Keep Track of IRS Rules on IRAs and Other Retirement Accounts

Owners of individual retirement accounts might face increased scrutiny by the IRS in the near future, posing the danger of hefty penalties for account mistakes that have previously gone unnoticed. As this recent online Wall Street Journal article notes, the IRS recently has been cracking down on secret foreign accounts and high earners. Now its attention is likely to turn to IRA account holders as the agency implements more aggressive enforcement strategies in reviewing IRA accounts. The agency will report its new policy regarding taxpayer errors to the Treasury Department by October 15, but until then, account owners should take extra care to ensure that any past withdrawal and contribution errors are corrected proactively and to prevent future errors, as the penalties for such errors can amount to 50% of the amount IRA holders failed to withdraw.

Here are some rules to keep in mind when reviewing your account with your lawyer, CPA or financial planner.

  • IRA owners are required to start making withdrawals from traditional IRAs by April 1 of the year after they turn 70½. Such withdrawals are calculated by dividing the total IRA balance as of December 31 of the year prior to turning 70½ by life expectancy, which can be found in IRS Publication 590.
  • IRA owners who have a spouse more than a decade younger who is their sole heir must consult a separate life-expectancy table in the same publication.
  • Workers whose money is in a 401(k) who don’t own more than 5% of the company do not have to make withdrawals from that account when the turn 70 ½, provided that they still work for the company sponsoring the account. However, withdrawals do have to be made if you roll your 401(k) over to an IRA, regardless whether you continue working for that employer after you turn 70½.
  • Traditional IRA owners cannot contribute more than $5,000 a year, or $6,000 if age 50 or older. IRA owners also cannot contribute more than their “earned income,” which includes wages, commissions, and alimony, but does not include rental-property income, pension, or deferred compensation. 
  • Mistakes regarding excess contribution can be corrected before October 15 of the following year by withdrawing the excess amount plus interest.
  • Inherited IRA accounts allow for tax-deferred growth and annual minimum required distributions. However, the person inheriting the account must make the required withdrawal and report it as ordinary income on his or her own tax return if the decedent account owner was over 70½ and failed to make the withdrawal for that year prior to death. Designated beneficiaries who inherit accounts from anyone other than a spouse must take withdrawals across their own life expectancies starting the year after the death of the original account holder. Beneficiaries who inherit an IRA account from a spouse can either roll the account into their own IRA or set up an inherited IRA and postpone taking required distributions until the decedent would have turned 70½.


Operation of Law: Coordinate your Will and Property Ownership, etc.

You know the importance of having a will. If you die "intestate" (without a will in legal language), your state's laws will determine the disposition of your assets. Your actual wishes will be irrelevant, even though they may be well-known to your friends and relatives.

An Effective Will

    Here are three basic things you should cover:
    Executor Designation. The executor is the person who becomes legally responsible for wrapping up your affairs after you die. He or she will pay outstanding bills, file any necessary tax returns, make tax payments, and dole out the remaining assets as instructed by your will. You should name at least one alternate choice, in case the first choice doesn't work out.
    Asset Disposition Instructions. A properly drafted will generally heads off disputes regarding which heirs get which assets.
    Guardian Designation. The guardian takes legal charge of your minor children, if you (and your spouse) die. Designate at least one alternate in case your first choice is unable to fulfill the role. For more information, click here to read our previous article, "Picking a Guardian for Your Kids"

But even if you do have a will, here is a critical point: Your will has no effect on asset distributions that automatically occur upon your death under "operation of law."

The most common applications of the "operation of law" principle is with life insurance death benefits and tax-advantaged retirement accounts.

For example, whoever you designate as the beneficiary of your life insurance policy will automatically receive the death benefit proceeds. It doesn't matter what your will says about who should receive the money.

Similarly, the person or persons designated as the beneficiary of your tax-deferred retirement account, traditional IRA, or Roth IRA will automatically receive that money by "operation of law." It makes no difference if your will contains contrary instructions.

Another example: When you co-own real estate with someone in "joint tenancy with right of survivorship," that co-owner automatically inherits the whole property, regardless of what your will says.

