Getting Your Financial Ducks In A Row Rotating Header Image

Early Distribution

Calculating the Social Security Retirement Benefit

Jan 25th, 2010
by jblankenship.
2 comments

social security lips by Aric RileyThere are three factors that go into determining the Social Security retirement benefit amount – your PIA (Primary Insurance Amount), your FRA (Full Retirement Age), and the age you are when you start receiving benefits.  We talked about the PIA here; then we talked about the FRA here.  Having these two numbers, we need to consider if you are applying for early benefits, and therefore a reduced amount, or if you’re delaying receipt of benefits to increase the payment amount.

Applying Early for Reduced Benefit Amount

When you apply early (before your FRA), a formula goes into effect to determine how much your benefit will be reduced.  First, determine how many months there are between your FRA and the age at which you’ll start receiving benefits.  The PIA will be reduced by a percentage based upon the number of months you come up with.  The first 36 months are multiplied by 5/9 of 1%, and any months beyond 36 are multiplied by 5/12 of 1%.

So, if your FRA is age 66, and you intend to begin receiving benefits in the month that you are age 62 and 6 months, your PIA would be reduced by 20% for the first 36 months (36 * 5/9% = 20%) plus an additional 2½% for the remaining 6 months (6 * 5/12% = 2½%) for a total of 22½%.  The maximum amount that the PIA can be reduced is 25% for folks with FRA of age 66, ranging up to 30% for those with FRA of age 67.

When you come up with this reduction factor, it is then applied to your PIA, and the result is your anticipated benefit amount.  You can see in the table below how waiting a few months or years can make a big difference to the benefit amount.  And this change can have a huge impact on your lifetime benefits – because once you start receiving your benefit, it won’t change other than with the annual COLA increases – unless you continue to work while receiving benefits, which could increase your PIA.  The other way to increase your benefit is to take the “do over” – described here.

Delaying Receipt of Benefits to Increase the Amount

If you are delaying your retirement beyond FRA, you’ll increase the amount of benefit that you are eligible to receive.  Depending upon your year of birth, this amount will be between 7% and 8% per year that you delay receiving benefits – which can be an increase of as much as 32½% if you delay until age 70 and you were born in 1941 – when your FRA is 65 years and 8 months, and the increase amount is 7½% per year at that age.  See the table below for the increase amounts per year based upon birth year:

Birth Year FRA Delay Credit Minimum
(age 62)		 Maximum
(age 70)
1940 65 & 6 mos 7% 77½% 131½%
1941 65 & 8 mos 7½% 76?% 132½%
1942 65 & 10 mos 7½% 75 5/6% 131¼%
1943-1954 66 8% 75% 132%
1955 66 & 2 mos 8% 74 1/6% 130?%
1956 66 & 4 mos 8% 73?% 129?%
1957 66 & 6 mos 8% 72½% 128%
1958 66 & 8 mos 8% 71?% 126?%
1959 66 & 10 mos 8% 70 5/6% 125?%
1960 & later 67 8% 70% 124%

So you can see the impact of delaying receipt of retirement benefits – it can amount to more than 50% of the PIA, when you consider early benefits versus late benefits.  Of course, by taking benefits later, you’re foregoing receipt of some monthly benefit payments; given this, early in the game you’d be ahead in terms of total benefit received.  This tends to go away as the break-even point is reached in your mid-70′s to early-80′s in most cases, which we’ll review in a later article.

Photo by Aric Riley

Things to Consider as You Set Up a SOSEPP

Jan 23rd, 2010
by jblankenship.
2 comments

water bottle caps by Incase DesignsSo, you’ve decided that you’d like to begin taking distributions from your IRA funds – and you’re under age 59½, so you need to structure your distributions as a Series of Substantially Equal Periodic Payments (SOSEPP).  (For more background information on the SOSEPP, see this article.) It is important to do this right, because once you set up the plan, you’re pretty much stuck with it.

Steps to Set Up a SOSEPP

The first step in setting up a SOSEPP is to figure out just how much you’ll need to take each year.  In the best of all circumstances, your SOSEPP plan will take small enough payments that it will not exhaust your IRA funds… Working with a financial advisor or an actuary, you can figure out how much money is required to support the SOSEPP payments that you require.

