Roth IRA CD: 2 issues re bank’s early withdrawal penalty
This relates to a person over age 59.5 and thus is not about the 10% penalty related to age but rather [i]bank[/i] penalties. Any ideas are appreciated.
If an early withdrawal is made from a CD invested in a Roth IRA, can that penalty amount be indirectly rolled over along with the net penalty amount? For example, a CD valued at $10,000 at the time it is “broken” is subject to an early withdrawal penalty of $500. This results in a $9,500 net withdrawal. Can the Roth IRA holder deposit the full $10,000 into another Roth IRA account or is she limited to $9,500?
Also, I understand that “Penalty on early withdrawal of savings” can be deducted on form 1040 line 30. In the 1040 instructions booklet, reference is made to that amount being on forms 1099-INT or 1099-OID. What I was wondering is whether an early withdrawal penalty on a CD in, e.g., a Roth IRA can also be deducted on line 30.
The relevant statute is I.R.C. § 62(a)(9):
Penalties forfeited because of premature withdrawal of funds from time savings accounts or deposits
The deductions allowed by section 165 for losses incurred in any transaction entered into for profit, though not connected with a trade or business, to the extent that such losses include amounts forfeited to a bank, mutual savings bank, savings and loan association, building and loan association, cooperative bank or homestead association as a penalty for premature withdrawal of funds from a time savings account, certificate of deposit, or similar class of deposit.
http://www.law.cornell.edu/uscode/text/26/62
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Losses in retirement accounts do not seem to be of the type listed in 26 USC Section 165:
http://www.law.cornell.edu/uscode/text/26/165
Thus, even though form 1040 and its instructions booklet do not explicitly exclude penalties in retirement accounts, the line 30 deduction appears primarily if not exclusively intended for taxable savings. In that case, the “no conditions” claim below would be incorrect and it seems questionable to make the deduction:
There are no conditions or requirements to meet. As long as you take money out of a savings certificate before the specified maturity date and are subject to a penalty, you can deduct the penalty in full.
Permalink Submitted by Alan Spross on Tue, 2012-04-17 00:05
I agree that the IRS could have eliminated any confusion here by simply indicating in the 1040 Inst that this deduction does not apply to retirement account penalties. Sec 408(e) states that IRA accounts (includes Roth IRAs) are considered tax exempt accounts other than with respect to UBTI and distributions. Many other deductions such as cap losses do not apply to these accounts.
1) Rollover question – Roth owner can only roll over the amount that is distributed, ie the amount reported on 1099R or 9,500 in your example.
2) Above the line deduction CD early withdrawal penalty – Not very clear, but the various code sections, particularly 408(e) strongly point to this deduction not being applicable to IRA accounts. If the penalty is not reported on 1099 INT, it should not be deducted on line 30. Further, Sec 165 refers to a long list of deductions that are clearly not applicable to tax deferred accounts and many of those losses are tied to calculating basis when an IRA only allows a misc deduction if closed out for less than the defined IRA basis, ie the amount of non deductible contributions (or all contributions in the case of a Roth IRA).
I would therefore conclude that the taxact blog should have included the limitation of this deduction to taxable accounts.
Permalink Submitted by Alan Sheldon on Tue, 2012-04-17 01:18
Thanks a lot, Alan. One angle I thought of to deduct a Roth IRA penalty is (if possible) take the distribution in-kind and [i]then[/i] break the CD. For a CD, easier said than done I’m guessing but if pulled off I think that would be a safe enough deduction.
Permalink Submitted by Alan Sheldon on Tue, 2012-04-17 01:39
Never mind!
“you can do this [transferring in kind] with almost all IRA assets except bank products”
http://budgeting.thenest.com/transfer-ira-account-3650.html
Permalink Submitted by Alan Spross on Tue, 2012-04-17 02:38
I don’t think there is any regulation that requires a bank to trigger early withdrawal if the CD is transferred out of a bank IRA to a same bank taxable CD. But that’s what most of them probably do, as it’s another way to recover operating expenses.