You may have other assets that are affected by the "operation of law" rules. Talk with your estate planning adviser to ensure your wishes are carried out.

Finally, at the same time you have your will drafted or revised, be sure to get all your beneficiary designations and real property ownership arrangements in line with your current intentions about who should receive what, after you die.

From today's TrustCounsel eNewsletter.

IRS Announces 2011Retirement Plan Contribution Limits

Below is text of IR-2010-108 (emphasis added):

IRS Announces Pension Plan Limitations for 2011 

WASHINGTON — The Internal Revenue Service today announced cost of living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2011. In general, these limits will either remain unchanged, or the inflation adjustments for 2011 will be small. Highlights include:

  • The elective deferral (contribution) limit for employees who participate in section 401(k), 403(b), or 457(b) plans, and the federal government’s Thrift Savings Plan remains unchanged at $16,500.
  • The catch-up contribution limit under those plans for those aged 50 and over remains unchanged at $5,500.
  • The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are active participants in  an employer-sponsored retirement plan and have modified adjusted gross incomes (AGI) between $56,000 and $66,000, unchanged from 2010. For married couples filing jointly, in which the spouse who makes the IRA contribution is an active participant in an employer-sponsored retirement plan, the income phase-out range is $90,000 to $110,000, up from $89,000 to $109,000. For an IRA contributor who is not an active participant in an employer-sponsored retirement plan and is married to someone who is an active participant, the deduction is phased out if the couple’s income is between $169,000 and $179,000, up from $167,000 and $177,000.
  • The AGI phase-out range for taxpayers making contributions to a Roth IRA is $169,000 to 179,000 for married couples filing jointly, up from $167,000 to $177,000 in 2010. For singles and heads of household, the income phase-out range is $107,000 to $122,000, up from $105,000 to $120,000. For a married individual filing a separate return who is an active participant in an employer-sponsored retirement plan, the phase-out range remains $0 to $10,000.
  • The AGI limit for the saver’s credit (also known as the retirement savings contributions credit) for low-and moderate-income workers is $56,500 for married couples filing jointly, up from $55,500 in 2010; $42,375 for heads of household, up from $41,625; and $28,250 for married individuals filing separately and for singles, up from $27,750.



Continue Reading...

Is Your 403(b) Account Safe from Creditors?

403(b) plans are employee-funded retirement savings plans offered by educational institutions and 501(c)(3) charitable organization.  While the plans of private schools are automatically covered by the Employer Retirement Income Security Act 0f 1974 (ERISA), public schools and universities are exempt.  While this exemption means less regulation to worry about, there is disadvantage to employees.

ERISA, which is a federal law, protects covered retirement plans from creditors of account owners.  Thus, this protection does not rely on state law.  For non-ERISA 403(b) plans, however, there is no federal protection.  We thus have to look to state law to see if the plans are protected from creditors.

North Carolina law protects traditional and Roth IRAs from the claims of creditors.  N.C.G.S. Section 1C-1601(9).  403(b) plans are not included in this protection.

Therefore, if you work for a public educational institution and have a 403(b) account, you should be aware that it may not be protected should you ever be sued.

Retirement Assets with no automatic creditor protection:

  • SEP IRAs
  • Inherited IRAs
  • 403(b) Plans (public school employees)

If you have any of these accounts with substantial funds, see an asset protection attorney about how you might be able to protect the account.


The IRS Loves Retirement Accounts

Planning for tax-qualified plans, which includes IRAs, 401(k)s and qualified retirement plans, requires a careful examination of the potential taxes that impact these assets. Unlike most other assets that receive a “basis step up” to current fair market value upon the owner’s death, IRAs, 401(k)s and other qualified retirement plans do not step-up to the date-of-death value. Therefore, beneficiaries who receive these assets do so subject to income tax. If your estate is subject to estate tax, the value of these assets may be further reduced by the estate tax. And if you name grandchildren or younger generations as beneficiaries, these assets may additionally be reduced by the generation-skipping transfer tax. All tolled, these assets may be reduced by 70% or more.