Once an amount is determined, a new IRA can be opened and the money required rolled over into that account.  Other IRAs and 401(k) accounts will then hold the remainder of your funds – which provides your savings for future needs, once the SOSEPP is no longer in effect, or a “safety valve” for you to use in the event that you need additional funds at some point.  Of course, taking an additional amount from one of these other accounts would require payment of the 10% penalty (unless one of the other exceptions applies) – but this is much better than taking too much from your SOSEPP IRA and busting the plan, which carries some heavy penalties.

Keep in mind, especially if you’re setting up your SOSEPP early in your life, it will be possible to set up another SOSEPP from a different account should the need arise.  You would just have two series’ going on at the same time, with different variables impacting each series.

In other cases, you may just want to take the greatest possible payment that you can from your collective plans, which can be easily determined when the span of the plan is understood, given your age and the amount in the IRAs.

Several choices are necessary to set up the plan:

  • Choose one of the three permitted methods – RMD, amortization, or annuitization
  • Choose a life expectancy table – single, joint, or uniform life expectancy
  • Choose an interest rate (if using amortization or annuitization)
  • Decide whether to use annual recalculation (if using amortization or annuitization)
  • Choose the account balance valuation date
  • Determine the “period” for your payments.  These can be monthly, quarterly or annually, but must at least be annual, and must be at the same regular interval each “period” once set up.

All of these details must be attended to when setting up the plan, and careful attention should be paid when making these decisions.  If you set up such a plan early in your life (say at age 50 or earlier) you will have to live with your choices for a considerable amount of time.  Understand what each choice means and can mean in the future as you make these decisions.

For more information on the SOSEPP – including all of the methods, the life expectancy tables, and all of the other details, see the IRA Owner’s Manual.

Photo by Incase Designs

The Heartbreak of Withholding From Indirect Rollovers

Jan 5th, 2010
by jblankenship.
No comments yet

heart break by NDrewCTaking early withdrawals from your retirement plans is rarely a good idea, and should only be considered when it’s the last possible option available to you, generally speaking.  But this article is more about the pain you could experience if you don’t handle a rollover correctly – bypassing the trustee-to-trustee transfer option and going with an indirect rollover.

Withholding Rule For Indirect Rollovers

In general, if you take an early withdrawal (pre-age 59½) from an IRA or a Qualified Retirement Plan (QRP) that includes pre-tax money, the custodian of the account is required to withhold and pay to the IRS 20% of the pre-tax amount withdrawn.  This can still be a tax-free transaction if you finish the indirect rollover process correctly and place the entire amount of the distribution back into an IRA or QRP within 60 days.  However, if you don’t complete the indirect rollover, you’re likely to get a tax surprise…

A transaction like this is called an “indirect rollover”, as opposed to a direct or a trustee-to-trustee rollover.  In the event that you complete the indirect rollover within 60 days, you will need to come up with the 20% that was withheld in order to have a full rollover – otherwise you’ll have to pay tax and a penalty on the amount that was not rolled over.

An Example

For example, let’s say you’re 50 years of age, and you have a 401(k) from a former employer that you’d like to roll over into your IRA account.  The 401(k) is worth $50,000.  For whatever reason, you opted to have the 401(k) custodian send you a check for the amount, which you then plan on sending to the IRA custodian for deposit (within the allowable 60 day period, as an indirect rollover).

Lo and behold, when the check arrives, it’s only made out for $40,000!  This is because the custodian was required to withhold 20%… and so now, since you don’t have any savings to speak of, you can only send the $40,000 over to the IRA custodian.  Guess what?  Come tax time, you will have to include that “lost” $10,000 as income, plus you’ll get to pay a 10% early withdrawal penalty as well.  So if you’re in the 25% tax bracket, you get to pay $3,500 in tax and penalties (25% times $10,000 plus 10% times $10,000).

Now, the original 401(k) that was worth $50,000 is reduced to an IRA worth $40,000 and a tax refund of $6,500 (since $10,000 was withheld and your tax and penalties were only $3,500).  This swift little maneuver has cost you 7% of your retirement plan!  Plus, you’ve lost tax-deferral on $10,000…

ALWAYS Do the Direct Rollover

It is for this reason that, whenever possible, you always should do a direct, or trustee-to-trustee transfer when rolling over IRA and QRP funds to a new account.  When you do a trustee-to-trustee rollover, no withholding applies, so you don’t have to make up any difference, and your tax-deferred amount remains intact.

