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

Aggregating Inherited IRAs

aggregating inherited IRAsThe question came up recently about combining inherited IRAs. The general rule is that you can combine IRAs that you have inherited from the same person. So if you inherited two IRAs from your Mom, you could combine them into one inherited IRA. But if you inherited an IRA from your Mom and inherited an IRA from your Dad, you could not combine them. Sounds simple, right? Let’s take a look at some scenarios.

Dad had two IRAs when he died. The beneficiary form for one IRA names his children. The beneficiary form for the other account names a trust (or the estate). The IRA will be distributed out of the trust into inherited IRAs for the children who are the beneficiaries of the trust (or the estate). You now have two IRAs that you have inherited from Dad – or do you? These IRAs should generally not be combined for two reasons. One, technically you have two different beneficiaries – you and the trust (or the estate). Two, unless you are the oldest trust (or estate) beneficiary, you will have two different life expectancies for the two inherited IRAs – one will use your single life expectancy, the other will use the single life expectancy of the oldest trust (or estate) beneficiary.

Mom had two IRAs when she died. One was her own IRA that names you as the beneficiary. The other was the IRA she inherited from her sister where she has named you as the beneficiary. These inherited IRAs cannot be combined. Here you will definitely have two different life expectancies. On the IRA you inherited from Mom, you will use your own life expectancy using your age in the year after Mom died. On the IRA that Mom inherited from her sister, you will continue to use Mom’s remaining life expectancy.

One final example; your uncle has an IRA that names you and your sister as the beneficiaries. Your sister dies two months after your uncle dies. You now inherit the entire IRA, both your half and your sister’s half. Again you will have two different life expectancies. You will be able to use your own age for your half of the IRA. On the other half you will have to use your sister’s age since she was alive on the date your uncle died. You will not be able to combine these IRAs.

In all of these scenarios the RMD will have to be calculated and distributed separately for each IRA. You can never take the RMD for an inherited IRA from an IRA that you own or vice versa. IRAs inherited by non-spouse beneficiaries have RMDs beginning in the year after the death of the account owner regardless of the age of the beneficiary. Beneficiaries under the age of 59 ½ never have to pay the 10% early distribution penalty. But if they do not take their required distribution, they will be subject to the 50% penalty for a missed distribution.

- By Beverly DeVeny and Jared Trexler

Happy Parenthood! 3 Tax Planning Moves To Consider Making For Your New Child

3 tax planning moves for new childI’m still having a hard time believing it's true, but by the end of tomorrow, I'm going to become a father for the first time. I am obviously super excited and can't wait to experience all the joys – and even some of the pains – of fatherhood. I know that being a father is nothing to take lightly and there are many responsibilities. Some of the responsibilities are financially-oriented and for a few of those, there are tax efficient ways of achieving one's goals.

Now obviously, everybody’s situation is different, but below are 3 tax-planning moves I plan to make as soon as possible once I become a father. Perhaps one or more of them is relevant for you and your planning.

  1. Fund a 529 Plan – 529 plans are great way to save money for a child’s education. These accounts, like IRAs, allow you to accumulate funds on a tax-favored basis. Although there is no federal income tax deduction for contributions to a 529 plan, funds grow tax-deferred while in a 529 account and, if distributions are used to pay qualified higher education costs, those distributions are tax-free. Plus, although there is no federal income tax deduction available, many states offer a state income tax break for contributions made by its residents to its own plan. Just like IRAs, the earlier one starts saving in a 529 plan, the better off they will be. With higher education costs continuing to sky rocket, I’m going to start as early as I can!
  2. Attempt to Establish a Roth IRA as Soon as Possible – There are no minimum age requirements to open a Roth IRA. In theory, even a newborn can have one. The key, however, is that a person, regardless of age, needs some sort of “compensation” to make a Roth IRA contribution. Usually, that compensation is some sort of earned income. Now you might ask, “How can a newborn have earned income?” Well, there are a number of ways. Perhaps you own a business and you use your child’s likeness on marketing material. You could pay them for that, legitimately of course. Then, an amount equal to that earned income could be contributed to their Roth IRA (provided they meet the other requirements). I personally have no idea when my child will generate earned income. Maybe it will be soon. Maybe not for 20 or more years. That said, whenever the time comes, I am going to do everything in my power to start his tax-free retirement savings off as early as possible, even if it means I have to make a contribution to his Roth IRA with my own money.
  3. Update my Beneficiary Forms – Updating one’s beneficiary forms doesn’t sound like a tax-planning move, but instead, simply an estate planning move. In reality, it is both. Designated beneficiaries – generally living, breathing people named on the beneficiary form – are able to stretch distributions over their life expectancy. This helps an account grow tax-deferred as long as possible and minimize the tax impact on any distributions.
If something were to happen to me in the near future and my son were to inherit my retirement funds, he would be able to distribute those funds over more than an 80-year period.

