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IRA BLOG

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

WHAT TO DO IF YOU MISSED YOUR 2021 RMD

By Sarah Brenner, JD
Director of Retirement Education

Did you take your RMD from your IRA for 2021? Hopefully, the answer is yes because for most IRA owners and beneficiaries the deadline for taking a 2021 RMD was December 31, 2021. There is an exception. If you reached age 72 in 2021, you still have time. Your deadline for taking your 2021 RMD from your IRA is April 1, 2022.

The end of 2021 was a busy and stressful time. You may have not gotten your RMD out in time.  If you missed the RMD deadline, statistics show you are not alone. Government figures show a surprisingly high number of IRA owners fail to take their RMDs.

There is a 50% penalty assessed on the amount of the RMD that is not taken by the deadline. For example, if you failed to take your $10,000 RMD for 2021, you would be subject to a $5,000 penalty in addition to your RMD being taxable for the year. If only part of the RMD is taken, the 50% penalty is assessed on the amount not taken. For example, if your RMD for 2021 was $8,000 and you took only $2,000, you would be subject to a 50% penalty on the $6,000 not taken. Your penalty would be $3,000.

If you missed your RMD, the IRS can waive the 50% penalty for good cause. Here are the steps you will need to take to have the penalty waived:

  • Take the RMD. To have the 50% penalty waived by the IRS, you must correct your error. You must take the RMD amount that was not taken in 2021.
  • File the 2021 IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. When you file this form, you do not have to prepay the penalty. But if the form is filed without payment of the 50% penalty and the IRS later determines that the penalty is owed, you could also owe interest on the penalty amount. Form 5329 must be filed to start the IRS statute of limitations clock.
  • Attach a letter of explanation to Form 5329. The letter should include the reason why the 2021 RMD was missed, the fact that it has now been taken, and a statement that you have taken steps to ensure that future RMDs will be taken on time.

After submitting your request, you must wait for the IRS response. The IRS may respond to your waiver request within a few months. If you have not heard from them in three years, that means they have granted the waiver.

Getting a waiver of the 50% penalty for failing to take your RMD may seem complicated and time consuming, but it can be worth the effort. Many taxpayers have had successful results. If you have questions or need assistance with the process, it’s always best to contact a knowledgeable financial advisor or tax preparer for advice.

https://www.irahelp.com/slottreport/what-do-if-you-missed-your-2021-rmd

YOUR FIRST RMD AND SEP IRAS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi,

I turn 72 this year and have to take my first required minimum distribution (RMD). I am also in the process of converting most of my IRA into a Roth IRA. I know I have to take my RMD first before the conversion. Since this is my first year of RMDs, I know one of the options is to delay the RMD until April of next year. Is it possible to set aside the RMD amount in my IRA for the RMD to be done in 2023 but do the Roth conversion first this year (2022)? Or will I have to do the RMD in 2022 (even though I have the option of waiting until April of next year) before I do the planned Roth conversion this year?

Thanks,

Glenn

Answer:

Glenn,

Even though an IRA owner has the option to delay his very first RMD to April 1 of the following year, that does not permit him to do Roth conversions before taking the delayed RMD. If an RMD is required for 2022 (as is the case here), the RMD must be taken before any funds can be converted. This is true even if this is your first RMD and it could potentially be delayed until April of 2023. Of course, once the 2022 RMD is taken, you can then convert as much as you want over and above the RMD amount.

Question:

I will be 72 this year and will be taking my first RMD. I know that if I have 2 traditional IRAs I can calculate the RMD amount for each IRA, and then I can take the total RMD from just one of those IRAs (rather than an RMD from each IRA). My question: If I have an IRA and a SEP IRA, after calculating the RMD from each of them, can I take the total RMD from just one of them? I am not sure if a SEP IRA and an IRA are considered to be different types of retirement accounts (like a 401K and an IRA).

Please advise.

Thank you.

Chris

Answer:

Chris,

SEP IRAs and traditional IRAs (as well as SIMPLE IRAs) can be aggregated for RMD purposes. You are correct that the RMD for each account must be calculated separately, but the total RMD for all IRA accounts (in your case the SEP IRA and the traditional IRA) may be taken from one (or more) of the IRA accounts.

https://www.irahelp.com/slottreport/your-first-rmd-and-sep-iras-todays-slott-report-mailbag

IS IT TOO LATE TO OPEN UP A SMALL BUSINESS RETIREMENT PLAN FOR 2021?

By Ian Berger, JD
IRA Analyst

As we move into 2022, small business owners may be wondering whether they still have time to establish a new retirement plan for 2021. The short answer is: “It depends.”

There are several retirement plan options especially designed for small business owners, including the self-employed. These include SEP IRAs, SIMPLE IRAs and Solo 401(k)s. All three can be opened up and maintained easily and inexpensively, and all allow tax-deductible contributions that can be significantly higher than the IRA contribution limit.

SEP IRAs. SEP IRAs give you the most flexibility. A new SEP can be set up and funded for a prior year. So, a new SEP for 2021 can be established as late as the deadline, with extensions, for the business’s 2021 tax return. Depending on the type of business, that can be as late as 9/15/22 or 10/15/22.

Solo 401(k)s. The rules for adopting a new solo 401(k) for a prior year are confusing. The SECURE Act includes a provision that allows extra time to set up new non-IRA based employer plans like 401(k) plans. The old rule was that such new plans had to be adopted by the last day of the employer’s tax year (typically 12/31). Now businesses have until the due date for the corporate tax return, including extensions, to put a new plan into place (just like new SEP IRAs).

However, that extended deadline only applies to solo 401(k) employer contributions – not to elective deferrals. The IRS says that a self-employed individual must make a 401(k) deferral election by the last day of the year. For a deferral election for 2021 to have been made by 12/31/21, a 2021 solo 401(k) plan offering elective deferrals had to be in place by that date.

That means it’s too late to adopt a solo 401(k) for 2021 if you wish to make elective deferrals. But it’s not too late if you limit your 2021 solo plan contribution to employer contributions. Since 2021 elective deferrals aren’t allowed, the maximum 2021 contribution for a new solo plan adopted in 2022 is $58,000. By contrast, if a new plan had been adopted in 2021, the contribution limit for owners over 50 would have been $64,500 if the $6,500 elective deferral catch-up contribution had been used.

SIMPLE IRAs. SIMPLE IRAs have the most restrictive rules. A new SIMPLE cannot be adopted for a prior year. Instead, it must be established by 10/1 of the year it becomes effective. This means a new SIMPLE IRA for 2021 had to be established by 10/1/21 and can’t be set up in 2022.

https://www.irahelp.com/slottreport/it-too-late-open-small-business-retirement-plan-2021

QCD REMINDERS AND PITFALLS

By Andy Ives, CFP®, AIF®
IRA Analyst

Less than two weeks into the new year seems like a good time to provide a few reminders and warnings when it comes to Qualified Charitable Distributions (QCDs). As a quick refresher, remember these QCD facts:

  • Only available to IRA (and inherited IRA) owners who are age 70½ and over.
  • Capped at $100,000 per person, per year. (For a married couple where each spouse has their own IRA, each spouse can contribute up to $100,000.)
  • QCDs cannot be done from employer plans – like a 401(k).
  • Only applies to direct transfers of IRA funds to charities and not gifts made to private grant making foundations, donor advised funds or charitable gift annuities.
  • No deduction can be taken for the charitable contribution, and nothing can be received in return for the donation (like a T-shirt or tote bag).

We suggest doing QCDs early in the year to avoid any conflict with the “first-dollars-out rule.” The first dollars withdrawn from an IRA are deemed to be the RMD (required minimum distribution). If an IRA owner is looking to offset the income from an RMD with a QCD, those transactions must be done in conjunction with each other. You cannot take an RMD payment and then decide to retroactively do a QCD with those same dollars. As mentioned in the facts above, a QCD “only applies to direct transfers of IRA funds to charities.” QCDs can be done after an RMD is taken, but the QCD will be an additional distribution on top of the RMD.

The first-dollars-out rule is not the only pitfall that can disrupt a QCD. Some IRA accounts are allowed check-writing privileges. Checks written to a charity from a “checkbook IRA” do qualify as a valid QCD. However, these IRA checks have the potential to cause QCD havoc. While a good-intentioned IRA owner may have written the check to a charity in late December, the custodian may not recognize the distribution until the check is cashed! If you wrote a checkbook IRA check to charity in December last year, it is recommended that you confirm the check was also cashed by the charity in 2021. Otherwise, the custodian could justifiably code the transaction as a 2022 QCD. Compounding the problem, if the IRA QCD check was also intended to offset the 2021 RMD, and if the check wasn’t cashed, we could have a missed RMD situation.

One final QCD pitfall to be aware of – the potential for a QCD to be taxable. We know that QCDs are used to exclude the donation amount from income. However, there is a situation when the QCD can become a taxable distribution.

The SECURE Act eliminated the 70 ½ age limitation for contributing to an IRA. If you have earned income at any age, you can now contribute to an IRA. However, if you are 70 ½ or older and make a deductible IRA contribution, any subsequent QCD (up to the amount of the deductible contribution) will be taxable. The IRS considers this double dipping. The amount of the deductible contribution will offset the same amount of a QCD, no matter how far into the future the QCD is done. As such, our recommendation is to not make deductible IRA contributions when also doing QCDs. Consider a Roth contribution instead.

While the holidays were the season of giving – be sure you gave properly with your QCD.

https://www.irahelp.com/slottreport/qcd-reminders-and-pitfalls

10-YEAR PAYMENT RULE AND 2022 POST-DEATH REQUIRED MINIMUM DISTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Has the IRS clarified the 10-year rule on inherited IRAs? Do you have to take RMDs each year or can you wait until the 10th year? Also, does this rule apply to inherited Roth IRAs?

Thanks,

Daniel

Answer:

Hi Daniel,

Yes, the IRS has clarified that annual RMDs from an inherited IRA are not required under the 10-year payout rule. The 10-year rule only requires that the entire account be distributed by December 31 of the year of the 10-year anniversary of the original IRA owner’s death. The rule does also apply to Roth IRAs.

Question:

My wife inherited an IRA from her mother. I understood she had to take out yearly distributions. We have calculated these distributions by taking the Single Life Expectancy Table for her age when her mother died in 2015. My wife was 73 then, so the divisor was 14.8. We have been subtracting one from that number each year since then — last year was 8.8 and this year 7.8. Do I understand that now she may use the new for 2022 life expectancy tables for her distribution from this inherited account? She’ll be 80 this year, and the divisor for age 80 is 20.2.

Bill

Answer:

Hi Bill,

It appears that your wife started taking RMDs from the inherited IRA in 2015 at age 73. However, her first RMD wasn’t required until 2016 – the year after her mother died. The 2016 RMD should have been based on a 14.1 life expectancy factor (the factor under the old Single Life Expectancy Table for a 74 year-old). Subtracting one from 14.1 each year after 2016 would mean that the 2021 factor was actually 9.1.

It’s not a problem if prior distributions were higher than the RMD. Based on your math, it appears your wife may have taken a little more annually than she needed to.

