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Ed Slott welcomes you to The Slott Report, your source for IRA, retirement and tax planning information.

A Tale of Two Spouses Inheriting IRAs

Ann and Zelda are both 72 years young and now widows after their 74-year-old spouses died this year. Both inherited an IRA from their spouse in the amount of $100,000. Ann’s advisor had her move the funds to an inherited IRA. The account is titled Alan, deceased, IRA fbo Ann. Zelda’s advisor had her move the funds into an IRA in Zelda’s name. The account is titled Zelda’s IRA.

There age and circumstances are where the similarities end. From here their stories are very different.

Ann’s Inherited IRA
As a beneficiary, Ann must calculate her required minimum distributions (RMDs) based on her age. Her factor comes from the IRS Single Life Table. When she takes her first RMD in 2015 at the age of 73, her life expectancy factor is 14.8 years. Assuming no earnings on her IRA, she divides the $100,000 by 14.8 and learns she has to take a distribution of $6,757 in 2015.

Ann named her children as the beneficiaries of her inherited IRA. Brad is 45 and Cathy is 40. At Ann’s death, both Brad and Cathy will continue using Ann’s age to calculate their RMDs. Assuming Ann dies in 2015, Brad and Cathy will have to use a factor of 13.8 in 2016 (based on Ann’s age in 2015 and reduced by one).

Zelda’s IRA
As an account owner, Zelda will calculate her RMDs based on her age and a factor from the IRS Uniform Lifetime Table. For a 73 year old, the life expectancy factor is 24.7 years. Dividing her balance of $100,000 by 24.7 means Zelda has an RMD of $4,049.

Zelda named her children, Xavier and Yvette, as the beneficiaries of her IRA. They are 45 and 40. At Zelda’s death in 2015, they will both get to use their own ages to calculate their RMDs. Xavier will have a single life expectancy factor of 37.9 (age 46) and Yvette (age 41) will have a factor of 42.7 (based on their ages in 2016).

If only RMDs are taken from Zelda’s account, her account will last much longer than Ann’s account. Zelda’s RMD is smaller and the RMDs to her children, when they inherit, will be smaller. This will make the account last longer and will reduce the amount of income tax that will have to be paid each year on the RMDs.

The difference is $2,708 in the first year ($6,757 - $4,049) . The difference in the life expectancy factors for the children is almost 30 years of distributions. Zelda’s children will have 30 years more of distributions than Ann’s children. It’s the difference of A to Z.

- By Beverly DeVeny and Jared Trexler

Can I Recharacterize Funds Rolled Over From an Employer Retirement Plan to a Roth IRA?

This week's Slott Report Mailbag looks at IRA trust beneficiary maneuvers and how to disclaim yourself as an IRA beneficiary. As always, we recommend you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

1.

Ed,

IRA questions
Send questions to mailbag@irahelp.com
My 89-year-old mother died this year with an IRA worth about $100,000. She named her trust as the beneficiary of the IRA.

The trust calls for the four of us children to split everything equally and then shut down. My research indicates we qualify as "pass through" beneficiaries and the IRA can be split up into four inherited IRA's.

My question, can we split the IRA up into four "Inherited IRA's" and then use the five-year rule since the trust was the designated beneficiary?

Bob Hobbs

Answer:
Assuming the trust qualifies as a see-through trust, the five-year rule does not apply. All four children could use the single life expectancy of the oldest child. The trust can assign the inherited IRA out of the trust to each beneficiary of the trust. This should only be done via a direct trustee-to-trustee transfer from the inherited IRA for the trust to an inherited IRA for each child. Some IRA custodians may be unwilling to do this without a private letter ruling from IRS. Ideally, you should also check with a trust attorney to make sure everything is in order.

2.

When I retired from the Federal Government in 2012, I rolled over my Voluntary Contributions into a traditional IRA. However there was no 1099-R given by the Government. How do I report the rollover? Do I need to generate and submit my own 1099-R? The distribution was in 2012. Do I need to amend my 2012 tax form to show the distribution? To complicate matters, my advisor rolled over both the after-tax contributions and pre-tax earnings into a traditional IRA. We are recharacterizing the after-tax contributions to a Roth IRA in 2013.

Thank you for any info.

Judy Hampton

Answer:
Assuming the funds were rollover eligible, a Form 1099-R should have been issued. You then should have reported the distribution on your 2012 federal income tax return (Form 1040) and reported it as a nontaxable rollover. You cannot recharacterize funds rolled from an employer plan to a Roth IRA. You can only convert them. Now that the funds are in an IRA, you cannot generally convert just the after-tax funds to a Roth IRA tax-free. The pro-rata tax rule applies so part of the conversion will be tax-free and part will be taxable. Form 8606 will also need to be filed with your amended 2012 tax return to reflect the after-tax amounts that went into your IRA. You should talk with a qualified tax-preparer about amending your 2012 tax return.

