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IRA BLOG

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.

TIME TO SIMPLIFY YOUR RETIREMENT

By Sarah Brenner, JD
Director of Retirement Education

As you approach your golden years, you may be looking to simplify your life to wring the most out of retirement. It may be time to right size and move from a larger house with an abundance of maintenance to a smaller space that is easier to manage. It may also be time to declutter and organize years of belongings. Make a new start. Retirement accounts should not be overlooked as part of this process. Consolidating these accounts can go a long way towards simplifying life.

The days of retiring with a pension after 40 years with the same company are long gone. It is not unusual for today’s retirees to have worked multiple jobs and participated in multiple employer plans. Sometimes assets get left behind in plans long after workers leave employment simply because the participant never got around to moving the dollars out. You may have multiple, mostly overlooked IRAs with a multitude of different financial institutions, from banks to credit unions to mutual fund companies.

Consolidation Benefits

There are multiple benefits to consolidating retirement accounts, starting with less account information to track. Additionally, overlooked and left-behind employer plan and IRA assets may not be performing as well as they could be if actively managed. This can not only result in lost investment opportunities, it can also create escheatment issues. States are becoming more aggressive going after unclaimed property, and IRAs and plans are no longer off limits.

Required minimum distributions (RMDs) can also be a problem when an individual has multiple retirement accounts. The more RMDs that need to be taken, the more likely it is that a mistake will be made.

IRA Rollover Advantages

An IRA is a great place to consolidate retirement funds. It can help you stay in control by not having to keep track of several company plans and IRAs — along with all the beneficiary designations and withdrawal options for each account. Consolidating into an IRA also helps ease the burden of taking RMDs. After consolidation, you will no longer have to worry about RMDs from both your plan and your IRA.

Within an IRA, there is a universe of investment options to choose from which far exceeds the limited number of investments typically offered by an employer plan. An IRA owner can customize investment choices to meet her personal needs. Changes to fit risk tolerance and retirement needs can be made instantly.

The bureaucracy you may face when dealing with a plan can also be avoided. Employer plans may also have restrictions on withdrawals, but IRA owners generally have immediate access to funds, regardless of age. Also, qualified charitable distributions (QCDs), which are available at age 70½, can only be made from IRAs, not plans.

If you have a number of different retirement accounts cluttering things up, it may be time to consolidate and simplify!

https://www.irahelp.com/slottreport/time-simplify-your-retirement

A POSSIBLE SOLUTION TO THE “MEGA IRA” RESTRICTIONS

By Ian Berger, JD
IRA Analyst

The Build Back Better Act of 2021, recently passed by the House Ways and Means Committee, includes a number of retirement plan provisions.  They were summarized in the September 22, 2021 Slott Report.

Two of those provisions are targeted at so-called “Mega IRAs.” One provision would prohibit additional contributions to a traditional or Roth IRA for a calendar year under certain circumstances. No contributions could be made if the value of someone’s retirement accounts exceeded $10 million as of the prior December 31 and the individual has income in excess of $400,000 (if single) or $450,000 (if married filing jointly). The second proposal would require these persons to receive distributions from their accounts to bring down the total value to $10 million. (There is a separate mandatory distribution rule for those with total account balances exceeding $20 million.)

Most individuals will not be affected by these provisions. For those who may be impacted, keep in mind that in determining whether someone has over $10 million in retirement benefits, the proposals take into account traditional IRAs, Roth IRAs and company defined contribution (DC) plans [i.e., 401(k), 403(b) and 457(b) plans]. The proposals do not take into account the value of company defined benefit (DB) plans, including traditional DB plans and cash balance plans.

These proposals are another reason why high-income small business owners may want to consider establishing DB plans. Even apart from the House bill, DB plans provide definite advantages. For example, deductible contributions to DB plans are not subject to IRS limits, unlike contributions to DC plans. Annual deductible contributions for older business owners can be especially high, in excess of $200,000, compared with a limit of $64,500 for DC plan contributions. And, a DB plan can be used in tandem with an existing DC plan or SEP IRA.

But there are certain tradeoffs for these tax benefits. DB plans have relatively high administrative costs, including the requirement to hire an actuary. Furthermore, contributions can fluctuate from year to year and may be required in years when the company is struggling. Finally, there are rules making it difficult to shut down a DB plan.

One caution about cash balance DB plans, which usually offer lump sum payments. A high-wealth individual looking to stay below the $10 million threshold by using a cash balance plan should not roll over a cash balance lump sum into his IRA. Doing so will bring the former cash balance assets under the restrictions of the House bill. However, the alternative to taking a lump sum (i.e., taking periodic payments out of the cash balance plan) would expose those payments to immediate taxation.

Finally, starting up a DB plan wouldn’t allow someone to roll over existing IRA or DC plan funds into the DB plan in order to avoid the $10 million threshold. DB plans can’t accept rollovers.

https://www.irahelp.com/slottreport/possible-solution-%E2%80%9Cmega-ira%E2%80%9D-restrictions

NONSPOUSE BENEFICIARIES AND 2021 RMDS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Dear Ed Slott and Company,

I am a longtime subscriber, having met and talked with Ed at several industry conferences, going back well over 20 years. Which, with all of Ed’s great work and active networking, puts me in a pretty big club!

In any event, a CPA has turned to me with a problem.

A client of his passed away earlier this year with $1.7M in her IRA. Her Estate was the beneficiary of the IRA. Her 80+ year old siblings are the beneficiaries of the estate. I know, not great facts. But, it gets worse.

The CPA consulted with the executor and the broker who handled the account. They all agreed not to do anything until hearing more from the CPA.

A few weeks after that, the broker and the Executor decided to liquidate the holdings in the IRA, even though an Estate IRA was never opened. They then sent a check to a Bank account for the Estate, which is of course a checking account, not an IRA.

I am told that IRS regulations prevent an estate from rolling back into an IRA. Is this true?

Thank you,

Tom

Answer:

Hi Tom,

Thanks for your support over the years! Unfortunately, the news here is not good. The rules are very strict when it comes to nonspouse beneficiaries, such as an estate, and rollovers. Once a distribution from an inherited IRA is paid to a nonspouse beneficiary, it is irreversible. It cannot be rolled over or put back into an IRA. Only a spouse beneficiary can roll over a distribution from an inherited IRA. We see this mistake made far too frequently and unfortunately there is no fix.

Question:

Hello,

I have a question about clients who have inherited IRAs and need to take an RMD for 2021 but did not take their 2020 RMD because of the Covid RMD waiver. Will they use the life expectancy number they used for 2019 RMD and subtract 1 or subtract 2 from that number to account for the skipped 2020 RMD?

Thanks,

Randy

Answer:

Hi Randy,

We are getting many questions on how to calculate RMDs for 2021. There is a lot of confusion in the wake of the 2020 waiver under the CARES Act. Here is how it would work. A nonspouse beneficiary who is required to take RMDs based on life expectancy would subtract 2 from the factor that was used in 2019. Even though no RMD was required for 2020, it is still counted when determining the life expectancy factor for 2021.

https://www.irahelp.com/slottreport/nonspouse-beneficiaries-and-2021-rmds-todays-slott-report-mailbag

EARNINGS ARE EARNINGS WITHIN A TRADITIONAL IRA

By Andy Ives, CFP®, AIF®
IRA Analyst

When it comes to taxes and the 10% early distribution penalty, do not allow the underlying investments within a Traditional IRA to confuse what is applicable. Earnings within an IRA are just earnings. It does not matter if those earnings come from appreciation, capital gains, dividends, rents, annuity income, interest, or really any other form of growth. If it happens within the IRA, it is essentially just “earnings.”

As such, if those earnings are withdrawn, regardless of the type of earnings, they will all be taxed the same – as ordinary income. And if those earnings are withdrawn before the age of 59 ½ – assuming no exception applies – they will also get hit with a 10% penalty. (Technically, the 10% penalty is referred to an “additional tax,” but a punch in the nose is a punch in the nose, whether it was a right fist or a left.) There is no special type of earnings within an IRA that can avoid taxes or the 10% penalty if withdrawn early – again, assuming no exception applies.

If a person under the age of 59 ½ has an annuity in his IRA, and if that annuity kicks off income, that income will not bypass the 10% penalty if withdrawn. If it is paid out to the IRA owner, it is a distribution and will be subject to all the rules and regulations of any other early distribution. Simply because the under-59 ½-IRA owner says it is the earnings from his annuity is irrelevant. That payout will be taxed as ordinary income and will be subject to the 10% early withdrawal penalty.

Where could that income payment from the annuity have gone? To a cash account within the IRA where it could sit or be reinvested.

Same thing with real estate. You are more than welcome to own a rental property within your IRA. Commercial buildings, summer homes, apartment complexes – you name it. All can be held within an IRA. But what to do with the rental income? Can it be paid out to the IRA owner? Of course, but it will “change its character” from rental income to ordinary income upon distribution. And if you are under 59 ½, expect a 10% penalty if no other exception applies.

To avoid taxes and a possible penalty, where could that rental income have gone? You guessed it…to a cash account within the IRA where it could sit or be reinvested.

Same deal when a stock held in an IRA pays a dividend. Same deal when a mutual fund pays a capital gain. Same deal when a municipal bond is accidentally purchased within an IRA and pays what would otherwise be tax-free interest (if it had been properly positioned in a non-qualified account). IRAs are already tax-exempt. You can’t double up the tax exemption with a muni bond. “Tax-free” interest from a municipal bond held in an IRA would change its character and be treated as ordinary taxable income upon withdrawal from the IRA.

There is an unusual type of income within an IRA that can, in fact, be taxable even if it isn’t withdrawn. That is “unrelated business taxable income,” or UBTI. We will tackle that subject some other time. For now, recognize that earnings within a Traditional IRA are just that –earnings. When earnings are withdrawn, they are subject to ordinary income taxes. And, if under age 59 ½, there will also be a 10% early withdrawal penalty…if no exception applies.

https://www.irahelp.com/slottreport/earnings-are-earnings-within-traditional-ira

WHAT THE NEW TAX PROPOSALS MEAN FOR ROTH CONVERSIONS

By Sarah Brenner, JD
Director of Retirement Education

It’s hard to keep up with the news out of Washington these days! We have been getting a ton of questions on how the new tax proposals recently passed by the House Ways and Means Committee would impact Roth conversions. Here is the rundown.

After-Tax Conversions

Congress is looking to slam the door on the so-called “back door Roth IRA” and “mega back door Roth IRA” strategies. The key point to understand here is that these strategies involve conversions of after-tax dollars. For example, currently the back door Roth IRA conversion allows an individual to make a nondeductible after-tax contribution to a traditional IRA and then convert it tax-free to a Roth IRA. This is a way that higher earners can avoid the Roth IRA contribution limits and fund a Roth IRA.

The current proposals would end this strategy. It would also shut down the strategies of funding an employer plan with after-tax dollars and converting them to a Roth IRA or converting them to a Roth account within the plan.

These types of conversions would be outlawed beginning next year. This would apply to everybody, regardless of income.

Pre-tax Conversions

Many conversions do not involve after-tax dollars at all. Instead, they involve pre-tax funds that when converted result in a tax bill. These types of conversions would be allowed to continue next year. Congress loves the revenue they bring in and is not ready to quit them yet. Instead, pre-tax conversions would be subject to income limits beginning 10 years down the road, starting for 2032. The ability to convert pre-tax dollars would be eliminated for taxpayers with income over $400,000 if single and over $450,000 if married.

IRA owners with long memories may remember that Roth IRA conversions had an income limit in the aughts. Congress is looking to return to the bad old days and bring it back …. but not for ten years.

What You Can Do Now

First, take a deep breath and remember that right now we only have proposals. As anyone who watched School House Rock on Saturday mornings as child can tell you, it is a long path before a bill becomes a law.

However, it is smart to recognize that Roth conversions are on Congress’s radar. If you have been on the fence about converting to a Roth, 2021 may be your year. For back-door Roth conversions, it may be your last chance. For pre-tax conversions, the time might be right too. Congress is taking aim at the tax code, and current rates and rules may not be around for long.

https://www.irahelp.com/slottreport/what-new-tax-proposals-mean-roth-conversions

INHERITED IRAS AND 2021 RMDS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Good morning,

I have an inherited IRA. I took a manual withdrawal from it in late August. I thought I had deleted my auto withdrawal on the custodian’s website. I just noticed today that another distribution was taken on 9/17. I have done nothing with the money in the core account that it was transferred to. Is there any way for me to reverse this error?

Thank you for any assistance.

Cynthia

Answer:

Cynthia,

Since this is an inherited IRA, there is no way to return the unwanted distribution. Non-spouse beneficiary owners of inherited IRAs are not allowed to do 60-day rollovers, so no mechanism exists to return the funds. Even if you were to petition the IRS, they would not accept the excuse of accidentally not turning off the automatic withdrawal feature. The only possible fix would be if this inherited IRA came from your deceased spouse. Only in that situation could you – as a spouse beneficiary – do a spousal rollover with the extra distribution into you own IRA.

Question:

I have clients, a husband and wife, that both turn 72 in December of this year, one on 12/19 and the other on 12/26.  Under the new RMD rules, are they required to take an RMD for 2021?  If so, I am pretty sure they could wait until the tax deadline of 2022 to take their 2021 RMD, but then wouldn’t they have to take two RMDs in 2022?  Let me know as soon as you have a chance.  Thanks.

Joseph

Answer:

Joseph,

You are on the right track. Since 2021 is the first year for these individuals to take a required minimum distribution (RMD), they are allowed to delay that first RMD until April 1, 2022. (Notice the deadline is April 1 and not the tax filing deadline.) If a person delays all or part of his first RMD until the following year, then the delayed RMD must be taken by April 1, and the RMD for the following year must also be taken by December 31 of that same year. Both distributions will be taxable in the year they are withdrawn.

https://www.irahelp.com/slottreport/inherited-iras-and-2021-rmds-todays-slott-report-mailbag

RESTRICTIONS ON 401(K) IN-SERVICE WITHDRAWALS

By Ian Berger, JD
IRA Analyst

Congress designed 401(k) plans as retirement savings vehicles – not as checking accounts. So, there are restrictions on when employees can make “in-service withdrawals” (i.e., withdrawals  while still working).

It’s important to remember that while 401(k) plans must abide by these withdrawal rules, plans are free to impose even more restrictive rules. So, you’ll need to check your plan summary or ask your plan administrator or HR rep for the particular withdrawal rules that apply to you.

Many plans allow in-service withdrawals of certain kinds of contributions for any reason once employees meet certain age or service requirements. (Most plans also offer hardship withdrawals at any age. Those will be covered in a future blog post.)

Each type of 401(k) contribution is subject to different withdrawal restrictions:

Pre-tax deferrals and Roth contributions

Your plan can allow in-service withdrawals of pre-tax deferrals and Roth contributions (if offered), plus associated earnings, at age 59 ½ or older.

After-tax contributions

If your plan offers non-Roth after-tax contributions, the plan can allow those contributions and their earnings to be withdrawn at any time.

Employer contributions

Many plans permit in-service withdrawals of vested company contributions, such as matching or profit sharing contributions, and their earnings. The IRS rules are very flexible here. Plans can allow withdrawals at a specified age (even earlier than age 59 ½), after at least five years of plan participation or after the contribution has been in the plan for at least two years. Practically, however, most plans that allow in-service withdrawals of these funds permit them at age 59 ½ (like pre-tax deferrals and Roth contributions). Doing so simplifies plan administration and ensures that employees won’t be stuck with the 10% early distribution penalty.

Safe harbor contributions

Some 401(k) plans make “safe harbor” employer contributions to allow them to automatically satisfy certain IRS limits on contributions by highly-paid employees. Safe harbor contributions and associated earnings are not eligible for in-service withdrawal before age 59 ½.

Rollover contributions

401(k) plans are permitted to allow incoming rollovers of pre-tax retirement accounts (“reverse rollovers”). Plans can allow in-service withdrawals of rollover contributions and their earnings at any time, regardless of age or service. Once again, however, many plans set age 59 ½ as the cutoff point.

Taxation

Keep in mind that in-service withdrawals of pre-tax funds (i.e., elective deferrals, company contributions, safe harbor contributions and rollover contributions, plus associated earnings) are taxable to you. (If made before age 59 ½, they may also be subject to the 10% penalty.) Roth accounts and after-tax contribution accounts are treated separately. If a Roth 401(k) withdrawal is a “qualified distribution,” it comes out completely tax-free. If not qualified, a portion of each Roth withdrawal is taxable. When after-tax contributions are withdrawn, a portion of each withdrawal is also usually taxable.

https://www.irahelp.com/slottreport/restrictions-401k-service-withdrawals

CHECKING I.D.’S AT THE DOOR – KEY RETIREMENT ACCOUNT AGES AND RULES

By Andy Ives, CFP®, AIF®
IRA Analyst

In most states the legal age for alcohol consumption is 21. And you must actually be 21. When you hand your driver’s license to the bouncer and he shines a little flashlight on your date of birth, it is not good enough to say you will be turning 21 in a couple of months. Unless today is your 21st birthday or later, the bouncer will wave you away, denying access to the premises.

While you must attain the age of 21 to have a legal drink – simply hitting a specific birthday is not always the deciding factor when it comes to allowing (or requiring) certain retirement account transactions. Here we discuss four important ages applicable to IRAs and/or workplace retirement plans like a 401(k). For two of these landmark times, a person must attain a specific age to proceed. In the other two, it is acceptable to be turning the relevant age later that year.

Age 55 Penalty Exception. The age-55 exception is available in the year when a person turns 55. You do not have to actually be 55 to take advantage of this benefit. Note that the age-55 exception applies to workplace plans only. It does not apply to IRAs or IRA-based company plans like a SIMPLE or SEP. If a plan participant separates from service in the year he turns 55 or later, he can take a withdrawal from that specific plan and avoid the 10% early distribution penalty. You cannot separate from service in a year before turning 55 and delay the distribution until the year you turn 55. That will not qualify. Also know that this is a universal IRS exception and not something plans can opt out of.

Age 59 ½ Early Withdrawals. Unless another exception applies, a person must be 59 ½ to access IRA or workplace retirement plan dollars without a 10% early withdrawal penalty. Unlike the age-55 exception, it is not good enough to be turning 59 ½ later that same year. You must actually hit that specific 59 ½ birthday. (Don’t worry about counting the days of the year. Just add six months to your 59th birthdate to see when the exception becomes available to you.)

Age 70 ½ for a QCD. Similar to the age 59 ½ rule, a person must actually be age 70 ½ to be eligible for a QCD (“qualified charitable distribution”). QCDs are only permitted from IRAs. You cannot do a QCD from a workplace plan like a 401(k), and turning 70 ½ later in the year is not sufficient. Also, if you have an inherited (beneficiary) IRA, you still must be 70 ½ to do a QCD. How old the original IRA owner was when he died, or how old he would have been today had he lived, is irrelevant. The 70 ½ age limit for a QCD is a hard-and-fast entry date.

Age 72 for RMDs. Required minimum distributions (RMDs) start in the year a person turns 72. Technically, the first RMD does not need to be taken until the “required beginning date,” which is April 1 of the year after a person turns 72. Regardless, the indicator for beginning RMDs is the year in which a person turns 72. Additionally, an account owner can take his RMD before actually turning 72. (Note that RMDs from a company plan could potentially be delayed if the plan has the still-working exception.)