Starting in 2022, the new IRS life expectancy tables must be used. To calculate your wife’s 2022 RMD, we determine what the factor would have been for 2016 (her first RMD year) under the new Single Life Expectancy Table. That factor for a 74-year-old is 15.6. Then we subtract one for each succeeding year to arrive at a 9.6 factor for 2022. (Note that the 20.2 factor you mentioned is from the Uniform Lifetime Table, which is the incorrect table in your situation.)

https://www.irahelp.com/slottreport/10-year-payment-rule-and-2022-post-death-required-minimum-distributions-today%E2%80%99s-slott

NEW 2022 IRS LIFE EXPECTANCY TABLES AVAILABLE HERE

By Sarah Brenner, JD
Director of Retirement Education

The IRS has released new life expectancy tables for calculating required minimum distributions (RMDs) for 2022. The most commonly used tables are the Uniform Lifetime and the Single Life Expectancy Tables.  The Uniform Lifetime Table is used by most IRA owners who need to take 2022 lifetime RMDs. The Single Life Expectancy Table is used by IRA beneficiaries who must take an annual RMD for 2022.

We have been getting a lot of questions from our readers asking where they can find these tables. For your convenience the Slott Report is providing them below. For future reference, you can also find the new tables (as well as other updated information for 2022) on our website at IRA and Tax Tables 2022 | Ed Slott and Company, LLC (irahelp.com)

Uniform Table

To be used for 2022 and later-year RMDs

Age of IRA Owner or Plan Participant Life Expectancy (in years)
72 27.4
73 26.5
74 25.5
75 24.6
76 23.7
77 22.9
78 22.0
79 21.1
80 20.2
81 19.4
82 18.5
83 17.7
84 16.8
85 16.0
86 15.2
87 14.4
88 13.7
89 12.9
90 12.2
91 11.5
92 10.8
93 10.1
94 9.5
95 8.9
96 8.4
97 7.8
98 7.3
99 6.8
100 6.4
101 6.0
102 5.6
103 5.2
104 4.9
105 4.6
106 4.3
107 4.1
108 3.9
109 3.7
110 3.5
111 3.4
112 3.3
113 3.1
114 3.0
115 2.9
116 2.8
117 2.7
118 2.5
119 2.3
120+ 2.0

 

Single Life Expectancy Table

To be used beginning with 2022 RMDs

(To be used for calculating post-death required distributions to beneficiaries)

 

Age of

IRA or Plan Beneficiary

Life Expectancy

(in years)

Age of

IRA or Plan Beneficiary

Life Expectancy (in years)

Age of

IRA or Plan Beneficiary

Life Expectancy

(in years)

0

1

2

3

4

5

 

84.6

83.7

82.8

81.8

80.8

79.8

 

41

42

43

44

45

 

44.8

43.8

42.9

41.9

41.0

81

82

83

84

85

 

10.5

9.9

9.3

8.7

8.1

 

6

7

8

9

10

78.8

77.9

76.9

75.9

74.9

46

47

48

49

50

40.0

39.0

38.1

37.1

36.2

86

87

88

89

90

7.6

7.1

6.6

6.1

5.7

11

12

13

14

15

73.9

72.9

71.9

70.9

69.9

51

52

53

54

55

35.3

34.3

33.4

32.5

31.6

91

92

93

94

95

5.3

4.9

4.6

4.3

4.0

16

17

18

19

20

69.0

68.0

67.0

66.0

65.0

56

57

58

59

60

30.6

29.8

28.9

28.0

27.1

96

97

98

99

100

3.7

3.4

3.2

3.0

2.8

21

22

23

24

25

64.1

63.1

62.1

61.1

60.2

61

62

63

64

65

26.2

25.4

24.5

23.7

22.9

101

102

103

        104

105

 

2.6

2.5

2.3

2.2

2.1

26

27

28

29

30

59.2

58.2

57.3

56.3

55.3

66

67

68

69

70

22.0

21.2

20.4

19.6

18.8

106

107

108

109

110

2.1

2.1

2.0

2.0

2.0

31

32

33

34

35

54.4

53.4

52.5

51.5

50.5

71

72

73

74

75

18.0

17.2

16.4

15.6

14.8

111

112

113

114

115

2.0

2.0

1.9

1.9

1.8

36

37

38

39

40

49.6

48.6

47.7

46.7

45.7

76

77

78

79

80

14.1

13.3

12.6

11.9

11.2

116

117

118

119

120+

1.8

1.6

1.4

1.1

1.0

https://www.irahelp.com/slottreport/new-2022-irs-life-expectancy-tables-available-here

HITTING THE RESET BUTTON FOR 2022 RMDS

By Ian Berger, JD
IRA Analyst

Welcome to 2022!

One of the big changes in the retirement account world this year will be the calculation of required minimum distributions (RMDs). RMDs for IRA owners and plan participants are calculated using life expectancies from IRS tables. There are three tables:

1. The Uniform Lifetime Table, used to calculate lifetime RMDs in most cases.

2. The Joint Life Expectancy Table, used instead of the Uniform Lifetime Table when a spouse is the sole IRA or plan beneficiary and is more than 10 years younger than the IRA owner or plan participant.

3. The Single Life Expectancy Table, used to calculate post-death RMDs for designated beneficiaries of IRA owners who died before 2020 and for “eligible designated beneficiaries” of owners who died after 2019.

The IRS has issued a new set of tables effective for 2022 RMDs. The new tables reflect the pre-pandemic increase in life expectancies and will result in slightly smaller RMDs.

For 2022 lifetime RMDs, the new Uniform Lifetime Table (and Joint Life Expectancy Table) will be used without any adjustment to account for the fact that pre-2022 RMDs were calculated using the old tables. However, beneficiaries (other than spouses) who inherited before January 1, 2022 and are using the Single Life Expectancy Table will be required to “reset” their 2022 RMD. Here’s how it works:

1. For 2022 RMDs, beneficiaries do not use the new Single Life Expectancy based on their age in 2022.

2. Instead, use the new Single Life Expectancy Table to determine what the life expectancy factor would have been for the very first RMD under the new table. (Assume the new table was in existence back when the first RMD was calculated.)

3. Then, subtract 1 year for each succeeding year to arrive at the 2022 life expectancy factor.

Example: Justin’s father died in 2018 and left him an IRA. For his first required distribution in 2019 (when he turned age 57), Justin used a 27.9-year life expectancy factor under the previous Single Life Expectancy Table. Justin’s 2020 RMD was waived by the CARES Act. His 2021 RMD was calculated using a 25.9-year factor (27.9 – 2). In 2022, Justin turns age 60. Under the new Single Life Expectancy Table, the life expectancy factor for a 60-year-old is 27.1. However, Justin cannot use that factor. Instead, he must reset his 2022 RMD by determining what his life expectancy factor would have been in 2019 (at age 57) under the new table. That factor is 29.8. Justin then subtracts 3 years (for 2020, 2021 and 2022) from that factor to produce a 26.8 life expectancy factor for his 2022 RMD.

https://www.irahelp.com/slottreport/hitting-reset-button-2022-rmds

BUILD BACK BETTER AND THE RULE OF 55: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Ed,

Since the Build Back Better bill is still in legislative limbo, does that mean that backdoor Roth IRA contributions are still available for 2022? If so, what do you suggest if someone makes a backdoor Roth contribution early in 2022 and then the legislature retroactively disallows it when the bill is finally passed?

Thanks,

Ralph

Answer:

Hi Ralph,

As the final hours of 2021 tick away, it is now clear that the Build Back Better legislative proposal that included the elimination of the backdoor Roth IRA conversion will not become a reality this year. This means that back door Roth IRA conversions will still be available for 2022.  Will this proposal ever become a reality? No one really knows. It is highly unlikely, however, that any law eliminating back door Roth IRA conversions that is passed in 2022 would be retroactive or even effective for 2022. There would be too much confusion. If anything passes, which is still uncertain, it would likely be effective for 2023 at the earliest.

Question:

I read an article on your website and I had a question that I haven’t seen published before.

Let’s say I resign from a company at age 53 and leave my 401k with them.  Can I begin withdrawing from that old 401k plan at age 55?  Or, is the rule you have to be employed with that company the year you turn 55, announce you are retiring, then begin distributions?

Thanks

Kevin

Answer:

The rule of 55 can be tricky. This rule allows an exception to the 10% early distribution penalty that usually applies to distributions taken from employer plans prior to age 59 ½. Your question addresses a common area of confusion. To take advantage of the age 55 exception, you must separate from service in the year you reach age 55 or older. If you separate from service before then, you cannot use the exception. It is the age at separation that matters, not the age at the time of the distribution. In your situation, because you resigned when you were age 53, you cannot use the exception, even though you plan to take distributions at age 55.

https://www.irahelp.com/slottreport/build-back-better-and-rule-55-todays-slott-report-mailbag

THE PRO-RATA RULE EXPLAINED – YOU ARE NOT GETTING DOUBLE TAXED

By Andy Ives, CFP®, AIF®
IRA Analyst

SCENARIO: Teddy, age 60, has an existing Traditional IRA with a current balance of $93,000. This is all deductible, pre-tax money. Teddy would like to contribute to a Roth IRA, but his income level exceeds the Roth IRA income threshold. To skirt this problem, Teddy makes a 2021 $7,000 non-deductible contribution to his Traditional IRA with the idea to then covert the $7,000 as a Backdoor Roth. Teddy erroneously thinks that his $7,000 conversion will be tax free. He is surprised to learn that the bulk of the conversion is, in fact, taxable. Teddy complains that he is being double taxed because he “already paid the taxes on that $7,000 basis.”

Teddy does not understand the pro-rata rule. He is not being double taxed. The pro-rata rule dictates that when an IRA contains both nondeductible and deductible funds, each dollar withdrawn (or converted) from the IRA will contain a percentage of tax-free and taxable funds. This ratio is based on the percentage of after-tax dollars in the entire balance in all of a person’s Traditional IRAs, SEP and SIMPLE plans.

Teddy cannot cherry-pick only the after-tax funds and just convert those. Also, it would make no difference if Teddy contributed the $7,000 to a totally different IRA at a different custodian. The IRS sees all IRAs, SEPs and SIMPLEs under a person’s name as one big bucket of money. So, what is the “pro-rata math” on Teddy’s Backdoor Roth conversion, and how will his accounts be impacted after the transaction?

Teddy has no SEP or SIMPLE plans. His only IRA is the one that had $93,000 of all pre-tax dollars. Once Teddy contributed the $7,000 of after-tax dollars, his IRA value was $100,000. The total percentage of after-tax dollars was 7%, and the total percentage of pre-tax dollars was 93%. Based on these percentages, the pro-rata rule dictates that every withdrawal or conversion will include a proportionate amount of pre-tax and after-tax dollars. As such, Teddy’s Backdoor Roth conversion of $7,000 in not all after-tax. It is 93% pre-tax and 7% after-tax. This results in a split of $6,510 taxable dollars and $490 after-tax dollars moving into Teddy’s Roth IRA.

After the conversion, Teddy still has $100,000 in his IRAs, divided as follows:

  • $7,000 in a Roth IRA that is all after-tax money.
  • $93,000 in a Traditional IRA – but that Traditional IRA now also contains $6,510 of after-tax basis. (And what percentage of $93,000 is $6,510? It is 7%!)