There are several strategies available to help reduce the impact of these taxes:

  • Structure accounts to provide the longest term payout possible (stretch).
  • Name a Retirement Trust as Beneficiary
  • Take the money out during lifetime and pay the income tax, then gift the remaining cash either outright or through an irrevocable life insurance trust.  Or consider a Roth conversion.
  • Take the money out during lifetime and buy an immediate annuity to provide a guaranteed annual income, to pay the income tax, and to pay for insurance owned by a wealth replacement trust.
  • Name a Charitable Remainder Trust as beneficiary with a lifetime payout to your surviving spouse. The remaining assets would pass to charity at the death of your spouse.
  • Give the accounts to charity at death.



Continue Reading...

Top 10 Facts About Taking Early Retirement Plan Distributions


From the IRS:

If you took an early distribution from your retirement plan, here are some things you need to know:

1. Payments you receive from your Individual Retirement Arrangement before you reach age 59 ½ are generally considered early or premature distributions.

2. Early distributions are usually subject to an additional 10 percent tax.

3. Early distributions must also be reported to the IRS.

4. Distributions you rollover to another IRA or qualified retirement plan are not subject to the additional 10 percent tax. You must complete the rollover within 60 days after the day you received the distribution.

5. The amount you roll over is generally taxed when the new plan makes a distribution to you or your beneficiary.

6. If you made nondeductible contributions to an IRA and later take early distributions from that same IRA, the portion of the distribution attributable to those contributions is not taxed.

7. If you received an early distribution from a Roth IRA the distribution attributable to contributions is not taxed.

8. If you received a distribution from any other qualified retirement plan, generally the entire distribution is taxable unless you made after-tax employee contributions to the plan.

9. There are several exceptions to the additional 10 percent early distribution, such as when the distributions are used for purchase of a first home, certain medical and educational expenses or if you become disabled. Other exceptions can be found in IRS Publication 590, Individual Retirement Arrangements (IRAs).

10. More information about early distributions from retirement plans and the additional 10 percent tax can be found in IRS Publication 575, Pension and Annuity Income and Publication 590, Individual Retirement Arrangements (IRAs). Both publications are available on or by calling 800-TAX-FORM (800-829-3676).


  • Publication 575, Pensions and Annuities (PDF 227K)
  • Publication 590, Individual Retirement Arrangements (IRAs) (PDF 449K)  
  • Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts   (PDF 72K)
  • Form 5329 Instructions (PDF 40K)


US Supreme Court Awards Retirement Plan to Ex-Spouse

If you divorce, make sure that you change your retirement account beneficiaries!  As obvious as that advice sounds, it is not uncommon, particularly when there is no remarriage, for one to forget to designate a new beneficiary. Even a waiver signed by your former spouse may not be effective to prevent him or her from getting the benefits upon your death.  This report on a recent United States Supreme Court case is courtesy of the NAELA e-newsletter:

The decedent did not change the plan beneficiary after the divorce, but the executrix contended that the spouse waived her rights to plan benefits and thus the benefits reverted to the estate. The plan administrator argued that the waiver was an alienation of the benefits which was prohibited under the Employee Retirement Income Security Act of 1974, 29 U.S.C.S. § 1001 et seq. (ERISA), and that the waiver was not a qualified domestic relations order (QDRO) as required to be exempt from the anti-alienation provision. The Court unanimously held that the spouse's waiver did not violate the anti-alienation provision, but the administrator properly distributed benefits to the spouse. The spouse's waiver was not rendered invalid as an assignment or alienation of the benefits since the spouse did not attempt to direct her interest in the benefits to the decedent's estate or any other potential beneficiary. However, since the waiver was not a QDRO, the plan required the decedent to change the plan beneficiary or the spouse to expressly disclaim the benefits and, in the absence of either event, the administrator was required to distribute the benefits to the spouse as the named beneficiary under Egelhoff v. Egelhoff, 532 U. S. 141, 148 (2001).

Kennedy v. Dupont Savings and Investment Plan, 2009 U.S. LEXIS 869 (January 26, 2009)