It’s important to note that in our example above, if you had the $10,000 available to you in savings or elsewhere to make up the difference for the withholding, you could still complete the indirect rollover without tax or penalty by sending a total of $50,000 to the IRA custodian within 60 days.  Then when you file your taxes for the year, that $10,000 withheld would amount to either a refund to you or a reduction in the amount of tax that you had to pay for the year.

Photo by NDrewC

Options For a Spousal Inherited IRA

Dec 6th, 2009
by jblankenship.
2 comments

wedding 1946 by dlisbonaIn these articles we’ve discussed inherited IRAs and how to handle them – but we have not covered all of the options for a Spousal Inherited IRA separately.  There are some differences, specifically more options available, so this is an important topic.  It should be noted that the majority of this article applies to inheriting IRAs or Qualified Retirement Plans (QRPs, such as a 401(k) or 403(b)), although the term IRA is used throughout.  The receiving account must always be an IRA, though.

As a person who has inherited an IRA from your spouse, you have the following options if you are the sole beneficiary of the IRA:

  • Leave the IRA where it is, and begin taking distributions based upon your own life (see Table I for the factors).  This is the default position.
  • Rollover the IRA to an inherited IRA (see this post for more information).  In this case, you’re treating the situation as if you’re a non-spouse beneficiary.
  • Rollover the IRA into an existing or new IRA in your own name.  This is the special provision that spouses can use that a non-spouse beneficiary can not.  (Note:  you could also leave the IRA where it is and just begin treating the account as if it was your own – more on this below.)

Rollover Into Your Own IRA

There’s nothing terribly complex about the mechanics of a spousal rollover of an inherited IRA – you simply put in motion the paperwork for a rollover, making sure that both the original custodian and the new custodian are aware of the fact that you’re taking advantage of this special provision for spouses.  It is also possible to leave the IRA in place where it is and treat the IRA as your own – this will become the default if you 1) make a contribution into the account; or 2) fail to take the RMDs as if the account were inherited.

Now you have the IRA funds in your own account – which you can contribute to, convert to a Roth IRA, or whatever you’d like.  Plus, if you’re under age 70½, you don’t have to start Required Minimum Distributions (RMDs) from the account. This brings up the one possible downside that you should be aware of as well, prompting a word of caution…

A word of caution

IF you go ahead and rollover the IRA from your deceased spouse’s account into an account in your own name, if you’re less than age 59½, you do not have free access to the funds in the account – one of the 72(t) exceptions must apply, or you’d be charged the extra 10% penalty in addition to taxes on the withdrawal.  It is for this reason that many inheriting spouses do not take the IRA on as their own account – especially when there is a need to access the funds for income.

One more provision

As mentioned earlier, the provision for the spousal beneficiary to treat the IRA as her own is generally for a spouse that is the sole beneficiary.  There are two ways to resolve this situation if the spouse would like to rollover the account to her own IRA and there are more than one beneficiary.

  1. Other beneficiaries could disclaim the inheritance, leaving only the spouse (see this article for more information).  Many times, a well-intentioned IRA owner will designate her spouse and a child or grandchild (or a trust for the whole mob of children and/or grandchildren) as split beneficiaries of an IRA account.  This can bring about unintended results, such as very young children having to take RMDs that they do not need.  By disclaiming the inheritance and leaving only the spouse, the spouse can set up a new IRA in her own name, with the same original, now disclaimed, beneficiary or class of beneficiaries as the beneficiary(s) of the new account. This will fulfill the original owner’s intent, while opening up the account to the extra privileges available to an owner of an IRA versus an inheritant.
  2. A somewhat less messy method is available – as a spousal beneficiary, but not the sole beneficiary, you can take a distribution of your entire share from the account, and then roll it over to an IRA in your own name, as long as it’s within the 60-day period following the distribution.  You may need to make up the difference of the withholding – in general a distribution from an IRA will be subject to 20% withholding.  If you don’t roll over the full amount into your own IRA, you will be taxed and perhaps assessed a 10% penalty on the amount that you did not roll into the new account.  Using this method eliminates the disclaimer requirement which might be necessary if there are many other beneficiaries or if the other beneficiaries do not wish to disclaim.  (Note:  This method is STRICTLY for a spousal beneficiary.  A non-spouse beneficiary will bust the stretch IRA by taking a distribution of this type, even if they rollover the amount into a properly-titled account within the time allotted.  Those rollovers should ONLY be done via trustee-to-trustee transfer.)
Photo by dlisbona

Sam, You Made The Pants Too Short!