Teddy did not pay double tax. He still has his after-tax dollars, with most of those monies still in his Traditional IRA. He was only able to convert a portion based on the pro-rata split. In Teddy’s case, he converted 7% of his Traditional IRA, which meant that he was only converting 7% of his after-tax dollars. If Teddy had converted $50,000 (half his total IRA), then he would have also converted half ($3,500) of his after-tax dollars.

Since the pro-rata rule stipulates that a proportionate amount of pre- and after-tax dollars get converted, Teddy will have to monitor the basis in his Traditional IRA. Each year going forward, for almost any withdrawal or conversion, Teddy will have to reconcile his pro-rata mix. There are exceptions to the pro-rata rule and ways to clean this up…but that is for a future article.

https://www.irahelp.com/slottreport/pro-rata-rule-explained-%E2%80%93-you-are-not-getting-double-taxed

HAPPY NEW YEAR!

By Andy Ives, CFP®, AIF®
IRA Analyst

In 2021, the Slott Report produced roughly 100 diverse retirement-related articles and answered approximately 100 reader questions in our weekly Mailbag. We do our best to present topical IRA and retirement plan issues in the most creative, interesting, and informative manner. We hope you enjoyed the content and learned some new things.

Thank you to our loyal readers! We look forward to another combined 200+ fresh articles and Mailbag responses in 2022.

From all of us at the Slott Report, have a healthy, safe and Happy New Year!

https://www.irahelp.com/slottreport/happy-new-year-1

WHAT 2022 MAY MEAN FOR YOUR RETIREMENT ACCOUNTS

By Sarah Brenner, JD
Director of Retirement Education

Pop the champagne! It is almost time to turn the page on the calendar to a new year. What will 2022 mean for your retirement accounts? All signs point to a very busy year ahead. Here is what we may expect for retirement accounts in 2022.

1. New life expectancy tables for calculating required minimum distributions (RMDs) go into effect. In 2022, at long last, the IRS has put new life expectancy tables in place for calculating RMDs from retirement accounts. The new tables are good news for account holders because they will mean slightly smaller RMDs on account of longer life expectancies. These new tables can be used by anyone who is taking RMDs, even those who inherited an account a long time ago or those way beyond their RMD required beginning date. One exception is for those who reached 72 in 2021 and decided to delay their first RMD into 2022 (before April 1, 2022). Those individuals need to use the old tables to calculate that delayed 2021 RMD even though they can take it in 2022.

2. SECURE Act Regulations May Be Coming Soon. The SECURE Act was a mammoth piece of legislation. All signs indicate that the SECURE Act regulations will also be substantial. Word on the street is that they will be hundreds of pages long. These regulations are badly needed to fill in some of the gaps in the SECURE Act and clarify some gray areas. Particularly when it comes to trusts as retirement account beneficiaries, unanswered questions remain. The IRS has indicated that these regulations may be here sooner rather than later. Stay tuned as early 2022 may very well be when we see them.

3. Build Back Better May be Back. The Build Back Better Act (BBB) with its changes to the retirement account rules, including the end of the back door Roth IRA and new rules for Mega IRAs, did not become a reality in 2021. But do not count it out in some form in 2022. Proposals, especially those that raise revenue like the BBB retirement account related ones, have a way of resurfacing. Keep an eye on Congress because it may have an eye on your retirement account in 2022.

4. Prepare for Son of SECURE. Even though the SECURE Act transformed the retirement account landscape, there were some proposals to strengthen retirement savings which did not make the final cut. Expect those proposals to be taken up in Congress again in 2022. More “Rothification,” delayed RMDs, and new rules for qualified charitable distributions could all be on the way if the “Son of SECURE” becomes a reality.

Stay tuned to the Slott Report in 2022 for all the latest developments! We will be keeping an eye on all things retirement account related. The year ahead promises to be an exciting one.

https://www.irahelp.com/slottreport/what-2022-may-mean-your-retirement-accounts

5 IRA RULES FOR WHICH WE ARE THANKFUL IN 2021

By Sarah Brenner, JD
Director of Retirement Education

Thanksgiving 2021 is upon us. This is the time of the year when we gather together and express our gratitude. When it comes to our retirement accounts, we often complain about the negatives. There are restrictions that are not logical and rules that are complex and confusing.

To celebrate Thanksgiving, it is a Slott Report tradition to change it up and take a few moments to give thanks for the IRA rules that do work well and help us save for our families’ futures.

Here are 5 IRA rules for which we are thankful:

1. Portability. The days of staying in one job for lifetime and retiring with a pension are long gone. Nowadays people change jobs frequently. We give thanks for the rules which recognize the increased mobility of the workforce and allow more portability between retirement plans. Rollovers from plans to IRAs, and trustee to trustee transfers between IRAs, allow us to protect and maximize our retirement savings.

2. Roth IRA distributions. The Roth IRA is one of the best tax breaks out there. If you follow the rules, you can take tax-free distributions of years of accumulated earnings. What’s not to like? For these accounts, we are grateful.

3. Qualified charitable distributions (QCDs). Being charitably inclined is a good thing! We give thanks for QCDs which encourage gifts to charity by allowing tax-free transfers of IRA funds to charities. We are also grateful for the added benefits of QCDs. They not only decrease adjusted gross income, but also can satisfy the year’s required minimum distribution requirement.

4. Breaks for spouse beneficiaries. Being married has its benefits under the tax code when it comes to IRAs. We are thankful for the special breaks available to those who are married, such as spousal IRA contributions and the ability to do a spousal rollover as a beneficiary.

5. Roth IRA conversions. A Roth conversion gives an IRA owner the opportunity to trade a tax bill now for the payoff of tax-free earnings in the future. With the current low tax rates this is a deal that many have been eager to take. We are grateful for this strategy which allows for a more secure retirement by reducing concerns about rising taxes.

Happy Thanksgiving from all of us at the Slott Report!

https://www.irahelp.com/slottreport/5-ira-rules-which-we-are-thankful-2021

HEALTH SAVINGS ACCOUNTS AND THE YEAR-OF-DEATH RMD: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi Mr. Slott:

I enjoy your website’s very helpful information! I know that the IRS rules limit us to one indirect (60-day) IRA rollover every 12-month period. Are Health Savings Account (HSA) indirect rollovers counted as one of these rollovers, or are the IRA and HSA once-per-12-month rules separate? In other words, can an IRA owner perform one of each in any one 12-month period?

Many thanks,

Jeffrey

Answer:

Jeffrey,

While they have similar characteristics, IRA 60-day rollovers are separate from HSA 60-day rollovers. In fact, these rollovers are not even reported on the same tax document. IRA rollovers are reported on IRS Forms 1099-R and 5498, while HSA rollovers are reported on Forms 1099-SA and 5498-SA. As such, an IRA and HSA owner could do both an IRA-to-IRA 60-day rollover and an HSA-to-HSA 60-day rollover in the same 12-month period.

Question:

Scenario: Client dies on the last day of the year, December 31st. Client had not taken her required minimum distribution (RMD) during the year of death. Obviously, the IRA beneficiary won’t have time to take the year-of-death RMD. Instead, the beneficiary takes the year-of-death RMD in the first quarter of the following year. I cannot find an exception, so I assume the automatic 50% late withdrawal penalty applies. Perhaps the beneficiary should file IRS Form 5329 to report the late RMD and simultaneously request a waiver from our friends at the IRS?

Answer:

You are correct that there is no exception for missing the year-of-death RMD – not even for the beneficiary when the original IRA owner dies on December 31. You are also correct that the best way forward is for the beneficiary to take the missed RMD and promptly file IRS Form 5329. (This is a stand-alone form and does not need to be filed with a tax return.) Do not pay the 50% penalty. Instead, include a letter requesting a waiver. Explain what happened, say that the RMD has been taken, and that it will not happen again. It is our experience that the IRS has been agreeable to waiving the penalty in such situations.

https://www.irahelp.com/slottreport/health-savings-accounts-and-year-death-rmd-todays-slott-report-mailbag

A LOOK BACK AT A “NORMAL” 2021

By Ian Berger, JD
IRA Analyst

As 2021 draws to a close, many of us will naturally look back and try to make some sense of the past year. On the whole, it would be hard to classify 2021 as an “uneventful” year. But in the world of IRAs and workplace plans, it actually was – especially compared to the previous two years.

Recall that December 2019 saw passage of the SECURE Act, which made monumental changes to the tax rules governing retirement accounts. For example, the first RMD (requirement minimum distribution) year was extended from age 70 ½ to 72, the stretch IRA was eliminated for most non-spouse beneficiaries, and the age 70 ½ limit on traditional IRA contributions was lifted. Just three months later, in March 2020, the CARES Act was signed into law, allowing special distributions for those affected by COVID-19 and suspending RMDs for 2020.

By contrast, 2021 was relatively uneventful. No new federal legislation affecting retirement accounts was passed by Congress this year. Meanwhile, after a one-year hiatus, RMDs roared back to life for 2021. The new IRS life expectancy tables, used to calculate RMDs, were delayed into 2022 after originally intended to be effective in 2021. And, speaking of delays, it looks like we’ll have to wait until next year for the IRS regulations that will hopefully address the many unanswered questions in the SECURE Act.

With the new life expectancy tables, the SECURE Act regulations, and possibly new legislation, 2022 promises to be a busier year. But no matter what the new year brings, you can count on us to continue to keep you up to date with the latest developments in the world of IRAs and employer plans.

We would like to thank all of you for taking the time to read the Slott Report and for all of your great questions and comments. And, best wishes for a healthy and happy holiday season!

https://www.irahelp.com/slottreport/look-back-%E2%80%9Cnormal%E2%80%9D-2021

YEAR-END ESTIMATED TAX “LIFE HACK”

By Andy Ives, CFP®, AIF®
IRA Analyst

A “life hack” is any trick, shortcut or simple and clever technique for accomplishing a familiar task more easily and efficiently, in all walks of life. For example, tie a colorful ribbon to your luggage to make it more easily identifiable on the airport conveyor belt. Life hack! Make ice cubes out of coffee so as to not water down your iced latte. Or, turn on your car’s seat warmer to keep the take-out pizza hot on the trip home. Life hack!

Life hacks can also be found in the financial world.

Many taxpayers need to make estimated tax payments. Generally, taxpayers should make these payments in four equal amounts throughout the year. (April 15, June 15, September 15, and January 15 of the following year.) If you fail to pay enough tax, or if your payment is late, you may be charged a penalty. Did you take a large capital gain late in the year? Did you earn more income than expected? Uh, oh. These could cause an estimated tax problem.

Believe it or not, there is a basic “life hack” for anyone who may have underpaid their Federal estimated taxes: Leverage the federal withholding option on an IRA withdrawal!

If it is discovered that previous estimated tax payments were not enough to cover income for the year, a taxpayer could take a distribution from his IRA. The IRA owner could elect to have up to 100% withheld for taxes. This tax withholding will be treated as if it were paid in evenly throughout the year, across all quarterly payments, even if the withholding tax was taken from a distribution on December 31st. Life hack! (Note that if the IRA owner is under age 59 ½ and no other exception applies, there will be a 10% early distribution penalty, even if 100% of the distribution is withheld for taxes.)

