The deposit of non-qualified money into a traditional IRA account
I recently was contacted by a person who said he had a problem with IRA Variable Annuity. Upon discussion He explained that he had established the IRA with a direct rollover from his 401(k) account. Several years later his wife was in the process of renewing a CD, but was very discouraged by the rates that were being offered. Remembering that the annuity offered a 6% income guarantee she had her husband inquire with the annuity as to whether they would take additional money into his IRA. They said they would and gave them instructions on how to wire the money. This couple gave the instructions to the bank and the bank wired the money to the annuity company. The results, today we have a traditional IRA variable annuity worth about $550,000, of which part $150,000, came from a non-qualified CD.
My questions: What are the tax liabilities? How do they unravel This
Permalink Submitted by Alan - IRA critic on Mon, 2015-01-26 19:39
Apparently, the insurance company thought that this was a rollover from another retirement plan, and they likely issued a Form 5498 reporting a rollover contribution to the annuity IRA. No word from the IRS on this is a good indication that the IRS has a flawed computer matching programming because there was no 1099R to match the 5498 to. But this is still an excess IRA contribution (except for the small amount of any regular contribution he might have been eligible to make for that year) and there is no statute of limitations on excess contributions. This would result in a 6% excise tax for each year on the excess amount, but any earnings on the excess amount would stay in the IRA if this contribution was made before 2014. A distribution of 150,000 (less any regular contribution he would have been eligible to make) needs to be distributed from the IRA, and it will take a detailed explanatory statement with the 2015 tax return to convince the IRS that the distribution should not be taxable because it was an excess contribution that they never deducted. The end result is that the only tax cost would be the 6% excise taxes for each year plus interest on late paid excise taxes if the IRS chooses to bill interest. However, there could also be insurance company surrender charges deducted from the account. Since earnings will remain in the IRA, he might as well wait at this point until late this year to withdraw the 150,000 so another year of earnings will be generated in the IRA. The next excise tax would not be incurred until next January 1 (for 2015). The excise taxes are paid on a Form 5329 for each year the excess contribution remained in the IRA. There would also be a final 5329 showing the removal of the excess amount with the 2015 return, but no 2015 excise tax if the excess is out by year end. Is he subject to RMDs yet?
Permalink Submitted by Ronald Peters on Tue, 2015-01-27 01:16
Since this had no earned income in the year of this deposit our issue is with the entire &150,000 amount. This person is several years away from his first RMD.Are there any other ways, other than a massive excess contribution that IRS could choose to look at this?
Permalink Submitted by Alan - IRA critic on Tue, 2015-01-27 01:29
Not that I am aware of. The IRS does not have authority to waive excess contribution excise taxes like they do other things such as extending rollover or recharacterization deadlines. The insurance company could have checked more carefully that this was tax deferred money, but it does not sound like trying to hold the insurer responsible would have much of a chance of success. Perhaps appealing any direct early surrender penalties would be as far as they should go. I assume that it has been verified that the expiring CD was not an IRA CD.