Oct 23rd, 2009
by jblankenship.
No comments yet

high water pants by TimWilson With apologies to the writer and performers of the original “Sam, You Made The Pants Too Long!”… This article is about what happens when your IRA declines substantially in value and you’ve put a 72t Series Of Substantially Equal Periodic Payments plan (SOSEPP) into play – and the decline in value has brought your IRA to a point where the balance will no longer support your Equal Payments.

What Happens When Your IRA Will No Longer Support Your SOSEPP?

Here’s an example:  You’ve set up a SOSEPP in your IRA, beginning at age 50.  As we all know (see this post for details) you have to keep the payments going until you reach age 59½.  During that time, many things can happen, both positive and negative.  In this case, the IRA began with a balance of $100,000, and your annual payments are $3,000.  Things go fine for the first few years, although your account doesn’t seem to be growing.  So, you decide to take a leap and invest it all in a wild-eyed fund – some Madoff fellow’s running it.  Then, lo and behold, one morning you wake up and find that your IRA balance has become – $12 total.  You’re age 56, so you have three and a half more years that you are supposed to be taking this regular payment of $3,000 from your account!  What do you do?  You’ve read about the crazy penalties for busting a 72t payout plan – yikes!

Options

Calm down.  Take a breath, it’s really not so bad.  There are several options:  You could rollover funds from another account into the IRA, either from another IRA account or a 401(k).  You could also choose to make your one-time change to your SOSEPP plan.  Or, you could choose to let it die, and go on with your life.  The best option is the last one – it allows you to be as flexible as you can be.

If you chose the first option, it certainly would work – and your SOSEPP would just continue on as originally planned.  But what if you have decided at this stage that you really don’t need that series of payments anyway?  And it’s just a pain in the rear keeping up with the paperwork and remembering to take the payment each year…?

The same holds true for the one-time change to the RMD method.  If you did that, now you’d have to re-calculate your payment each year on a very small balance.  Once again, a pain in the rear – so why not just take the third option?

Let it die

If you go ahead and take the last payment out of your account (the remaining $12) and close the account – your SOSEPP is no longer in effect.  You now have the option of starting a new SOSEPP from another IRA account, or just discontinuing the idea of the 72t payout.  If you chose to start a new plan, you’d have to start over with a new five-year or (since in the example, you’re age 56) for three and a half more years until you reach age 59½.

What’s key to understand in this is that, for SOSEPP’s, the IRS considers each IRA account separately – yeah, I know, for everything else, all IRAs are considered as one.  What can I say?  They don’t want you to get too comfortable and start predicting how they’ll move – just when you think they’re gonna zig?  they zag.  So with that in mind, if one account (the one with the SOSEPP attached) runs dry, there’s no penalty if you just drop it and move on with your life.

That’s literally all there is to it.  No penalty, no muss, no fuss.

Photo by TimWilson

IRA Trick – Eliminate Quarterly Estimated Tax Payments

Oct 13th, 2009
by jblankenship.
3 comments

the old cat trick by wstryder Retirees:  don’t you get tired of making those quarterly tax payments?  January, April, June and September, like clockwork, you have to hand over tax money, just because you’re receiving a pension, retirement funds, and/or Social Security benefits.  What if there was a way to send this money off one time, and then you wouldn’t have to remember it every few months?

There is.

IRA Trick – Eliminating Quarterly Estimated Tax Payments

A little-known fact about IRA distributions is that when you have taxes withheld from the distribution (which are then sent directly to the IRS), the withheld money is considered to have been received throughout the year – even if it is received late in December.  Using this fact to your advantage, you could figure out how much your total estimated tax payments should be for the year sometime in early December, and then take a distribution from your IRA in that amount.  Here’s the trick:  Instead of taking the distribution yourself, fill out a form W-4P to direct the funds to be withheld and sent to the IRS.  Voila!  You’ve now made even payments to the IRS for each of the four quarters, on time with no penalties!