But what to do about the missing IRA dollars that were sent to the IRS? If the IRA distribution is eligible for rollover, the IRA owner can replace those IRA dollars with a 60-day rollover. But weren’t the IRA dollars sent to the IRS? How can they be rolled over?

We don’t rollover the exact same dollars. We replace the dollars sent to the IRS with non-IRA funds from a savings or checking account (or some other source). As long as you complete the rollover within 60 days, and as long as the IRA owner has not done another 60-day rollover within the previous twelve months, this strategy will allow the IRA to be made whole.

Had we attempted to make up the difference of underpaid estimated taxes with a single payment directly from a non-qualified account (like a checking account), the payment would have all counted for the fourth quarter, potentially resulting in an estimated tax penalty. By leveraging the Federal tax withholding option on an IRA withdrawal, those payments are smoothed out and deemed to have been paid in evenly over the year. Additionally, by following the 60-day rollover guidelines, we can replace the IRA dollars sent to the IRS. The net result is timely paid estimated tax payments and a fully funded IRA.

Life hack!

https://www.irahelp.com/slottreport/year-end-estimated-tax-%E2%80%9Clife-hack%E2%80%9D

CHANGING BENEFICIARIES AND THE 10-YEAR PAYOUT RULE: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I have a client, age 65, who passed away and left her IRA to her estate. Two nephews and a niece are beneficiaries of the estate.  Is there a way to add beneficiaries after her passing?

I spoke with a financial company, and they said you need some type of court order or ruling to allow this. They indicated that it happens and is allowable, but gave no further details. This would allow us to change the IRA beneficiary to the nephews and niece, and distribution would be over 10 years under the SECURE Act vs. 5 years.

I would appreciate your input as I researched this and came to a dead end.

Steve

Answer:

Hi Steve,

Normally, a beneficiary designation is etched in stone and cannot be changed after the original account holder’s death. However, in certain unusual cases, a court may be able to change the beneficiaries. However, even if that happens, the original named beneficiary is still considered the beneficiary for IRA distribution purposes.

So, it is possible that a court could change the beneficiaries here and allow the IRA to be paid to the nephews and niece. But the estate would still be the beneficiary in applying the IRS payout rules. Since the client died before his required beginning date for RMDs, this means all IRA funds would still have to be paid out to them by December 31 of the 5th anniversary of the client’s death.

Question:

Do adult children who inherited a parent’s Roth IRA in 2020 need to make a required minimum distribution (RMD) each year for the 10 years? Or may they leave it alone and deplete the account at the end of the 10th year? I’ve heard it both ways and would like to know which is correct.

Thank you,

Pam

Answer:

The children are not required to take an RMD each year over the 10-year period. They have total flexibility to take all, some, or none of it over the 10 years. The only requirement is that the entire account be emptied by 12/31/30 (December 31 of the year of the 10th anniversary of the parent’s death). Some of your confusion may be because the IRS originally said annual RMDs were required, but the IRS has since acknowledged that this was a mistake.

https://www.irahelp.com/slottreport/changing-beneficiaries-and-10-year-payout-rule-today%E2%80%99s-slott-report-mailbag

ILLIQUID ASSETS AND RMDS

By Sarah Brenner, JD
Director of Retirement Education

Tis the season. Yes, it is the holiday season, and it is also the season to take RMDs. RMDs are back for 2021 after being waived by the CARES Act for 2020. With the return of RMDs come questions. One question we have been getting a lot this year involves RMDs when IRA investments are illiquid.

When it comes to RMDs from IRAs, the rules are pretty straight forward. If you have a traditional IRA (or a SEP or SIMPLE IRA) and you are age 72 or older during 2021, you must take an RMD. If this your first RMD calendar year you can delay your 2021 RMD until April, 1, 2022. Everyone else must get their 2021 RMD out of their IRA by December 31, 2021. The clock is ticking, and time is almost up. Many IRA custodians, in order to avoid last minute mistakes and allow enough time for processing, have deadlines even sooner. Missing the RMD deadline is serious business because there is a 50% penalty on any RMD amount that is not taken.

For most IRA investments, once the RMD calculation is done, processing the distribution is no big deal. A cash distribution or even a distribution of property can easily be done. But for some IRA investments it is not so simple. Some IRA assets are much harder to liquidate. Some annuity products, some hard to sell investments, and real estate may be difficult or almost impossible to liquidate. Distributing the RMD in shares of the investment may also be complicated or not possible. Despite these issues, there is no exception for illiquid assets to the RMD requirements. These requirements apply to all IRA, regardless of the type of investment.

What if your IRA is entirely illiquid? There are some possible solutions. One of them is aggregation. The RMD rules allow you to aggregate your RMDs from your IRAs and take the total amount from one account. If you have one IRA that is illiquid you could simply take the RMD for that account from another IRA. Remember, there are limits here. You cannot satisfy your RMD for your IRA from a workplace plan or a Roth IRA. Another possibility is to make a tax year IRA contribution if you are eligible to inject some cash into an IRA. The SECURE Act makes this possible by allowing IRA contributions at any age, but you would need to have earned income and you would be limited to $7,000. That may not be enough to satisfy the RMD.

Your options are limited, and the problem will not go away. Each year an RMD must be taken. While it is possible to get an IRS waiver of the 50% penalty, that can only be done after the missed RMD is taken. These issues are why it is a good idea, if your IRA is invested in alternative investments, to plan ahead. As you approach your required beginning date, be sure to keep enough liquid assets in your IRAs to satisfy your RMDs.

https://www.irahelp.com/slottreport/illiquid-assets-and-rmds

WHAT’S THE STATUS OF ALL THOSE CONGRESSIONAL RETIREMENT PROPOSALS?

By Ian Berger, JD
IRA Analyst

During 2021, Congress has taken up a number of different retirement proposals, and it’s been difficult to keep track of them. Here’s an update of how things stand at the moment. Of course, new developments could occur at any time, so stay tuned.

Build Back Better Act

On November 19, 2021, the House of Representatives passed the Build Back Better Act (BBB) by a  220-213 margin. The $1.7 trillion bill includes a number of changes to retirement account rules. Those changes are similar to – but not exactly the same as – the changes proposed in an earlier House Ways and Means Committee bill. It is currently unclear whether the Senate will pass the House version of the BBB, a different version that may or may not include the retirement provisions, or none at all. In any case, here are the BBB changes:

Conversions of After-Tax Dollars. The so-called “Backdoor Roth IRA’ and “Mega Backdoor Roth IRA” conversion strategies would be eliminated effective January 1, 2022 – for all individuals, regardless of income.

Conversions of Pre-Tax Dollars. Roth conversions of pre-tax IRA and company plan funds would be barred for high-income individuals (single taxpayers with modified adjusted gross income over $400,000, and married taxpayers filing jointly with MAGI over $450,000). However, this proposal wouldn’t be effective until 2032.

Contribution and RMD Limits for Mega IRAs. High-income individuals (as defined above) whose combined IRA and defined contribution retirement accounts exceed $10 million would be subject to two new limits. First, they wouldn’t be allowed to make additional IRA or Roth IRA contributions. Second, a required minimum distribution (RMD) would be required – regardless of age. These limits wouldn’t apply until 2029. (By contrast, the Ways and Means Committee provision would have been effective in 2022.)

New Reporting Requirement. There is a proposed new annual requirement for employer defined contribution plans to provide information to the IRS on account balances of $2.5 million or more. The new reporting requirement was also delayed until 2029.

Statute of Limitations for IRA Noncompliance. The BBB extends the statute of limitations from 3 to 6 years for the IRS to go after misreporting of IRA valuations and prohibited transactions. This would be effective January 1, 2022.

Provisions Dropped. Two controversial provisions of the Ways and Means Committee bill were dropped from the BBB. The first would have prohibited IRA investments limited to “accredited  investors.” The second would have tightened the prohibited transaction self-dealing rules.

SECURE 2.0 and Other Related Bills

Meanwhile, several different retirement bills, some with common elements, have been making their way through Congress. The goal of these bills is to further improve retirement savings opportunities. Those bills include the Securing a Strong Retirement Act of 2021), commonly known as “SECURE 2.0,” which the House Ways and Means Committee passed back in May. Among the provisions of SECURE 2.0 is a delay in the RMD age and an increase in IRA and plan catch-up contributions. Although SECURE 2.0 and the other related bills have enjoyed bipartisan support, it is unlikely any of those bills will be passed until at least early 2022.

Remember, the BBB has only been passed by the House, and SECURE 2.0 and related bills are only proposals. As soon as is something is finalized, the Slott Report will let you know.

https://www.irahelp.com/slottreport/what%E2%80%99s-status-all-those-congressional-retirement-proposals

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

By Sarah Brenner, JD
Director of Retirement Education

Question:

If the owner of an inherited IRA was required to take RMDs from the IRA prior to his death, can a beneficiary who is younger than age 70 1/2 request QCDs from the inherited IRA?

Note: We understand the beneficiary is required to take RMDs based on the deceased owner’s life expectancy because the new owner inherited the IRA in 2019.

Thank you,

Bruce

Answer:

Hi Bruce,

This is an interesting question. A beneficiary of an inherited IRA can do a QCD and use the QCD to satisfy the RMD for the year. However, to be eligible the beneficiary must be age 70 ½ or older. It is the beneficiary’s age that matters. The age of the IRA owner does not. Even if the IRA owner was age 70 ½ or older at death, that would not make the beneficiary eligible for a QCD if the beneficiary was younger than 70 ½.

Question:

Upon death of a spouse, can the IRA of the deceased spouse be rolled over to the existing IRA of the beneficiary spouse, or must it be transferred to a new IRA account of the spouse beneficiary?

Sid

Answer:

Hi Sid,

A spousal rollover can be done to an existing IRA in the spouse beneficiary’s own name, or a new IRA can be set up. Either way will work.

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

EXCEPTIONS TO THE PRO-RATA RULE – WAYS TO “ISOLATE BASIS”

By Andy Ives, CFP®, AIF®
IRA Analyst

My November 29 Slott Report entry was titled “The Pro-Rata Rule Explained – You are Not Getting Taxed Twice.” I closed that article by stating there are exceptions to the pro-rata rule and ways to clean up an IRA that contains a mix of pre-tax and after-tax dollars (basis). Included here are three exceptions to pro-rata and how IRA owners could potentially “isolate basis” – reduce an IRA to only after-tax dollars, thereby setting the stage for a tax-fee Roth conversion.

Qualified Health Savings Account Funding Distribution (QHFD). An IRA owner is allowed to make a one-time tax-free transfer from an IRA to a health savings account. This transfer is not subject to the 10% early withdrawal penalty and is a unique way to fund an HSA, if only for one time. The drawback is that the amount of the transfer is capped by the HSA contribution limits for that year, based on the IRA owner’s coverage (i.e., self-only or family). Since a QHFD can only be done with pre-tax dollars, it is an exception to the pro-rata rule.

The amount of a QHFD is limited, so using this strategy to separate pre-tax dollars from after-tax within an IRA can only go so far. For an IRA owner trying to completely “isolate basis” in his IRA with a QHFD, he must have a relatively small taxable IRA balance. (The 2021 HSA family contribution limit for age 55 or older is $8,200.)