- By Jeffrey Levine and Jared Trexler

Don't Just "Forget" About the 60-Day IRA Rollover Window ... It Will Cost You

60-day IRA rollover mistakeA taxpayer learned a costly lesson recently when he forgot to complete an IRA rollover within the 60-day time fame. He asked the IRS for more time to do the rollover, but they turned him down. As a result, his IRA distribution couldn’t be rolled over tax-free so that meant his IRA distribution was taxable.

A person we’ll call “Tom” received a distribution from his IRA in early March 2013. He later deposited that amount into his checking account about eleven days later. In mid May 2013, he tried to roll over that amount into another IRA, but he was told that the 60-day period had expired four days ago.

He realized that if he couldn’t do the rollover, his IRA distribution would be taxable. Not wanting to pay the taxes, he applied to the IRS for a private letter ruling (PLR), asking the IRS to give him more time to complete the rollover. He told IRS he was aware of the 60-day limit, but also admitted that he forgot to timely do the rollover and let the 60-day clock expire.

The IRS has the authority to waive the 60-day period and give taxpayers more time to complete a rollover in certain circumstances. Taxpayers must request a PLR from IRS asking for a waiver of the 60-day period due to reasonable error.

Generally, the IRS gives taxpayers more time to do a rollover when there was some casualty, disaster, or some other event beyond the reasonable control of the individual that prevented him from timely doing the rollover. The IRS looks at all the facts and circumstances such as financial institution or advisor error, and other outside factors such as a death in the account owner’s family, health problems, disability, and other factors beyond the person’s reasonable control.

In this case, Tom’s only excuse was that he simply forgot to do the rollover within 60 days. He didn’t claim that he was suffering from mental health issues or that some stressful event happened to him during those 60 days; he simply said he forgot. So, because he couldn’t come up with any extenuating circumstances that prevented him from doing the rollover, the IRS had no choice but to deny his request for more time to complete the rollover. (PLR 201428012, July 11, 2014).

Simply forgetting to do the rollover is not a good enough reason for the IRS to give you more time to do it.

- By Joe Cicchinelli and Jared Trexler

Ruling to Remember: What NOT To Do When a Trust is the IRA Beneficiary

In Private Letter Ruling (PLR) 201425023, released by IRS on June 20, 2014, the IRS ruled that a surviving spouse who received IRA proceeds through a trust, which was the beneficiary of her deceased husband’s IRA, could not roll over the IRA funds she received because more than 60 days had passed since she received the funds. The IRS denied her request for more time to do the rollover because she didn’t provide sufficient proof of financial institution error. More importantly, the PLR is a good example of what not to do when a trust is the beneficiary of an IRA.

Facts of the PLR
IRA trust beneficiary“Ben” had an IRA and named a trust as the beneficiary of his IRA. The trustees of the trust were his two children. Ben’s wife “Ann” was the beneficiary of 25% of the assets of the trust. After Ben died, the entire proceeds of the IRA were paid to the trust as IRA beneficiary. The funds were deposited into the trust’s checking account. The PLR didn’t say who authorized the IRA distribution, but most likely Ben’s children as trustees ok’d the distribution.