The downside to this plan is that, in the event of the taxpayer’s untimely death before the annual distribution is made, the estimated payments will be considered as unpaid up to the date of death, and therefore the estate will be responsible for paying the underpayment penalty.  Other than that shortcoming, this trick could provide you with several months’ additional interest/return on your money, plus remove the hassle of the quarterly filings.

But, Jim, what if I’m retired and under age 59½?  Won’t there be a penalty?

There doesn’t have to be, although I’d place this particular move into the “higher degree of difficulty” category of tricks – not to be taken lightly.

Pre-59½ Retiree: How to Avoid Penalty?

Same situation as before, but now you must take another step:  once you’ve taken the distribution and properly filed the W-4P to have the distribution withheld as tax – execute a 60-day rollover, placing the same amount of money either into the same IRA or another IRA… effectively, you’ve pulled the old switcheroo with the IRS on this:  What has happened is you’ve paid tax with a distribution that didn’t happen!

How can this be?  Well, the IRS allows you to replace (or rollover) money from any source back into your IRA, so it doesn’t matter that your original distribution was used for withholding.  So you have made up for missing all those quarterly estimated payments (no underpayment penalty now) plus by rolling over the funds you’ve avoided the 10% early withdrawal penalty as well.

Caveat

I mentioned that this last trick fits into the “higher degree of difficulty” category of tricks.  The reason I say this is because using your account in this fashion (essentially a 60-day loan) can be hazardous – the primary reason is that 60 days is all you have, and 60 days can be a relatively short period of time.  Plus, the IRS HAS NO SENSE OF HUMOR ABOUT THIS.  If you miss the rollover period by one day, you’re outta luck.

In addition to the 60-day period, there is also the limitation of only one 60-day rollover per 12-month period.  Again, remember: no sense of humor at the Service.  This is especially true if it’s clear that you’ve been pulling a fast one on them with a scheme like suggested above.  It is for these reasons that this rollover trick should only be used in the most dire of circumstances – such as if you completely forgot to make quarterly payments and are facing a stiff underpayment penalty, for example.  Otherwise, I’d suggest leaving this one alone.  By all means, you should not try this trick year after year.

Photo by wstryder

IRA Inheritance – Not Taking Timely Distributions

Jul 18th, 2009
by jblankenship.
1 comment

inheritance by Marco BellucciA commenter from my post on splitting an inherited IRA sparked this particular post – his question was “What are the consequences for not re-titling an inherited IRA as F/B/O?”  You can see my response to that specific question at the original article…

But that question sparked the idea of discussing what happens when a beneficiary doesn’t act in a timely fashion with regard to taking Required Minimum Distributions from the inherited IRA?  That’s our topic for today.

The Inheritance

So, let’s say you inherited an IRA from your mother – this was her own IRA that she had contributed to or rolled over funds from a qualified plan at some point, and had designated you as the sole primary beneficiary.  Things get really hectic and confusing after the death of a parent, and sometimes we don’t cover all of the bases properly… and in this example, you didn’t realize that you needed to begin taking Required Minimum Distributions (RMD) from your inherited IRA as of December 31 of the year following the year of your mother’s death.  As of now, for example’s sake, let’s say we’re in the fourth year after your mother’s passing. (see Notes below)

At this point you have two choices:  take the entire balance of the IRA as a distribution before the end of the fifth year; or “unwind” the mistake by taking your RMDs for the first four years, paying the 50% excess accumulations penalty on each distribution, and then continuing on with your lifetime RMDs.  In each case, of course, you would be required to pay ordinary income tax on the distributions.

Five Year Distribution

This one is the “default” distribution option – and the rules are that you must take the complete distribution (either a series of payments or a lump sum) within the five years following the year of the original owner’s death.  In the example we’ve started, this means that you have roughly a year to complete this distribution. 

Since ordinary income tax is owed on distributions from your inherited IRA, if the balance is significant this could represent a sizeable tax bill for you.  It might even put you into a higher (or much higher) tax bracket, causing lots of unnecessary additional tax – if you took the other route.