3.

My father, age 92, has four kids and will split his IRA and money in four equal parts. I am one of the four, and do not need the money, but would like my siblings to refuse their IRA portion so I may pass it on to my kids. How do I do this?

Answer:
You cannot do what you want without your father’s cooperation. Your father would have to name new beneficiaries on the IRA beneficiary form. When those beneficiaries are properly named, you can disclaim your share of your inheritance and it will automatically go to your children without any action on the part of your siblings. You may also want to discuss changing beneficiaries with your siblings so there are no unpleasant surprises or family discord after your father’s death. A disclaimer is a legal document and we recommend that you consult with an attorney before disclaiming any part of your inheritance.

- By Joe Cicchinelli and Beverly DeVeny

5 Questions Commonly Asked by 401(k) Participants

401(k) questionsOn Monday, we will be celebrating Labor Day, a holiday established to pay tribute to the American workforce. Much of that workforce has access to some type of employer plan and, for more than 50 million workers, that plan is a 401(k) plan. So, with that in mind and in honor of Labor Day, this week we take a look at 5 answers to questions commonly asked by 401(k) participants.

1. I am currently working and contributing to my company’s 401(k). I would also like to contribute to an IRA. Can I do that?

Absolutely! Participating in your employer's retirement plan never prevents you from being able to make an IRA contribution. That said, depending on your total income, your contribution may not be deductible. If neither you, nor your spouse, were covered by a company plan last year, any IRA contributions you made for 2013 would be deductible. That's true whether you made $15,000 or $15 million. If, however, either you or your spouse were covered by a company plan last year, your IRA deduction could be reduced or eliminated depending on your overall income.

2) I have two totally separate jobs that both have 401(k) plans. Can I contribute to both of them?

Yes, you can contribute to both of them. You can strategically allocate your deferrals to get the most out of any company matches that you might be eligible for but, that said, your total salary deferrals to both plans can be no more than the $17,500 limit. If you’re 50 or older by the end of the year, then you can defer a total of $23,00
0 between the two plans. While your salary deferral limit is coordinated between the two plans, if the two employers are unrelated and unaffiliated, you can still receive up to $52,000 in each plan (including company matches and profit sharing components).

3) I am still working and contributing to my employer’s 401(k) plan, but I’d like to roll over my existing balance to an IRA. Can I?

This is a difficult question to answer, because it depends on a number of factors, including your age, the type of money (i.e., salary deferrals, company match) you’re trying to rollover and your plan’s specific rules. That said, if you’re under age 59 ½, and still working, it’s unlikely that you’ll have access to much, if any, of your plan assets to execute a rollover. If, on the other hand, you’re over 59 ½ and still working, it’s generally going to be up to the specific rules in your employer plan as to how much, if any, of your funds you have access to.

4) I want to put money into a Roth account, but my current employer’s 401(k) doesn’t seem to have that option. What can I do?

The law allows an employer with a 401(k) to offer a Roth option within the plan, but there is no law requiring them to do so. If you would like to have this option, it’s worth asking your employer if they’ll consider amending the plan to add it. In absence of that, you can make a contribution to a Roth IRA, assuming you’re eligible to do so. For more on that, you can check out this page.

5) My spouse is the beneficiary of my 401(k), but I want it to go to my children. How can I do that?

Under a federal law known as ERISA (which, coincidentally, was signed into law on Labor Day 40 years ago in 1974 by then new President Gerald Ford), your spouse is typically the automatic beneficiary of your 401(k), even if you did not name them as the beneficiary on your beneficiary form. If you want to name someone else, it’s a two-part process. First, you must get your spouse to sign a waiver, acknowledging that they are releasing their rights to your 401(k) assets. Use a professional for this to make sure it is executed correctly. Next, you need to fill out new beneficiary forms that name your alternate beneficiaries. Without completing both of these steps, you’re unlikely to achieve your desired outcome.

- By Jeffrey Levine and Jared Trexler

You Usually Don't HAVE to Name Your Spouse as IRA Beneficiary

If you are married and participate in your employer's ERISA covered retirement plan, such as a 401(k) or pension plan, your spouse must generally be the beneficiary of that company plan. Even if you didn’t name your spouse as the beneficiary, possibly because you weren’t married at the time you started working there, your spouse is usually automatically treated as the beneficiary of your company retirement plan.

