Custodian Error in IRA and Reimbursement?

Submitted by Kyle Eaton on Fri, 2020-01-10 19:25

I have a client for whom we were attempting to use an IRA to repurchase state government service credits. Paperwork was submitted to the custodian. Custodian issued the check to the government program, but neglected to include the required paperwork. Long story short, the client ended up missing the deadline and the check was returned. I reached out to the government retirement program and was told that the client would have to submit a new purchase request. Unfortunately that request would be for the next fiscal year and would include a cost increase of 8% to repurchase the credit. That amounted to almost $2,000 my client would be out-of-pocket. I requested that the custodian make the client whole. Fortunately it appears they did.

Here are my questions. It looks like the custodian deposited the difference directly into the client’s IRA account. When it comes to custodial errors, are they allowed to deposit funds directly into an IRA. I am aware of rolling back in funds from class action lawsuits, can anyone point me to the code or reg that deals with custodial deposits.

Second question, what did my client just receive? Was it income? And then a contribution to her IRA account? Trying to figure out whether it will impact her ability to do future IRA contributions for this year. I am sure I will have this conversation within the next day or so with the custodian, but wanted to see if anyone else has experienced this.

Thank you for any insight you might be able to provide.

Kyle



Submitted by Alan - IRA critic on Fri, 2020-01-10 23:36

  • If the IRA custodian check was made out to the govt program FBO client, it was a direct rollover check to be reported on Form 1099R, Code G. There is no 60 day rollover requirement for a direct rollover check, but client will know within 3 weeks if there is a 1099R issued. Since the funds were not accepted by the govt plan, the govt plan should not issue a 1099R, but client needs to find out if that is the case. Not sure which of these transactions occurred in 2019 or 2020 either. At the end of the day, the client needs to report consistently with the forms that are issued by the custodians with the end result being no taxable distribution and no rollover. Not knowing what info returns are to be issued, it is not clear how easy this will be. This is not a regular IRA contribution and probably well exceeds the IRA contribution limit anyway. It should be treated as a cancelled direct rollover, and it will be easier to resolve if the IRA custodian will not report the direct rollover check 
  • If this check was outstanding on 12/31, it would not be included in the year end IRA balance reported on Form 5498 as the check was made out to a qualified plan. However, the restoration of the balance to the IRA means that the year end balance should be corrected to include the amount as never having left the IRA. This is important if there are any RMD distribution years affected, or other IRA distribution if the IRA has basis. 
  • In short, the IRS does not care whether the direct rollover was completed or not as long as the 1099R forms, 5498 form, and client’s tax return all conform. 

Submitted by Kyle Eaton on Sat, 2020-01-11 00:23

Sorry if I was unclear. The original repurchase amount is not what I am questioning. The client made the maximum contribution earlier in the year. But the repurchase was a direct rollover and the custodian simply canceled the check well before year-end and placed the $6k back into the account. What I am questioning is the $2,000 additional that the custodian journaled into the IRA to cover the 8% in the purchase price. That did not occur until today. Will that be reported on the 2020 Form 5498? Even though the contribution was not made by the individual?

Submitted by Alan - IRA critic on Sat, 2020-01-11 02:04

  • So the original purchase amount remains in the IRA plus the IRA custodian added 2,000 more to the IRA today, and the client intends to request a new direct rollover in the original amount plus the 2,000?   If so, the client will have to ask the custodian if the 2,000 is going to be reported to the IRS as an IRA contribution for 2019, for 2020, or instead will not be reported as a regular contribution at all. I am not aware of what authority the custodian is operating under with the IRS as custodian authority to make such changes is not public info. However, unless it is reported as a 2019 contribution  bringing the total up to 8000, it does not appear to create an excess IRA contribution problem.  If I now have the facts right, only the custodian can clarify what they are going to report as IRA regular contributions. 
  • If the custodian plan to report 8000 as 2019 contributions and will not change the 2000 to a 2020 contributions, it will create a 2019 excess which client will have to remove with earnings.

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