While almost everyone has an IRA, very few investors are aware of the complex and ever-changing rules which govern them. Every year, there are dozens of important court cases and IRS rule changes which add to IRA complexity. This year is no exception. Here are the two that top my list:
AFTER-TAX ROLLOVERS FROM PLANS TO IRAS AND ROTH IRAS
It is not uncommon for a retirement account, such as a 401(k), to have some after-tax dollars mixed in with all of the pre-tax dollars. This is especially true if you are one of the more highly compensated employees in your firm. While these funds cause you no trouble in your company retirement plan, the same is not true once you roll them over to an IRA. Although the amounts may be small in comparison to your overall account, without proper record keeping, you could end up paying taxes on those amounts a second time!
When you are ready to transfer plan assets into your IRA, it is important to ask if they contain any after-tax dollars. If the answer is yes, then it is likely preferable to request those dollars not be sent to your IRA.
Let’s say that you added $5,000 in aftertax dollars to your IRA and, over time, those funds grew to $15,000. The amount you are asking to be excluded from the IRA rollover is the original $5,000 contribution. The $10,000 which was generated by investment returns are still pre-tax dollars and will be rolled over to your IRA without causing any trouble.
If you’re wondering what would happen if you rolled over these $5,000 in after-tax dollars to your IRA, the answer is it would require some additional accounting by you or your tax person, along with an extra page on your tax return for every year in which you make a contribution or withdrawal to your IRA. It’s a messy process where the IRS requires you to allocate some of the non-taxable $5,000 to each withdrawal you make from your IRA for the rest of its life. If you have not filed the proper paperwork through the years, the amount will be lost and all of your distributions will be taxable, regardless of the fact that you already paid tax on a portion of them.
In the past, we recommended the aftertax dollars be paid directly to clients. However, the IRS has recently allowed those after-tax dollars to be rolled to a Roth IRA. So, now you have two good choices: Roth rollover or paid directly to you.
IRA ROLLOVERS AND THE 60-DAY RULE
Before 2015, IRA owners were allowed one 60-day rollover to or from each IRA per 12-month period. Starting January 1, 2015, the limit will be applied by aggregating all of an individual’s IRAs (including Roth IRAs) and treating them as if they were one IRA for purposes of applying the once per 12-month rule. While some IRA owners used the 60-day rule to move funds from one IRA to another, many were using this rule to make extended loans to themselves. This latest IRS rule change will effectively limit the use of your IRA for personal loans.
The new rule will apply for rollovers starting in 2015. If you have a rollover distribution from an IRA received during 2014 and properly rolled over (normally within 60 days) to another IRA, it should have no impact on a distribution or rollover initiated in 2015 involving any other IRA. Please note this rule change is for the 60- day rollover provision only and does not limit trustee-to-trustee transfers of retirement accounts.
Once a decision has been made and your retirement money is in motion, it’s often too late to fix problems, and most of the rules in this area are unforgiving. If you are about to receive or move retirement money, it is very important to speak with an advisor who is experienced and up-to date on the latest IRA rules.
This article originally appeared in Westlake Malibu Lifestyle Magazine.
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Robert J. Katch is the founder of Manchester Financial, an Investment Counsel/Wealth Management firm located in Westlake Village. For more information call 800-492-1107.
This material provided for general and educational purposes only, and is not legal, tax or investment advice. For each strategy or option mentioned, there are detailed tax rules that must be followed.