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Be aware of important 2014 IRA updates

From Ken Rudzinski, Five-Star Wealth Manager, comes valuable insights and practical, timely strategies on a wide range of financial planning topics, including investments, retirement, insurance, taxes and estate planning.

If your traditional IRA(s), SEP-IRA(s) or SIMPLE-IRA(s), 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/updates:

Routine IRA updates

• For 2014, the maximum traditional IRA contributions remain the same as for 2013, ie, $5,500 for taxpayers aged younger than 50 years, and $6,500 ($1,000 catch-up added) for those aged 50 and older. The same limits apply to ROTH IRAs.
• SIMPLE-IRA limits also remain the same as 2013, ie, $12,000 for taxpayers aged younger than 50 years, and $14,500 ($2,500 catch-up added) for those aged 50 years and 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. If your joint AGI is below $96,000 ($60,000 for singles), however, 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 but you are, the AGI range becomes $171,000 to $181,000 for tax deductible IRA contributions for the noncovered 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).

 

Ken Rudzinski

In a recent, albeit controversial, tax court ruling, the tax court ruled that the 60-day rollover applies to all of a taxpayer’s IRAs, and not to each separately. So, a 60-day rollover from any one IRA nullifies any further tax-free 60-day rollover from any other taxpayer IRA within a 365-day period. In other words, a second (or additional) rollover would result in a fully taxable event for the rollover amount plus a 10% penalty for taxpayers aged younger than 59.5 years. The case is being appealed but taxpayers — especially those who use such rollovers for temporary liquidity — should note this potential land mine. Instead, 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 70.5 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. Bad news! You cannot take an RMD from one type of account from another type of account, the IRS ruled.

You cannot use your IRA for RMDs from your employer plan, and vice versa. Having taken the money only from his SEP-IRA (SEP-IRAs and SIMPLE-IRAs are both considered IRAs for the purposes of RMDs), the taxpayer failed to remove the RMD from his employer plan, resulting in a 50% excise tax penalty on the failed RMD. The key in this case is separate type plans. You can use one IRA to cover the RMD for all your IRAs.

In another case, a divorced spouse, aged 50 years, elected to rollover to her own IRA her share of her husband’s 401(k) as directed under a “qualified domestic relations order”, or QDRO. She then took a distribution, and was penalized 10% by the IRS for a pre-age 59.5 distribution. This planning mistake 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 59.5 distributions to avoid the 10% penalty. Bottom line: if you may need some or all of money from a 401(k) divorce settlement prior to age 59.5, do not roll the QDRO money to an IRA.

In my book, The Physician’s Guide to Avoiding Financial Blunders (2010, Slack Inc), I wrote about IRA mistakes. One mistake I referenced 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 with the intention of getting back to that later. All too often that detail is forgotten.

In the case of a common disaster, where both spouses die, the IRA without contingent beneficiaries becomes not only probatable and subject to state intestacy laws, but the ultimate beneficiaries are deprived of stretching out the income tax over their life expectancies, a valuable tax planning tool.

So, when was the last time you checked your IRA [and 401(k)/403(b)] beneficiary designations? If you don’t check, who will?

Ken Rudzinski, CFP, CLU, ChFC, CRPC, CASL, CAP, a partner in the financial planning firm Heritage Financial Consultants, is a registered representative and investment advisor representative with Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor in Wilmington Del. Rudzinski offers insurance through Lincoln affiliates and other companies. This information should not be construed as legal or tax advice. You may want to consult a legal or tax advisor regarding this material as it relates to your personal circumstances. CRN-810740-020314.

If you have questions regarding this article, they can be emailed to the author at Kenneth.Rudzinski@LFG.com. The author does not have the ability to respond in the comment section below. General Healio.com questions should be directed to editor@Healio.com