Recognize that some retirement account exceptions and transactions are available only at a specific age. Others are more general and can be leveraged in the year when a person turns a particular age. Be sure to know what IRA bars and nightclubs you can enter, or else the IRS bouncer could check your I.D., shake his head, and turn you away.

https://www.irahelp.com/slottreport/checking-id%E2%80%99s-door-%E2%80%93-key-retirement-account-ages-and-rules

CONGRESS LOOKS TO ELIMINATE BACK-DOOR ROTH STRATEGIES

By Sarah Brenner, JD
Director of Retirement Education

The House Ways and Means Committee has released a draft of proposed changes to retirement accounts, including adding income limits for conversions and eliminating the back-door Roth conversion strategy. These proposals are designed to raise revenue and are likely, at least in part, a response to recent headlines about large Roth IRAs held by billionaires. Unless otherwise noted, the proposals would be effective for 2022. Here is what this means for your retirement account.

Contribution Limits for Large IRAs. The proposal creates new rules for those with very large IRA and defined contribution retirement account balances. Specifically, it prohibits further contributions to a Roth or traditional IRA for a taxable year if the total value of an individual’s IRA and defined contribution retirement accounts generally exceed $10 million. The limit on contributions would only apply to single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, and married taxpayers filing jointly with taxable income over $450,000.

RMDs for Large IRAs. If an IRA owner’s combined traditional IRA, Roth IRA and defined contribution retirement account balances generally exceed $10 million at the end of a taxable year, an RMD would be required for the following year. This minimum distribution is only required if the taxpayer’s taxable income is above the thresholds described in the section above (e.g., $450,000 for a joint return). The RMD generally would be 50% of the amount by which the IRA owner’s prior year aggregate traditional IRA, Roth IRA and defined contribution account balance exceeds the $10 million limit.

Income limits on Roth Conversions. Roth conversions for both IRAs and employer-sponsored plans for single taxpayers with taxable income over $400,000, and married taxpayers filing jointly with taxable income over $450,000, would be eliminated. However, this proposal would not be effective until 2032.

No Conversions of After-Tax Dollars. The proposal would prohibit after-tax IRA and plan contributions from being converted to Roth, regardless of income level. This would eliminate the back-door Roth IRA conversion and Mega backdoor Roth IRA conversion strategies.

IRA Investments Limited.  The bill would prohibit an IRA from holding any security if the issuer of the security requires the IRA owner to have certain minimum level of assets or income, or to have completed a minimum level of education or obtained a specific license or credential. This rule would include a 2-year transition period for IRAs already holding these investments.

Expand the Statute of Limitations for IRA Noncompliance. The bill proposal would extend the statute of limitations for IRA noncompliance related to valuation-related misreporting and prohibited transactions from 3 years to 6 years. This would help the IRS pursue these violations that may have originated outside the current statute’s 3-year window.

Prohibition of Investment of IRA Assets in Entities in Which the Owner Has a Substantial Interest. The bill makes the current prohibited transaction rules that apply when the IRA owner has an interest in a particular investment much stricter. There is a 2-year transition period for IRAs already holding affected investments.

IRA Owners Treated as Disqualified Persons for Purposes of Prohibited Transactions Rules. The bill clarifies that, for purposes of applying the prohibited transaction rules with respect to an IRA, the IRA owner or IRA beneficiary is always a disqualified person.

While these changes are currently just proposals, retirement account owners have been put on notice. No one knows for sure what Congress will do, but given the current climate in Washington, changes like these could have some traction. We at the Slott Report will be carefully monitoring any new developments. Stay tuned!

https://www.irahelp.com/slottreport/congress-looks-eliminate-back-door-roth-strategies

ELIGIBILITY RULES FOR ROTH IRA CONTRIBUTIONS AND DEDUCTIBLE TRADITIONAL IRA CONTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

If your employer contributes to either a SEP IRA or a SIMPLE IRA, can you (the employee) also contribute to a Roth IRA?

Regards,

Alfred

Answer:

Hi Alfred,

Yes, you can make Roth IRA contributions even if you participate in a SEP or SIMPLE IRA in the same year. Active participation in a plan only matters for determining whether a traditional IRA contribution is deductible. Be aware, however, that there are income restrictions on making Roth IRA contributions.

Question:

Help!  My client changed jobs mid-year and the new company does not provide a retirement plan.  She has participated in her old 401(k) plan throughout this year, having contributed $15,000. Her husband fully contributes to his own 401(k) plan. My question is, since she can’t continue in a 401(k) plan for the balance of this year, could she contribute $4500 into an IRA plan this year (with a tax deduction) to equal what she would have done in a 401(k) plan?

Mark

Answer:

Hi Mark,

It depends. By virtue of participating in the 401(k) earlier this year, your client is considered an active plan participant for 2021. This means her ability to make a deductible traditional IRA contribution depends on her and her husband’s combined modified adjusted income (MAGI) for 2021. If their combined MAGI is less than $105,000, she can make a fully deductible IRA contribution; if between $105,000 and $125,000, she can make a partially deductible contribution; and if it exceeds $125,000, she can’t make any deductible contribution. If these income limits preclude her from making a deductible IRA contribution, your client may want to consider a Roth IRA, which has higher income limits.

https://www.irahelp.com/slottreport/eligibility-rules-roth-ira-contributions-and-deductible-traditional-ira-contributions

FIXING A 60-DAY ROLLOVER ERROR

By Ian Berger, JD
IRA Analyst

Are you moving assets between IRAs or from a company plan to an IRA (or vice-versa)? You should know that using a direct transfer is a much better idea than doing a 60-day rollover. Direct transfers avoid all of the possible issues which can occur with 60-day rollovers:

  • If the deadline is missed, the rollover amount will be considered a taxable distribution and may be subject to a 10% early distribution penalty.
  • A late rollover will be treated as an excess contribution in the receiving IRA and subject to a 6% annual penalty unless timely withdrawn.
  • Even if you do a valid 60-day rollover, a company plan distribution is subject to 20% withholding for federal income taxes  – and maybe state withholding as well.
  • 60-day IRA rollovers are subject to the once-per-year rollover rule. That rule restricts certain rollovers of a distribution that occurs within 12 months of a prior distribution that you rolled over. (The rule doesn’t apply to company plan-to-IRA rollovers, IRA-to-company plan rollovers or Roth conversions.)

With a direct transfer, you don’t have to worry about any of these problems. Despite this, some folks still wind up doing 60-day rollovers and, inevitably, wind up missing the deadline. If you don’t have a legitimate excuse for missing the deadline, you’ll face some or all of the serious consequences discussed above.

However, if the late deadline wasn’t your fault, you might be in luck. In 2016, the IRS introduced a free self-certification program for fixing late rollovers. Self-certification only requires you to provide a letter to the receiving custodian indicating your error was due to one or more of 12 specified reasons. (The letter does not need to go to the IRS.)  Some of these reasons are:

  • An error by the custodian making the distribution or the custodian receiving the rollover;
  • The rollover check was misplaced;
  • The rollover check was mistakenly deposited into a non-retirement account;
  • Postal error; and
  • Death or serious illness of a family member.

Self-certification was designed to replace the old way of fixing late rollovers, which required requesting a private letter ruling (PLR) from the IRS. The IRS can waive the 60-day deadline where “equity or good conscience” requires a waiver. However, the filing fee for a PLR request is $10,000, and attorney or CPA fees for submitting the request can run thousands of dollars more. So, you definitely want to use self-certification if you can.

But seeking a PLR can be a necessary option if you miss the rollover deadline for a reason outside the 12 reasons required for self-certification. Recently, in PLR 202134019, the IRS gave a waiver to an IRA owner who had relied on someone else to do a rollover that, lo and behold, never got done.

The important point is that you don’t have to concern yourself with fixing a late rollover if you don’t do a rollover in the first place. A direct transfer is a better way to go.

https://www.irahelp.com/slottreport/fixing-60-day-rollover-error

YEAR-OF-DEATH RMDS

By Andy Ives, CFP®, AIF®
IRA Analyst

When an IRA owner taking required minimum distributions (RMDs) dies before removing his annual RMD, that year-of-death RMD (or whatever portion remains) must still be withdrawn. Upon passing, the year-of-death RMD immediately becomes the responsibility of the beneficiary. If it is not withdrawn before the end of that same calendar year, it is a missed RMD and potentially subject to a 50% penalty. Even if the IRA owner dies late in the year, December 31 remains the deadline for the beneficiary to take the year-of-death RMD.

If there is more than one beneficiary, the year-of-death RMD may be split in any manner among the beneficiaries. There is no requirement to distribute it equally. As long as the proper amount is paid out in time, the IRS does not care who takes the year-of-death RMD. For example, if one beneficiary chooses a lump sum payout for her portion while the other beneficiaries choose to establish inherited IRAs, that lump sum payout to a single beneficiary could satisfy the entire year-of-death RMD requirement (assuming it was enough to cover the RMD amount).

The year-of-death RMD is not paid to the original owner’s estate unless the estate is the named beneficiary. Occasionally, a person will die right before his RMD was scheduled to be automatically paid out. If the RMD is then erroneously paid to the deceased account owner, the RMD must be returned to the IRA and properly distributed to the beneficiary. The year-of-death RMD can be transferred to an inherited (beneficiary) IRA first and paid later in the year. Some custodians require that the year-of-death RMD be handled in this manner to help clarify the tax reporting for the beneficiary.

What if an IRA owner was planning on using a QCD (qualified charitable distribution) to remove the RMD amount from his income, but died before he requested the QCD? Can the beneficiary request the QCD be completed in the name of the decedent with the year-of-death RMD? No. Again, the year-of-death RMD is the responsibility of the beneficiary and cannot be paid to the decedent’s estate, personal accounts, or handled as a QCD in the name of the decedent.

If the decedent can’t do a QCD, can the beneficiary do a QCD from the new inherited IRA? Can the beneficiary do a QCD to cover the year-of-death RMD in his own name? Yes, but only if the beneficiary is otherwise eligible to do a QCD. Meaning, the beneficiary (as is the case with all people when it comes to QCDs) must be at least age 70 ½. And you must actually be 70 ½, not turning 70 ½ later in the year.

Example: Leroy, age 75, died peacefully in his sleep. Leroy had an IRA RMD for $40,000 that he had yet to take. Leroy named his sister Matilda, age 73, and his brother Ron, age 69, as his IRA beneficiaries. Matilda and Ron are responsible for taking Leroy’s $40,000 year-of-death RMD. It does not matter how it is divided between the two. Matilda knew that Leroy wanted to do a QCD for his entire RMD amount to a local charity. Matilda does not need the money. Since she is over age 70 ½, she tells Ron that she will honor Leroy’s wishes and cover the full year-of-death RMD with a QCD from her new inherited IRA. This will satisfy the year-of-death RMD and minimize the tax hit to Ron. (Since Ron is only 69, he cannot do a QCD yet and would have had to take a taxable distribution of his portion of the year-of-death RMD.)

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

RETIREMENT ACCOUNT RELIEF FOR DISASTER VICTIMS

By Sarah Brenner, JD
Director of Retirement Education

President Biden has declared September to be National Preparedness Month. The goal is to encourage Americans to be more prepared for natural disasters. Unfortunately, from flooding on the east coast to fires on the west coast the news headlines seem to be full of these devastating events, and an increasing number of Americans have been affected.

You may not realize that if you are the victim of a natural disaster, you may be eligible for some relief when it comes to your retirement account.

The IRS can postpone certain tax deadlines for individuals affected by federally declared disaster areas. These postponed deadlines can also apply to retirement accounts. For example, the relief includes more time to complete certain acts such as IRA rollovers or recharacterizations, correction of certain excesses, and extending the deadline for making IRA contributions.

When a deadline is postponed, the IRS will post information on its website giving the new deadline and specifying which taxpayers are affected.

Here is a link: Tax Relief in Disaster Situations | Internal Revenue Service (irs.gov).

Currently, victims of Hurricane Ida, flooding in Tennessee, and California wildfires are among those eligible for relief. For example, the deadline to complete certain retirement account related transactions has been extended until January 3, 2022, for victims of Hurricane Ida.

While the IRS can grant some tax relief to victims of natural disasters, its ability to do so is limited. There is some relief that that IRS does not have the power to give. For example, it cannot exempt early retirement account distributions from the 10% penalty. Such a change would require a change in the law and can only be made by Congress.

Congress has passed such legislation in the past for certain victims of Hurricanes Harvey, Irma, and Maria and the California wildfires. Similar legislation was also passed back in 2005 to help the victims of Hurricane Katrina and in 2020 for persons affected by COVID-19

However, legislation giving retirement account relief to disaster victims is not always a sure thing. Unfortunately, politics can get in the way. Just ask victims of Hurricane Sandy in 2012. Similar proposed legislation for victims of the superstorm that struck the Northeast stalled in Congress and never became law.

There have been proposals to make penalty-free disaster distributions a permanent part of the tax code. These proposals may gain some traction in Congress as, unfortunately, natural disasters seem to be becoming more frequent these days.

https://www.irahelp.com/slottreport/retirement-account-relief-disaster-victims

IRA ROLLOVERS & KEEPING TRACK OF YOUR CONTRIBUTIONS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

Ed

I heard on a podcast that you are the number one authority on IRAs, so I want to go to the most informative source.  Could you answer this question for me?

I have a Roth IRA and suddenly I was unable to view and edit my beneficiaries. I was told by the custodian that it was because the account was moved from a previous bank when they were bought out. I contacted the current custodian and they told me to open another Roth IRA with them and just transfer the funds.

Do you see any issues with me doing this such as the 5-year rule or early withdrawals?

Sincerely,

Robert

Answer:

Hi Robert,

You can go ahead and transfer your Roth IRA funds without worry. This will not affect the 5-year holding periods required for tax- and penalty-free Roth IRA distributions. It is a good decision to go with the direct trustee-to-trustee transfer rather than having distribution be a paid to you and then doing a 60-day rollover. Transfers avoid the headaches of both the 60-day rule and the once-per-year rule that apply to 60-day rollovers.

Question:

I opened a Roth IRA in 2021 with a $7,000 contribution.  Where will I report this when I file my taxes? Thank you in advance for answering this question.

Answer:

This is a question that comes up a lot and the answer may surprise you. Roth IRA contributions are not reported on your federal income tax return. The Roth IRA custodian will send you and the IRS Form 5498 showing the Roth contribution. However, it is still a good idea to keep your own records and track your Roth IRA contributions. This information is important to determine when your Roth IRA funds can be accessed tax- and penalty-free.

https://www.irahelp.com/slottreport/ira-rollovers-keeping-track-your-contributions-todays-slott-report-mailbag

HOW DO REVOCATION-ON-DIVORCE LAWS WORK WITH ERISA PLANS?

By Ian Berger, JD
IRA Analyst

What if you have an IRA with your spouse as primary beneficiary, get divorced without changing your beneficiary and then die? Who inherits your IRA benefits.

If you live in one of the 26 states (as of June 2018) that have “revocation-on-divorce” (ROD) laws, your ex-spouse would automatically be removed as beneficiary upon divorce. Instead, your IRA would go your contingent beneficiary or, if none, to the default beneficiary under your IRA agreement.

In the 2018 Sveen v. Melin decision, the U.S. Supreme Court approved the Minnesota ROD law as it applied to life insurance. In that case, Mark Sveen purchased a life insurance policy and named his wife Kaye as primary beneficiary and two children from a prior marriage as contingent beneficiaries. Mark and Kaye subsequently divorced, but Mark had not changed the beneficiary form by the time he died. The result of the Supreme Court ruling is that the life insurance proceeds went to the two children since Kaye was removed by the ROD law.

The Sveen decision led to speculation that ROD laws could (depending on the law’s particular wording) also apply to inherited IRAs. And, in fact, just days after the Sveen decision, the Supreme Court approved a lower court ruling that said an ex-spouse could be removed as IRA beneficiary after divorce under the Arizona ROD law.

If these laws apply to IRA benefits, shouldn’t they also apply to 401(k) plans and other ERISA company plans? Well, not so fast. When ERISA was enacted back in 1974, Congress included a “preemption clause” that says that ERISA supersedes any state law that relates to company retirement plans. The purpose of this clause was to protect companies doing business in more than one state (think Walmart) from having to comply with a patchwork of different state laws.

The Supreme Court has interpreted the preemption clause very broadly. One example of this was its 2001 Egelhoff v. Egelhoff  decision. There, David Egelhoff designated his wife Donna as beneficiary under his Boeing Company pension plan, an ERISA plan. The couple divorced, David never changed his beneficiary designation, and then he died. The Supreme Court ruled that the Washington state ROD law was superseded by ERISA because it clearly relates to ERISA retirement plans. For that reason, Donna was still entitled to receive the pension plan’s death benefits despite the divorce.

So, although state ROD laws can apply to IRAs (which aren’t covered by ERISA), they can’t apply to ERISA-covered plans like 401(k)s. But don’t forget the bigger picture. You shouldn’t have to worry about whether your state has a ROD law and, if so, whether it’s superseded. Just make you have filled out a beneficiary designation form for all your IRAs and company plans and be sure change your form when necessary after a life event such as divorce. That way, you can be certain that your retirement savings will go to the person (or persons) you want to receive them.

https://www.irahelp.com/slottreport/how-do-revocation-divorce-laws-work-erisa-plans

QUALIFIED CHARITABLE DISTRIBUTIONS AND THE “MEGA” QCD STRATEGY: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

I appreciate all of the information you pass along, both through PBS and now through the American College. In one of your recent presentations, you discussed QCDs and their often-overlooked value. I recommend QCDs to “eligible” clients. Since the adoption of the new age 72 for RMDs, the question I have is this: As I understand the rules, people who are age  70 1/2 or older can do QCDs up to $100,000 annually. But now RMDs don’t start until age 72. Does this create a “split” definition as to who can use QCDs?  That is to say, is there a gray area for those in the “gap” for the beginning age for RMD’s?

Thank you,

Charles

Answer:

Charles,

You are correct that qualified charitable distributions (QCDs) are only available to those IRA owners who are age 70 ½ and older. You are also correct that RMDs now do not begin until age 72. By raising the RMD age to 72, the SECURE Act essentially created a small window of time where a person could do a QCD and not be subject to RMDs. While QCDs are typically used to offset RMDs, an eligible person could always do a QCD for more than the RMD. The same essentially holds true for those who are between the ages of 70 ½ and 72 – they have no RMD, but can still do a QCD.

Question:

Hi Ed,

My wife and I recently watched your interview on Morningstar and you introduced the “Mega QCD.” Both my wife and I are currently at age 69, so we are not eligible for a QCD this year.  However, it seems like we are qualified to make a “Mega QCD” contribution in 2021. We would like to use our IRA money to make charitable contributions of $120,000. We have questions on how to report the “Mega QCD” on our tax form.  Hopefully, you can help us to clarify.

Thanks.

Victor

Answer:

Victor,

The “Mega QCD” is not a true QCD nor is it an actual product. “Mega QCD” is just a catchy name we gave to a charitable contribution tax strategy that is only available for 2021. In the past, taxpayers could only deduct annual cash donations of up to 60% of their adjusted gross income (AGI) for that year. This 60% limit was waived by the CARES Act, thereby allowing up to 100% of cash donations to be deducted. However, the waiver will expire at the end of 2021 when it will go back to the standard 60% limit. The “Mega QCD” strategy is nothing more than a cash distribution from an IRA or company plan of an unlimited amount and a subsequent donation of that unlimited amount to a charity.

