fact meant that soon after Roth IRAs became law, those looking for tax loopholes started advising under 59 ½ IRA owners that they could get out of the 10% penalty by doing a conversion. IRA owners could just convert their IRA to a Roth IRA and then, the next day, withdraw funds from the Roth IRA tax- and penalty-free.

Congress quickly shut this loophole and now we have the “conversion five-year rule”: If the converted funds are not held for at least five years or until age 59 ½, any withdrawal before that time would be subject to the 10% penalty the account owner would have paid if she had withdrawn from her traditional IRA.

Don’t confuse this “conversion five-year rule” with the other five-year rule (the “forever five-year rule”). that also applies to Roth IRAs. The forever five-year rule determines whether distributions of earnings from Roth IRAs are tax-free. That rule works differently from the conversion rule. The forever rule for tax-free distributions always applies no matter what your age is. Also, it begins with your first contribution or conversion to any Roth IRA, and it never restarts even if future contributions or conversions are made.

https://www.irahelp.com/slottreport/watch-out-five-year-rule-converted-roth-funds

ROLLOVER TRIVIA: 5 Q&AS

By Andy Ives, CFP®, AIF®
IRA Analyst

The “Martin Scenario”: Martin, age 40, has never done an IRA rollover before. He took a distribution from his traditional IRA in December 2021 for $10,000 and deposited it into his checking account. Martin took another distribution from his IRA in January 2022 for $50,000. He also deposited this into the same checking account.

Trivia Question #1: Does the fact that Martin commingled both IRA distributions into his checking account present any problems for a future rollover?

Answer: It does not. There are no rules precluding a person from combining an IRA distribution with other accounts or using the money while it is out on rollover for 60-days.

Question #2: Can Martin roll over both the $10,000 and the $50,000 distribution?

Answer: No, he cannot. That would violate the one-rollover-per-year rule. Also, he cannot consolidate the distributions and roll over one $60,000 amount. The one-per-year rule is based on the number of distributions, not the number of rollover deposits.

Question #3: Since the $10,000 distribution came out first, is that the only distribution that can be rolled over?

Answer: No. Since both distributions were taken within the previous 60 days, Martin can choose which distribution gets rolled over. As long as he completes a rollover within 60 days, he can rollover any amount up to $50,000.

Question #4: If Martin elects to roll over the $50,000, is he stuck paying the taxes AND the 10% early withdrawal penalty on the $10,000 early distribution?

Answer: Not necessarily. If Martin rolls over the $50,000 and no other exception applies, then yes, taxes and the penalty on the remaining $10,000 will apply. However, if he is still within the 60 days, Martin could deposit the $10,000 into a Roth IRA. This will qualify as a valid Roth conversion. The taxes will still be due, but there is no 10% penalty on a Roth conversion. Additionally, Roth conversions do not count against the one-rollover-per-year rule and can be done in an unlimited amount annually.

Question #5: Does the fact that Martin took the $10,000 distribution in December and converted it to a Roth IRA in January present any problems?

Answer: Crossing calendar years with rollovers or conversions is perfectly acceptable. However, it will create some tax reporting matters. Martin will receive a 1099-R for 2021 showing the gross $60,000 distribution. IRS Form 5498 showing the rollover and Roth conversion in 2022 will not be released until early 2023. Fortunately, the 5498 is not needed to file his taxes. Martin will indicate on his 2021 return that the $10,000 was converted to a Roth and the $50,000 was rolled over, and the IRS will receive confirmation of the transactions next year when the 2022 5498 is sent to them by the custodian.

The “Martin Scenario” is relatively basic, but the different pitfalls and possibilities for what happens after an IRA distribution are mind numbing. Be sure to know the rules and repercussions before executing any IRA transaction.

https://www.irahelp.com/slottreport/rollover-trivia-5-qas

ONCE-PER-YEAR ROLLOVER RULE AND NEW LIFE EXPECTANCY TABLE: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

My question relates to an IRA withdrawal that is then deposited as a Roth conversion. Will this withdrawal count as a once-per-year IRA rollover?

Thanks in advance for your wonderful advice.

Regards,

Peter

Answer: 

Hi Peter,

Thanks for the kind words. Roth conversions are not subject to the once-per-year rollover rule. Only traditional IRA-to-traditional IRA and Roth IRA-to-Roth IRA rollovers count.

Question:

My question is about the Uniform Lifetime Table. I started taking my lifetime RMDs in 2018 when I was age 70-1/2. So, for this year (I will be 74) I would be using the divisor of 23.8 using the old Uniform Lifetime Table. My questions is: Do I keep using that table, or should I use the new 2022 RMD Uniform Lifetime Table, therefore making the divisor 25.5?

Sincerely,

Gary

Answer: 

Hi Gary,

You should switch to the new Uniform Lifetime Table and take advantage of the longer life expectancies, in your case, 25.5 for 2022. This will result in a slightly lower annual RMD.

https://www.irahelp.com/slottreport/once-year-rollover-rule-and-new-life-expectancy-table-today%E2%80%99s-slott-report-mailbag

ROLLING OVER LAST YEAR’S IRA DISTRIBUTION

By Sarah Brenner, JD
Director of Retirement Education

The rollover rules can be especially challenging at the end of the calendar year. If you took a distribution from your IRA at end of 2021 and are considering a rollover in 2022, here is what you need to know.