Apparently, Ann had a problem with how the trust was interpreted and administered and started legal action against Ben’s children as co-trustees of the trust. Eventually, they worked out their differences. Ann and the trustees entered into a settlement agreement which said that the trust would attempt to establish a rollover IRA in Ann’s name for her 25% portion of the IRA funds that were distributed from the trust.

As a result of the settlement agreement, Ann opened an IRA in her name assuming that she would be allowed to roll over the amount she received from the trust. Shortly after the settlement agreement in October 2009, her 25% share of the IRA proceeds were paid from the trust and deposited directly (rolled over) into the IRA in Ann’s name. This distribution occurred after 60-days from when the entire IRA was distributed to the trust. Ann received a K-1 from the trust for 2009 showing a taxable distribution.

Ann must have realized that more than 60-days had lapsed since the IRA distribution was made from the trust, so she applied to the IRS for a waiver of the 60-day rollover period for financial institution error. While in the PLR request she referred to “financial institution error,” she really was blaming the trustees and their attorney for the delay, not the financial institution. Specifically, she claimed that the trustees and their lawyer had duties under state law to her as a beneficiary of the trust and that they failed to fulfill those duties.

She alleged that the trustees and their lawyer failed to fulfill their duties under state law when they allowed the entire IRA distribution to the trust. She also alleged that after the distribution, the trustees’ lawyer failed to timely inform the trustees and the IRA custodian of Ann’s rollover options as Ben’s spouse.

IRS Denies Waiver of 60-day Rollover Period
The IRS denied her request for a waiver of the 60-day rollover period. While not giving much detail, the IRS simply stated that the information and documentation that Ann submitted were insufficient evidence of financial institution error. So, the money she received from the trust and then rolled over to her own IRA was not eligible for rollover. As a result, the IRA distribution could not be treated as a tax-free rollover. It also likely created an excess IRA contribution.

Invalid Rollover Creates Excess IRA Contribution
In this case, Ann did the rollover before she requested the PLR. Either she assumed the funds were rollover eligible or she thought the IRS would give her a waiver of the 60-day rule due to the trustees and their lawyer’s alleged mistakes. She was wrong.

Without a 60-day waiver from IRS, the funds were not eligible to be rolled over to her IRA. The fact that she did roll over the money over means that the deposit is treated as a regular tax-year contribution for 2009. Assuming the deposit was more than $6,000 (the IRA contribution limit for 2009 for someone age 50+), then any amount above that is automatically treated as an excess IRA contribution. If an excess contribution is not timely removed by October 15 of the year after, it is subject to a 6% penalty each year until it’s corrected.

The 6% excess contribution penalty is reported on IRS Form 5329. If Form 5329 is not filed, the statute of limitations (normally 3 years) never begins to run adding more penalties and interest to an already costly situation.

Common Mistakes When a Trust is the IRA Beneficiary
While there are many good reasons to name a trust as the beneficiary of an IRA, the main reason is for control. If the IRA owner wants to control how the funds are paid out after he dies, a trust can do that.

Trusts are also often named as the IRA beneficiary for creditor protection purposes. In light of the June 2014 Supreme Court’s ruling in the Clark case where the court ruled that inherited IRAs are not protected in bankruptcy under federal law, more IRA owners may consider naming a trust as the beneficiary of their IRA to protect the money from the beneficiaries creditors.

Trusts by themselves are complicated. The IRA required minimum distributions rules are complicated too. When you mix the two by naming a trust as the IRA beneficiary, problems often occur. Below are some common mistakes that are made after an IRA owner dies with a trust as the beneficiary.

Paying Out Entire IRA to Trust
After the IRA owner dies, paying out the entire IRA to the trust should NOT be done, unless the trust says so. Only the required minimum distribution (RMD) needs to be paid to the trust, not the entire balance. If the entire IRA balance is paid to the trust (a nonsposue beneficiary), the trust cannot roll over the funds back into an IRA. The entire IRA distribution will be taxable.

After the IRA owners dies, the IRA should simply be retitled (transferred) into an inherited IRA for the trust, the same that would be done for any nonspouse IRA beneficiary. For example, the IRA could be retitled: “Jane Doe Family Trust as beneficiary of Jane Doe IRA” or something similar that identifies the deceased IRA owner and the trust as beneficiary.