The IRA or plan distribution will be reported on your 1099-R and will count towards your AGI on your tax return. However, you would be able to show an itemized deduction of the full amount of the donation on Schedule A. Note that a taxpayer taking the standard deduction cannot itemize a charitable deduction and therefore cannot benefit from the “Mega QCD” strategy.

https://www.irahelp.com/slottreport/qualified-charitable-distributions-and-mega-qcd-strategy-todays-slott-report-mailbag

REAL ESTATE IN AN IRA – AVOIDING A “NUISANCE PROPERTY”

By Andy Ives, CFP®, AIF®
IRA Analyst

Yes, you are allowed to own real estate in an IRA. Of course, not every IRA custodian will accommodate such an investment, but that doesn’t mean it is forbidden. If you want to own a beach house in your IRA, or a commercial building, or an apartment complex, you have every right to do so.

But tread carefully. Owning real estate in an IRA could create the possibility of a prohibited transaction. You cannot vacation at the beach house, and you can’t change a lightbulb at the apartment complex yourself. To keep an arm’s length distance, it is best to have all repairs, rentals and general upkeep handled by an independent third-party property manager. Any fees owed to the property manager must be paid by the IRA, as payment with personal funds would be a prohibited transaction.

The prohibited transaction rules can be complicated, and if violated, an IRA account owner will find himself in a world of hurt. (The entire IRA is deemed to be liquidated, the tax-qualified status is lost, and any tax and penalties will be due based on a full distribution of all IRA assets.) But prohibited transactions are not the only issues an IRA owner needs to be concerned with. Here are five general items to consider when an IRA owns real estate:

Creditor protection. It is suggested that real estate be purchased through an LLC within the IRA. If there is an accident at the property, an LLC can help shield the IRA owner.

Liquidity. A house is not a liquid asset. You can’t cut the porch off and take it as a distribution. When an IRA account owner has only real estate in his IRA, he better find some liquid assets to withdraw if he is subject to required minimum distributions (RMDs). Since IRA RMDs can be aggregated, one option is to take the RMD from another IRA with more liquidity.

Valuation. Speaking of RMDs – how are they calculated? The December 31 IRA balance is divided by a life expectancy factor. If an IRA holds real estate, it is up to the account owner to value that property and establish a legitimate 12/31 balance. It is recommended that an independent property appraiser be hired by the IRA account owner – and paid with IRA assets. The custodian will not assume this valuation responsibility.

Rollovers. Can an IRA owner take the house out of the IRA as a distribution and replace it with cash for the same value? No. The same property rule dictates that if you take out cash, you roll over cash. If you take out stock, you roll over stock. If you take out a house, you roll over that house. Be careful when moving real estate from one account to another.

Selling the property. A full cash sale is easy. But what if the property is sold and financed? Now there is a promissory note in the IRA. What is the value of that note? What if the property buyer stops paying? An entirely new set of questions have now been introduced.

Real estate is a perfectly acceptable investment within an IRA. But the regulations are strict. Proper account management is paramount. Be sure to know the rules and how to keep your IRA real estate asset from becoming a “nuisance property.”

https://www.irahelp.com/slottreport/real-estate-ira-%E2%80%93-avoiding-%E2%80%9Cnuisance-property%E2%80%9D

STRATEGIES WHEN YOUR IRA CONTRIBUTION CANNOT BE DEDUCTED

By Sarah Brenner, JD
Director of Retirement Education

The other day an advisor called us with an issue that comes up frequently, especially in these tumultuous times. His client had made an IRA contribution for 2021 and was planning on deducting that contribution. However, his job situation changed, and he became an active participant in a retirement plan at a new job. While the new job and access to a retirement plan were good things, there was an unfortunate consequence. His IRA contribution could no longer be deducted for 2021. Why? He became an active participant in a plan and his income was too high for a deductible IRA. Here are some strategies to consider if you find yourself in this situation.

1. Withdraw the contribution. If the contribution is not deductible, you may decide that you do not want to make an IRA contribution at all. That is your choice and there is nothing wrong with that. You will need to remove the contribution and the net income attributable to it by October 15, 2022. There will be no excess contribution penalty and the contribution will not be taxable. Only the net income attributable will be taxable and potentially subject to the 10% early distribution penalty.

2. Recharacterize the contribution. If you are eligible, you may want to consider recharacterizing your nondeductible IRA contribution as a Roth IRA. There are income limits for making Roth IRA contributions, so this option will not be available to everyone. However, If eligible this can be a good strategy. Recharacterization is not a taxable transaction. The funds will be directly transferred to your Roth IRA. The deadline for making this choice is October 15, 2022.

3. Keep the nondeductible contribution. Maybe you want to keep the funds in the IRA, even if you cannot deduct the contribution. This can be done. You will need to file Form 8606 with your 2021 federal income tax return to claim this nondeductible contribution. In the future when you take distributions from your traditional IRA, these funds will be returned to you tax free.

4. Do a back-door Roth conversion. Here is a creative solution that may work for you if you are interested in a Roth IRA, but your income is too high to take advantage of recharacterization. You can make a nondeductible traditional IRA contribution and then convert it to a Roth IRA. This is called a back door Roth conversion. Unlike tax year Roth contributions, there are no income limits on conversions.

What strategy is best? It really depends on you and your retirements savings goals. You may want to discuss you situation with a knowledgeable financial advisor to be sure that you make the move that is right for you.

https://www.irahelp.com/slottreport/strategies-when-your-ira-contribution-cannot-be-deducted

ROTH IRA CONTRIBUTIONS AND QCDS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

I am 72 years old and have a Roth IRA. I have some extra cash in a bank account. Can I put that into my Roth IRA and how much can I contribute for 2021?

Answer:

You could potentially contribute up to $7,000 to a Roth IRA this year, but there are a few strings attached. First, you must have 2021 earned income (pay from work or self-employment) of at least as much as the amount you contribute. (If you don’t have enough earned income but you’re married, your spouse could make a Roth IRA contribution for you if the spouse has enough earned income to cover both your Roth IRA contribution and the spouse’s contribution)

Second, you can’t make any Roth IRA contribution if your modified adjusted gross income (MAGI) exceeds a certain amount. For 2021, the limit for single individuals is $140,000 and for married individuals filing jointly is $208,000. You could make a partial contribution if your MAGI doesn’t exceed $125,000 (if single) or $198,000 (if married filing jointly). If your MAGI exceeds those limits, you could make a nondeductible traditional IRA (assuming you have enough earned income) and convert it to a Roth IRA using the “Backdoor Roth IRA” strategy.

Question:

Can you do a Qualified Charitable Distribution (QCD) to a donor advised fund?

Answer:

Unfortunately, no. QCDs can only be made directly to a charity and not to donor advised funds or private grant making foundations.

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

THE MEGA BACKDOOR ROTH IRA STRATEGY AND SOLO 401(K) PLANS

Ian Berger, JD
IRA Analyst

In the August 16, 2021 Slott Report, we showed that someone participating in a 401(k) plan through a “regular” job could also establish a solo 401(k) plan through a side job and potentially contribute up to $58,000 this year in after-tax contributions to the solo plan. However, this only works if the company sponsoring the regular 401(k) plan and the entity sponsoring the solo 401(k) (e.g., a sole proprietor) are considered unrelated under IRS rules.

The reason this strategy is so appealing is that it allows you to immediately convert those after-tax contributions to a Roth IRA through the “Mega Backdoor Roth.” That way, you could fund a Roth IRA with amounts far in excess of the $6,000 (or $7,000 if age 50 or older) limit on annual Roth IRA contributions. Even better, the conversion would be virtually tax-free. The distribution of the after-tax contributions are non-taxable. Although the earnings are taxable, you could defer taxation by rolling them over a traditional IRA.

Bear in mind that a few conditions must be met for the Mega Backdoor Roth strategy to work:

1. The solo 401(k) plan must allow after-tax contributions.

2. The plan must also allow in-service distributions of after-tax contributions.

3. You would need to be able to afford to contribute the after-tax contributions.

Example: Erin has a regular job with Global Industries that sponsors a 401(k) plan and has recently established a solo 401(k) through a sole proprietorship. Global and Erin’s sole proprietorship are not considered related entities. Erin makes sure that her solo 401(k) offers after-tax contributions and permits in-service withdrawals of those contributions. Erin’s sole proprietorship is extremely profitable in 2021, allowing her to contribute $58,000 in after-tax contributions to the solo plan. Erin wants to take advantage of the Mega Backdoor Roth, so she takes a distribution of her after-tax account (consisting of $58,000 of contributions and $2,000 of earnings). She converts the $58,000 tax-free to a Roth IRA and rolls over the $2,000 to a traditional IRA.

Many regular (non-solo) 401(k) plans – especially those sponsored by small and medium-sized companies – do not offer after-tax contributions. That’s because those contributions are subject to an IRS “nondiscrimination” test. That rule prohibits after-tax contributions for higher-paid employees unless lower-paid employees make a certain level of contributions. Since high-paid employees are most likely to have the funds to contribute, that test is often impossible to pass. Without after-tax contributions, the Mega Backdoor Roth strategy doesn’t work. But solo 401(k)s are exempt from the nondiscrimation rule, so there’s no problem with permitting after-tax contributions in solo plans.

https://www.irahelp.com/slottreport/mega-backdoor-roth-ira-strategy-and-solo-401k-plans

AGGREGATING RMDS – WHAT IS (AND WHAT IS NOT) ALLOWED

By Andy Ives, CFP®, AIF®
IRA Analyst

Recently, I had a conversation with an advisor who wanted a second opinion. He disagreed with how a 401(k) custodian was handling his client’s required minimum distribution (RMD). To arm himself with facts, the advisor contacted us so he could push back on that custodian. After listening to the details, the scenario was clear. It brought me no joy to inform the advisor that the custodian was correct – and there was no fix for what the advisor had done. I could offer no magic corrective bullet. Deflated, the advisor realized he had to explain how his faulty advice cost the client an additional and unnecessary $25,000 in taxable earned income for the year.

Where did this advisor go wrong? He botched the RMD aggregation rules.

Example: Karl, age 74 and retired, has three retirement accounts:

 

  • IRA at Bank Uno with a $10,000 RMD.
  • IRA at Bank Two with a $17,000 RMD.
  • 401(k) at his former employer with a $25,000 RMD.

Karl is incorrectly informed by his advisor that he can add the IRA and plan RMDs together and take them all from any one of the accounts. In January, Karl took a $52,000 withdrawal from his IRA at Bank Uno. Karl was under the false impression that his annual RMDs were satisfied.

Six months later, Karl and the advisor contacted the 401(k) and requested a full rollover of the plan assets to one of Karl’s IRAs. The 401(k) custodian informed Karl they would send one large check to be rolled over, and another check for the $25,000 plan RMD. Karl said, “But I already took my plan RMD. I took it from my IRA.” Their conversation deteriorated from there.

The custodian was correct in this scenario. Had Karl proceeded with the full rollover, he would have compounded his problems by creating an excess contribution in his IRA for the RMD amount. (RMDs cannot be rolled over.) As things stood, Karl needed to take the additional $25,000 from his plan. Unfortunately, he could not return (roll over) the previous $25,000 he took from the IRA, because it was after 60 days. That withdrawal had to remain as a normal (and unnecessary) distribution.

Be careful with multiple RMDs! The basic aggregation rules are as follows:

IRAs (including SEP and SIMPLE IRAs) – RMDs for each IRA account must be calculated separately, but the total RMD for all IRA accounts may be taken from one (or more) IRA.

Company Plans [excluding 403(b) and IRA-based Plans] – RMDs for each company plan [excluding 403(b) and IRA-based plans like a SEP or SIMPLE] must be calculated separately for each plan and taken separately from each plan.

403(b) Plans – RMDs for each 403(b) account must be calculated separately, but the total RMD for all 403(b) accounts may be taken from one (or more) of the 403(b) accounts.

https://www.irahelp.com/slottreport/aggregating-rmds-%E2%80%93-what-and-what-not-allowed

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

By Sarah Brenner, JD
Director of Retirement Education

Question:

Ed,

My client recently passed away at the age of 86 and the beneficiaries were his twin grandchildren who are six years old.  Does their 10-year clock to withdraw the funds start right away, or can they wait until they are 18 years old to start their 10-year clock to withdraw the funds?

Vivek

Answer:

Hi Vivek,

Your client’s grandchildren would be subject to the 10-year rule under the SECURE Act. The 10-year clock starts in the year after the year of death of the IRA owner. Only minor children (not grandchildren) of the IRA owner are considered to be eligible designated beneficiaries (EDBs). EDBs can take required minimum distributions until they reach the age of majority under state law or when they finish school (up to age 26). Then, the 10-year rule would apply to them, too. However, in this case, the twins are not EDBs.

Question:

I am the executor of my 94-year-old father’s estate.  He died March, 2021.  He had taken $15,000 of his $40,000 RMD before he passed.  My brother and I are listed as beneficiaries on his IRA along with a charity.  The charity received $40,000 in cash as a beneficiary.  So, has my father’s RMD for 2021 been satisfied?  Thanks in advance.

Answer:

The regulations are clear that the year-of-death RMD must be taken. However, it can be taken by any beneficiary. Your father had an RMD for the year of death of $40,000 of which $25,000 was yet to be paid at the time of death. When the charity took the $40,000 distribution, that satisfied the remaining RMD for the year of death and nothing further would need to be taken.

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

10 THINGS TO KNOW ABOUT ESAS

By Sarah Brenner, JD
Director of Retirement Education

It’s back to school time! Any parent will tell you that education can be expensive. You cannot afford to miss out on any possible option out there that may help you save. One savings tool that you might overlook is the Coverdell Education Savings Account (ESA). Here are 10 things you need to know about ESAs.
1. You may establish an ESA with the custodian of your choice. The paperwork you complete is very similar to the paperwork necessary to establish an IRA.

2. Contributions are made to the account to help save for education expenses of a designated beneficiary. The designated beneficiary is a child under the age of 18. Contributions may be made for designated beneficiaries older than 18 if they have special needs.

3. When you establish the ESA, you will need to name a responsible individual. The responsible individual controls the ESA, including investment choices and when distributions are taken. Many custodians will allow you, as the contributor, to name yourself as the responsible individual.

4. The maximum contribution amount is $2,000 per year for each designated beneficiary, but you may contribute that amount to ESAs for multiple beneficiaries. For example, if you have three grandchildren, you could contribute $2,000 each year to each of their ESAs.

5. There is no earned income or taxable compensation requirement to contribute to an ESA. There are no age limits either.

6. There are income limits. If your income is above them, you might consider giving the funds to the child or another person with income under the limits and having them make the contribution to avoid those limits.

7. The contribution deadline is generally the tax-filing deadline, April 15. Your ESA contribution is not deductible, but the earnings will be tax-free if the funds are used to pay for qualified education expenses. If you are already funding a qualified tuition plan or 529 plan, you can fund an ESA as well. ESA funds are even eligible to be rolled over to qualified tuition plans.

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

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

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

https://www.irahelp.com/slottreport/10-things-know-about-esas

MAKING SENSE OF THE 401(K) MULTIPLE PLAN LIMITS

By Ian Berger, JD
IRA Analyst

We continue to get lots of questions about the company savings plan contribution limits. There are actually two different contribution limits – the “deferral limit” and the “overall limit.” This makes things very confusing, especially if you’re in multiple plans at the same time or you change jobs in the middle of the year.

Deferral limit. The deferral limit is based on the total pre-tax and Roth contributions you make to ALL your plans in one calendar year. Contributions to ALL plans are combined for the deferral limit – even if the plans are sponsored by companies that aren’t related under the tax rules. For 2021, the deferral limit is $19,500. However, if you’re age 50 or older by the end of the year, you can defer up to an additional $6,500 in “catch-up” deferrals, for a total of $26,000.

Example 1: Kyle, age 48, has a regular job with Acme Industries that sponsors a 401(k) plan and also has a solo 401(k) through a sole proprietorship. Acme and his sole proprietorship are not related entities. Kyle has already contributed $19,500 of elective deferrals to Acme’s plan in 2021. Even though the companies aren’t related, Kyle can’t make any elective deferrals to the solo because he’s already maxed out on the deferral limit through the Acme plan.

Non-Roth after-tax contributions (if allowed by the plan) do not count towards the $19,500/$26,000 deferral limit.

There is one instance where contributions to all plans are not aggregated: If you’re eligible for both a 457(b) plan and either a 401(k) or a 403(b) plan, you can defer up to the maximum deferral limit to EACH plan.

Overall limit. This limit (also known as the “annual additions limit” or “415 limit”) regulates the amount of ALL contributions (pre-tax deferrals, Roth contributions, after-tax contributions, and employer matching and profit sharing contributions) that can be made to ANY single plan in any year. For 2021, this limit is $58,000, or $64,500 if you make age 50-or-over catch-up contributions. [Note that 457(b) plans cannot take advantage of the overall limit; all contributions are limited to $19,500 or $26,000.]

Contributions made to all plans maintained by the same company are combined for the overall limit. And, contributions made by two or more companies related under the tax rules are also aggregated. But, if you are in two plans sponsored by unrelated companies, you get the benefit of a separate overall limit for each plan.

Note: For small employer plans [like solo 401(k) plans and SEPs], the rules are more complicated because of IRS deduction limits.

Example 2: Since Acme and Kyle’s sole proprietorship (from Example 1) are unrelated, there are separate overall limits for the Acme plan and his solo 401(k). Assuming Kyle receives a $4,500 employer match from the Acme plan, he could make up to $34,000 ($58,000 – $19,500 – $4,500) of after-tax contributions to the Acme plan. Although he can’t make any pre-tax deferrals or Roth contributions to his solo 401(k) because of the deferral limit, he could theoretically make up to $58,000 between after-tax and employer contributions to the solo plan.

https://www.irahelp.com/slottreport/making-sense-401k-multiple-plan-limits

BACKDOOR ROTH IRAS AND MISSED RMDS: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

I read of a way to move money from an IRA to a Roth without incurring any taxes. You set up an IRA account and make a non-deductible contribution of $6,000, then you convert it into a Roth.   Is this legal and possible?

Thanks!

Answer:

This strategy is called a “Backdoor Roth IRA.” Roth IRA accounts have income limits. Not everyone can contribute. However, when a person makes too much money to contribute directly to a Roth IRA, he can use the “backdoor.” Yes, a non-deductible (after-tax) contribution can be made to a traditional IRA, and then those dollars can be immediately converted to a Roth. Since these are after-tax dollars that are converted, there is no tax due on the conversion (assuming no earnings on the after-tax dollars). But be careful! You cannot “cherry pick” the after-tax dollars in your IRA and only convert those. If you have any pre-tax (deductible) dollars in any IRA, SEP or SIMPLE plan, those dollars must be considered under the pro-rata rule. Pro-rata dictates that any conversion will include a proportionate share of pre- and after-tax dollars. The only way a Roth conversion can be 100% tax-free is if you have no pre-tax dollars in any of your IRAs, SEP or SIMPLE plans.

Question:

Hi there. I am a CPA and have been a fan of yours for many years. Our firm has a client who missed multiple years of required minimum distributions (RMDs) and will file a Form 5329 for each year and request a penalty waiver. For purposes of each subsequent years’ calculated RMD, is it possible to reduce the IRA account balance for the prior year’s missed RMD or not?  I have looked extensively and cannot find that is permissible, and a literal reading of the instructions seems to say ‘no’ because the RMD would be based on the actual 12/31 balance. We have not faced this situation before and only ask because it seems like this results in a compounding of the 50% penalty from year to year on the same dollars.

Thanks for any insight you may have.

