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A Medicaid and Roth IRA Planning Horror Story

An attorney's client has a couple of small IRA accounts. He is not currently working. There is a possibility that he may need to qualify for Medicaid in the future. He has a large amount of cash just lying around. The attorney's idea? Just tuck the cash into a Roth IRA. After all, it is after-tax money so what's the problem?

medicaid Roth IRA planningWell, there are several problems. First of all, there are the Roth IRA contribution rules. You must have some sort of compensation, like earned income, and your modified adjusted gross income (MAGI) must be below a certain threshold. This client is not working. If his spouse is employed, he could use his spouse’s earnings to make his Roth contribution, assuming their combined income is below the applicable MAGI threshold. The next problem - you can only contribute $5,500 in 2013 to a Roth IRA (if you are age 50 or older during the year, you can contribution an extra $1,000 for a total of $6,500).

Suppose he makes the contribution anyway. Then what? The problems continue. Our client now has an excess contribution in the Roth IRA. Excess contributions are subject to a penalty of 6% per year for every year that they remain in the Roth IRA. This penalty is reported on IRS Form 5329, which is required to be filed with the client’s tax return each year.

Suppose he does not file this return. Then what? Again, the problems continue. There is a signature line on Form 5329. It is considered a separate tax return. If you don’t file a tax return, then there can be failure to file penalties for each year you do not file. And, if the unpaid penalty is large enough, our client could be subject to accuracy related penalties.

Finally, if our client does not file Form 5329, the statute of limitations does not start to run on all of these penalties. IRS can assess them at any time - along with interest.

Bottom line…You need to know the rules for retirement accounts before you make your contributions. IRS Publication 590, Individual Retirement Arrangements (IRAs), is a good place to start. If something goes wrong, it is not the advisor who will be responsible for taxes, penalties and interest. It will be you, the client.

- By Beverly DeVeny and Jared Trexler


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Thursday's Slott Report Mailbag

Consumers: Send in Your Questions to [email protected]

You recently said that a 401(k) distribution would add to your MAGI (modified adjusted gross income) for the purpose of determining if you are subject to the 3.8% healthcare surtax. What about Roth IRA distributions? Would they also count towards your total MAGI income for surtax purposes?


IRA distributions are exempt from the 3.8% surtax, but taxable distributions from IRAs can push income over the threshold amount, causing other investment income to be subject to the surtax. Because Roth IRA distributions are generally tax-free, they don’t count towards your total MAGI.