Unwinding the Mistake

In order to avoid the excess taxes described above in the Five Year Distribution, you would need to go back and take distributions for the three prior years that you missed, based upon your Table I factor.  For example, let’s say your inherited IRA was worth $100,000 at the end of the year in which your mother passed away, and your age in the following year was 28.  According to Table I, your life expectancy is 55.3 years.  Dividing the IRA balance by 55.3 gives us a RMD of $1,808.32.  That’s your first distribution.

Continuing the example, you’d use Table I again along with the balance of the IRA at the end of the first year (minus $1,808.32) to come up with the RMD for the second year.  For the sake of the example we’ll assume that the IRA is growing at a fixed rate of 5% per year, and so the balance at the end of the second year is $105,000, which you subtract $1,808.32 from to come up with your balance of $103,191.68.  Your Table I factor for this year (age 29) is 54.3, yielding an RMD of $1,900.40.

For the third year, your IRA has grown to $110,250.  Subtracting your two years’ worth of RMD leaves you with $106,541.28, and your Table I factor is 53.3, giving you an RMD for the year of $1,998.90.

Adding these three years’ worth of RMDs together equals $5,707.62, which you’d take out in a distribution for the prior years.  This amount is subject to ordinary income tax (just like your W2 wages), but is also subject to a special tax on “excess accumulation”.  This tax is for failure to take RMDs in a timely fashion, and amounts to 50% of the distribution that was required, or $2,853.81.  While you could take this amount out as an additional distribution, keep in mind that you’d have to pay ordinary income tax on that amount - but at least you wouldn’t have to pay the 50% penalty on it.  You’d probably be better off just paying in half of what you take out in the RMDs, since you hadn’t had that money in your hands anyhow…

For this year, you would also need to take a RMD – and continuing our example your IRA balance at the end of last year was $115,762.50 – from which you would subtract the RMDs of $5,707.62, leaving $110,054.88.  Your Table I factor is 52.4, which provides you with an RMD of $2,100.28, which you need to take as a distribution by the end of the year.  (For this particular year, 2009, you do not have to take an RMD at all since RMDs have been waived for this year, but you’ll need to continue this RMD calculation process for each year hereafter unless other waivers are put into place.)

Don’t Try This At Home, Kids

I know I’ve cautioned you about this before, and perhaps you see it as a little self-serving (tax guy recommends a tax guy, duh!) but you can really cause yourself some extra grief if you foul this one up.  It would be worth it to have a tax professional review your calculations at the very least – and to tell the truth, you’re probably just as well to have the tax guy do the calculations for you because the cost is likely about the same for him to review your work as to do it himself.  The tax pro can help you with the required filing of Form 5329 (to account for the excess accumulation tax) as well.  In addition to the tax, interest may be owed as well on the accumulation tax due in prior years.

Notes:

It should be noted that the fact that the decedent is your parent is not critical to the facts of this example – only that you are inheriting the IRA from someone other than your spouse.  A spousal inheritance is a different animal altogether.

A factor of this example that IS important is that the IRA belongs specifically to the decendent and is not an inherited IRA.  If you’ve inherited an IRA that was already an inheritance, if it was specifically directed to you as the designated beneficiary then the rules are the same – but if you received the IRA via the estate, you’ll have to follow the five-year distribution rule exclusively.

Lastly, it is also important to note that the example only identifies a single primary beneficiary – if there is more than one beneficiary, the process described would be complicated by the fact that the oldest of all the beneficiaries (with the smallest Table I factor) would be the one whose distribution period is used for all beneficiaries, since the IRA was not split by the end of the year following the year of the death of the original owner.

Photo by Marco Bellucci

Splitting Inherited IRAs

Jul 16th, 2009
by jblankenship.
6 comments

These things can give you a splitting headache…

splits by cheetah100In the case of an IRA, often it is desirable to split an account into two (or more) accounts in order to better accommodate a distribution plan upon the death of the primary owner of the account.  This can be done prior to the death of the IRA owner, or it could be done after the death of the IRA owner, as long as it’s accomplished before the end of the year following the year of death.

Why is this important?

When an IRA is inherited by a non-spouse individual, that individual is required to begin taking distribution of that IRA, based either upon their own age or the age of the decedent.  In most cases when the beneficiary is younger than the decedent, it is advantageous to stretch those payments out over the longer period of time.