First, it is important to understand that it is possible to roll over a distribution from last year. Sometimes IRA owners have doubts as to whether a distribution taken in one calendar year can even be rolled over in the next. There is no problem with this! Nothing prevents you from taking an IRA distribution in December of 2021 and rolling it over in January of 2022 as long as you be sure to follow all the applicable rollover rules. You will want to be especially careful of the 60-day rule for rollovers during this busy time of year.

Another concern you may have is how to handle a distribution from your IRA in 2021 that you roll over in 2022 on your tax return. Do you report this transaction on your 2021 tax return or wait for 2022? Here is how it works: The IRA custodian will report the distribution from your IRA on a 2021 Form 1099-R. The rollover will be reported by the IRA custodian on a 2022 Form 5498. You will report the distribution and the rollover on your 2021 federal income tax return. Be aware that the 2022 5498 will not be released until early 2023! Thankfully, you do not need the 5498 to file your tax return.

Don’t fall for a common misunderstanding of the one-rollover-per-year rule. The rule says that you may only roll over one distribution from all of your IRAs in a one-year period. The one-year period begins with the date you receive the distribution you later roll over. The one rollover per year does not apply on a calendar year basis. A new calendar year does not mean you have a clean slate for purposes of this rule. If you take an IRA distribution on December 15 of 2021 and roll it over in January of 2022, you may not roll over another IRA distribution until December 15 of 2022.

If you are taking required minimum distributions (RMDs), there is another wrinkle. After taking your 2021 RMD, if you took an additional distribution in December of 2021 and rolled over those funds in 2022, you must include the amount rolled over in your December 31, 2021 fair market value when calculating your 2022 RMD. This rule prevents IRA owners from avoiding RMDs by having an IRA balance of zero on December 31. Any outstanding distributions are to be added back to the December 31 prior-year balance. You cannot escape your RMD by emptying out your IRA in December and then rolling over the funds in January.

Keep in mind that if you are establishing a new IRA with your rollover in 2022, your IRA custodian will not be reporting any 2022 RMD information to you (because they have no 12/31 balance). If you are rolling over to an existing IRA, the RMD amount the IRA custodian reports to you will be less than your actual RMD. This is because the IRA custodian reports RMD information to IRA owner based on the December 31 prior-year balance with no adjustments. You must make the adjustment yourself. Add the amount rolled over to the December 31 balance to calculate your correct 2022 RMD amount.

https://www.irahelp.com/slottreport/rolling-over-last-year%E2%80%99s-ira-distribution

GREAT NEWS FOR 72(T) PAYMENTS!

By Ian Berger, JD
IRA Analyst

72(t) payments have suddenly become a better deal for IRA owners and company plan participants.

Also known as “substantially equal periodic payments,” 72(t) payments are advantageous because they are exempt from the 10% early distribution penalty that usually applies to withdrawals before age 59 ½. You can take them from an IRA at any time, but only from a workplace plan after leaving your job.

There are several downsides to 72(t) payments. First, they must remain in place for at least 5 years or until age 59 ½, whichever comes later. This means a 45-year old IRA owner must maintain her payments for almost 15 years. Second, if the payments are modified before the end of the 5-year/age 59 ½ duration, you are subject to a 10% penalty (plus interest) on all payments made before 59 ½. Modification will normally occur if you change the payment schedule (e.g., stop payments), change the balance of the account from which payments are being made (e.g., a rollover to the account), or change the method used to calculate the payment schedule (except for a one-time switch to the RMD method – see below).

There are three acceptable ways to calculate 72(t) payments:

  • The required minimum distribution (RMD) method. Payments are calculated like lifetime RMDs. So, they fluctuate each year. The RMD method normally produces the smallest payout among the three methods. Once you use the RMD method, you can’t switch out of it.
  • The fixed amortization method. Payments are calculated like fixed mortgage payments. After using this method for at least one year, you can switch to the RMD method without penalty.
  • The fixed annuitization method. Payments are calculated by dividing the account balance by an annuity factor. Like the amortization method, they remain fixed, and you can switch to the RMD method after the first year.

So, what’s the exciting news? Well, the second and third methods require use of an interest rate to calculate the amortization or annuity factor. In the past, the IRS has said this factor can’t exceed 120% of the Federal mid-term rate in effect for either of the two months before the start of the 72(t) payments. The Federal mid-term has been historically low for a number of years. For February 2022, 120% of the Federal mid-term rate is only 1.69%.

However, on January 18, the IRS released Notice 2022-6, which said that 72(t) payment schedules started in 2022 or later can use an interest rate as high as 5%. (And, if 120% of the Federal mid-term rate rises above 5%, you can use a rate as high as the 120% rate.) This is great news because the higher the interest rate, the higher the payments will be. This change allows you to squeeze higher payments out of the same IRA balance. (Note that you can’t change interest rates for a series of 72(t) payments already in place.)