Qualified Charitable Distributions (QCDs). QCDs are available to IRA owners aged 70 ½ or older and capped at $100,000 per person, per year. A QCD only applies to direct transfers of IRA funds to charities. Gifts made to private grant making foundations, donor advised funds or charitable gift annuities do not qualify. Like QHFDs, QCDs apply only to taxable amounts, which makes QCDs another exception to the pro-rata rule. By leveraging annual QCDs, an IRA owner could significantly reduce taxable dollars in his IRA, thereby further isolating basis.

Rollovers from IRAs to Company Plans. A third exception to the pro-rata rule and method to isolate basis is what some refer to as a “reverse rollover” – rolling IRA money to a company plan, like a 401(k). Only pre-tax funds can be rolled from an IRA to a company plan. As such, this is the most popular way to isolate basis. But it is not available to everyone. A person must have access to a work plan, and that plan must accept rollovers. Not all do. For those IRA owners fortunate enough to be able to complete a “reverse rollover,” the entire IRA basis problem can be cleaned up in one fell swoop.

There are no limits to how much can be rolled over like there is with QHFDs and QCDs. An IRA owner looking to isolate basis could roll over his entire bucket of pre-tax IRA dollars into a work plan, leaving behind only the after-tax dollars. At that point he could process a tax-free Roth conversion of the after-tax dollars in his IRA. The former pre-tax IRA dollars in the plan could then be returned to the IRA the following year. (Warning: If you pursue this strategy, it is imperative that you NOT roll the pre-tax plan dollars back to the IRA until at least the next year, or they will be included in the previous Roth conversion pro-rata math.)

Of course, all this talk of converting after-tax dollars to a Roth IRA could be made null and void by the current tax proposals. Time will tell if such transactions are outlawed. As for those looking to clean up their IRAs by isolating basis in 2021, the window of opportunity is still open!

https://www.irahelp.com/slottreport/exceptions-pro-rata-rule-%E2%80%93-ways-%E2%80%9Cisolate-basis%E2%80%9D

PROCEED WITH CAUTION WHEN INVESTING YOUR IRA IN GOLD

By Sarah Brenner, JD
Director of Retirement Education

In volatile times like these, when inflation is looming, retirement savers may look to invest their IRAs in gold. Advertisements on the internet and cable tv make it look easy, but that is not the full story. The recent Tax Court case of McNulty v. Commissioner shows the risks to retirement savings if the rules are not carefully followed.

In this case, a Rhode Island nurse lost it all when the Tax Court ruled that her self-directed IRA investment in gold coins that she kept in her possession in her own house were a taxable distribution. To make matters worse for her, the Court also slapped her with an accuracy penalty for relying on internet research instead of a professional advisor.

While gold coin and gold bullion are acceptable IRA investments, there are strict rules that must be followed. An IRA owner who expects to hold gold coins in her hand, as suggested by some internet promotions, will be out of luck. The Tax Code makes it clear that if gold coins or bullion are to be held in an IRA, they must be in the custody of a qualified trustee or custodian.

In the McNulty case, Mrs. McNulty set up a self-directed IRA with an LLC which bought gold and silver American Eagle coins. She kept the coins in her home, and that was a fatal error. The Court found that a taxable distribution occurred when Mrs. McNulty took possession of the gold coins in her IRA. The entire investment was considered distributed and taxable. Her retirement savings was gone.

The Court also hit the McNultys with accuracy penalties. These penalties for underpayment of taxes can be avoided if a taxpayer acted with reasonable cause and in good faith. One way to do this is to seek professional advice. The McNultys admitted that they did not seek advice from their CPA. Instead, they looked to the website promoting the investment in gold. According to the Court, this website was an advertisement of products and services and not professional advice.

The McNulty case is a good reminder that many of those advertisements you may see about holding gold in IRAs can misleading. Many of them may lead you to believe that you can keep your IRA gold at home, maybe with the help of an LLC. This is a fatal mistake. If you take possession of the gold in your IRA, it’s a taxable event. Your savings are gone. The case also shows how free internet research can end up costing you a lot. Relying on information on a website can be a mistake because the IRS does not see this as seeking professional advice. Independent professional advice is critical, especially when it comes to alternative investments like gold.

https://www.irahelp.com/slottreport/proceed-caution-when-investing-your-ira-gold

401(K) PLAN RULES AND SPECIAL NEEDS TRUSTS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Good afternoon, Mr. Slott. I am trying to complete my taxes for last year, and the tax agent is stating that, because I had two 401(k) rollovers (each from a different employer), that I would be charged a penalty for one of these. Although I did receive checks for both rollovers, the monies were rolled over into a new 401(k) plan with my new employer within a week of receiving the checks, and none of it was used for any other purposes. If I remember correctly, both checks were made out to the new 401(k) plan provider “for the benefit of” myself to avoid a “direct” distribution situation.

Your article stated that 401(k) plans are exempt from the once per year rule. I just want to be certain that I didn’t do anything incorrectly that could have caused me NOT to be exempt from the rule so that I can advise and clarify with my tax agent regarding this. I definitely do not want to cause myself a tax issue later on because of incorrect filing. Would you have a moment to advise? Thank you in advance for any assistance you can provide.

Cordially,

Jason

Answer:

Jason,

Based on the transactions you described, you are free and clear of any tax or penalty issues. 401(k) plan-to-401(k) plan rollovers do not count against the one-rollover-per-year rule. (While you didn’t ask, I will note that neither do 401(k) plan-to-IRA rollovers, and neither do Roth conversions.) Even if the checks from the 401(k) plans were made payable directly to you, you still could have rolled them both over to the other plan or to an IRA. In fact, you did everything properly and can confidently “advise and clarify” with your tax agent.

Question:

Hello,

What are the current “stretch” RMD rules for a Special Needs Trust that inherits an IRA? My understanding is that a disabled individual, or a trust established for that individual, can still use the lifetime stretch for RMDs when inheriting an IRA. Does it make a difference whether the trust is a primary or a contingent beneficiary? And does the lifetime stretch also apply to Roth IRAs as well as traditional IRAs?

Thank you,

David

Answer:

David,

Your understanding is correct. A beneficiary who qualifies as “disabled” is considered an “eligible designated beneficiary” and is permitted to stretch payments from an inherited IRA over their own single life expectancy. If an IRA names a special needs trust as beneficiary, and if the disabled person is the trust beneficiary, that person is still allowed to stretch payments. While the trust will be the owner of the inherited IRA, a properly drafted special needs trust will enable the trust beneficiary to stretch required minimum distributions. It does not matter if the trust was named as primary or contingent beneficiary, nor does it matter if the original IRA was a traditional or Roth. Both types of IRAs are allowed to be stretched through a special needs trust for a disabled trust beneficiary.

https://www.irahelp.com/slottreport/401k-plan-rules-and-special-needs-trusts-todays-slott-report-mailbag

HOW GOVERNMENTAL 457(B) PLANS DIFFER FROM TOP HAT 457(B) PLANS

By Ian Berger, JD
IRA Analyst

Many sections of the tax code are confusing, but section 457(b) is one of the major offenders. Within that section are the rules for two different types of company retirement plans —  governmental plans, and “top hat” plans for management employees of tax-exempt employers like hospitals. The two types of 457(b) plans are subject to a number of different rules. Here are the major differences:

Eligibility. Governmental 457(b) plans can cover all employees, including rank-and-file workers. But top hat plans must be limited to employees who are key management or are highly paid. In a hospital setting, this typically means doctors and high-level executives.

Employee contributions. If you’re in a governmental 457(b) plan, you can make pre-tax deferrals and, if offered by the plan, Roth contributions (but not “traditional” after-tax employee contributions). In a top hat plan, you can only make pre-tax deferrals.

Plan loans. Municipal 457(b) participants can borrow against their accounts (if the plan allows). Top hat plan participants can’t make plan loans.

Accessibility. If you’re in a governmental 457(b) plan and 59 ½ or older, you can take withdrawals while still working. That’s not allowed in a top hat plan.

Rollovers. Municipal workers can roll over 457(b) funds to an IRA or to another employer plan that accepts rollovers. By contrast, top hat funds can’t be rolled over to an IRA or another plan.. However, if the plan allows, they can be transferred tax-free to another employer’s top hat plan that accepts them. If a direct transfer isn’t available (or is available, but isn’t elected), the top hat payout is taxable in the year of distribution.

Creditor protection. A governmental 457(b) participant in personal bankruptcy can completely protect their account from bankruptcy creditors. But someone facing a non-bankruptcy lawsuit only receives the protection offered by state law.

Governmental 45(b) plan funds must be held apart from the employer’s assets in a trust fund. By contrast, top hat plan funds must remain property of the employer. So, even though top hat assets can’t be reached by the employee’s creditors, they can be reached by the employer’s creditors at all times. This makes top hat plans riskier than governmental plans. That level of risk is why Congress limited eligibility to highly-paid employees who can better bear that risk.

To reduce this risk, some employers with top hat plans offer “rabbi trusts,” first offered by a congregation to its rabbi. With a rabbi trust, top hat plan funds still remain subject to the employer’s creditors, but the employee is protected if the employer refuses to pay the promised benefits due to a change of heart or because another entity becomes the employer as a result of a corporate transaction.

https://www.irahelp.com/slottreport/how-governmental-457b-plans-differ-top-hat-457b-plans

12/31/21 DEADLINE MAY LOOM FOR STARTING NEW SOLO 401(K) PLAN

By Ian Berger, JD
IRA Analyst

Are you considering opening up a new solo 401(k) and looking to maximize your 2021 contribution? If so, you may need to act quickly. There is a December 31, 2021 deadline for establishing a new plan if you want to make 2021 elective deferrals.

In a solo 401(k), the business owner is considered to wear two hats — an employee and an employer. This allows the owner to make elective deferrals as an employee and employer contributions as an employer. That can result in higher contributions than allowed with a SEP or SIMPLE IRA.

You can make elective deferrals up to $19,500 for 2021, or $26,000 if age 50 or older. (Those limits will increase to $20,500/$27.000 for 2022.) You can also make employer contributions up to 20% of adjusted net earnings, or 25% of compensation if your business is incorporated. There’s also an overall limit on combined elective deferrals and employer contributions. For 2021, that limit is $58,000, or $64,500 if you are 50 or older and defer the additional $6,500. (For 2022, those limits go up to $61,000/$67,500.)

There is confusion over the deadline for opening up a new solo plan. That’s because of a provision in the SECURE Act giving businesses extra time to set up new retirement plans. Before the SECURE Act, businesses had to establish a new plan by the last day of their tax year. Now, they have until the due date for the corporate tax return, including extensions. Depending on the type of business, that will be as late as the following September 15 or October 15.

However, this extended deadline is available only for employer contributions – not for elective deferrals. If you’re a sole proprietor or partner and want to make elective deferrals for a tax year (e.g., calendar year 2021), the IRS says you must make a deferral election by the last day of that year (e.g., 12/31). But you can’t make a deferral election unless a plan has been put into place. This means that if you want to make deferrals for 2021, you must adopt a new solo plan and make a deferral election by 12/31/21.