IRA spousal beneficiaryWhy does that happen? Typically your spouse must be the beneficiary under pension law (ERISA) and the Tax Code. In fact, if you want to name someone other than your spouse as your plan’s beneficiary, you will need to get your spouse’s written consent to do so. But what about your IRA? Do you have to name your spouse as the beneficiary of your IRA? The answer is usually no.

If you have an IRA, the rules are different. The spousal rules under ERISA don’t control IRAs and the Tax Code doesn’t require you to name your spouse as the beneficiary of your IRA. So, in general, you can name anyone as the IRA beneficiary without having to get your spouse’s permission. However, your state’s law may give your spouse rights to some or all of your IRA or require spousal consent to name a non-spouse IRA beneficiary.

If you’re married and live in a community property state, your state’s law may recognize your spouse as the beneficiary of some of your IRA. Accordingly, you likely need to get your spouse’s written consent if you want to name a non-spouse beneficiary of your IRA.

According to IRS Publication 555 Community Property (revised January 2014) the community property states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In Alaska, a married couple can make a community property election. Oftentimes, your IRA custodian’s beneficiary form will have the spousal consent language on the form to make it easier for you to get spousal consent and name a non-spouse beneficiary.

While there are only 9 community property states (10 if you count Alaska), the other 40 states are not. So, in most cases, you don’t need spousal consent to name a non-spouse beneficiary of your IRA. Ultimately, it’s your responsibility to get spousal consent if it’s required by state law. You may need to speak with an attorney who is knowledgeable in the community property rules.

- By Joe Cicchinelli and Jared Trexler

TWO IRA Rollovers From ONE Account in ONE Year: Nothing Good Happens

What happens to your IRA if you accidentally do two rollovers in one year? Nothing good.

IRA rollover mistakeIf you request two distributions on two different dates, then you can decide which one you want to rollover with the 60-day rollover period. As long as you have the funds, the smart choice is to roll over as much as you can of the larger distribution. This reduces the amount you will have to include in income for the year and any 10% early distribution penalties you might owe.

The tougher scenario is one that an advisor asked me about recently. A client had two distributions from one IRA within a one - period. He had rolled them both over. Now it was time to fix the situation. The client wanted to know if he could “keep” the larger rollover and “undo” the smaller rollover thus reducing his taxes and penalties on his mistake.

Unfortunately for this client, the larger rollover was the second one he had done. He has no choice of which rollover to keep. Once a rollover is done, any subsequent rollovers within the one-year period generally become excess contributions in the IRA account, and the second rollover is the one that he must undo.

He has until October 15 of the year after the excess contribution to remove it from the IRA – plus or minus earnings or losses on the excess contribution. He must tell the IRA custodian he is removing an excess contribution so it will be properly coded on the IRS Form 1099-R issued for the distribution. He will owe taxes and penalties, if applicable, on the original distribution – the one he inadvertently rolled over.

When the excess contribution is not timely corrected, then the client will owe a penalty of 6% per year for every year that the excess amount remains in the IRA. He must file Form 5329 to calculate and report this penalty to IRS. This form is considered a stand-alone return. If it is not filed, the statute of limitations does not start to run. IRS can, and has, come back at any time to collect the penalty, interest, failure to file penalties, and, if the amount owed is large enough, accuracy related penalties.

This is not something you want to ignore if you are in a similar situation. Unfortunately, many IRA custodians put their clients at risk by making it easy for them to receive a check to move their funds and making it virtually impossible for them to do a direct transfer to a different IRA account. Direct transfers are not subject to the once-per-year limit.

Beginning in 2015, you will only be able to do one 60-day rollover a year, no matter how many IRA accounts you have. I have no doubts that we will see many clients losing their retirement savings when they are simply trying to move their IRA funds. Compounding this problem is the inability of IRS to allow you to correct the problem. They do not have any authority under the tax code to give you a “do over.”

- By Beverly DeVeny and Jared Trexler

Should I Keep All IRAs Separate?

This week's Slott Report Mailbag looks at combining IRA monies into one big IRA, how 401(k)s affect calculating yearly IRA distributions and whether leaving equal IRA shares to your three children is possible.  As always, we recommend you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

1.

ed slott IRA questions
Send questions to mailbag@irahelp.com
Is there any reason to keep a nondeductible Traditional IRA separate from a pre-tax Traditional IRA? I know the pro-rata rule applies to Roth conversions, IRA distributions, etc. so I was wondering if there's any reason why someone shouldn't consolidate their Traditional IRAs together in order to simplify.

Dale

Answer:
There’s no reason to keep nondeductible money in a separate IRA because the Tax Code treats all of your Traditional, SEP, and SIMPLE IRAs as one IRA for purposes of the pro-rata tax rule.