David

Answer:

David,

While the RMD was missed, it was still part of the account and must still be included in the 12/31 balance for the next years’ RMD. You cannot go back and retroactively reduce the year-end balance by the missed RMD amount. The fact that the untaken RMD remained in the account and must be included in the subsequent year’s 12/31 balance will result in higher subsequent RMDs. The larger the RMD, the larger the penalty for not taking it. You are correct that multiple years of missed RMDs will compound the problem. At least you are on the right track by filing Form 5329 and requesting a penalty waiver.

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

UPDATE YOUR BENEFICIARY FORMS!

By Andy Ives, CFP®, AIF®
IRA Analyst

Regardless of whether you open an IRA, participate in a 401(k) plan, buy a life insurance policy, or start a college saving plan for a child, there is a critical detail which should never be overlooked: naming a beneficiary. Typically, the account application will include a space for doing just that. Sometimes a second form may be required when a person wants to change an existing beneficiary.

Despite what appears to be a basic piece of information – “Who is your beneficiary?” – and despite the ease of writing in another person’s name or a charity to inherit assets after the death of the account owner, beneficiary forms are constantly overlooked, lost, or mishandled. Time and again the beneficiary designation section is left blank. Time and again people fail to update their beneficiary forms after a major life event.

Did you get married or divorced? You should review your beneficiary forms for a possible update. Did your spouse predecease you? Review your beneficiary forms. Are your children now grown and mature enough to handle money? Did someone develop an addiction problem and can no longer be trusted with money? Did a beneficiary reveal himself to be unworthy of your assets? Did you identify a charity that you want to support? Review your beneficiary forms.

Also, do not assume a beneficiary form is on file at the bank or with the custodian that handles your account. While most institutions do their best to maintain accurate records, forms occasionally get lost. Ultimately it is your responsibility to designate a beneficiary, to ensure the  designation stays current, and to provide that information to your next of kin.

Example: Ron, age 60, is having a difficult year. He divorced from his wife, and his adult son developed a substance abuse problem. Ron’s now ex-wife and son are listed on all his accounts as primary and contingent beneficiaries, respectively. Despite his heartbreak, Ron reviews his beneficiary forms. He elects to change his IRA beneficiary to a charity that assists those with addiction issues. He also changes the beneficiary on his 401(k) and on a life insurance policy to a trust that will control the assets for his son after Ron’s death.

If a person fails to complete or update a beneficiary form, we are forced to look to the default beneficiary as indicated on the custodial form or plan document. With a default beneficiary, the organization in charge of the account essentially dictates who receives your assets after death. This could be the estate, or a succession of possible beneficiaries could be delineated. For example, plan documents often list a sequence of beneficiaries, like (1) surviving spouse; (2) surviving children; (3) surviving parents; (4) brothers and sisters; and (5) estate.

Do you want your account custodian to name your beneficiary for you? Of course not. But have you experienced a life change – marriage, birth, the death of a loved one? Has it been many years since you opened your account? Check your beneficiary forms.

It never fails to surprise how many people think their beneficiary information is correct when, in fact, their forms are missing, incomplete, or simply list the wrong person. Be like Ron. Get your beneficiary act together.

https://www.irahelp.com/slottreport/update-your-beneficiary-forms

YOUR QCD QUESTIONS ANSWERED

Sarah Brenner, JD
Director of Retirement Education

A Qualified Charitable Distribution (QCD) is a way for you to move funds out of your IRA to a qualifying charity income tax free. This can be a great strategy for those who are charitably inclined and looking to save on taxes. Here are the answers to some of the most frequently asked questions about QCDs.

How old do you have to be to take a QCD?

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

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

Which retirement accounts are eligible for a QCD?

You may take a QCDs from your traditional IRAs or Roth IRAs. QCDs are also permitted from SEP and SIMPLE IRAs that are not ongoing. This usually means you can’t make a QCD from a SIMPLE or SEP for a calendar year if the employer has made a contribution for that year. You may never take a QCD from your employer plan.

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

Because QCDs apply only to taxable amounts, it is unlikely that a QCD would be done with Roth IRA funds. The only Roth funds that you could ever use would be earnings in a Roth IRA when you have not held any Roth IRA for more than five years.

How much can you take as QCD?

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

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

How can QCDs help with my RMDs?

Here is good news if you are charitably inclined and must take a required minimum distribution (RMD). You can use a QCD to satisfy your RMD for the year as long as the QCD is made before the RMD comes out. A QCD is not limited to your RMD amount for the year as long as it does not exceed $100,000.

How should I move my funds if I am doing a QCD?

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

https://www.irahelp.com/slottreport/your-qcd-questions-answered

ROTH IRAS FOR CHILDREN AND ROLLOVERS OF RMDS: TODAY’S SLOTT REPORT MAILBAG

Ian Berger, JD
IRA Analyst

Question:

Can you put funds into a Roth IRA for a 14 year old using money you have paid the child for doing chores?

Client was told all he needed to do was keep a record of what was paid by to the child.

I have always enjoyed your presentations.

Thank you,

Cathy

Answer:

Hi Cathy,

This a common question, but unfortunately there isn’t much guidance from the IRS on this issue. We do know that parents can open up IRAs (including Roth IRAs) for their children. However, the child mut have enough of his own “compensation” to support the IRA contribution. Here, “compensation” means taxable income, and that’s the problem.

Payments a parent makes to a child for common household chores are usually not taxable income. In that case, they can’t be used for an IRA contribution. Money that a child receives from a third-party, such as babysitting or mowing loans for neighbors, may be a different story. Those amounts may count, as long as the child claims those amounts on a tax return. Your child would want to retain good documentation of any earnings.

Question:

I retired in 2011 and rolled my Thrift Savings Plan into an IRA.  Currently I must take a RMD every year from that IRA.  If I roll over some stock from my IRA into my Roth IRA, will that qualify as a RMD (required minimum distribution) or would I have to also withdraw cash to meet the RMD requirements?

Answer:

You don’t necessarily have to withdraw cash out of your traditional IRA to satisfy the RMD rules; you can also take stock out. However, no RMD (cash or stock) can ever be rolled over, and the first payments out of the traditional IRA in any year are considered  to be RMDs. So, if you want to convert all or some of your traditional IRA to a Roth IRA, you will need to first take the RMD (in cash or stock) and then convert the remainder.

https://www.irahelp.com/slottreport/roth-iras-children-and-rollovers-rmds-today%E2%80%99s-slott-report-mailbag

COURT DECIDES THAT BANKRUPTCY CREDITORS CANNOT TOUCH INHERITED 401(K) FUNDS

Ian Berger, JD
IRA Analyst

Suppose you inherit 401(k) (or other ERISA plan) funds and then file for bankruptcy before receiving those funds. Can you lose those 40(k) dollars to your bankruptcy creditors? According to a recent decision of a Bankruptcy Court in North Carolina, you don’t have to worry.

In the case of In re: Dockins, No. 20-10119 (Bankr. W.D.N.C. June 4, 2021), Kirk Morishita, an employee of Wells Fargo Bank, designated his then-girlfriend, Holly Corbell, as beneficiary of his 401(k) account. The relationship did not last, and several years later, Holly married Chris Dockins.

In February 2020, Kirk died while still employed at Wells Fargo and with Holly still as his 401(k) beneficiary. Wells Fargo set up a 401(k) account in Holly’s name with a value of over $35,000. The Dockinses then filed for bankruptcy and excluded the $35,000 from the property that was available to their creditors. The bankruptcy trustee went to court to challenge the exclusion of the inherited 401(k).

The judge had to decide which of two U.S. Supreme Court decisions takes precedence when someone inherits 401(k) funds. In the 1992 Patterson v. Shumate case, the Supreme Court decided that retirement benefits covered by ERISA are shielded from creditors in a bankruptcy. [Most 401(k) plans, and some 403(b) and 457(b) plans, are ERISA plans. IRAs are not covered by ERISA.] Bankruptcy protection results from an ERISA requirement that ERISA plans cannot pay benefits to anyone other than a participant or a beneficiary.

But in the 2014 Clark v. Rameker case, the Supreme Court said that inherited IRA funds are not protected from bankruptcy creditors. The Court reasoned that only “retirement funds” are protected, and inherited IRAs are not “retirement funds” because they are normally paid soon after death – not when the beneficiary retires.

The Bankruptcy Court decided to follow the Patterson decision, not the Clark decision. The Wells Fargo plan is an ERISA plan – not an IRA. As required under ERISA, the Wells Fargo plan provided that “your 401(k) Plan account cannot be reached by creditors either by garnishment or any other process. Also, you may not pledge or assign your 401(k) Plan account to anyone else.” For that reason, the Dockinses get to keep Holly’s $35,000 inherited 401(k) dollars.

The Bankruptcy Court cautioned, however, that the result would have been different if Holly had withdrawn the account before she and her husband filed for bankruptcy. Inherited ERISA plan dollars are shielded only if the funds remain in the plan when the bankruptcy filing takes place.

Keep in mind that this is only one decision from one judge. It is entirely possible that other courts could rule differently. However, if you have inherited retirement funds and are considering bankruptcy, be aware that at least one judge has distinguished between inherited ERISA plan benefits and inherited IRAs.

https://www.irahelp.com/slottreport/court-decides-bankruptcy-creditors-cannot-touch-inherited-401k-funds

401(K) PLANS & IRA CUSTODIANS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Educations

Question:

If you are an employee who participates in a 401(k) who retires at age 73, do you have to take an RMD in the year you retire, or can you take your RMD by April 1 of the year following retirement? If you can take your RMD by April 1 of the following year, does that mean you have to take two RMDs in that year?

Answer:

If you are using the still-working exception to delay RMDs from your plan, you must take an RMD for the year you retire. You can delay that first RMD until April 1 of the year following the year you retire. However, if you do delay your first RMD until the next year, you would need to take two RMDs in that year. The first would need to be taken by April 1, and the second would need to be taken by December 31.

Question:

Hello,

Could you answer this question? Can I establish a new inherited IRA at one custodian and, if I am not satisfied with that institution, can I then transfer that inherited IRA to a different institution? Thank you for your guidance.

Sincerely,

Judy

Answer:

Hi Judy,

It is possible to move inherited IRA assets from one IRA custodian to another, but it must be done correctly. You can only do a direct trustee-to-trustee transfer from one inherited IRA to a new inherited IRA. Be careful here. The funds must move directly. A nonspouse beneficiary cannot do a 60-day rollover. If the funds are distributed to you, you will not be able to put them back in an inherited IRA, and this is a mistake that cannot be fixed.

https://www.irahelp.com/slottreport/401k-plans-ira-custodians-todays-slott-report-mailbag

5 HSA BENEFITS THAT MAY SURPRISE YOU

By Sarah Brenner, JD
Director of Retirement Educations

You may be familiar with Health Savings Accounts (HSAs). These accounts have been around now for a while. They work with high deductible health insurance and are known for their triple tax benefits. Contributions can be deducted. Earnings are tax deferred while in the HSA account and, if HSA funds are used for qualified medical expenses, both contributions and earnings are tax-free when distributed. While you may know the basics, here are 5 HSA benefits that may surprise you:

1. There are currently no income limits for HSA contributions, and you do not need to have earned income to contribute. As long as you have HSA compatible high deductible heath insurance you can make an HSA contribution for the year. No one makes too much to contribute and, unlike an IRA, there is no requirement that you have earned income to be eligible.

2. If you make an HSA contribution, currently you may deduct that contribution regardless of how high your income is. Everyone who is eligible to make an HSA contribution can deduct it. No one makes too much money to take the deduction. It never phases out or goes away, even for the highest earners.

3. You can take tax-free distributions from your HSA for qualified medical expenses, including those of a spouse or dependent. This is true even if your spouse or child is not covered under the HSA-compatible high deductible health insurance. Your HSA can benefit your family members. This is true even if they do not have high deductible coverage themselves.

4. You can take a tax-free distribution from an HSA to reimburse yourself for qualified medical expenses in prior years as long as the expenses were incurred after you established your HSA and you have proof of those expenses. There is no requirement that the expense and the HSA distribution take place in the same year. In fact, the distribution could happen years later and still be a qualified tax-free distribution from the HSA.

5. You cannot contribute to an HSA once you are enrolled in Medicare. However, you can keep your existing HSA and you can still take tax-free distributions for qualified medical expenses. Many people are unaware of these rules and mistakenly believe HSAs cannot be kept past Medicare enrollment. That is not the case. You can keep your HSA and you can continue to tap it to pay your medical bills.

https://www.irahelp.com/slottreport/5-hsa-benefits-may-surprise-you

A SYLLABUS ON PENALTY-FREE IRA WITHDRAWALS FOR HIGHER EDUCATION EXPENSES

By Ian Berger, JD
IRA Analyst

It’s that time of the year! College bills for the Fall semester are arriving, and you may be thinking of tapping into your retirement savings to help with the costs. If you’re under age 59 ½, be careful. Your withdrawal may be subject to a 10% early distribution penalty unless you are able to take advantage of an exception to that penalty. (Remember that, even if you qualify for the exception to the penalty, distributions from traditional IRAs will be taxable.) Here’s what you need to know about the higher education expense exception:

1. Take it from your IRA. Penalty-free withdrawals for higher education are only available from your IRA (including SEP and SIMPLE IRAs). If you take an early distribution from your company plan, you’ll be hit with the 10% penalty.

2. Watch the timing. There are no dollar limits on penalty-free withdrawals; however, the distribution can’t exceed the amount of education expenses paid in the same calendar year.

3. Make sure the school qualifies. Any accredited post-secondary (post-high school) educational institution – including a foreign institution – qualifies as long as it is eligible to participate in a student aid program administered by the U.S. Department of Education.

4. Make sure the student qualifies. To be penalty-free, the expense must be for education of the IRA owner or his spouse, or for any child or grandchild of either. Siblings, nieces, nephews and cousins don’t qualify.

5. Make sure the expense qualifies. Qualifying expenses include tuition, fees, books, supplies and equipment required by the school. Expenses for computers and related equipment used at school are penalty-free – even if not required by the school. Note that a person must be considered at least a half-time student in order for room and board to qualify. Finally, expenses paid for with tax-free educational assistance (i.e., with scholarships, Pell grants, Coverdell education account distributions and veterans’ educational assistance) are not eligible for the 10% exception.

6. Keep good records. It is important for you to retain good documentation of the expenses you paid for with the IRA funds. In case of an IRS audit, the burden is on you to prove the distribution was for a qualified education expense.

7. File 5329. Your IRA custodian will issue a Form 1099-R showing an early distribution, but the 1099-R will not reflect an exception to the 10% penalty. It will be up to you to file Form 5329 to claim the exemption.

https://www.irahelp.com/slottreport/syllabus-penalty-free-ira-withdrawals-higher-education-expenses

 

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

By Sarah Brenner, JD
Director of Retirement Education

Question:

Hi,

I have a client who died in 2021 before taking his 2021 RMD. He designated various charities as beneficiaries of his IRA.

The IRA custodian is advising the executor to take the RMD, however according to a previous post by Mr. Slott, Revenue Ruling 2005-36 states in this scenario the RMD is to be paid to the beneficiaries. I suggested the client ask the custodian to request confirmation from their legal department.  Any other steps?

Thank you,

LP

Answer:

You are right to question the IRA custodian on this. The rules are clear that when the IRA owner dies without taking the RMD for the year of death, it must still be taken. There is often confusion, though, over who must take it. When an IRA owner dies, the funds then belong to the beneficiary. So, it is the beneficiary who must take the year of death RMD if the IRA owner dies prior to taking it. This was confirmed by the IRS in Revenue Ruling 2005-36. You may want to share this guidance with the IRA custodian as support for your position.

Question:

Hi, I bought your 2020 edition of Retirement Decisions Guide and had a question regarding changes in IRA inheritance.

Regarding a Roth IRA, if a spouse inherits, is the spouse exempt from ever taking any distributions and if so, would that only be if the spouse made the Roth his/her own rather than treating as an inherited Roth?

And any nonspouse inheriting a Roth, are they only required to take the entire account by the end of the 10th year but do not need to take any before then?

Sorry to bother you but I can’t find these 2 questions addressed anywhere else.

Thanks for all of the advice you have shared over the years

Donna

Answer:

Thank up for being a reader of the 2020 Retirement Decisions Guide!

Roth IRA beneficiaries are subject to the new SECURE Act rules when a Roth IRA owner dies after 2019. A spouse beneficiary can do a spousal rollover to her own Roth IRA, or she can keep the Roth IRA as an inherited IRA. If a spousal rollover is done, no distributions are required. If it remains an inherited IRA, she can still use the stretch as an eligible designated beneficiary (EDB) under the SECURE Act or she can elect the new 10-year rule. A nonspouse beneficiary who is not an EDB would be subject only to the 10-year rule.

The 10-year rule requires that the account be emptied within 10 years of the year of death. However, there are no annual required distributions in the 10-year period.

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

10 NUA Q&AS

By Andy Ives, CFP®, AIF®
IRA Analyst

1. What is the NUA (Net Unrealized Appreciation) tax break? It is the opportunity to pay tax at long-term capital gains rates on the appreciation of company stock held within a company plan vs. paying ordinary income rates on that growth.

2. Who is a potential candidate for NUA? Anyone with highly appreciated company stock in their workplace plan, like a 401(k).

3. Can it be any company stock? It must be the company stock of the company that sponsors the 401(k). The company stock can be held as individual shares within the plan or as a stock fund that is converted to shares upon distribution.

4. How do you define “highly appreciated”? “Highly appreciated” is subjective. There is no magic percentage dictating what level of growth makes for a good NUA opportunity. Every person is different, and every person will have an NUA “tipping point” where it makes sense.

5. Can anyone take advantage of the NUA tax break? No. A person must hit an NUA “trigger event,” of which there are only four: Reaching age 59½ (although the plan is not required to allow an in-service distribution at that age); Separation from service (not for the self-employed); Disability (only for the self-employed); and Death. To be eligible for NUA, one of these triggers must be met.

6. What actions will “activate” the NUA trigger? Any distribution from the plan, such as an RMD, will activate the trigger. A partial rollover could activate the trigger, as could an in-plan Roth conversion. If the trigger is activated, the NUA lump sum distribution transaction must be completed by the end of that same calendar year, or that specific NUA trigger opportunity will be lost.

7. Do you have to completely empty the 401(k) account? Yes, there must be a full lump sum distribution. A successful NUA transaction requires the entire 401(k) balance to be emptied in one calendar year. Typically, non-NUA assets get rolled to an IRA, and the NUA stock is transferred in-kind to a non-qualified brokerage account.

8. Will late additions to the plan disqualify the lump sum distributions? No, dividends or other late additions that trickle into the 401(k) account in the next year will not disqualify the lump sum payout.

9. Can an NUA transaction be done before age 59 ½? Yes, if another trigger is activated, like separation from service. The age-55 exception will allow some people under age 59 ½ to avoid the 10% penalty on the NUA transaction. If under age 55, the 10% penalty will only apply to the cost basis of the NUA stock (and any non-NUA stock assets that are not rolled over).