If you miss the 12/31/21 deadline, you can still adopt a new 2021 plan in 2022 – by the 2021 corporate tax return deadline with extensions. However, that would limit your 2021 contributions to employer contributions only. Since you wouldn’t be able to make 2021 salary deferrals, the maximum 2021 contribution for a new solo plan adopted in  2022 (even for those age 50 or older) would be $58,000.

The timing rules for solo 401(k) elective deferrals are even stricter if your business is incorporated. In that case, you must make a deferral election before the compensation you are deferring would have been paid to you. So, it is getting very late in the year for an incorporated business owner looking to open a new solo plan for 2021 to make significant 2021 deferrals.

https://www.irahelp.com/slottreport/123121-deadline-may-loom-starting-new-solo-401k-plan

RMD RULES AND ROTH CONVERSIONS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Can someone take an in-service withdrawal from their 401(k) and directly transfer it to their IRA, then take a QCD from the IRA to satisfy the RMD amount attributed to the 401(k)? I am 72 years old and I am still working, but own more than 5% of the company; therefore I can’t use the “still working” exception.

Initially I don’t think it can work, but I figured I would ask the experts of IRA planning!

Thank you.

Dan

Answer:

Hi Dan,

It’s good to think outside the box but this strategy won’t work. That is because there is a rule called the “first money out” rule. This rule says that if you have an RMD due from a retirement account for a year, then the first money out of the account during the year is your RMD. Therefore, the RMD amount could not be directly rolled over to an IRA. Instead, it must be taken from the plan.

Question:

I was considering whether or not to do a Roth IRA conversion. I am 75 years old and in moderately good health. I have RMDs of approximately $120k. I have 2 separate IRAs. The RMDs come out of one of the two annually — currently the same one since starting the RMDs. Can I do my conversion from the IRA that has not had any distributions — presumably after taking my RMD from the other?

Thanks for your help over the years.

Tom

Answer:

Hi Tom,

The rules say that if you have an RMD for a year, you must satisfy it before doing a conversion. RMDs can be aggregated and taken from one of your IRAs. Therefore, you could satisfy your RMD from the IRA that is being converted by taking it from another IRA prior to doing the conversion.

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

RESTORATIVE PAYMENTS

By Andy Ives, CFP®, AIF®
IRA Analyst

As we careen into the holiday season, there remains a deceitful underbelly of dirtbags operating their typical scams. Giant inflatable Christmas decorations in front of your home or a menorah in the window will not dissuade criminals from working a dishonest angle. “Good cheer” is the perfect cover for bad deeds. (See: The Grinch.)

Whether the leaves are changing, the snow is falling, or the summer sun is blazing, we must always be vigilant. Keeping watch over our possessions is, sadly, a year-round responsibility. Unfortunately, the bad elements occasionally maneuver through our defenses and gain access to our belongings. IRA accounts are just as susceptible to criminal activity as the cash in your wallet and the ornaments on your lawn. If your plastic reindeer are stolen or damaged in the night, you can always go to Home Depot and buy replacements. If your IRA assets are pilfered, what recourse do you have?

When IRA funds are mishandled or misappropriated, you may be able to roll over dollars received after bringing a lawsuit to recover the losses. In 2004, taxpayers sued an insurance company for improperly selling them certain annuities for their IRAs. They received settlements, and subsequent private letter rulings (PLRs) from the IRS allowed those amounts to be rolled over to their IRAs. In another example, an advisor stole former IRA funds from one of his clients in a nursing home after the IRA owner took a distribution. The IRS allowed the lawsuit settlement dollars to be rolled back to the IRA, thereby replacing the losses.

In later PLRs, the IRS began referring to settlement amounts paid back to IRAs as “restorative payments.” These restorative payments were not bound by the one-rollover-per-year rule or the 60-day rollover rule. This delineation between restorative payments vs. a standard rollover also allowed the IRS to avoid treating the payments as excess IRA contributions.

Be aware that “restorative payments” only include compensatory damages. Punitive damages and attorney’s fees do not qualify. Additionally, the payments can only be made to restore some or all of the IRA losses resulting from breach of fiduciary duty, fraud or federal or state securities violations (such as payments made pursuant to a court-approved settlement or independent third-party arbitration or mediation award). The IRS has specifically stated that “payments made to an IRA to make up for losses due to market fluctuations or poor investment returns are generally treated as contributions and not as restorative payments.”

Decorating the home, seeing loved ones, filling your belly with turkey and napping in front of the TV are high on most people’s holiday to-do lists. But maybe during some down time, consider a few tasks to help protect your assets. For example, be engaged and attentive. Check statements and records. Strive to have at least a basic understanding of IRAs and your accounts. Work with experienced financial professionals, and avoid handing over your financial and retirement reigns to a single person, even if that one person is a spouse or child.

Enjoy the holidays, surround yourself with good people, and make sure your 8-foot inflatable Santa (along with your IRA assets) are securely tied down. We don’t want any sticky-fingered pranksters running off with either.

https://www.irahelp.com/slottreport/restorative-payments

BIGGER 401(K) CONTRIBUTIONS COMING IN 2022

By Sarah Brenner, JD
Director of Retirement Education

The IRS has released the cost-of-living adjustments (COLAs) for retirement accounts for 2022. As expected, due to inflation in the economy, many of the dollar limit restrictions on retirement accounts will increase next year.

For savers looking to max out 401(k) contributions, 2022 will bring higher contribution limits. The salary deferral limit for employees who participate in 401(k) plans, including the Thrift Savings Plan, as well as 403(b) and 457(b) plans, is increased to $20,500, up from $19,500. The catch-up contribution limit remains unchanged at $6,500. Therefore, participants in these plans who are 50 and older can contribute up to $27,000, starting in 2022. The cap on compensation that can be taken into account for calculating retirement plan contributions is increased from $290,000 to $305,000.

The maximum SEP contribution will increase from $58,000 to $61,000. SIMPLE salary deferral contributions will increase as well, going from $13,500 to $14,000 for 2022. The catch-up contribution amount for SIMPLE IRAs remains unchanged at $3,000.

Surprisingly, the IRA contribution limit will remain at $6,000 for the fourth year in a row. The $1,000 IRA catch up contribution is not indexed for inflation. This will again allow those who are age 50 or over in 2022 to contribute $7,000 to an IRA for the year. The phase-out range for savers making contributions to a Roth IRA is increased to $129,000-$144,000 for single filers, up from $125,000-$140,000. For those who are married filing jointly, the income phase-out range is increased to $204,000-$214,000, up from $198,000-$208,000.

Phaseout ranges for active participants in employer plans looking to make deductible traditional IRA contributions have also been increased. For single individuals covered by an employer retirement plan, the phase-out range is increased to $68,000-$78,000, up from $66,000-$76,000. For married couples filing jointly, if the spouse making the IRA contribution is covered by an employer retirement plan, the phase-out range is increased to $109,000- $129,000, up from $105,000-$125,000.  For those not covered by an employer retirement plan but are married to someone who is covered, the phase-out range is increased to $204,000-$214,000, up from $198,000-$208,000.

More details on the COLAs for 2022 can be found at IRS announces 401(k) limit increases to $20,500 | Internal Revenue Service

 

https://www.irahelp.com/slottreport/bigger-401k-contributions-coming-2022

CALCULATING YOUR RMD & ROTH CONVERSIONS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

When calculating my required minimum distribution (RMD) amount, is my Roth IRA balance added to my traditional IRA balance? I understand I don’t have to withdraw from my Roth – just want to know how RMD’s are calculated.

Thanks

Answer:

When calculating your RMD, only the traditional IRA balance on 12/31 of the previous year is included. Your Roth IRA is a separate entity and has no bearing on your traditional IRA RMD. If you have multiple traditional IRAs, each IRA must calculate its own RMD, but the total RMD amount can be aggregated and taken from one (or more) of your traditional IRAs.

Question:

I recently transferred a Federal TSP (Thrift Savings Plan) retirement account to a traditional IRA. Is it possible in the same year to convert it to a Roth IRA?

Answer:

Yes, in the same year, you can convert all or a portion of the IRA dollars that were rolled over from the Thrift Savings Plan. Neither the direct rollover from the TSP to the IRA nor the Roth conversion will count against the one-rollover-per-year rule, so no worries there. Be aware that these transactions will generate a string of tax forms, but when netted together and reported properly, the IRS will see what happened. For example, the TSP will issue a 1099-R showing the plan money leaving. The IRA custodian will issue a 5498 showing the TSP money being rolled over. For the Roth conversion, the IRA custodian will issue its own 1099-R and also report the transaction on the 5498.

https://www.irahelp.com/slottreport/calculating-your-rmd-roth-conversions-todays-slott-report-mailbag

THE 401(K) HARDSHIP WITHDRAWAL RULES IN A NUTSHELL

By Ian Berger, JD
IRA Analyst

The September 29, 2021 Slott Report summarized the rules for taking non-hardship withdrawals from 401(k) plans. This article will focus on the hardship withdrawal rules.

Most company savings plans allow you to pull out your funds to take care of a financial hardship at any age. But plans are not required to permit these withdrawals, so check your written plan materials or ask your plan administrator.

Hardship withdrawals from 401(k) and 403(b) plans must satisfy two conditions. First, they must be for an “immediate and heavy financial need.” Second, the withdrawal must be necessary to satisfy the financial need.

Immediate and heavy financial need. The IRS has published a list of seven “safe harbor” expenses. In most plans, you will automatically satisfy the immediate and heavy financial need requirement if your expense fits into one of those categories. Here are the safe harbor expenses:

  • Medical expenses for you, or your spouse, dependents or plan beneficiary.
  • Costs related to purchasing your primary residence (but not mortgage payments).
  • Tuition, fees and room and board expenses for the next 12 months of postsecondary education for you, or your spouse, children, dependents or plan beneficiary.
  • Payments necessary to prevent eviction from your principal residence or to prevent foreclosure on a mortgage on a principal residence.
  • Funeral expenses for you, or your spouse, children, dependents or plan beneficiary.
  • Certain expenses to repair damage to your principal residence.
  • Expenses and losses incurred by the employee on account of a disaster declared by FEMA, provided the employee lived or worked in a designated disaster area.

The last safe harbor, published in September 2019, has proven to be a lifeline for many employees with COVID-related expenses.

Necessary to satisfy the need. To prove that the withdrawal is necessary to satisfy your financial need, you must certify that you haven’t requested more than is necessary to pay the expense (including taxes or penalty). You also must confirm that you don’t have enough cash or other liquid assets to cover the expense and you don’t have other access to your retirement funds.

Section 457(b) standard. If you participate in a 457(b) plan that allows hardship withdrawals, you’re subject to a stricter standard. You must prove that your expense resulted from an “unforeseeable emergency” – that is, from an extraordinary circumstance that you could not have foreseen and that was beyond your control. For example, you can’t get a 457(b) hardship withdrawal to cover the cost of purchasing a home or for college expenses.

