Buying CDs Doesn’t Magically Give You an IRA

Tuesday, September 11, 2012

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

When you open a new IRA, certain forms and paperwork must be filled out. Failure to do so can result in large IRS penalties and other harsh tax consequences as a recent court case showed.

A woman retired and received a large distribution from her former employer’s retirement plan. She thought she deposited a large part of the distribution, in a tax-free rollover, to an IRA. She bought bank CDs and assumed that qualified as an IRA rollover and thus was tax-free. However, she never actually opened an IRA because she never signed an IRA contract with the bank.

She also never signed a rollover form, which is required by the IRS. All she did was simply buy CDs outside of an IRA, which is not remotely the same as a tax-free IRA rollover. The Court said she owed income taxes and a 10% early distribution penalty because of the failed rollover.

To open a new IRA, several documents must be signed. First you must sign an IRA contract with the financial institution, which could be an insurance company, bank, broker, etc. That contract will include an IRA agreement and a disclosure statement. The IRA agreement is the controlling contract between you and the financial institution. The disclosure statement, which is usually attached to the back of the agreement, describes the IRA in layman’s language. The final document you should fill out is the beneficiary form.

If you are doing a rollover, you also must sign a rollover form, which the financial institution should provide to you. Lastly, you must buy an investment inside the IRA, such as a CD, annuity, mutual fund, etc. Simply buying an investment, without filling out the other paperwork, does not establish an IRA.
 

 

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