Naming Family Members as Trustee of a Trust
Naming family members as trustee of trust has potential benefits and pitfalls. Family members will usually know the family dynamics and needs of the trusts’ beneficiaries and may be in better position to know when to make distributions than a third party trustee such as a bank that doesn’t know the family history. This is especially true in an accumulation (discretionary) trust where the trustees have to decide when to pay the IRA funds to the trust beneficiaries or retain them inside the trust.

One of the primary potential pitfalls is that the family members probably don’t have expertise in acting as a trustee and ideally should seek advice from professionals. If a disgruntled trust beneficiary questions whether the trustees are doing their job correctly, it certainly could cause friction in the family to say the least.

In PLR 201425023, it’s wasn’t clear whether the decedent’s children as co-trustees made a mistake, but the fact that the entire IRA balance was paid to the trust is suspect. One of the trust’s beneficiaries, the decedent’s wife, initiated legal action against the trustees which resulted in a settlement agreement. The odds that the settlement agreement caused problems in their family are pretty high.

Advisor Action Plan

  • Encourage trustees of a trust to not distribute any IRA funds without first getting professional advice.
  • Do not make a total distribution from the IRA to the trust after the IRA owner dies. Only the RMD needs to be paid out.
  • After the IRA owner dies, make sure the IRA is set up as an inherited IRA with the trust as beneficiary of the decedent.
  • Tell surviving spouse beneficiaries that whenever applying for a 60-day rollover waiver, doing a spousal rollover before the PLR request is received is risky. If the IRS denies the waiver, then an excess contribution will likely happen in the surviving spouse’s IRA.
- By Beverly DeVeny and Jared Trexler

What A Younger Spouse Should Do When Inheriting an IRA

Richard has an IRA and has named his wife Diane as the beneficiary. Richard dies unexpectedly at age 52. Diane is 50. What should she do with Richard’s IRA?

This is a case when the spouse should probably remain a beneficiary of the IRA. Here's why.

A beneficiary does not have to pay the 10% early distribution penalty on amounts withdrawn from the inherited IRA. If Diane needs to use IRA funds for any reason, she can take as much or as little as she wants and only pay income tax on the amounts she withdraws. She will not owe the 10% penalty. If Diane moves the inherited IRA into her own name, however, she will owe the penalty – unless one of the exceptions to the penalty applies.

A spouse beneficiary does not have required minimum distributions (RMDs) until the deceased account owner would have been 70 ½. Diane will have no RMDs until Richard would have been 70 ½ – 18 years from now. If she does not need any funds from the IRA, she can leave them in the account to continue to grow and compound, tax deferred.

Once Diane reaches the age of 59 ½, when she will no longer be subject to the 10% early distribution penalty on funds in her own retirement account, she can move the inherited IRA into an IRA in her own name. There is no deadline for a spouse to do this. She can make the IRA her own even if she has regularly taken funds out of the account.

Diane should be sure to make the funds her own before the year Richard would have been 70 ½. Here's why.

Diane, as a beneficiary, would have to use the Single Life Table for calculating her RMDs from the inherited IRA. The RMDs would be larger each year than they would be if Diane owned the account and used the Uniform Lifetime Table. As a result, Diane would be paying more in income tax each year, and she would be depleting the account at a faster rate than she would have to if the account was an owned account.

Plus, Diane’s beneficiaries of the inherited account would not be able to use their own life expectancies at Diane’s death. Instead, they would have to continue using Diane’s life expectancy. Her beneficiaries would be successor beneficiaries – a beneficiary’s beneficiary. They would not be an original beneficiary. As a result, the annual distributions would almost certainly be larger, the beneficiaries would owe more in income tax each year, and the account would be depleted at a faster rate.

- By Beverly DeVeny and Jared Trexler

Slott Report Mailbag: Can I Mix Pre-Tax and Post-Tax Money in the Same IRA?