10. Is NUA an all-or-nothing deal? No. Partial NUA transactions are allowed. However, any company stock that is rolled over to an IRA will forever lose the NUA tax-break opportunity.

https://www.irahelp.com/slottreport/10-nua-qas

5 TAKEAWAYS FROM ED SLOTT’S INSTANT IRA SUCCESS WORKSHOP

By Sarah Brenner, JD
Director of Retirement Education

On July 15 and 16, financial advisors from around the country gathered virtually for Ed Slott and Company’s Instant IRA Success workshop. We took a deep dive into the rules governing retirement accounts and engaged in some lively discussions of issues that advisors on the front line are facing regularly as they help their clients plan for a secure retirement. Here are five takeaways to share from our recent meeting:

1. The SECURE Act has upended retirement planning. The SECURE Act became a reality in 2020 and with it came the end of stretch IRA for most IRA beneficiaries. In its wake are many questions about the new rules and where to go from here when it comes to transferring wealth to the next generation. At the workshop, there was much discussion as to the correct interpretation of the new 10-year payment rule, especially in light of the recent confusion related to Publication 590-B. In its revision to that publication, the IRS had to make revisions to correct the impression that RMDs would be required during the 10-year period. It is clear as well that there is a lot of interest from both advisors and retirement savers in potential replacements for the stretch IRA, such as life insurance or charitable trusts.

2. Many believe we are headed for tax increases. There is much uncertainty when it comes to tax planning right now, stemming from concern that today’s rates won’t be around long. Several informal polls taken during the meeting show that many advisors believe that the historically low income tax and federal estate tax levels are likely to rise in the near future.

3. The Net Unrealized Appreciation (NUA) tax break is currently generating a lot of interest as markets boom. The NUA tax break allows plan participants who take lump sum distributions, including in-kind distributions of highly appreciated employer stock, to take advantage of favorable capital gains tax rates. With markets way up and many taking early retirement due to the pandemic, this is a perfect storm for NUA.

4. IRA trusts may be less useful, but for some IRA owners they will still be needed. The SECURE Act may have downgraded trusts as a planning strategy for IRAs with the new 10-year rule for most beneficiaries including trusts. However, advisors recognize that for some situations like minor beneficiaries, special needs beneficiaries and those with credit issues, a trust still may be a good choice. Advisors and their clients are eagerly waiting on SECURE Act guidance from the IRS to fill in the gaps on how the rules for trusts as IRA beneficiaries will work going forward.

5. Roths still rule. Roth accounts were the subject of lots of attention during the workshop. We had discussions about the recent news reports of a tech titan’s multibillion Roth IRA, stories of continued client interest in Roth conversion, and reports of Congress’ move toward more “Rothification.” Knowing the rules, including the often confusing five-year rules for tax-and -penalty-free distributions, is more important than ever.

Thank you to all who attended Instant IRA Success and made it a great event for everyone! If you could not make this past workshop, consider joining us for our next virtual Instant IRA Success workshop which will be held on September 23 and 24.

https://www.irahelp.com/slottreport/5-takeaways-ed-slott%E2%80%99s-instant-ira-success-workshop

ONCE-PER-YEAR ROLLOVER RULE AND ROTH CONVERSIONS: TODAY’S SLOTT REPORT MAILBAG

Ian Berger, JD
IRA Analyst

Question:

Mr. Slott,

Would a person who took a Coronavirus-Related Distribution from his IRA in 2020, with intent to repay within 3 years, be disqualified from taking a distribution and making a 60-day rollover in 2021 if it is within 12 months of the CRD

Thank you,

Betty

Answer:

Hi Betty,

The repayment of a CRD is considered a trustee-totrustee transfer between IRAs. As such, the once-per-year rollover rule does not apply. Therefore, there would be no reason why a 60-day IRA rollover could not be done within 12 months of the CRD.

Question:

Hello Sir/Madam,

We had a question on Roth conversions in our office that is stirring up quite a debate, and we are hoping that you could add your expert opinion,

Bob Smith, Age 65 (in 2021), US Resident, US Citizen & US Tax Filer

  1. Bob has a Traditional IRA worth $100K (with no cost basis).
  2. In January of 2019, he opens up a new Roth IRA and converts the entire $100K amount into this new Roth via a Roth conversion in Jan 2019.
  3. Bob pays the tax due in 2019 for this Roth conversion on his federal tax return.
  4. In January of 2021, Bob takes a withdrawal of $10,000 from this Roth conversion account.  Let’s assume that Bob invested the funds in the money market and this Roth is still worth the original $100K at the time of the withdrawal.

 

Question:  Has Bob violated the 5-year holding period rule that would subject him to the penalty?  Or, is he exempt because he is over age 59 ½?

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

All my best,

Steve

Answer:

Hi Steve,

Distributions of Roth conversions are never subject to the 10% early distribution penalty if the individual has attained age 59 ½. So, Bob’s distribution would be penalty-free  If he were under 59  ½, the 5-year holding period would apply, and he would have to wait until 2024 to receive a penalty-free distribution.

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

HOW DO THE RMD RULES WORK WHEN A PENSION PLAN LUMP SUM IS PAID?

Ian Berger, JD
IRA Analyst

In the May 17, 2021 Slott Report, we discussed the rules governing required minimum distributions (RMDs) from defined benefit (DB) plans, also known as “pension plans.” We said that DB plan payments usually have no problem satisfying the RMD rules, but there are two special rules that sometimes apply.

One special rule kicks in when someone elects a “joint and survivor annuity” with a non-spouse beneficiary more than 10 years younger. (A joint and survivor annuity is an annuity payable over the participant’s lifetime and, if the beneficiary outlives the participant, continues over the beneficiary’s remaining lifetime.) When the beneficiary is more than 10 years younger than the participant, the survivor benefit cannot exceed a certain percentage of the amount payable to the participant. The maximum percentages are based on the age differences between the participant and the survivor and are set forth in an IRS table. The May 17 Slott Report has an example of how this works.

The second special rule applies when a DB lump sum payment is made in a year when an RMD is required. This often happens when a company with a pension plan offers a “lump sum buyout” to retirees. In a lump sum buyout, the retiree is given a limited opportunity to elect a lump sum payment in exchange for giving up future periodic payments.

In that situation, the portion of the lump sum that is an RMD cannot be rolled over. A DB plan can calculate the portion of the lump sum that is an RMD in one of two ways. The first is by using the defined contribution plan/IRA RMD rules and treating the lump sum amount as the retiree’s account balance as of the previous December 31. The second is to treat one year of annuity payments as the portion of the lump sum that is an RMD.

Example: Savannah, age 74, is a DB plan retiree receiving monthly annuity payments of $2,000. In 2021, Savannah’s former employer offers her a lump sum of $300,000, which she accepts. If the plan calculates Savannah’s 2021 RMD using the defined contribution plan/IRA plan rules, her RMD would be $12,605 ($300,000 / 23.8). Savannah could roll over $287,395 ($300,000 – $12,605). If the plan calculates her RMD using the alternative method, the 2021 RMD would be $24,000 ($2,000 x 12), and Savannah could roll over $276,000 ($300,000 – $24,000).

https://www.irahelp.com/slottreport/how-do-rmd-rules-work-when-pension-plan-lump-sum-paid

CAN EDBS SPLIT INHERITED IRAS?

By Andy Ives, CFP®, AIF®
IRA Analyst

A surviving spouse has a number of options regarding how to deal with IRAs inherited from his or her deceased spouse. The age of both the deceased and surviving spouse will most often dictate the decision as to how to proceed. Typically, a surviving spouse who is age 59 ½ or older will do a spousal rollover with the assets. A spousal rollover allows the surviving spouse to consolidate the inherited IRA into her own, thereby minimizing future paperwork and confusion. She will have full and unfettered access to the assets (other than potential taxes due).

For surviving spouses who are under age 59 ½, the option to keep the inherited assets as a beneficiary (inherited) IRA often makes the most sense. This strategy acts as a safety net should she need access to the inherited IRA dollars. As a beneficiary IRA, the surviving spouse would have full access to the inherited assets, penalty free. At age 59 ½, she can do a spousal rollover, thereby consolidating the inherited IRA into her own. At that point, when she is over age 59 ½, the 10% penalty will never again apply. (Note: there is no deadline to complete the spousal rollover. Even if her husband tragically died when she was only in her 30’s, she could elect an inherited IRA, have full access to the dollars, and then do a spousal rollover 20+ years later.)

On occasion, surviving spouses will elect to split the inherited IRA assets, which is permitted. The surviving spouse might choose to move half of the money into her own account (spousal rollover) and keep the other half as an inherited IRA. One rationale for such a split could be to limit the under-age 59 ½ spouse’s access to inherited dollars by leaving a smaller portion in the beneficiary IRA. The reasons for splitting are far and wide.

This permission for surviving spouses to split inherited IRAs raises an interesting question. We know that, under the SECURE Act and recently clarified by the IRS, an eligible designated beneficiary (EDB) can choose the 10-year payout OR choose to stretch inherited IRA payments over his or her own single life expectancy. However, this choice is only available if the deceased IRA owner dies prior to his required beginning date (RBD). If the deceased owner is past his RBD, the EDB can only stretch payments. (You cannot elect to stop RMDs via the 10-year payout option.)

Is an EDB, like a surviving spouse, also allowed to split an inherited IRA, thereby choosing the 10-year payout option on part of the assets, and stretching the rest? This question is unknown as it is not addressed in the SECURE Act.

Example: Two adult brothers, ages 60 and 61, die in a car crash. Both deceased siblings owned their own IRA and named their younger sister Grace, age 55, as their primary beneficiary. Grace is an EDB as she is “not more than 10 years younger” then either of her older brothers. Since both of the brothers died before their RBD, Grace can choose to stretch payments over her own life expectancy, or she can choose the 10-year payout option.

If she wanted to, it seems completely reasonable that Grace could stretch one of the brother’s IRAs and choose the 10-year payout for the other. After all, these are two different decedents. But could she split one of the IRAs, stretching a portion and taking the 10-year on the other portion? That is a question that is still unknown.

https://www.irahelp.com/slottreport/can-edbs-split-inherited-iras

QUALIFIED CHARITABLE DISTRIBUTIONS AND THE 10-YEAR RULE: TODAY’S SLOTT REPORT MAILBAG

Sarah Brenner, JD
Director of Retirement Education

Question:

Ed,

I recently saw an email from you on QCDs when deductible IRA contributions are made in the same year. It discussed how these two transactions interact with each other.

I am also wondering if the offset to the QCD would also occur for a SEP IRA or SIMPLE IRA contribution?

Thank you for your help.

Doug

Answer:

Hi Doug,

There are some complicated rules that apply when an individual makes deductible IRA contributions and does qualified charitable distributions (QCDs). The bottom line is that this should be avoided because it can result in part or all of a QCD being considered taxable.

It is a different story, however, when it comes to QCDs and a SEP or SIMPLE contribution. Making a SEP or SIMPLE IRA contribution will not impact the tax advantage of the QCD.

Question:

We are reading several interpretations of the new 10-year rule for designated beneficiaries for inherited IRAs. Does the 10-year rule begin in the year following the original account owner’s death? For example, if the account owner dies in 2020, the clock begins in 2021, and the account must be fully liquidated by the end of 2030?

Thanks for your assistance!

Jesse

Answer:

Hi Jesse,

You are correct. The funds will need to be distributed by December 31 of the tenth year following the year of death. If the IRA owner dies 2020, the account would need to be emptied by December 31, 2030.

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

HOW YOU CAN REDUCE YOUR RMD

Sarah Brenner, JD
Director of Retirement Education

When you contribute to a traditional IRA you make a deal with Uncle Sam. You can get a tax deduction and tax deferral on any earnings in your IRA. However, eventually the government is going to want its share and will require funds to come out of these accounts. That is when you must start required minimum distributions (RMDs). You may not need the money and you may not want the tax hit. Here are some strategies that can help reduce your RMD.

QCDs

If you are planning on giving money to charity anyway, why not do a Qualified Charitable Distribution (QCD) from your IRA? If you are 70 ½, you may transfer up to $100,000 annually from your IRA to a charity tax-free. The QCD will also satisfy your RMD, but without the tax bite.

Still-Working Exception

Are you still working after age 72? If you do not own more than 5% of the company where you work and the company plan offers a “still working exception,” you may be able to delay taking RMDs from your company plan until April 1 following the year you retire. If your plan allows, you can roll your pre-tax IRA funds to your plan and delay RMDs on these funds too. Just be careful. If you have an RMD for the year from your IRA, you must take it before you can roll over the rest of the funds.

QLACs

A Qualifying Longevity Annuity Contract (QLAC) is a product designed to help with longevity concerns. Any funds you invest in the QLAC are not included in your balance when it comes to calculating your RMDs until you reach age 85. This will reduce your RMDs. You can purchase a QLAC with the lessor of 25% of your retirement funds or $135,000. The 25% limit is applied to each employer plan separately, but in aggregate to IRAs.

Roth IRA Conversions

If reducing RMDs is a top concern for you, you may want to consider a Roth conversion. This is because you are not required to take RMDs from your Roth IRA during your lifetime. While conversion is a taxable event, you can exchange a one-time tax hit for a lifetime of never having to worry about RMDs and their tax consequences. Keep in mind your beneficiaries will need to take RMDs from the inherited Roth IRA. However, these distributions will most likely be tax-free.

The Sweet Spot

Once you reach age 59 1/2, you can access your IRA funds without penalty. From age 59 ½ to age 72 is the sweet spot for IRA planning. The money is yours penalty-free if you choose to take a distribution. However, you are not required to withdraw specific amounts each year during the “sweet spot” as you will be once RMDs are required. Take advantage of these years to take money from your IRA on your own schedule. If you are now retired and your income is lower, this may be the time to take taxable IRA distribution to reduce RMDs later. You might consider using these funds to purchase life insurance or fund an HSA (Health Savings Account), if you are eligible.

https://www.irahelp.com/slottreport/how-you-can-reduce-your-rmd

THE PRO-RATA RULE & IRA BENEFICIARIES: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi. My name is John and I have a Roth question. I have read your most recent book but did not find the answer to this question. I have made non-deductible contributions to a traditional IRA for many years, so about half of the account is basis. I have no Roth account (yet). I recently left my job and rolled over my 401(k) into a separate rollover IRA. Will I have to include this rollover IRA along with the traditional IRA as part of the pro-rata rule in order to take advantage of Roth conversions? Hopefully, I did not screw up by removing funds from my prior employer.

Thanks for your help,

John

Answer:

John,

Please don’t shoot the messenger, because the answer is not what you want to hear. Yes, you will have to include your “rollover IRA” in the pro-rata calculation. The IRS dictates that you must include all of your traditional IRAs, SEP and SIMPLE plans when doing the pro-rata math for a Roth conversion. It does not matter if these accounts are held at different institutions. Sadly, had you left the 401(k) dollars in the plan until the year after the Roth conversion, they would not have counted in the pro-rata calculation.

Question:

I would appreciate your views on the following scenario. IRA owner over the age of 72 has children who are not good with money. Owner anticipates dying in the next few years. If his kids are the beneficiaries of his estate, and if he names his estate as beneficiary of his IRA, then will the executor of his estate be able to disperse the IRA over the remaining “lifetime” of the deceased, thus controlling (more or less) the distribution of his IRA to the children? I realize it will eventually run out, but the IRA owner may appreciate that his kids will not have immediate access to all of the IRA.

Thanks in advance for your guidance and comments.

Doug

Answer:

Doug,

While this plan could work, it has the potential to fall apart. Yes, an estate as a non-designated beneficiary (and since the IRA owner is over the age of 72) would require RMDs to be paid to the estate from the estate-owned inherited IRA. The estate would then disseminate the RMD to the beneficiaries of the estate. However, an RMD is just that – a minimum payment. A person could always take more. This plan would require a strong and independent executor of the estate to rigidly adhere to the annual RMD schedule. To further complicate things, unhappy beneficiaries eager to get higher payouts could even mount legal challenges. Such a plan would also require the estate to stay open (adding additional expenses) for a number of years. A trust would probably be a better option. Trusts can be specifically designed to prevent spendthrift children from burning through accounts. The trustee of the trust could be allowed to distribute any amount annually, or none at all. This could continue in perpetuity. Granted, the IRA would need to be emptied within 10 years based on SECURE Act guidelines, and anything remaining in the trust after that time would get hit with high trust tax rates. Nevertheless, with a trust, you could extend the father’s hold on the assets beyond the 10-year period and beyond his single life expectancy.

https://www.irahelp.com/slottreport/pro-rata-rule-ira-beneficiaries-todays-slott-report-mailbag

THE “MEGA QCD” OFFERS A WAY AROUND THE QUALIFIED CHARITABLE DISTRIBUTION RESTRICTIONS FOR 2021

Ian Berger, JD
IRA Analyst

Would you like to make charitable donations from your IRA but aren’t eligible for a qualified charitable distributions(QCD) because you’re under age 70 ½? Are you eligible for QCDs but want to donate more than the $100,000 annual limit? Are you interested in making charitable gifts from your 401(k) or other company savings plan? If you answered “yes” to any of these questions, you should be aware of a tax strategy just just for 2021 that we call the “Mega QCD.”

QCDs are a great way to transfer funds from your IRA directly to charity. The IRA withdrawal doesn’t count as taxable income, making it especially valuable if you’re taking the standard deduction rather than itemizing deductions on your taxes. QCDs can also be used to satisfy any required minimum distributions (RMDs) you must take in the year of the QCD.

But QCDs have restrictions. You must be age 70 ½ or older to use them. Annual QCDs are limited to $100,000 per person. And, QCDs can only be made from IRAs – not company plans.

For 2021 only, there’s a way to get around each of these limits. Normally, your itemized deduction for charitable contributions in a year can’t exceed 60% of your adjusted gross income (AGI). But Congress suspended the 60% charitable deduction limit for 2020 cash donations and extended that suspension to 2021. (This was done to try to help struggling charities during the pandemic.) So, for 2021, any cash gift to charity – no matter how large– can be deducted up to your AGI.

This means you can take any withdrawal from your IRA or company plan during 2021 and turn around and donate that same amount to charity. The distribution will be taxable to you as AGI, but because of the suspension of the 60% limit, all of that AGI will be wiped away from your taxes as a charitable deduction.

Since the Mega QCD isn’t technically a QCD, you’re not limited to $100,000. And, unlike a QCD, you don’t have to be 70 ½ to use the strategy. (Just remember that if you’re under 59 ½, you’ll be hit with a 10% early distribution penalty that can’t be wiped away.) Even better, the Mega QCD can be used for company plans as well as for IRAs – as long as you’re eligible for a plan withdrawal.

A few caveats: If you’re required to take 2021 RMDs, the Mega QCD can’t be used to offset RMDs like QCDs can. But there’s nothing preventing you from doing a QCD up to $100,000 to offset any RMDs and also using the Mega QCD to make charitable gifts beyond $100,000.

Also, many additional taxes, credits and deductions (like medical expense deductions, Medicare IRMAA charges and taxation of Social Security benefits) are tied to AGI. IRA or company plan withdrawals, even if deductible, can boost your AGI and may raise your taxes. Finally, the Mega QCD is available for 2021 only and only works if you’re itemizing deductions.

By all means, talk to your financial advisor or CPA before pulling the trigger on this strategy.

https://www.irahelp.com/slottreport/%E2%80%9Cmega-qcd%E2%80%9D-offers-way-around-qualified-charitable-distribution-restrictions-2021

“NOT MORE THAN 10 YEARS YOUNGER” – THE INTRIGUING EDB CATEGORY

By Andy Ives, CFP®, AIF®
IRA Analyst

By now, we all know the SECURE Act outlined a group of people that are still permitted to stretch inherited IRA payments over their own single life expectancy. This group is called “eligible designated beneficiaries” (EDBs). Yes, anyone who inherited an IRA prior to the SECURE Act is grandfathered and can continue to stretch required minimum distribution (RMD) payments. However, if you inherit IRA assets after the SECURE Act (i.e., if the original IRA owner died in 2020 or later), only EDBs can stretch.