If there is more than one beneficiary, unless the IRA is split, the Required Minimum Distributions will be based upon the attained age of the “designated beneficiary” – who is the oldest beneficiary as of September 30 of the year following the year of death.

If you’ve split the IRA into separate IRAs for each beneficiary, each titled as “John Jones, deceased, FBO Jane Brown” (probably not exactly like that because the names will be different in almost all cases), then the individual IRAs can be distributed according to the age of each individual beneficiary.  The IRA must be split by December 31 of the year following the year of death.

Note: bear in mind that you don’t have to have the IRA split into separate IRAs for each beneficiary by September 30 of the year following the year of death – this is just the administrative date for determination of the designated beneficiary.  In the event that the IRA is split into separate inherited IRAs by December 31 of the year following the year of death, then administratively the designated beneficiary of each separate IRA as of September 30 would be the individual “FBO” owner of the account.

Photo by cheetah100

TWO 5-year Rules for Roth IRAs

Jul 8th, 2009
by jblankenship.
No comments yet

In case the rules surrounding Roth IRAs weren’t confusing enough so far, there are actually TWO different 5-year rules that can apply to your Roth IRA account.

first ride on the bus by busymommy

5-Year Rule #1: The Account’s Age

In general, the first 5-year period begins on January 1 of the tax year when you established and first funded the account.  This 5-year rule is important in determining if any distributions you receive from the account are qualified.  In order to be qualified, a withdrawal must occur at least 5 years after that account establishment date (January 1 of the year you first funded the account).   In addition to the 5-year rule, one of the following conditions must also apply in order for your distribution to be considered qualified:

  • You are over age 59½
  • You are disabled
  • You (the account owner) are deceased
  • The distribution is for a qualified first home

See the IRS’ flowchart at this link in order to determine if your distribution is qualified.

5-Year Rule #2: Age of a Conversion

This 5-year period generally begins on January 1 of the year of a conversion to a Roth IRA from a traditional IRA or from a qualified retirement plan such as a 401(k).  Any amount that is attributable to such a conversion that was subject to taxation upon the conversion that is distributed before the 5-year period is complete would be subject to an additional 10% penalty tax applied to the distribution.  This would also include post-conversion earnings on those amounts that had been converted within the previous 5 years.  Possible exceptions to this rule are as follows:

  • You have reached age 59½.
  • You are disabled.
  • You are the beneficiary of a deceased IRA owner.
  • You use the distribution to pay certain qualified first-time homebuyer amounts.
  • The distributions are part of a series of substantially equal payments.
  • You have significant unreimbursed medical expenses.
  • You are paying medical insurance premiums after losing your job.
  • The distributions are not more than your qualified higher education expenses.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution.
  • The distribution is a qualified disaster recovery assistance distribution.
  • The distribution is a qualified recovery assistance distribution.

Why These Rules Are Important: Distribution Ordering Rules

These two rules come into play when considering the order in which distributions are attributed.  The IRS has specific rules determining just which money is coming out of your account and how it is to be treated, depending on if it’s qualified or not.  The order of distribution is as follows:

  1. Regular contributions
  2. Conversion and rollover contributions, on a first-in, first-out basis, meaning that the total of conversions and rollovers from the earliest year come out first.  These conversions and rollovers are further sorted as follows:
    1. Taxable portion (that portion that was taxed during the conversion or rollover)
    2. Non-taxable portion
  3. Earnings on all contributions

It should be noted that, in determining the amounts for #2 (conversion and rollover contributions) that certain aggregation rules apply:

  • Add all distributions from all your Roth IRAs during the year together.
  • Add all regular contributions made for the year (including contributions made after the close of the year, but before the due date of your return) together. Add this total to the total undistributed regular contributions made in prior years.
  • Add all conversion and rollover contributions made during the year together. For purposes of the ordering rules, in the case of any conversion or rollover in which the conversion or rollover distribution is made in 2008 and the conversion or rollover contribution is made in 2009, treat the conversion or rollover contribution as contributed before any other conversion or rollover contributions made in 2009.

Of course, the regular contributions can always be taken out of the account tax free (no 5-year rule applies).  After that, your two 5-year rules kick in on the rest of the types of funds in your account.

Photo by busymommy
← Earlier Posts Newer Posts →