Tax consequences. Hardship withdrawals don’t come free. You’ll likely be hit with income taxes and the 10% early distribution penalty. Keep in mind there is no hardship exception to the 10% penalty. Also, you can’t roll over your withdrawal to an IRA or back into the plan.

https://www.irahelp.com/slottreport/401k-hardship-withdrawal-rules-nutshell

CLARIFYING SOME ROTH CONVERSION MISCONCEPTIONS

By Andy Ives, CFP®, AIF®
IRA Analyst

As Roth IRA conversions become more popular, questions and misconceptions abound. In no particular order, here are a dozen Roth IRA conversion facts to be aware of:

1. Anyone with an IRA can do a Roth conversion. There are no income limits. You can have $0 earned income and do a Roth conversion. You can make a million dollars and convert.

2. There is no limit on the amount that can be converted. If you have an IRA worth $3 million and want to convert the whole thing – go for it.

3. Inherited (beneficiary) IRAs cannot be converted.

4. There is no penalty on a Roth conversion, regardless of age. Understandably, IRA owners get a little gun-shy when they complete any transaction before the age of 59 ½. Rest assured that there is no 10% penalty on a Roth conversion, no matter how old you are.

5. Beware, however, that if you are under 59 ½ and have the taxes on the conversion withheld (paid) from the IRA, there can be a 10% penalty on the amount withheld. Why? Because the taxes withheld never get converted. They are essentially an early withdrawal that is sent to the IRS. As such, it is highly recommended that if you are under 59 ½, you pay the taxes due on a Roth conversion from a source other than the IRA.

6. Speaking of the taxes – they are not due immediately upon conversion. The amount of the Roth conversion is added to your income for the year, and you can settle up with the IRS next April. (Keep an eye out for IRS Form 1099-R showing the conversion amount.)

7. Partial conversions are allowed. Implementing a strategy of partial Roth conversions specific to your financial situation can help manage taxes and mitigate risk.

8. A Roth conversion must be initiated by the end of the calendar year (December 31) to qualify for that same tax year. (The funds being converted must be withdrawn from the traditional IRA by year end.) There is no such thing as a “prior-year conversion.”

9. For IRA owners taking lifetime required minimum distributions (RMDs), i.e., they are older than 70 ½ or 72, the RMD must be taken before any Roth conversion can be done.

10. Each Roth conversion will start its own 5-year clock which must be satisfied (or you turn 59 ½) before the converted dollars can be withdrawn penalty-free. Once you have held any Roth IRA for five years and are 59 ½ or older, earnings on converted dollars can come out tax- and penalty-free.

11. Roth IRAs have favorable ordering rules for distributions. It does not matter how many Roth IRAs you have, nor does it matter if you segregate your “contributory Roth IRA” from your “conversion Roth IRA.” The IRS only sees one big bucket of Roth IRA money under your name. Regardless of which Roth IRA you take a distribution from, Roth ordering rules dictate that contributions come out first, then converted dollars, then earnings.

12. Be careful! Roth conversions are added to adjusted gross income (AGI). This can impact “stealth taxes” on items tied to AGI such as IRMAA surcharges, financial aid, and taxability of Social Security.

https://www.irahelp.com/slottreport/clarifying-some-roth-conversion-misconceptions

ANOTHER GOOD REASON TO DO A SPOUSAL ROLLOVER

By Ian Berger, JD
IRA Analyst

As discussed in the October 18 Slott Report, spousal beneficiaries of IRAs can take advantage of certain payout rules that aren’t available to non-spouse beneficiaries.

For example, a surviving spouse who remains a beneficiary can defer required minimum distributions (RMDs) until the year her deceased spouse would have turned age 72.  Also, when RMDs begin for surviving spouse beneficiaries, the spouse can go back to the IRS Single Life Expectancy (SLE) Table each year to recalculate her life expectancy factor.

Instead of remaining a beneficiary, a surviving spouse can roll over inherited IRA funds to her own IRA (a “spousal rollover”). A spousal rollover can be done at any time. It often makes sense for a surviving spouse to remain a beneficiary until she turns 59 ½ and then do a spousal rollover. This allows the spouse to tap into the IRA funds without worrying about the 10% early distribution penalty.

Doing a spousal rollover allows the spouse to be treated as the owner of the rolled over funds. This permits the spouse to defer RMDs on the rollover dollars until she reaches her own required beginning date (i.e., April 1 of the year following the year she turns 72). A rollover also allows the spouse to calculate her RMDs by using the Uniform Lifetime Table (rather than the SLE Table), resulting in significantly smaller RMDs. (Note that, despite the term “spousal rollover,” the movement of money from the deceased spouse’s IRA to the surviving spouse is typically done via direct transfer.)

A less obvious perk of a spousal rollover is that the IRS treats it as retroactively effective back to January 1 of the year it is done. (Different rules apply if the rollover is done in the year of the IRA owner’s death.) This means that a surviving spouse who has been taking RMDs as an inherited IRA beneficiary won’t need to take a final RMD on the inherited funds in the year of a spousal rollover. And, since RMDs are now based on the spouse’s own age, a spouse who is younger than age 72 won’t need to take RMDs on the rolled-over funds either.

This came up recently in the case of a 57-year-old surviving spouse who elected to remain an IRA beneficiary because she needed the inherited IRA funds. The surviving spouse has been subject to annual RMDs because her husband was taking RMDs when he died. Now the surviving spouse is remarrying and no longer needs the funds, so a spousal rollover makes sense. Even though the rollover won’t be done until later this year, it will be treated as occurring on January 1, 2021. This allows the spouse to avoid a 2021 RMD on the inherited funds. And, she won’t need to take RMDs on the rolled over funds until she turns 72.

https://www.irahelp.com/slottreport/another-good-reason-do-spousal-rollover

THE ONCE-PER-YEAR ROLLOVER RULE AND THE RECENT PROPOSALS BY CONGRESS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

I have four IRAs. Does the once-per-year IRA rollover rule mean I can only take one distribution per year in total or does it mean I can only take one distribution per year from each of my four IRAs?

Glen

Answer:

Hi Glen,

The once-per-year rollover rule can be confusing. The IRS has made it clear in guidance that this rule does apply in the aggregate. It does NOT apply on a per IRA basis. This means that no matter how many IRAs you have, you cannot roll over any IRA distribution that occurs within 12 months of another distribution that was rolled over.

Question:

Dear Sir or Madam,

I have a question about the new proposals in Congress. Are inherited IRAs added to the totals to see if a taxpayer is above $10 million?  By definition they are already in RMD phase, so I wonder if they are excluded from those forced RMDs of assets above $10 million?

Thanks for your help,

Michael

Answer:

Hi Michael,

There have been a lot of questions about the recent proposals coming out of Congress that would restrict very large IRAs and require distributions from them. The proposal as currently written would include inherited IRAs when determining whether a taxpayer exceeds the $10 million threshold.

It is important to remember that right now these are only proposals. No one knows for sure whether they will become law, but we are keeping a close eye on them.

https://www.irahelp.com/slottreport/once-year-rollover-rule-and-recent-proposals-congress-todays-slott-report-mailbag

PERSEVERE, CHARLIE BROWN!

By Andy Ives, CFP®, AIF®
IRA Analyst

Charlie Brown, wearing a ghost costume full of too many eye holes cut in all the wrong spots, famously peered into his trick-or-treat bag and said, “I got a rock.”

One of the best parts of Halloween remains. It is the moment at the end of the night when, after an evening of hard work, a plastic jack-o-lantern or pillowcase full of candy is dumped onto the living room floor. Oh, what sweet treats were collected! The scents of chocolate and sugar waft into the air and, after a glorious moment, the booty is organized into piles of “like” and “don’t like,” chocolate and not-chocolate, like lollipops and licorice and gum.

Imagine the absolute disappointment if Charlie Brown were to dump his goody bag onto the floor and nothing but rocks spilled out. Heartbreaking. An utterly depressing conclusion.

I like to think the other members of the Peanuts gang shared some candy with Charlie Brown, or maybe the few rocks he received were just part of an unlucky streak. Maybe he trudged onward and his homemade costume wasn’t judged so harshly on the stoeps of the later houses he visited. Maybe those “rocks” were gag gifts and there was chocolate inside. I hope he ultimately received some good candy. Maybe his parents, in their odd “wah-wah-WHAwah” voices, had a bucket of chocolate bars left over and gave them to Charlie Brown at the end of the night.

No one deserves a bag of rocks. Not on Halloween, not in retirement. However, not everyone’s parents are able to give their child a chocolate nest egg. Not everyone has friends who can share the wealth. Recognize that some of us get more rocks, and some rocks are insurmountable without assistance. Go ahead and collect your candy. But if your pillowcase is full of chocolate at the end of a life-long trick-or-treat adventure, maybe reconsider eating it all yourself.

As for those wearing a ghost costume with a few too many eye holes – your outfit can be fixed. Also, check your retirement goody bag frequently so you know what’s been collected. If you have a string of bad luck, stay positive. Talk to others and formulate a strategy to replace rocks with treats.

Monitor your investments and bank accounts. If something isn’t working, make a change. Consult with professionals who can help design a better costume or reconfigure your trick-or-treat route. Reassess goals. How much candy do you need? What path must be taken to accumulate that candy? Will you share some with the less fortunate? Organize.

Blindly meandering through life, only to dump a financial bag full of rocks on the floor at the end of a career, would be tragic. Do not allow it to happen. Opportunities abound. Stay open and alert to new ideas. Work hard. Visit all the houses. Be curious. Communicate. Mind your candy, and be generous.

If you “got a rock,” then keep ringing doorbells. Treats will come.

Persevere, Charlie Brown!

https://www.irahelp.com/slottreport/persevere-charlie-brown

RETIREMENT PLANNING FOR THE SELF EMPLOYED

By Sarah Brenner, JD
Director of Retirement Education

Not everyone has a boss. In an economy upended by COVID, individuals, sometimes by choice and sometimes not, are striking out on their own and starting new businesses or becoming part of the gig economy. A critical issue for these workers is how to save for retirement. If you are self-employed, you may ask which retirement account is best for you. This question requires careful analysis because there is not one plan that is right for everyone.

Traditional or Roth IRA

For many who are new to gig work or have just started their own business, the best place to start saving for retirement may be with a traditional or Roth IRA. This is the easiest way to go. It simply requires making a contribution. However, the annual contribution limits are much lower than for other retirement savings options. For 2021, the maximum IRA contribution is $6,000 for those under age 50 and $7,000 for those over age 50. For those just starting out, the low dollar limit may not be a problem, but for higher earners it may not allow enough savings.

For those who are interested in a Roth option, a Roth IRA may be a good idea because there are no Roth options available for SEP IRA or SIMPLE IRA plans. However, Roth IRAs are subject to income limits, so this may not work for those with higher incomes. (Such individuals would need to use the “backdoor Roth IRA” strategy.)

SEP IRA Plan

One of the most common retirement plan solutions for the self-employed is a SEP IRA plan. These plans are inexpensive to adopt and administer. However, SEP IRAs only allow employer contributions – not elective deferrals.

SEP IRA plans offer a great deal of flexibility. Contributions do not have to be made each year and the amount can vary. The plan also does not have to be established or funded until the business’s tax-filing deadline, including extensions.

The SEP limit for 2021 for self-employed individuals is 20% of up to $290,000 of compensation (adjusted net earnings), limited to a maximum annual contribution of $58,000. (For a SEP for businesses not self-employed, the limit is the same, except “25%” is substituted for “20%.”)