The list of EDBs is short: Surviving spouses; Minor children of the account owner up to the age of majority (or if still in school, up to age 26); Disabled individuals; Chronically ill individuals; Individuals not more than 10 years younger than the IRA owner.

That last group is intriguing – “individuals not more than 10 years younger than the IRA owner.” It is a massive amount of people. Subtract 10 years from your age. Anyone in America (and beyond) who falls into that age category (or older) is a potential EDB for your IRA.

Example 1: Jana turns 50 years old today. Subtract 10 years. Anyone who is turning 40 today, and anyone who is older than 40 today, could qualify as an EDB for Jana’s IRA. Even people who are older than Jana could qualify for the stretch on her IRA as they are “not more than 10 years younger” than her.

All of Jana’s siblings are age 40 or older. They would qualify as EDBs for Jana’s IRA. Jana’s living parents are ages 75 and 80. They would both qualify as EDBs for her IRA. Jana’s neighbors, ages 44 and 43, respectively, would qualify. In fact, most of the faculty at the university where Jana teaches could qualify as an EDB for her IRA because the bulk of the professors are age 40 or older. (There is no requirement that a person must be related to qualify as an EDB.)

While the “not more than 10 years younger” EDB category is only loosely defined in the SECURE Act, logic tells us that it is measured from specific birthdate to birthdate. There is no wiggle room. There is no language about “how old a person turns or would have tuned this calendar year.” The SECURE Act dictates that EDBs are established based on specific age on the date of death. Period. Just because a person passes away does not mean he stops aging.

Example 2: Ike is age 68 and 6 months old when he dies. Any of Ike’s beneficiaries who are exactly age 58 and 6 months old or older on his day of death will qualify as an EDB. Ike’s friend Abe is listed as a beneficiary on Ike’s IRA, but Abe just turned 58. He is not an EDB on the day of Ike’s death when EDBs are determined. Abe thinks that if he waits 6 months to claim the inherited IRA, he will become an EDB. Abe thinks that, since Ike died at age 68 and 6 months, if he waits to establish an inherited IRA when he is 58 and 6 months, he will be able to “age into” stretching payments. Abe is incorrect. The “not more than 10 years younger” EDB eligibility requirement is time-stamped on the day when Ike passed away.

Be aware of the intriguing “not-more-that-10-years-younger” EDB category. It includes a heck of lot more people than you might think.

https://www.irahelp.com/slottreport/%E2%80%9Cnot-more-10-years-younger%E2%80%9D-%E2%80%93-intriguing-edb-category

THE ONCE-PER-YEAR ROLLOVER RULE AND THE ROTH IRA 5-YEAR WAITING PERIOD: TODAY’S SLOTT REPORT MAILBAG

Ian Berger, JD
IRA Analyst

Question:

I rolled over an IRA in March 2021 from an TD Ameritrade institutional account to a TD Ameritrade retail account. I currently would like to do a 60-day short-term rollover. Would this not be allowed because of the one rollover per 12 month period or is a 60-day short-term rollover treated differently? Thank you for your time.

Answer:

Any traditional IRA-to-traditional IRA rollover or (Roth IRA-to-Roth-IRA rollover) is subject to the once-per-year rollover rule. That would include a “short-term” rollover. So, if you receive another IRA distribution within 12 months of your receipt of the TD Ameritrade institutional account, you can’t do a tax-free rollover – even a “short-term” rollover – of the second distribution.

Question:

Hello, I did a back door conversion of 401(k) money to a Roth IRA in 2019. I was older than 59 ½ when I did that (born 1953). I am under the belief that the account must be in existence for 5 tax years before earnings can be withdrawn without tax.

Others tell me that since I was older than 59 ½  and paid taxes on conversion, both my converted funds, subsequent contributions and earnings are okay to be withdrawn anytime. In other words, there is no 5 year waiting period. Is that correct?

Thanks,
Howard

Answer:

Hi Howard,

This is an issue that trips up lots of people. Whether earnings on your 2019 conversion (and on any subsequent contribution) are tax-free depends on when you did your first contribution or conversion to ANY Roth IRA.

If you did your first contribution or conversion before 2017, then your 5-year waiting period is over, and you can take tax-free earnings now. But, if your first contribution or conversion was after 2016, earnings won’t be tax-free until the end of the 5-year period that started on January 1 of the year for which you did that first contribution or conversion. Also keep in mind that the IRS says that earnings are considered to come out after contributions and conversions, so you can always take out the principal amount of your Roth IRA contributions or conversions tax-free.

https://www.irahelp.com/slottreport/once-year-rollover-rule-and-roth-ira-5-year-waiting-period-today%E2%80%99s-slott-report-mailbag

5 THINGS YOU MUST KNOW ABOUT THE AGE-55 RULE

Sarah Brenner, JD
Director of Retirement Education

The pandemic has upended the workplace and caused many people to rethink their career path. For some older workers this may mean considering early retirement. For those workers, access to retirement savings can be key, and avoiding early distribution penalties is critical. While most distributions taken from a retirement account before age 59 ½ are subject to an early distribution penalty, the tax code carves out an exception for distributions from certain employer plans taken by those who are age 55 or older in the year they separate from employment. Here are 5 things you must know about the age-55 rule.

1. You must be age 55 or older in the year you separate from service. This rule can be tricky, if you separate from service prior to the year you reach age 55, you cannot use this exception. This is true even if you wait until the year you turn age 55 to take the distribution. It is your age in the year of separation from service that matters, not your age at the time of the distribution.

2. The age-55 exception only applies to the plan where you separate from service at age 55 or later. Many workers have more than one employer plan. They may still have funds in a plan with an employer they left years ago. The age-55 exception only applies to those assets you have in a plan where separation from service happened in a year you reached age 55 or later.

3. The age-55 exception never applies to IRAs. The rules for exceptions to the 10% early distribution penalty can be confusing. Some exceptions apply to both plans and IRAs. Some apply only to IRAs, and some apply to just plans. The age 55 exception only applies to plans. It never applies to IRAs. It also does not apply to IRA-based work plans like SEP or SIMPLE plans.

4. If you roll over to an IRA, the age-55 exception is lost. Rolling funds over from a plan to an IRA after leaving a job can be a good move in many cases, but not always. If funds are rolled over to an IRA from a plan, the age-55 exception is lost on those funds. If you are considering taking advantage of the age-55 exception, you will want to stick with the plan and forego the IRA, at least until you reach age 59 ½.

5. The age-55 exception is not an optional provision. Employer plans have a lot of flexibility when it comes to what provisions they offer. Just because the law allows some options, that does not necessarily mean that a plan will. However, some parts of the tax code are not optional. A plan cannot make the age-55 exception off limits if you are eligible.

https://www.irahelp.com/slottreport/5-things-you-must-know-about-age-55-rule

CLARIFYING THE ROLLOVER/TRANSFERS RULES WHEN AN RMD IS DUE

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

In the June 16, 2021 Slott Report, we discussed how an in-service distribution made in the year of separation from service can inadvertently create an excess IRA contribution if that distribution is rolled over when a required minimum distributions (RMD) is due. A related issue is how rollovers and transfers from 401(k) plans (or other company plans) and IRAs are treated differently when an RMD is required.

If you do a 60-day rollover from an IRA (that is, the distribution is paid directly to you) in a year when an RMD is due, the RMD is required to come out first. That’s because RMDs are not eligible for rollover. The same rule applies to 60-day rollovers from 401(k)s. If you mistakenly roll over all or a portion of an RMD from either an IRA or a plan, the rolled over RMD is considered an excess IRA contribution. You will then be subject to an annual 6% penalty unless you withdraw the excess amount (the RMD), plus any earnings attributable to it, by October 15 of the following year.

However, if you do a direct (trustee-to-trustee) transfer (that is, the funds are paid directly to another custodian) instead of a 60-day rollover, the rules are different for IRAs and plans. If the transfer is from an IRA, the RMD does not have to be distributed before the remaining amount can be transferred. But you would still have to remember to take the RMD by the end of the year from the new IRA. If you forget, you could be hit with a 50% excise tax on the unpaid RMD – although the IRS will often waive that penalty.

You do not have the same flexibility with an RMD if the direct transfer is made from a company plan. In the eyes of the IRS, a company plan transfer is a distribution and then a rollover. Repeat after me: RMDs can’t be rolled over. So, whether it’s a 60-day rollover or a direct transfer from a plan, the RMD must be paid first.

Another source of confusion concerns the due date of the first RMD when rolling over 401(k) funds. Usually, you can defer your first RMD to April 1 of the following year. (However, that means you will have two taxable RMDs in that following year.)

But what if you retire in the year you first become subject to RMDs and want to do a transfer or rollover from your 401(k) that same year? Unfortunately, if you proceed with the transfer or rollover, you cannot defer the first RMD until the next year. The only way to delay the first RMD would be to also delay your 401(k) rollover or transfer until a subsequent year. If you put off your 401(k) rollover or transfer until the very next year, both of your first two RMDs must come out before you can do the rollover or transfer.

Keep in mind that the rules in the preceding paragraph also apply if you use the “still-working exception” to delay your first RMD until the year of retirement beyond age 72.

https://www.irahelp.com/slottreport/clarifying-rollovertransfers-rules-when-rmd-due

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

Sarah Brenner, JD
Director of Retirement Education

Question:

A client of mine born in 1952 passed away in March 2021 and the IRA passed to her mother who is 91 years old. So, the 10 year rule applies to liquidate the IRA as she is not an eligible designated beneficiary (EDB). If the mother passes away at age 95 and leaves the inherited IRA to her son – how long does the son have to liquidate the account???

All the best

Stevan

Answer:

Hi Stevan,

Interestingly enough, the mother IS an EDB in this case! She is “not more than 10 years younger than the IRA owner.” However, based on her age, stretching payments over her life expectancy will only allow for about 5 years of payments. If she would pass away, the son as the successor beneficiary of an EDB would then have 10 years to empty the account.

An EDB can also elect the 10-year rule when the IRA owner dies prior to their required beginning date. This could be another option for her. If she dies prior to end of the 10-year period, her son, as her successor beneficiary, must distribute any remaining funds by the end of that same 10-year period. In this case, that would mean the inherited IRA must be distributed by December 31, 2031.

Question:

I am 43 years old and would like to pull $12K out of my employer-sponsored 401(k) and roll it into a Roth IRA. Can this be done, and if so, is there a penalty for doing so? Will I be taxed on the $12K if I roll it into a Roth?

Mark

Answer:

Hi Mark,

There are several issues here. First, in order to be eligible to convert funds from your 401(k), you must be eligible to take a distribution. Based on your age, if you are still working for the employer, that may not be possible. If you are eligible to take a distribution, you can choose to do a Roth IRA conversion if the funds are eligible for rollover. If the funds are pretax, they will be taxed when you convert (i.e., directly rolled over into a Roth IRA), but there will not be a 10% penalty. There is never a 10% penalty on a distribution that is converted to a Roth IRA.

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

 

RMDS, THE STILL-WORKING EXCEPTION, AND THE BEST-LAID PLANS

By Andy Ives, CFP®, AIF®
IRA Analyst

A required minimum distribution (RMD) from a 401(k) (or other employer plan) must be taken prior to rolling remaining plan dollars to an IRA. An RMD cannot be rolled over, so it must be withdrawn before any rollover is completed. While this concept appears somewhat basic, it is easy to get sideways with the rules. Additionally, unexpected changes in employment, combined with the still-working exception, can retroactively create RMD problems.

Many retired people of RMD age (70 ½ prior to the SECURE Act, age 72 since) look to consolidate retirement accounts. Since they are no longer working for a company, the idea of rolling 401(k) plan assets into an IRA makes sense. Easy enough. However, before a rollover can be completed, the annual plan RMD must be taken first. You cannot roll the entire balance into the IRA and then take the plan RMD from the IRA later in the year. Not allowed.

If the plan RMD is erroneously rolled into the IRA, then we have an excess contribution in the IRA for the RMD amount. This excess (plus any earnings attributable to the excess) must be removed from the IRA, and that withdrawal must be coded as an excess contribution withdrawal. If the excess is not removed by the following October 15, there is a 6% penalty for every year it remains.

Individuals of RMD age who are still working can oftentimes delay the start of plan RMDs. Most plans offer an optional plan feature called the “still-working exception.” If a plan participant does not own more than 5% of the company and the plan allows, she can delay her required beginning date (RBD) to April 1 of the year following the year of separation from service. (Note that this exception does NOT apply to IRAs, SEPs or SIMPLEs. It also does not apply to employer plans if a person is not currently working for that company.)

Nevertheless, despite the best-laid RMD plans, unexpected changes in employment can transform a proper rollover into a problematic excess contribution. Here’s how:

Example: Janice, age 74, has been working for a small business for 20 years. She has diligently made salary deferrals into the company’s 401(k) plan and has accumulated $250,000. Since the plan has the still-working exception, Janice does not need to take an RMD from the plan until she separates from service. Janice intends to retire next year. In preparation for retirement (and in order to access a particular investment unavailable in her work plan), Janice takes an in-service distribution of $100,000 which she rolls into her IRA. She wisely leaves $150,000 in the 401(k) so that it will not factor into her IRA RMD next year. After December 31, she plans to roll the remaining $150,000 to her IRA.

Soon after Janice’s $100,000 rollover, torrential rains and flooding destroy the company. The doors are shuttered, and the entire staff is let go. Since Janice has now officially “separated from service” – even though the separation was not her decision – the still-working exception no longer applies. Janice now has an RMD on her plan assets for this year. The “first-dollars out rule” dictates that the first dollars taken from a plan or IRA include the RMD. As such, Janice’s $100,000 rollover is retroactively deemed to have included her 401(k) RMD. Despite her best-laid plans, she now has an excess contribution in her IRA that must be addressed.

https://www.irahelp.com/slottreport/rmds-still-working-exception-and-best-laid-plans

MARRIAGE HAS ITS BENEFITS – 4 IRA RULES SAME-SEX COUPLES SHOULD KNOW

Sarah Brenner, JD
Director of Retirement Edcuation

June is PRIDE Month. This June also marks the sixth anniversary of the landmark Supreme Court case Obergefell v. Hodges, which legalized same-sex marriage. In the wake of this decision, millions of same-sex couples headed to the alter over the past few years.

Many of these newlyweds, never expecting to see a day when they would be allowed to marry, may not have paid much attention to the special breaks that married couples receive under the tax code. When it comes to IRA rules, spouses have many advantages, and couples in same-sex marriages are no exception. Here are four special IRA rules for spouses that same-sex couples should know about:

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

To make a spousal contribution for 2021, you must be legally married on December 31, 2021 and file a joint federal income tax return for 2021. For same-sex couples, this would not include civil unions. If you are divorced or legally separated as of that date, neither is eligible for a spousal contribution, even if they were married earlier in the year.

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

3. Spousal Rollover: Only a spouse beneficiary can roll over or transfer an inherited IRA from her deceased spouse into their own IRA. This is known as a spousal rollover. There is no deadline for a spousal rollover. Once the spousal rollover is done the funds are treated like any other IRA funds you own. There are no RMDs if you are not yet age 72. Non-spouse beneficiaries do not have this option.

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

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

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

https://www.irahelp.com/slottreport/marriage-has-its-benefits-4-ira-rules-same-sex-couples-should-know

INHERITED 401(K) PLANS AND THE RMD AGE: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

How can the beneficiaries of an estate roll a 401(k) paid to the estate to a Roth IRA? What steps must be taken?

Bob

Answer:

Bob,

Inherited IRAs cannot be converted to inherited Roth IRAs, but inherited 401(k) plans can be converted. This is an anomaly in the rules, but it is allowed. However, if the 401(k) was already paid to the estate, those former plan dollars cannot be rolled back to a traditional IRA or converted. Non-spouse beneficiaries cannot do 60-day rollovers with inherited IRA or plan dollars. Once they are paid out (in this case, to the estate), they must remain paid out and are taxable.

Question:

Dear Sir/Madam,

I have recently heard that the government may change the RMD age to 75 from the present 72.  Is there any truth to that?

Thank you,

Dr. John

Answer:

Dr. John,

There is proposed legislation in Congress that would gradually raise the RMD age from 72 to 75. As with all legislation, there are suggestions and negotiation before anything becomes law. Many of today’s rumors begin when people read “proposals” and confuse them for final policies. While rumors abound, it is important to focus on the current rules Yes, there are RMD age proposals, but the current RMD age is 72. If there are any authoritative changes, rest assured it will be big news and we will clearly write about it.

https://www.irahelp.com/slottreport/inherited-401k-plans-and-rmd-age-todays-slott-report-mailbag

IRS RECTIFIES MISTAKEN INTERPRETATION OF 10-YEAR PAYOUT RULE

By Ian Berger, JD
IRA Analyst

On April 14, we reported that the IRS was apparently interpreting the SECURE Act’s 10-year payout rule in a surprising way – to require annual required minimum distributions (RMDs). Now, the IRS has made it clear (without actually saying so) that its prior interpretation was a mistake.

The SECURE Act changed the payout rules for most non-spouse beneficiaries of IRA owners who die after 2019. Those beneficiaries can no longer use the stretch IRA. Instead, they are subject to a 10-year payout rule, which requires the entire IRA to be paid out within 10 years of the owner’s death.

Most everyone thought that annual RMDs would not be required under the 10-year rule. That’s the way the IRS interpreted the 5-year payout rule, which applies when an IRA owner dies before his required beginning date (RBD) without designating an individual beneficiary. Applying the 10-year rule the same way would give a beneficiary the flexibility to take out any amount (or no amount) from the inherited IRA in years 1-9, as long as she emptied the entire account by year 10.

But in a revision of Publication 590-B dated March 25, 2021, the IRS strongly hinted that it was treating the 10-year rule differently than it has treated the 5-year rule. It would require annual RMDs to be paid in years 1-9 and the remaining IRA funds to be paid out in year 10.

Many commentators believed the IRS had simply made a mistake, and that turned out to be the case. In a subsequent revision of Publication 590-B dated May 13, 2021, the Service made clear that annual RMDS aren’t required under the 10-year rule, after all:

For example, if the owner died in 2020, the beneficiary would have to fully distribute the plan by December 31, 2030. The beneficiary is allowed, but not required, to take distributions prior to that date.

The IRS may have cleared up that mess, but it created a new one. This involves the question of when exactly the 10-year period ends. The IRS has said that the 5-year payout period ends on December 31 of the year containing the 5th  anniversary of death. Most assumed that the 10-year period would be applied the same way and, indeed, one part of the most recent Publication 590-B confirms that:

The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death.

But hold on. Two paragraphs later, the IRS says that the ending date of the 10-year period is different when a beneficiary receiving stretch payments dies or when a minor child receiving stretch payments reaches the age of majority:

[I]n either of those cases, the 10-year period ends on the 10th anniversary of the beneficiary’s death or the child’s attainment of majority.

Fortunately, this won’t be an issue for anyone until at least 2030. But we’ll let you know when it is sorted out.

https://www.irahelp.com/slottreport/irs-rectifies-mistaken-interpretation-10-year-payout-rule

10-YEAR RULE: BENEFICIARY PLANNING “LOOPHOLE” CLOSED

By Andy Ives, CFP®, AIF®
IRA Analyst

With the passage of the SECURE Act, once common IRA beneficiary planning strategies have been upended. For example, no longer can just anyone stretch payments on an inherited IRA. You must qualify as an “eligible designated beneficiary” (EDB) to stretch using your single life expectancy. As we have written many times, EDBs include surviving spouses, minor children of the account owner (up to majority, or if still in school, up to age 26), disabled and chronically ill individuals, and individuals not more than 10 years younger than the IRA owner.