2.

Hi Mr. Slott,

Really enjoyed your PBS program - have been reviewing your DVDs.

A question to follow-up on your July 10th answer to the Pre and Post Tax monies that was posed by Michael from New Jersey:

I currently have a 401(k) from a former employer that is composed of a "mixed bag" of both pre and post tax contributions. I also own a rollover IRA that contains purely pre-tax contributions and a Roth IRA. The same broker manages all of these accounts. I converted monies from the rollover IRA to the Roth IRA and the 8606 Form that was ultimately generated did not reflect the "pro-rata rule" because I was advised that the monies in the 401(k) are not considered an IRA. Additionally, I was advised that I could continue to convert monies from the Rollover IRA to the Roth IRA without regard to the "mixed 401(k).” Is this correct?

Thanks

Ed from PA

Answer:
Yes, that is correct. Funds in your 401(k) plan are not counted for purposes of figuring the taxable amount of IRA distributions, including distributions that are converted to a Roth IRA. The only time a 401(k) plan will affect your IRA conversions is when you roll over 401(k) funds to an IRA.

3.

Hello,

I am updating my beneficiary forms for my IRAs and have been told by the agent of my IRA Custodian that I may not write in "equal" in lieu of percentages, which add up to 100%. I also cannot indicate 33 and a third percent. I have 3 children and want them to each receive the same amounts. I am trying to follow Ed's advice from the Retirement Rescue packet that I just received through my PBS television network. What should I do? Is the advice I have been given accurate?
Mary

Answer:
There should be a way to leave your 3 children equal shares of your IRA. We suggest that you ask the agent how to fill out the beneficiary form so you can leave your children equal shares. If they say it’s not possible or cannot answer your question, then you may want to consider transferring your IRA to a more cooperative IRA custodian.

- By Joe Cicchinelli and Jeffrey Levine

What Happens to My RMDs If I Annuitize my IRA Annuity?

Note: Earlier this year, in June, the IRS created a new type of retirement income annuity, called qualifying longevity annuity contracts (QLACs). QLACs have special rules with respect to RMDs. The annuities discussed in this article are not QLACs. For more information on QLACs, click here.

One common question both clients and advisors ask is “how will RMDs (required minimum distributions) be calculated from my IRA annuity after the annuitization?” If you have, say, only one IRA, with a $100,000 balance that is annuitized, the answer is simple. The annuitized amount that comes out of the IRA each year will satisfy your RMD obligation.

What if, on the other hand, you’re 74 – so you’re required to take RMDs – and have two IRAs, IRA “A” and IRA “B?” IRA “A” has a $100,000 value and IRA “B” has a $90,000 value, for a combined IRA total of $190,000. That would make your cumulative IRA RMD for this year about $8,000 and there’s no question that, if your IRAs weren’t annuitized, you’d be able to take the full $8,000 total from either of your IRAs separately or, between the two IRA in any amounts you prefer, as long as the total distributions were at least $8,000.
IRA annuities and required distributions
What if, however, you happen to annuitize IRA “A” and start to receive $9,000 a year as a lifetime income stream? Will the $9,000 you receive from the annuity satisfy your total RMD for all of 2014? Here’s where it starts to get a bit tricky.

Believe it or not, there is actually some debate over whether or not a distribution from an annuitized annuity can be used to satisfy RMDs for other IRAs in the year of annuitization. On one hand, once annuitized, IRA annuities generally follow defined benefit plan rules instead of the defined contribution rules. That would lead you to believe the answer is no. On the other hand, RMDs are based off of prior year-end balances. Since the annuitized annuity did have a prior year-end balance and wasn’t annuitized at the time, that might lead you to believe yes. In light of the grayness in this area, the conservative approach is to take the $9,000 annuity distribution from IRA “A” and an additional distribution from IRA “B” based on its prior year-end balance.

After the year of annuitization, things begin to become a little clearer. Most experts agree that there is no way to use the income from the annuitized annuity in IRA “A” to offset any of the RMD that must be taken from IRA “B.” In this situation, your annuity payout will only satisfy the RMD for IRA “A.” To put it another way, under the defined benefit plan rules that the annuitized IRA now follows, the annuity payment is the RMD for that IRA account. Your RMD for IRA B, with a total value of $90,000, would be just under $4,000 next year.

Annuitizing an IRA annuity isn’t a good or bad decision in a broad sense. It’s one that must be looked at separately, in each case, based on its own merits. Either way though, you should understand its effect on your RMDs.

- By Jeffrey Levine and Jared Trexler

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