SIMPLE IRA Plan

SIMPLE IRAs can also be adopted by self-employed individuals. Generally, a business can only adopt this plan if it employed 100 or fewer people during the previous calendar year and it is the only plan sponsored by the employer.

Unlike SEP IRAs, SIMPLE IRAs allow salary deferrals. For 2021, the salary deferral limit is $13,500, but there is an additional $3,000 catch-up contribution for anyone age 50 and older. These plans also require an annual employer contribution. The annual employer contribution must be either a dollar-for-dollar matching contribution (not to exceed 3% of compensation) or a 2% non-elective contribution.  (If a matching contribution is made, compensation is not limited. If a non-elective contribution is made, compensation is limited to $290,000 for 2021).

A self-employed individual stands in the shoes of both employee and employer. For 2021, the maximum SIMPLE IRA contribution available would be $33,000 ($16,500 in salary deferral + $16,500 in employer match).

Solo 401(k) Plan

A one-participant 401(k) plan is sometimes referred to as a “solo-401(k),” “individual 401(k)” or “uni-401(k).” A key point to understand is that a solo 401(k) is simply a type of 401(k) plan and is subject to many of the regular 401(k) rules. However, because there can be no employees (other than the self-employed individual and the spouse), these plans are exempt from complicated discrimination testing.

A self-employed individual can contribute both:

  • Elective deferrals up to 100% of compensation, but no more than $19,500 in 2021, or $26,000 in 2021 if age 50 or over; and
  • Employer nonelective contributions up to 20% of adjusted net earnings for those who are self-employed. (For a solo 401(k) for businesses not self-employed, the limit is the same, except “25%” is substituted for “20%.”)

For 2021, total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $58,000 (or, if lesser, 100% of the individual’s compensation).

Making the Choice

Choosing a retirement plan can be challenging if you are self-employed. Contribution limits are not the only factors to consider. You must also think about cost, ease of administration, and accessibility of funds to consider. A knowledgeable financial advisor can help answer your questions you may have in making your decision.

https://www.irahelp.com/slottreport/retirement-planning-self-employed

72(T) PAYMENTS AND INHERITED IRAS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

My situation is as follows: I am 56 years old and have an IRA which I have been taking SEPP/72(t) payments since 2008. I have not yet taken my distribution in 2021. I recently received a finding of disability from SSA which has been assigned an onset date in September 2020. Back pay will only be for Feb-Apr of 2021, so nothing effects prior tax years. Can I suspend/stop my SEPP/72(t)?

Thanks

Drew

Answer:

Drew,

Yes, a 72(t) payment schedule can be stopped due to a legitimate and long-term disability. However, the definition of disability is strict. It must qualify under IRS guidelines spelled out in Internal Revenue Code Section 72(m)(7). The IRA owner must truly fit the definition of disabled. For example, being “retired on disability” may not necessarily meet the requirements.

Question:

Hello IRA Gurus,

I have a straightforward IRA RMD question but have not been able to find a written answer that is exactly on point. I am hoping you can help. I inherited both a traditional and a Roth IRA from my sister several years ago. I am the only beneficiary. Do I have to take RMDs from each, or can I lump the total balances as of Dec 31 and withdraw only from the traditional IRA?

Much thanks,

Sally

Answer:

Sally,

In this case, each RMD (required minimum distribution) must be taken from the applicable inherited account. Only RMDs from the same type of inherited IRA and from the same decedent can be aggregated. Even though both of these inherited IRAs came from your sister, one is a traditional IRA and one is a Roth. Since they are different types of IRAs, despite coming from the same decedent, the RMDs cannot be aggregated.

https://www.irahelp.com/slottreport/72t-payments-and-inherited-iras-todays-slott-report-mailbag

ARE YOUR RETIREMENT ACCOUNTS PROTECTED FROM CREDITORS?

By Ian Berger, JD
IRA Analyst

One question that continues to come up is whether company retirement plan dollars are protected from creditors. This becomes an issue if you are forced to declare bankruptcy or you owe money after a legal action is brought against you.

If you’re in a plan covered by ERISA (the Employee Retirement Income Security Act), you don’t have much to worry about. Your plan account is just about completely shielded from creditors – whether or not you’ve declared bankruptcy. [There are exceptions for QDRO (qualified domestic relations order) payments to ex-spouses and IRS levies to recover unpaid taxes.]

Even if your plan is not an ERISA plan, your funds are still safe if you’re in bankruptcy. That protection comes from the federal Bankruptcy Code. But the situation may be different if you owe money from a non-bankruptcy lawsuit. In that case, your ability to shield your plan dollars depends on the law of the state where you live. Although some states offer complete protection similar to federal law, the protection in other states is not as strong.

Sometimes it’s hard to know whether you’re covered by an ERISA plan. Here are some guidelines.

ERISA plans include:

  • Most retirement plans sponsored by for-profit companies, including most 401(k) plans and defined benefit pension plans.
  • 403(b) plans sponsored by not-for-profit companies (such as hospitals) if the company makes contributions to the plan.

ERISA plans don’t include:

  • Plans with no employees other than the owner (and the owner’s spouse), such as a solo 401(k).
  • 403(b) plans sponsored by not-for-profit companies (such as hospitals) if the company doesn’t make contributions to the plan and its only involvement is administering employee deferrals.
  • Plans sponsored by governments or churches. These include the Thrift Savings Plan, which is a 401(k)-type plan for federal workers and the military. It also includes 403(b) plans for teachers or church employees and 457(b) plans for state and local municipal workers.
  • SEP and SIMPLE IRAs.

If you’re still not sure whether you’re in an ERISA plan, check your written plan summary or contact your HR rep.

What about IRAs? Your traditional and Roth IRAs are safe from creditors if you declare bankruptcy – but only up to an inflation-adjusted dollar limit (currently, $1,362,800). Since funds rolled over to IRAs from employer plans don’t count towards that limit, just about everyone should be well below that threshold. But outside of bankruptcy, your IRAs only receive whatever protection your state allows.

https://www.irahelp.com/slottreport/are-your-retirement-accounts-protected-creditors

SPOUSE AS IRA BENEFICIARY

By Andy Ives, CFP®, AIF®
IRA Analyst

When a married IRA owner dies, the surviving spouse is oftentimes the beneficiary. Of course, there are instances where a trust might be named as IRA beneficiary, or the children or a charity or someone else is listed. Regardless, typically it is the spouse, and how that spouse treats the inherited IRA dollars is important. While at first glance this appears to be a simple decision, there are multiple variables and options to consider.

For example, how old is the surviving spouse (“she”), and will that surviving spouse need access to the IRA dollars? If she is under 59 ½ and needs access, then establishing an inherited IRA is the best option. This way she can tap into the IRA at any time without the 10% early withdrawal penalty. Moving too quickly and consolidating the inherited IRA into her own would bring the 10% early withdrawal penalty back into effect (if no other exception was applicable).

An inherited IRA for a surviving spouse is not final. At any age – but usually after age 59 ½ – she can do a spousal rollover and combine the inherited IRA with her own IRA. Even if the surviving spouse was only age 30 when her husband died, she could choose an inherited IRA to have penalty-free access to those inherited IRA dollars. Then, at 59 ½, do a spousal rollover. Since she would then be beyond the age when the early withdrawal penalty would apply, consolidating the inherited IRA assets with her own at that later date would make sense.

Continuing with this scenario of a young surviving spouse electing an inherited IRA, the required minimum distribution (RMD) rules are also beneficial to surviving spouses. Non-spouse beneficiaries of an IRA are either bound by the 10-year payout rule or, for those beneficiaries eligible to stretch payments, required to take a distribution each year. This RMD is based on the non-spouse beneficiary’s single life expectancy. Surviving spouse beneficiaries, on the other hand, are not required to take an RMD until the deceased spouse would have been age 72. For the woman in the paragraph above (who was only 30 when her husband died), if he was a similar age, then her RMDs from the inherited IRA would not start for 40+ years. By then she most likely would have already done a spousal rollover at age 59 ½.

Speaking of a “spousal rollover,” that option is only available to surviving spouse beneficiaries. Despite the name, the inherited IRA assets are transferred from the deceased spouse to the surviving spouse. A spousal rollover via transfer is not a taxable event. However, if the surviving spouse did erroneously take a full distribution of her deceased husband’s IRA, those dollars could potentially be rolled over to her own IRA within 60 days. This is yet another benefit afforded to a surviving spouse. Non-spouse IRA beneficiaries cannot do 60-day rollovers. If a non-spouse beneficiary takes a distribution of inherited IRA dollars, there is no putting them back, and any applicable taxes would be due.

A surviving spouse beneficiary has extra flexibility when it comes to claiming a deceased spouse’s IRA. However, be careful to take the proper steps. Some variables to consider include the age of the deceased spouse, age of the surviving spouse, does the surviving spouse need access to the dollars, and what type of IRA is involved (Roth vs. Traditional). A word to the wise: all beneficiaries, spouses and non, should seek professional guidance before making any final decisions when inheriting an IRA.

https://www.irahelp.com/slottreport/spouse-ira-beneficiary

FIRST-YEAR RMDS AND IRA SURVIVING SPOUSE OPTIONS – TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I am retired and turned 72 in September, 2021, so I must begin required beginning distributions (RMDs) by April, 2022. I have traditional and Roth IRAs as well as a defined contribution plan with a former employer. I understand I must withdraw my RMD before withdrawing an amount for anything else (e.g., Roth conversion) from both my traditional IRA and my defined contribution plan. But is that requirement limited to withdrawals within each type of plan (IRA and defined contribution)?  In other words, am I allowed to take my RMD from my IRA and then do a Roth conversion from that IRA this year, while delaying my 2021 RMD from my defined contribution plan until April 2022?

Thanks in advance for answering.

Tom

Answer:

Hi Tom,

Yes, you can take your 2021 RMD from your traditional IRA this year while delaying your 2021 defined contribution (DC) plan RMD until next April 1. They are separate entities that require separate decisions.  Keep in mind that delaying your first DC plan RMD means you will have two plan RMDs in 2022 – one for 2021 (due by 4/1/22) and one for 2022 (due by 12/31/22).

Question:

The account owner, age 65, dies in 2021 and is survived by a 35 year-old spouse (30 years his junior – sole beneficiary of a traditional IRA). What are the rules (options) for the surviving spouse?

Many thanks!

John

Answer:

Hi John,

The surviving spouse has two options. She can remain a beneficiary of her deceased husband’s IRA, or she can move the IRA funds to her own IRA (a “spousal rollover”).

Remaining a beneficiary makes sense if the surviving spouse needs to tap into the inherited IRA funds before age 59 1/2, because any withdrawals would be exempt from the 10% early distribution penalty. But even if she doesn’t need the funds from the inherited IRA, she would be forced to start taking annual RMDs in seven years – when her deceased husband would have turned age 72. At age 59 ½, she could then do a spousal rollover with the inherited IRA. (A spousal rollover can be done at any time, but doing it before age 59 ½ would expose her to the 10% penalty on any pre-59 ½ distributions if no other exception applied.)  However, after the spousal rollover, RMDs wouldn’t be required until she turns age 72 – a long way off.