All other living, breathing IRA beneficiaries will now use the 10-year rule. There are no annual required minimum distributions (RMDs) during the 10-year window, but the account must be emptied by the end of the tenth year after the year of death.

In light of these new beneficiary payout rules, it came as no surprise that people began thinking of ways to leverage them for maximum benefit. Can I structure a payout this way? What if I do this? Some ideas were creative, some destined to fail. Occasionally, an idea was imaginative enough that it demanded debate as to its legitimacy.

For example, based on a creative inquiry, I wrote a Slott Report entry in May 2020 called “Does Membership Have its Privileges? Spouse Beneficiaries and the 10-Year Payout.” In that blog I discussed a beneficiary planning idea (loophole?) that was not clearly addressed in the SECURE Act. The premise was for a spouse beneficiary to elect the 10-year rule in order to stop RMDs on inherited dollars. If the deceased original owner had been taking RMDs, the spouse (also of RMD age) could potentially choose the new 10-year option created by the SECURE Act as opposed to doing a spousal rollover. If permitted, this would halt RMDs on those inherited dollars for a decade.

Alas, with the recent release of IRS Publication 590-B, “Distributions from Individual Retirement Arrangements,” this loophole appears to have been closed. For EDBs, including spouse beneficiaries, the payout options are predicated on whether the original IRA owner had reached his required beginning date (RBD) – April 1 of the year after turning of 72. The RBD determines when lifetime RMDs are to begin.

If RMDs were initiated to the original account owner (i.e., he died on or after his RBD), then the 10-year option is off the table for EDBs. Spouse beneficiaries can either do a spousal rollover or keep the account as an inherited IRA. Non-spouse EDBs can only stretch payments based on life expectancy.

Note that the elimination of the 10-year rule after the original IRA owner reaches his RBD is applicable to EDBs only. All other living, breathing IRA beneficiaries who are not EDBs can still use the 10-year rule. (In fact, the 10-year rule is the only option for non-EDBs.)

Despite all the acronyms included above, this scenario is now clear. As soon as we receive guidance on other SECURE Act uncertainty, we will pass it along.

https://www.irahelp.com/slottreport/10-year-rule-beneficiary-planning-%E2%80%9Cloophole%E2%80%9D-closed

ROTH CONVERSIONS & 401(K) RMDS: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Hi! I attended the February 2021 IRA seminar and had a question re: Roth conversions.  The seminar discussed rolling over assets held in a company plan into a Roth IRA. I’m dealing with a client that wants to roll over a lump sum from a state pension plan into a Roth IRA.  Can you tell me if in your experience this is generally permitted (assuming tax is paid on the conversion amount)?

Thank you in advance.

Patrick

Answer:

Hi Patrick,

Lump sum distributions from tax-qualified employer retirement plans can be rolled over to a Roth IRA. A state pension plan would qualify as a tax-qualified plan. Moving funds from the plan to a Roth IRA is a conversion, which is a taxable event.

Question:

If you are an employee who participates in a 401(k) and you are a non-owner employee and retire at, for example, age 73, do you have to take an RMD in the year you retire or can you take your RMD by April 1 of the year following retirement?

If you can take your RMD by April 1 of the following year, does that mean you have to take two RMDs in that year?

Answer:

If you delay RMDs beyond age 72 under the “still-working exception,” the first RMD is due for the year you retire. You can defer the RMD for that year until the following April 1, but that would give you two RMDs for that following year. Be careful, though. If you want to do a rollover of your 401(k) funds, any RMD due must be taken first before the balance can be moved to an IRA. So, if you do a rollover in the year you retire, the RMD must be distributed prior to the rollover and cannot be delayed until the following year.

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

SECURE ACT REGULATIONS EXPECTED “SOON”

By Sarah Brenner, JD
Director of Retirement Education

It has been well over a year since the SECURE Act became a reality, transforming the rules for inherited IRAs and doing away with the stretch IRA for most beneficiaries. While the SECURE Act statute gave us framework for the new rules, there are large gaps that need to be filled in and many unanswered questions remain.

IRA owners and practitioners who work with retirement plans have been struggling with these questions. There are issues with exactly how the new 10-year rule will work, and those issues were made more confusing by contradictory language in the recently released, and then corrected, IRA Publication 590-B. There are also questions about whether separate accounting still matters and how grandfathered and multi-beneficiary IRA trusts will be treated. These are just a few of many areas that need to be clarified.

This is where regulations come in. The regulation process is a long one. First, proposed regulations must be written, then there is a comment period and ultimately final regulations are issued. This can take a while. For the last set of regulations explaining the RMD rules, this process took over a decade.

For those of us wondering what is happening with this process there is a bit of good news. At the recent virtual Federal Bar Association Insurance Tax Seminar, Stephen Tackney of the IRS Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes) confirmed that proposed regulations are on the way and promised they will provide answers to many of the questions the SECURE Act has raised. However, exactly when the regulations will arrive is still unknown. “I always say it’s in the ‘soon’ category; that means later than imminent but before eventually,” Tackney said.

Stay tuned to the Slott Report for the latest updates. We will be monitoring any IRS guidance on the SECURE Act carefully and closely watching the regulation process unfold. Hopefully, there will be more details on exactly how the new rules for inherited IRA work and more answers to our many SECURE Act questions in the near future, possibly even before the end of 2021.

https://www.irahelp.com/slottreport/secure-act-regulations-expected-%E2%80%9Csoon%E2%80%9D

RMD RULES & INHERITED IRAS UNDER THE SECURE ACT: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

We have a client that owns two substantial IRA accounts plus a smaller beneficiary IRA.  Does the beneficiary IRA have its own RMD rules (the client has owned it for 10 years and has been taking RMD’s from it based on the old stretch IRA rules)?  Or can the beneficiary IRA be lumped together with the other IRA’s for RMD calculation purposes?  If so, can this year’s total RMD be withdrawn from the beneficiary IRA without having to touch the other two IRA’s?

Answer:

Your client’s own IRAs and the inherited IRA are separate entities with their own guidelines. If the client inherited the IRA before 2020 it would be subject to the old pre-SECURE Act rules. That means that annual RMDs would be required. These RMDs are calculated separately from any RMDs that might be required on his own IRA. He cannot aggregate the RMD from the inherited IRA with the RMD from his own IRAs. This is not allowed. He can aggregate RMDs for his own two IRAs, but the RMD from the inherited IRA must be taken from the inherited IRA.

Question:

Dear Mr. Slott:

Thank you for all you do to keep advisors informed! I read your columns regularly in Investment News and wherever else they appear.

I have a scenario, and then a two-part question for you.

I had a 71-year-old client pass away in February 2021. He was not yet required to take RMD’s due to the Secure Act extension to age 72. His daughter has inherited his IRA. She named her spouse as primary beneficiary. If the daughter were to pass away before her 10-year distribution period ends, what is the status for the surviving spouse beneficiary re: his own RMD’s? Must he liquidate by the end of her 10-year period? Does he get a lifetime RMD period as surviving spouse beneficiary, or something else? Second part of the question, same scenario, but for an Inherited IRA opened pre SECURE Act? What happens if daughter dies under that scenario, re: the surviving spouse beneficiary’s own RMD period? Thanks in advance for your reply.

Andrew

Answer:

Hi Andrew,

This is an interesting question. If the IRA owner dies in 2020 or later, the SECURE requires that the 10-year rule applies for designated beneficiaries. If that beneficiary dies prior to the 10-year period being over, then the successor beneficiary would need to empty the account by the end of whatever remains of the 10-year period. The successor does not get a new 10-year period, nor can the successor beneficiary stretch payments.

 

If the original IRA owner had died before the SECURE Act, the beneficiary would have been eligible for the stretch. However, if that first beneficiary dies after the SECURE Act went into effect, the successor beneficiary would be subject to the 10-year rule and would need to empty the inherited IRA by the end of the 10th year following the year of the original beneficiary’s death. As successor beneficiary, they get the 10-year rule, even if the successor is the spouse of the first beneficiary.

https://www.irahelp.com/slottreport/rmd-rules-inherited-iras-under-secure-act-todays-slott-report-mailbag

HOW THE ONCE-PER-YEAR ROLLOVER RULE IS MISUNDERSTOOD

By Ian Berger, JD
IRA Analyst

One of the cardinal sins you can commit with an IRA rollover is to run afoul of the IRS “once-per-year” rollover rule. Violating that rule triggers a taxable distribution and the 10% early distribution penalty if you are under age 59 ½. Plus, the forbidden rollover would be treated as an excess contribution subject to an annual 6% penalty unless timely corrected. Unlike missing the 60-day rollover deadline, violating the once-per-year rule is a mistake that cannot be fixed.

But the once-per-year rule is often misunderstood.

As background, remember that the once-per-year rule only applies to traditional IRA-to-traditional IRA rollovers or Roth IRA-to-Roth IRA rollovers.  The rule does not apply to company plan-to-IRA rollovers, IRA-to-company plan rollovers, or traditional IRA-to-Roth IRA rollovers (Roth conversions). Since 2015, the IRS has said that the once-per-year rule applies to all of a person’s IRAs – not to each IRA account separately. Traditional and Roth IRAs are combined when applying the rule. You can always get around the once-per-year rule by doing a direct transfer instead of a 60-day rollover.

Often, the once-per-year rule is expressed as disallowing more than one rollover in a one-year period. But that’s not how the rule really works. The rule actually says you can’t do a rollover of an IRA distribution made within one year of a prior distribution that was rolled over. So, the rule prevents you from doing more than one rollover of distributions made within a one-year period; it doesn’t necessarily prevent you from doing more than one rollover within a one-year period.

Example 1: Jackie received a traditional IRA distribution on November 1, 2020 that she rolled over to another traditional IRA on December 1, 2020. If Jackie receives a second traditional IRA (or Roth IRA) any time before November 1, 2021, the once-per-year rule prevents her from doing another 60-day rollover of that second distribution to another like IRA.

Example 2: Let’s say Jackie receives the second distribution on October 15, 2021 (within one year of the first distribution on November 1, 2020). She would still violate the rule even if she delays rolling over the second distribution until December 2, 2021 (more than one year after the first rollover on December 1, 2020).

Example 3: Now assume that Jackie receives the second distribution on November 10, 2021 (more than one year after the first distribution on November 1, 2020). She would not violate the once-per-year rule if she rolls over the second distribution on November 25, 2021 (within one year of the first rollover on December 1, 2020). In that case, doing two rollovers within a one-year period (on December 1, 2020 and November 25, 2021) is allowed.

https://www.irahelp.com/slottreport/how-once-year-rollover-rule-misunderstood

EXCESS IRA CONTRIBUTIONS – GAMING THE SYSTEM?

By Andy Ives, CFP®, AIF®
IRA Analyst

An IRA owner can contribute only so much to a Traditional and/or Roth IRA annually. The IRA owner must also have earned income. The contribution limit for 2021 is $6,000, with a catch-up provision of another $1,000 for those age 50 and over. If a person does not have earned income, he is ineligible to contribute (not counting spousal contributions). If he makes too much, he will be ineligible to make a Roth IRA contribution. (Roth IRA income phase-outs for 2021 are $198,000 – $208,000 for those married, filing joint; $125,000 – $140,000 for single filers)

Nothing exciting here. These are basic regulations.

If a person violates these hard-and-fast rules, then we have an excess contribution that must be addressed. There are a handful of remedies. One could recharacterize (change) a Roth IRA contribution to a Traditional IRA contribution, or vice-versa. (This option is only available up to the cutoff date of October 15 of the year after when the excess contribution was made.)

Another fix prior to the October 15 deadline is to withdraw the excess contribution plus “net income attributable” (NIA). There will be taxes due on the NIA, and a 10% early withdrawal penalty on those earnings if the IRA owner is under 59 ½ years old. Still another fix is to leave the excess in the account, pay a 6% penalty on that excess, and carry forward the excess amount to the next year (or future year) when the IRA owner is eligible to contribute.

But what about fixing an excess contribution after the October 15 deadline? We must remove the excess, but believe it or not, we can leave the earnings on that excess in the account. It’s true. The IRA owner will still have to pay a 6% penalty on the excess amount for every year it remains, but with a weird quirk in the rules, the earnings on the excess can remain in the IRA.

My guess is the 6% penalty amount was chosen to wipe out a nominal gain based on a typical and conservative investment return. But what if the markets have been roaring for years? What if some annual returns were 20%, 30%, or more? (Based on recent market activity, these are not unreasonable numbers.) Could someone leverage high returns to intentionally abuse the excess contribution rules?

Example: In 2010, Bernie started contributing $2,000 annually to a Roth IRA for his 8-year-old son Billy. He did this for 10 years. Son Billy had no income and was totally ineligible for an IRA. Bernie invested in an S&P 500 ETF. The 10-year average annual return on the S&P 500 over the decade was 13.6%. In 2020, the account was worth nearly $38,000. Bernie withdrew the $20,000 excess and paid the annual 6% penalties that had accumulated to $6,600. Since the earnings could remain, son Billy keeps the Roth IRA with the remaining $18,000.

Bernie got lucky with a bull market, but did he game the system? Was the penalty worth getting $18,000 into a Roth IRA for his teenage son? When Billy is 59 ½, at 6% average annual growth, that’s nearly $200,000 in a Roth IRA that should not exist. However, when it comes to tax-free Roth IRA earnings, excess contributions alone won’t help. Tax rules dictate that an ineligible contribution to a Roth IRA does not start the 5-year clock for qualified earnings. That requires an eligible Roth IRA contribution…which Billy could make on his own. A valid and minimal Roth IRA contribution could fully legitimize Billy’s somewhat bogus Roth IRA.

https://www.irahelp.com/slottreport/excess-ira-contributions-%E2%80%93-gaming-system

NON-SPOUSE BENEFICIARIES AND CALCULATING YOUR RMD: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Dear Mr. Slott,

I really enjoy your publications, website and educational programming on Public Television. You provide a tremendous service and information for investors and advisors alike. My questions pertains to distributions from an Inherited IRA and an Inherited Roth IRA for a non-spouse (daughter).

For example: Decedent (father) was age 75 at the time of death in 2020; daughter (sole beneficiary) was 53 last year. I understand as long as she begins RMDs in 2021 from both her Inherited Traditional and Inherited Roth IRA’s, she will not be forced to withdraw all funds within 5 years, but can withdraw over 10 years? Also, which IRS Table is used and is it the attained age of the beneficiary (in this case – 54 in 2021), or of the decedent if he/she were still alive?

Thank you in advance,

Jeff

Answer:

Glad to hear that our educational material is helpful! As for your questions, the adult daughter beneficiary in your scenario will not have a required minimum distribution (RMD) to take from either the inherited Traditional IRA or the inherited Roth IRA. (This assumes she is not disabled or chronically ill.) She will also not have to worry about her age or any life expectancy table to figure RMDs. Since dad died in 2020, she is bound by the SECURE Act and can only select the 10-year payout option. There are no annual RMDs required during this period, but the entire account must be emptied by the end of the 10th year.

The 5-year rule does not apply. That only comes into play when a person dies before their required beginning date (RBD) with a non-designated beneficiary, like an estate. If a person dies on or after their RBD with a non-designated beneficiary, then we use the decedents single life expectancy to calculate annual RMDs (sometimes called the “ghost rule”). However, neither the 5-year rule nor the ghost rule are applicable in the scenario you described.

Question:

I have a client who made a non-deductible IRA contribution of $6,000 into her IRA a number of years ago. She did file Form 8606 the year she made this contribution. She is now turning 72 years old and has to start taking her RMD from the IRA account. How is the non-deductible IRA contribution of $6,000 factored into her RMD calculation?

Laura

Answer:

When determining her RMD, the $6,000 will have no impact. Simply calculate the RMD like normal using the entire balance as of December 31 of the previous year. The taxation of distributions including RMDs, is based on the pro rata rule. The $6,000 non-deductible dollars (basis) in her IRA currently accounts for a certain percentage of the overall assets. For example, if the entire IRA is worth $300,000, the $6,000 would represent 2%. Any distribution would include 2% of that basis and would be 98% taxable.

https://www.irahelp.com/slottreport/non-spouse-beneficiaries-and-calculating-your-rmd-todays-slott-report-mailbag

SPECIAL RULES FOR SPOUSE IRA BENEFICIARIES

By Sarah Brenner, JD
Director of Retirement Education

The SECURE Act may have upended the rules for inherited IRAs, but the rules for spouse beneficiaries remain as advantageous as ever. In fact, naming a spouse as an IRA beneficiary is a better option than ever before. Now, an older spouse beneficiary will get more favorable payout options than a much younger adult child. Why? That is because the adult child must use the 10-year rule. No such restrictions exist for spouses. The SECURE Act keeps all the special benefits for spousal beneficiaries intact.

The special rules for spouse beneficiaries only apply if the spouse is the sole IRA beneficiary. However, even if the spouse is one of several IRA beneficiaries, the spouse can still qualify as a sole beneficiary if her share is split into a separate IRA by December 31st of the year following the year of the IRA owner’s death.

• Spousal Rollover – Only a spouse beneficiary can roll over or transfer her inherited IRA into her own IRA. There is no deadline for a spousal rollover. If the deceased spouse died on or after his required beginning date, the year-of-death required distribution has to be taken before a 60-day rollover is permitted. However, an RMD can be transferred (trustee-to-trustee) to another account and taken later in the year.

• Inherited IRAs for Spouses – Under the SECURE Act, most beneficiaries will need to empty the inherited IRA by December 31 of the tenth year following the year of death. However, eligible designated beneficiaries (EDBs) will still be able to take RMDs from the inherited IRA based on life expectancy. A spouse is an EDB. If the spouse is the sole beneficiary, and the IRA owner dies before his RBD, the spouse can delay these RMDs from the inherited IRA until the later of December 31st of the year after the year of the account holder’s death, or the year the account holder would have attained age 72.

If you inherited an IRA from your spouse, it may make sense to keep it as an inherited IRA when you are under age 59½, instead of doing a spousal rollover. If a spousal rollover is done, the account would be treated as your own IRA. If you want to take any money out before age 59½, there would be a 10% penalty which is assessed on retirement plan owners who tap into their retirement accounts early (assuming no other exceptions apply). But this 10% penalty does not apply to beneficiaries. After reaching age 59½, you would still have the rollover option available. Choosing to remain a beneficiary does not restrict you from being able to roll over later on. However, once the spousal rollover is done, there is no going back. Don’t jump to spousal rollover too quickly.

Example: Francie dies before her RBD, at 50, and named her spouse, Brian, as IRA beneficiary. Brian is 53 years old. He has two choices. He can either keep an inherited IRA or do a spousal rollover. If Brian chooses to remain a beneficiary, he does not have to begin taking RMDs from the inherited IRA until December 31 of the year that Francie would have attained age 72. That is more than 20 years with no RMDs. Brian also will be able to access the IRA funds without the 10% penalty apply, despite his age. He can decide at any time to do a spousal rollover.

https://www.irahelp.com/slottreport/special-rules-spouse-ira-beneficiaries

HOW DO RMDS WORK IN DB PLANS?

By Ian Berger, JD
IRA Analyst

Rules governing defined benefit (DB) plans are typically more complicated than defined contribution (DC) plan rules. But required minimum distributions (RMDs) are one area where the DB plan requirements are easier to understand.

