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Be aware of important 2014 IRA updates
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If your traditional IRAs, SEP-IRAs or SIMPLE-IRAs, alone or in combination, make up the majority of your retirement savings — and they do for most investors — then it is important to keep up with ever-changing tax laws. Failure to abide by recent IRS and Tax Court rulings may inadvertently cause you to run afoul of the myriad tax provisions that affect such tax-deferred accounts with perhaps the imposition of unnecessary income taxes, interest and penalties. Here are a few of those recent changes:
Routine 2014 IRA Updates
- For 2014, the maximum traditional IRA contributions remain the same as for 2013, i.e., $5,500 for taxpayers younger than 50 years, and $6,500 ($1,000 catch-up added) for those age 50 years and older. The same limits apply to ROTH IRAs.
- SIMPLE-IRA limits also remain the same in 2014 as 2013, i.e., $12,000 for taxpayers under age 50 years, and $14,500 ($2,500 catch-up added) for those age 50 or older.
- If you are an active participant in a qualified employer retirement plan, and your joint adjusted gross income (AGI) (with spouse) exceeds $116,000 ($70,000 for single taxpayers) you cannot have a deductible IRA. However, if joint AGI is below $96,000 ($60,000 for singles), you can have a tax-deductible IRA in addition to being enrolled in your employer-sponsored plan. In between those limits, your deduction is phased out proportionally.
- If your spouse is not covered by an employer-sponsored retirement plan (even though you are), the AGI range becomes $171,000 to $181,000 for tax deductible IRA contributions for the non-covered spouse.
Important IRA developments
In the past, IRS Publication 590 and various Private Letter Rulings (PLRs) have allowed multiple 60-day rollovers of IRA assets in a 365-day period, as long as the multiple rollovers did not involve the same IRA (although exceptions to the rule do exist in the law for first-time home buyer distributions, qualified reservist distributions, and others).
Kenneth W.
Rudzinski
In a recent, albeit controversial, Tax Court Ruling (Alvin L. Bobrow, et ux. v. Commissioner of Internal Revenue; January 28, 2014), the Tax Court ruled the 60-day rollover applies to all of a taxpayer’s IRAs, and not to each separately. If this ruling holds, a 60-day rollover from any one IRA nullifies any further tax-free 60-day rollover from any other IRA of the taxpayer’s within a 365-day period. In other words, a second (or third plus) rollover under these circumstances would result in a fully taxable event for the rollover amount plus a 10% penalty for taxpayers under age 59½ years. The case is being appealed, but taxpayers — especially those who use such rollovers from their IRAs for temporary liquidity — should note this potential land mine and avoid multiple 60-day rollovers in any given 365-day period. Instead, they should opt for direct trustee-to-trustee transfers where the 365-day rule is not applicable, meaning there is no limit on the number of such transfers during any given time period.
An often-misunderstood rule — and one recently clarified by the IRS — involved a taxpayer’s decision to use one or more IRAs among several IRAs for age 70½ years required mandatory distributions (RMDs). In the case at hand, the taxpayer had three accounts: a traditional IRA, an employer plan and a SEP-IRA. On the advice of his tax counsel, after calculating his total of required distribution amounts from the three accounts, he took the total RMD solely from his SEP-IRA. You cannot take an RMD from one type of account from another type of account, said the IRS.
You cannot use your IRA for RMDs from your employer plan, and vice versa. Having taken the money only from the SEP-IRA (keep in mind that SEP-IRAs and SIMPLE-IRAs are both considered IRAs for the purposes of RMDs), the taxpayer therefore failed to remove the RMD from his employer plan, resulting in a 50% excise tax penalty on the failed RMD. The key to remember in this case is to separate type plans. One IRA can be used to cover the RMD for all your IRAs.
Plan ahead to avoid costly mistakes
In another case, a divorced spouse, aged 50 years, elected to rollover to her own IRA her share of her ex-husband’s 401(k) as directed under a “qualified domestic relations order” or QDRO. She then needed money from the IRA for living expenses and took a distribution, but was penalized 10% by the IRS for a pre-age 59½ years (premature) distribution. This was a planning mistake that could have been avoided. Had she left the money in the 401(k) under the QDRO, she would have been able to take advantage of the QDRO exception that allows for early pre-age 59½ years old distributions from the QDRO to avoid the 10% penalty (although the distribution itself is taxable). The bottom line is if you may need some or all of the money from a 401(k) divorce settlement prior to age 59½ years, do not roll the QDRO money to an IRA.
My last point is not an update, but a reminder. In my book, The Physician’s Guide to Avoiding Financial Blunders, I wrote about IRA mistakes. One mistake I referenced then, but still see all too often, is the failure to name contingent beneficiaries. Husbands name wives and vice versa. But many times, especially in cases of second or third marriages, the contingent beneficiary line is left blank on the custodian’s form (or sometimes there is no place to write it in) with the intention of getting back to that later upon further reflection. Frequently that detail is forgotten.
In the case of a common disaster, where both spouses die, the IRA without contingent beneficiaries listed becomes not only probatable and subject to state intestacy laws, but ultimate beneficiaries are deprived of stretching out the income tax over their life expectancies, a valuable tax planning tool. When was the last time you checked your IRA and 401(k)/403(b) beneficiary designations? If you don’t check it, who will?