Even though the RMD method doesn’t use interest rates, all three methods do use life expectancy tables. The IRS has updated the life expectancy tables used to calculate RMDs for 2022 and later years. Notice 2022-6 says the new tables may be used for 72(t) payment schedules starting in 2022 and must be used for payment schedules starting in 2023. Finally, the Notice says you won’t have a modification if you have been using the RMD method and switch from the old tables to the new tables.

https://www.irahelp.com/slottreport/great-news-72t-payments

QCDS AND RMD REQUIREMENTS OF INHERITED IRAS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Hello.  Thanks in advance for fielding my question.

My mother died in 2021 in her 90’s. She was using $100,000 of her traditional IRA RMD as a QCD. In order to fulfill her 2021 charitable commitments, I did a QCD after her death.

Because I am not 70 ½ yet, my CPA tells me I need to include the IRA withdrawal in my income and take a charitable deduction because the assets had already moved to my inherited IRA account.

Is this correct?  Is there an exception I am missing here?

Thanks!

Answer:

Unfortunately, your CPA is correct. An IRA beneficiary can do a qualified charitable distribution (QCD). However, to be eligible the beneficiary must be age 70 ½ or older. If you are not old enough to do a QCD, your distribution would be treated as taxable. If you are eligible, you could then take a charitable deduction.

Question:

Hi,

I cannot seem to find the answer anywhere, so perhaps you could address this in one of your newsletters.

More and more now there are inherited IRAs of different types requiring RMDs.  I know you can treat them as combined for calculating RMDs, but what if they’re different types? For example:

Inherited Traditional IRA – RMD $3000

Inherited Roth IRA – RMD $3500

Can I just take all $6500 out of the traditional and leave the Roth to grow and vice versa? Or must I take the RMDs out from each separately since they are not like type?

Best,

Ev

Answer:

Hi Ev,

You are right that many beneficiaries are inheriting more than one IRA. If required minimum distributions (RMDs) are due, they may be able to be aggregated. However, this is only possible when the IRAs are the same type and inherited from the same decedent. In your example, if a beneficiary inherits both a traditional and a Roth IRA, those RMDs could not be aggregated.

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

ONE IRA ROLLOVER PER YEAR – BASED ON DISTRIBUTIONS

By Andy Ives, CFP®, AIF®
IRA Analyst

A person is allowed only one IRA-to-IRA or Roth-IRA-to-Roth-IRA 60-day rollover per year. This 12-month period is a full 12 months – it is not a calendar year. Accordingly, we refer to this as the “once-per-year rule.” For example, if a person received an IRA distribution in March that is subsequently rolled over, he is not eligible to initiate another 60-day IRA or Roth IRA rollover with a distribution received before the following March. The 12 months begin with the date the funds are received by the account owner. (Day of receipt is an important distinction. This could buy a person a couple of days when the 60-day deadline is approaching and a check was originally mailed to the IRA owner.)

It is also important to note that the one-rollover-per-year rule is based on the number of distributions from the IRA, not the number of deposits. For example, Eddie owns an IRA. He has not done any 60-day rollovers with a distribution taken in the previous 12 months. Eddie takes a single withdrawal from his IRA in the amount of $250,000. The check is made payable to Eddie, and Eddie deposits the check into his checking account. This is perfectly acceptable, and Eddie has 60 days from the time he received the check to complete a rollover.

Before the 60 days expires, Eddie elects to roll all $250,000 back into an IRA. However, Eddie wants to split the $250,000 into five equal parts of $50,000. He chooses five different banks and custodians where he has five different IRAs. Eddie rolls $50,000 into each of the five IRAs. Is this allowed?

Yes! The one-rollover-per year rule is based on the number of distributions, not the number of deposits. Eddie had only one IRA distribution. The fact that he split the money into five different IRAs is not an issue. However, the opposite is not permitted.

After 12 months, Eddie is once again able to complete a 60-day rollover as his one-rollover-per-year time restriction has been reset. He still has the five separate IRAs – all still valued at $50,000 each – but does not like the hassle of maintaining multiple IRAs or the investment performance. Eddie requests a check from each of the IRAs be sent directly to him. His plan is to consolidate the five checks into his checking account, and then within 60 days write a single check for the full amount to another IRA as a rollover. Is this allowed?

It is not. As mentioned, the one-rollover-per-year rule is based on distributions, and Eddie’s plan will create five separate distributions. Consolidating the five distributions into a single check from his checking account will not work. If Eddie proceeds to take five $50,000 distributions, he is only permitted to roll over one of them. He will be stuck with a $200,000 taxable distribution on the remaining dollars, and there is no fix. Eddie could roll over all or a portion of the $200,000 into a Roth IRA within 60 days – that would qualify as a valid Roth conversion, and Roth conversions are not subject to the once-per-year rule. However, the taxes would still be due.

Be careful with 60-day rollovers. Understand the rules or, better yet, avoid rollover problems altogether by doing direct transfers. Like Roth conversions, IRA owners can do an unlimited number of direct transfers in a year.

https://www.irahelp.com/slottreport/one-ira-rollover-year-based-distributions