Slott Report Mailbag: Back to Basics with Key IRA Questions
We are going back to basics in this week’s Slott Report Mailbag with questions revolving around the foundation of IRA planning. Converting and accessing funds and avoiding penalties are the fundamental keys you and your financial team grapple with each day. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.
1.
Can I convert my employer plan or IRA to a Roth IRA?
Answer:
All funds in traditional IRAs, SEP IRAs, and employer plans such as 401(k)s are eligible to be converted to a Roth IRA. Funds in a SIMPLE IRA can also be converted AFTER the SIMPLE account has been open for two years. A conversion before that date will be subject to a 25% penalty tax on the amount withdrawn AND the funds are not eligible for transfer to any other type of plan except another SIMPLE. To do a conversion of employer plan funds, you must be eligible to take a distribution from the plan.
2.
Who takes the year of death required distribution from an IRA?
Answer:
Any remaining amounts of the year of death required distribution MUST go to the beneficiary. The distribution never goes to the decedent or to the estate, unless the estate is the beneficiary. Any required distributions that are not taken will be subject to the 50% penalty and are reported on IRS Form 5498 by the beneficiary for the year the distribution was missed.
3.
I just found out I was not eligible to make a Roth contribution/conversion. What do I do now?
Answer:
1. Recharacterization – The funds can be recharacterized to a traditional IRA up to October 15th of the year after either the year of the conversion or the year for which the contribution is made. You must notify both the Roth IRA and the traditional IRA custodians that you are doing a recharacterization. A net amount is recharacterized. Gains or losses on the account for the time the funds are in the account that are attributable to the contribution/conversion must also be recharacterized. The funds must be moved in a trustee-to-trustee transfer back to an IRA. Once this is done, the funds are treated as though they had always been in the IRA.
2. Excess Contribution – This option can be used either before or after the October 15th date. If it is before October 15th of the year after either the year of the conversion or the year for which the contribution is made, then again a net amount must be withdrawn. The IRA custodian should be told this is a withdrawal of an excess contribution. The funds will go into your pocket and will no longer be in an IRA. Any earnings that are withdrawn will be taxable for the year of the contribution/conversion, not the year they are withdrawn.
If the October 15th date has passed, this will be your only option for removing the funds. However, you no longer have to calculate gains or losses. You only remove the amount of the contribution/conversion. This is good if you have gains in the account, bad if you have losses. You also will have to pay a 6% excess contribution penalty on the amount of the contribution/conversion that was in the account as of December 31st of the prior year. This penalty will also apply to a contribution made up to April 15th of the current year that was designated as a prior year contribution. The penalty is reported on IRS Form 5329 which is filed with your tax return. The penalty will apply for each year that the excess amount remains in the account (that is why you need to remove it as soon as possible).
3. Carry Forward – You can carry forward the excess amount and use it up in subsequent years as contributions for those years. This is generally only a good idea for contributions when you are fairly certain that you will be eligible to make a contribution in the next year. You will still owe the 6% excess contribution penalty for each year that you have excess funds in the account.
-By Joe Cicchinelli and Jared Trexler