This week's Slott Report Mailbag discusses IRA basis and the ever-popular question about Roth IRA and IRA distributions' tax status. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

ed slott IRA questions
Send questions to mailbag@irahelp.com
I currently have two Traditional IRAs, which were funded from rollovers from 401(k) and 403(b) accounts, and opened in 2013. I want to contribute to a Traditional non-deductible IRA for 2014 with after-tax funds then convert it to a Roth. My broker says I can’t mix pre-tax and post-tax money in an IRA. But if I file IRS Form 8606 will it show my basis for what I contributed to the Traditional IRA? Can you help?

Michael from New Jersey

Answer:
You can mix pre-tax and post-tax money in the same IRA. It doesn’t matter because under the pro-rata tax rule, all of your non-Roth IRAs are considered one IRA for tax purposes. You cannot convert just your nondeductible IRA contribution to a Roth IRA tax-free because you have other IRA money that contains pre-tax funds. Form 8606 will show your basis but it will also show you how a distribution from any IRA will be taxed. A portion of each distribution will come from your pre-tax dollars and a portion will come from your after-tax dollars.

2.

Good afternoon,

I am 44 years old and rebuilding my primary residence from Hurricane Sandy. To pay off my existing mortgage I am taking out all of my contributions from my Roth IRA and Traditional IRA. I opened my Roth IRA in April 1999 for 1998 contributions and my Traditional IRA contributions were all non-deductible because I contributed to 401(k).

Question: for my Roth, if I take my contributions only as a distribution do I pay any tax? For my Traditional IRA do I just pay the 10% early distribution penalty if I just take out my contributions? And if I take out my full balance on a deceased Beneficiary IRA do I have to pay ordinary income tax? Are all my tax statements correct if I take distributions from all three IRA accounts? I am keeping all gains in the Roth and Traditional IRA.

Answer:
All annual Roth IRA contributions can be withdrawn at any time without tax or penalty. For your Traditional IRA, despite the fact that all of your contributions were nondeductible, you cannot just withdraw those contributions tax-free. The earnings on those contributions are taxable. Under the pro-rata tax rule a portion of any distribution will be from your after-tax contributions and a portion will be from your pre-tax earnings. The 10% penalty will apply to the taxable amount of your IRA distribution. The withdrawal of funds from a beneficiary IRA will be taxable, but no 10% penalty because it’s due to death. In your Traditional IRA and the Beneficiary IRA, you cannot keep all gains in those accounts to reduce or avoid taxes.


- By Joe Cicchinelli and Beverly DeVeny

QLACs Shift From Tax Code Theory to Consumer Reality ... Soon

In response to my post last week on the IRS announcement of final regulations for Qualifying Longevity Annuity Contracts (QLACs), a number of Slott Report readers inquired about their availability. Here’s what some of them had to say:

qualified longevity annuity contract“Do you know which companies are currently offering QLACs?”
“I searched the internet for QLACs and couldn’t find one company that has one.”
“I called four companies to inquire about QLACs. Two of them said they don’t have any available and two of them didn’t even know what I was talking about!”

So what’s the deal? Quite simply, the final QLAC regulations that were released by IRS on July 1, 2014 are in effect already – they were effective beginning the next day, July 2, 2014 – but that doesn’t mean that insurance carriers already have products that conform to the new IRS specifications.

While the final QLAC regulations closely resemble the proposed regulations that were initially released back in February 2012, there are a number of changes insurance carriers will need to and/or want to incorporate into their products before they are actually released and made available for purchase.

That’s why – at least to the best of my knowledge – for now, QLACs exist in theory only.
If you think a QLAC may make sense as part of your plan, though, there is some good news. Over the past few years I’ve spoken with a number of insurance company executives who indicated they had full intentions of offering QLACs once the final regulations were released. Supposedly, some of those companies even began to work on QLAC products based on the proposed regulations which, given their similarity to the final regulations, will likely require only minimal tweaking before being finalized. Plus, many companies already offer products that are substantially similar to QLACs.
Put all of that together, and it’s likely that in the not too distant future QLACs will go from tax code theory to consumer reality.

2014 Retirement Guide Helps You Save and Stretch Wealth

- By Jeffrey Levine and Jared Trexler

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