If you’re in a DB plan, your benefit payments must begin no later than your “required beginning date” (RBD) – just like with IRA distributions or DC plan benefits. Your RBD is generally the April 1 following the year you reach age 72. However, if your DB plan allows the “still-working exception,” you can delay your RBD until you retire.

As a practical matter, most DB plan benefits begin at one of three dates; (1) the plan’s “early retirement date” (often age 55); (2) the plan’s “normal retirement date” (often age 65); or (3) the actual retirement date, for folks who work past their normal retirement date. So, most DB benefit payments automatically satisfy the RBD requirement.

Unlike in DC plans, DB plan participants don’t have individual accounts. So, the RMD in a DB plan isn’t calculated by dividing an account balance by life expectancy. Instead, DB plans satisfy the RMD rules if benefits are made in periodic payments over the life of the participant or the joint lives of the participant and a beneficiary, and the benefit amount doesn’t increase. (There’s an exception for cost-of-living increases.)

In just about every case, DB benefits are paid exactly that way. They are usually paid monthly, and participants can choose between a “single life annuity” (an annuity over the participant’s life only) or a “joint and survivor annuity” (an annuity over the participant’s life and, if the beneficiary outlives the participant, over the beneficiary’s remaining life).

This explains why the RMD rules are usually no big deal for DB plans.

There are, however, two RMD DB plan rules that are a little tricky. One rule kicks in when someone elects a joint and survivor annuity with a non-spouse beneficiary more than 10 years younger. In that case, the survivor’s benefit cannot exceed a certain percentage of the amount payable to the participant. The maximum percentages are set forth in an IRS table.

Example: Chloe retires at age 70 and elects a joint and 75% survivor annuity with her son, age 45, as beneficiary. Under that annuity, Chloe will receive payments over her lifetime and, if her son outlives her, he will receive 75% of that amount over his remaining lifetime. Because of the 25-year age difference, however, the plan cannot pay Chloe a joint and survivor annuity that provides a survivor benefit more than 66% of the benefit she will receive during her lifetime. Chloe will have to choose a different type of annuity.

The second rule applies when a DB lump sum payment is paid when an RMD is due. We’ll tackle that rule in a future Slott Report.

https://www.irahelp.com/slottreport/how-do-rmds-work-db-plans

SPOUSAL ROLLOVERS AND SUCCESSOR BENEFICIARIES: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Good afternoon. We have a client who was 19 years younger than her spouse. He passed away this year. We are planning to keep this as an inherited IRA for now. Can we move the assets to her own IRA at any time?

Thank you, stay safe and have a great day,

Julie

Answer:

Hi Julie,

Yes, a surviving spouse can roll over the deceased spouse’s IRA to her own IRA at any time after death. Often, younger surviving spouses delay doing a spousal rollover until they reach age 59 ½. That’s because, as long as the IRA remains an inherited IRA, the surviving spouse can take a distribution from it before 59 ½ without the 10% early distribution penalty.

Question:

I was in your workshop in February, and I just now have an issue that I would like a clarification.

Vince passed away in 2008, his daughter inherited the IRA and is stretching it over her single life expectancy. She passes away in May of 2020. Is her husband (the listed beneficiary of her stretch IRA) able to be an “eligible designated beneficiary” and continue the stretch, using his wife’s remaining life expectancy?

Sincerely,

Thierry

Answer:

Hi Thierry,

Thanks for attending our 2-Day IRA Workshop for Financial Advisors!

Unfortunately, because the daughter died after 2019, the husband (a successor beneficiary) cannot “step into her shoes” and continue the stretch. Instead, he is subject to the new 10-year payout rule under the SECURE Act. He is not required to take annual RMDs and can take as much or as little as he wants each year. However, he must empty the entire inherited IRA by December 31, 2030.

https://www.irahelp.com/slottreport/spousal-rollovers-and-successor-beneficiaries-today%E2%80%99s-slott-report-mailbag

NO IRA CONTRIBUTIONS AFTER DEATH

By Andy Ives, CFP®, AIF®
IRA Analyst

As we inch toward the extended 2020 tax deadline of May 17, many filers are still laboring over their returns. Some are completing the final return for a loved one lost in what was a brutal year. As is human nature, most taxpayers try to squeeze every last deduction and income-reducing item into their prior-year numbers. While maximizing all available and legal tax-cutting strategies is the proper way to file a return, be aware that not all tax benefits are available to all tax filers, especially after a person has passed away.

One common question is, “Can I make an IRA contribution for my deceased spouse or family member?”

The IRS ruled long ago that, once an IRA owner dies, a contribution cannot be made on that person’s behalf. The rationale from the IRS cannot be argued with. In one of the most logical IRS opinions ever issued, the IRS simply said that a contribution made after the death of the account owner “would not be a contribution for retirement purposes.”

In other words, a retirement contribution (either for the current year or prior year) cannot be made after you are dead because you no longer need a retirement plan. The IRS stated that “the primary purpose of the IRA is for retirement.” Even if a person was alive for the entire prior year and had qualified earnings, no contribution is allowed.

Example: Simon died from COVID-19 in February 2021, but he had not yet made his IRA prior-year contribution for 2020. Even though Simon had qualified earnings in 2020 and was alive for the entire year, his representative cannot initiate a prior-year 2020 IRA contribution on Simon’s behalf. If the contribution is made, it will be an excess contribution and potentially subject to a 6% penalty.

While a person with qualified earnings cannot have an IRA contribution made for him after death, a spousal contribution could be made based on the deceased person’s earnings. If Simon (from the example above) had a wife, and if she did not have any earned income of her own, she could make a prior-year 2020 IRA contribution for herself based on Simon’s qualifying income. After all, she is still alive and, in the eyes of the IRS, still in need of retirement dollars.

Conversely, a prior-year SEP IRA contribution can be made for an individual after that person has died. Why the differing rules? SEP contributions are not made by the account owner himself, but rather by the employer. The employer must still fund a SEP IRA for a qualifying employee, even if the employee has since passed away.

We can all agree that 2020 was a struggle, and we lost far too many people unnecessarily. As we work through our own tax returns (and those returns for the recently departed), be sure to know the rules. We all want to put the final punctuation mark on 2020. Be careful not to extend that miserable year by making an avoidable IRA contribution mistake.

https://www.irahelp.com/slottreport/no-ira-contributions-after-death

ARE YOU READY FOR THE SON OF SECURE?

By Sarah Brenner, JD
Director of Retirement Education

On May 5, the House Ways and Means Committee unanimously passed the Securing a Strong Retirement Act of 2021. According to lawmakers, the proposal is designed to pick up where the SECURE Act of 2019 left off and help increase retirement savings even more. The so-called “Son of SECURE” would make more big changes to retirement accounts. Here are some highlights:

“Rothification”

The trend toward more Roth accounts continues as Congress is proposing allowing both SIMPLE and SEP Roth IRAs. In addition, plan catch-up contributions would be required to be made to Roth plan accounts, and plans could allow participants to have employer matching contributions made as Roth contributions. Congress likes Roths because they bring in immediate revenue since they are funded with after-tax dollars.

Other Changes

Other changes include the following:

  • Increasing the required first-year required minimum distribution (RMD) age over time from age 72 to age 75.
  • Indexing $1,000 IRA catch up contributions for inflation.
  • Increasing the limit on catch-up contributions to 401(k) and other plans for individuals who have attained age 62, 63, or 64.
  • Allowing matching contributions on student loan payments.
  • Eliminating the requirement that premiums for QLACs be limited to 25% of an individual’s account balance.
  • Reducing the penalty for failure to take RMDs from 50% of the shortfall to 25%.
  • Expanding the IRS self-correction program (EPCRS) to include IRAs.
  • Indexing the $100,000 QCD limit for inflation and allowing a once-in-a-lifetime QCD to a split-interest entity such as a charitable remainder unitrust.
  • Expanding the age 50 exception to the 10% early distribution penalty to private-sector firefighters.
  • Changing the rules for when the statute of limitations begins for the excise tax on excess IRA contributions.
  • Limiting the repayment of qualified birth or adoption distributions to three years.
  • Allowing penalty-free withdrawals from IRAs and retirement plans for individuals in cases of domestic abuse.
  • Limiting the loss of tax-deferred treatment to the portion of an IRA t involved in a prohibited transaction.

 

Stay Tuned

While the “Son of SECURE” does enjoy wide bipartisan support, there is still a long road ahead before this proposal could become a law. The next step would be a vote of the full House. Then the Senate would need to take up the proposal. If there are any differences between the House bill and the Senate bill, those would have to be resolved and approved. Finally, the President would have to sign the bill into law. That process can take time and is far from certain. One thing that you can count on though is that we at the Slott Report will be watching developments in Washington DC closely and will keep you up-to-date on all breaking news.

https://www.irahelp.com/slottreport/are-you-ready-son-secure

ROTH CONVERSIONS UNDER THE SECURE ACT: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
Director of Retirement Education

Question:

I am 83 years old with an IRA rollover account, regular IRA account and a small Roth IRA. If I convert a portion of either the rollover or regular IRA to a Roth IRA and die before 5 years after the conversion, is there any penalty to me or the beneficiaries?  Also, can I convert to the existing Roth IRA or should I start a new Roth IRA?  I do not plan to make any withdrawals from any Roth IRA. Does it make a difference from which IRA I convert funds?

Thank you for your response,

George

Answer:

Hi George,

You can convert either the regular IRA or the IRA that was funded by a rollover. From a tax perspective it will make no difference. Unless you have some after-tax dollars in either IRA, the conversion will be fully taxable. You can also add the conversion to your existing Roth IRA. Starting a new Roth IRA would have no tax benefit.

When it comes to distributions to your beneficiaries, there would be no 10% penalty regardless of whether a five-year period has been satisfied. That is because the 10% early distribution penalty never applies to distributions from inherited IRAs. The only issue would be that your beneficiaries would have to wait out your five-year period to receive a qualified tax-free distribution of earnings.

Question:

If I have a client (husband and wife filing jointly) with earned income. Can they continue to contribute to a Traditional IRA beyond age 73?

Thank you,

Curt

Answer:

Hi Curt,

The SECURE Act brought good news for older individuals with earned income looking to contribute to a Traditional IRA. Starting for 2020 contributions, the rule prohibiting contributions once an individual reaches age 70 1/2 no longer exists. If your clients have earned income they can go ahead and make Traditional IRA contributions regardless of their ages.

https://www.irahelp.com/slottreport/roth-conversions-under-secure-act-todays-slott-report-mailbag

THE ROTH CONVERSION CONVERSATION: A MUST-HAVE!

By Andy Ives, CFP®, AIF®
IRA Analyst

When visiting the doctor, does he or she ask foundational questions to help determine your medical condition? Of course. “How are you feeling?” “Are you a smoker?” “What hurts?” Does the doctor take some basic measurements – height, weight, blood pressure? Does he listen to your heart and lungs? Most assuredly.

The doctor is establishing an overall picture of health so as to make informed medical decisions. Without such elemental knowledge, how could a proper diagnosis be made? How could “next steps” be recommended with any confidence? It is not possible to provide appropriate care or guidance simply by looking at a person. Assumptions could be a death sentence.

Who else needs to ask elemental questions? Who else needs to poke and prod to identify foundational information? Financial advisors. It is impossible to chart a path forward without a general understanding of a person’s overall financial goals and wellbeing. Probing questions are how advisors identify the suitability of certain transactions. They are how advisors can confidently make investment recommendations. Investigative inquiries uncover needs and other issues that are literally impossible to know without asking.

Yet for some reason, I keep hearing stories about financial advisors failing to address a certain topic: Roth conversions. In fact, my own parents fell victim to this financial oversight. Out of respect for their privacy I stayed out of their financial affairs. Sadly, I learned later, their previous advisor never broached the subject of Roth conversions. Partial Roth conversions, systematically implemented over a few years, coordinated with their tax advisor so as maximize tax brackets, would have been a prescription for financial health. My folks could have transitioned their IRAs from “forever taxed to never taxed.”

Alas, they missed all those years of maximum conversion tax efficiency. Yes, they can still do Roth conversions now, even though they are of RMD age, but it is a little less potent. RMDs must be taken first, and it is expected that taxes could rise in the near future.

Like a doctor administering a basic blood pressure test, a financial advisor inquiring about Roth conversions is critical. If your advisor fails to ask, then broach the topic yourself. Know that a Roth conversion is no panacea, and it is not always a good fit for every situation. But at least you can rest easy knowing you had the conversation.

I am frequently asked, “When is the cutoff when Roth conversions stop making sense?” The answer is never. There is no such end date. I don’t care how old a person is or how much money they have or what tax bracket they exist in. Simply assuming a person won’t do a Roth conversion based on any data point is borderline malpractice. Maybe a person’s supreme goal is to leave a tax-free inheritance to their heirs. If that is the ultimate objective, then tax brackets and additional tax on Roth conversions after taking an RMD be damned.

Roth conversions: have the conversation…or risk a sickly doctor/patient relationship. That is my professional “medical” opinion.

https://www.irahelp.com/slottreport/roth-conversion-conversation-must-have

2020 IRA CONTRIBUTION DEADLINE EXTENDED TO MAY 17

By Sarah Brenner, JD
Director of Retirement Education

Good news for retirement savers! There is more time to make your 2020 IRA contribution.

On March 17, 2020, the IRS extended the 2020 federal income tax-filing deadline to May 17, 2021. The extension also extends the deadline until May 17 to make a 2020 prior year contribution to a traditional or Roth IRA. If you have an extension to file your taxes beyond May 17, your IRA contribution deadline is not extended. You must make your IRA contribution by May 17. If you live in Oklahoma, Louisiana, or Texas, the federal tax filing deadline had already been extended to June 15. As such, the IRA contribution deadline in those states is also June 15.

If you are a sole proprietor, the due date for making a 2020 employer contribution to either a SEP or SIMPLE IRA is different. That deadline is the federal tax-filing deadline, plus any extension you might have. If you have an extension to October 15, 2021, you can make your SEP or SIMPLE contribution until that date. If you don’t have an extension, your deadline would be May 17, 2021 (unless you live in one of the states mentioned above).

Example: Jose is a sole proprietor. His business did well in 2020 and he would like to make both a SEP IRA and a Roth IRA contribution for 2020. He has an extension to file his federal income taxes until October 15, 2021. He must make his 2020 Roth IRA contribution by May 17, 2021. However, he has until October 15, 2021 to make his SEP contribution.

An IRA contribution will be considered “timely” as long as it is postmarked by May 17. This is true even if the contribution gets “held up in the mail” and does not arrive to the IRA custodian until weeks later.

Be careful! Any contribution made for the prior year should be clearly marked as such to avoid any confusion. If it not marked for the prior year, the custodian may report it as being for the current year.

The tax-filing deadline is a hard deadline for IRA contributions. If missed, there is no relief available, and the IRA custodian will report the contribution for the current year.

https://www.irahelp.com/slottreport/2020-ira-contribution-deadline-extended-may-17

THE IRS MAY BE COMING AFTER YOUR SOLO 401(K) PLAN

By Ian Berger, JD
IRA Analyst

If you sponsor a solo 401(k) plan, beware!

The IRS recently announced that it is targeting several employer plan areas for stepped-up auditing. One of those areas is solo 401(k) plans.

The fact that solo plans made the list is a signal that the IRS believes there are widespread compliance issues with these plans. While solo 401(k) plans don’t have as many rules to follow as employer-based 401(k) plans, there are still several requirements. The IRS announcement should be a warning to business owners with solo plans to make sure they are obeying those rules.

These are the areas that the IRS will likely be looking at:

Have you hired employees? If you have any employees (besides your spouse), you can’t have a solo 401(k). Hiring an employee would cause the plan to become a standard 401(k) and lose the administrative benefits of a true “solo(k).” Be aware that the definition of “employee” has recently expanded to include part-time workers. Previously, someone was not an employee if she did not work at least 1,000 hours in a 12-month period or was under age 21. Starting this year, someone who has worked at least 500 hours in three consecutive years and is age 21 or older by the end of the three-year period is considered an employee. (However, years before 2021 don’t have to be counted for the three-consecutive-year rule.) Keep in mind that, if your business must be aggregated with another business under IRS common control rules, the “no-employee” rule applies across both businesses.

Have you exceeded contribution limits? If you have a solo 401(k), you wear two hats – an employer and an employee. The good news is this allows you to make both elective deferrals and deductible employer contributions. The bad news is you must worry about three different contribution limits, First, annual elective deferrals can’t exceed a dollar amount — $19,500 for 2021 ($26,000 if age 50 or older). Remember that this deferral limit is per person (not per plan). So, if you have a solo 401(k) for your side job and a traditional 401(k) in your regular job, the most you can defer between both plans is $19,500 (or $26,000). Second, yearly employer contributions are limited to an amount that is normally 20% of adjusted net earnings. Finally, there’s an overall annual limit on combined contributions. For 2021, that limit is $58,000 (or $64,500 if the $6,500 catch-up deferral was made).

Are you filing Form 5500-EZ when required? Once solo plan assets reach $250,000, an annual Form 5500-EZ must be filed.

Is your plan document in order? Every solo 401(k) plan has an official plan document which sets forth the provisions of the plan. Make sure you are operating the plan exactly in sync with what the plan document says. Also, documents must be updated periodically to account for tax law changes. Make sure yours is up-to-date.

Doing your own compliance audit (with the help of a knowledgeable financial advisor) before the IRS comes knocking could save you a significant amount of money and aggravation.

https://www.irahelp.com/slottreport/irs-may-be-coming-after-your-solo-401k-plan

YEAR-OF-DEATH RMDS AND IRA CREDITOR PROTECTION: TODAY’S SLOTT REPORT MAILBAG

By Ian Berger, JD
IRA Analyst

Question:

Your newsletter is so helpful, and your book was a great resource to me when my mom passed away 5 years ago and I inherited her IRA.

I am 76 and have not taken my RMD for 2021. Should I pass away and my wife age 69 transfers my IRA to hers, must my RMD for 2021 be taken first?

Thanks much. A columnist in the Chicago Tribune led me to you years ago.

F. Perry

Answer:

Thanks for the kind words! If you die in any year before taking your full RMD for the year, your wife as beneficiary must take your RMD for that year. If she does a direct transfer of your IRA to hers, the year-of-death RMD doesn’t have to come out first. Instead, that RMD can be paid from your wife’s IRA – as long as it happens by the end of the year. If, however, she does a 60-day rollover, the RMD would have to be paid out first.

Question:

Good afternoon!

I have a question about a client that has a traditional IRA funded with rollover funds from a DB plan.  Client wants to make IRA Contributions to his IRA.  He was told by another advisor that the IRA he has now carries special liability protection because it was rolled over from a DB Plan years ago.  She told him not to add any funds to it or it would lose that protection.  Is that true?  Should we open a separate IRA for the contributions?

Thanks so much!

Best,

Becky

Answer:

Hi Becky,

Your client’s rollover funds enjoy unlimited protection against creditors if he files for bankruptcy. IRA contributions and earnings (non-rollover monies) are also protected in bankruptcy.  But that protection is lost once the non-rollover funds exceed a certain dollar limit ($1,362,800 in 2021) – still a very high amount. Adding new contributions to the existing rollover account won’t cause the rollover funds to lose their unlimited protection. However, it wouldn’t hurt to keep the funds in separate accounts to more easily keep track of which IRA monies have unlimited protection and which don’t. (Creditor protection against lawsuits outside bankruptcy depends on the law of the state where the IRA owner lives.)

https://www.irahelp.com/slottreport/year-death-rmds-and-ira-creditor-protection-today%E2%80%99s-slott-report-mailbag