Ask the Experts – March 10, 2015

Question: I have a client turning 70 ½ this year in 2015. I know she is still eligible to contribute to a Traditional IRA for 2014, but not for 2015. If she opens a new IRA and contributes $6,500 for 2014, will she have to take a required minimum distribution for 2015 from that account?

Answer: No

IRS Publication 590 Individual Retirement Arrangements clarifies that an individual can make contributions to their IRA for a given year until the due date for filing their tax return for that year, not including extensions. In other words an individual generally has until April 15, 2015 to make a contribution to their IRA for 2014.

Publication 590 also gives us the rules for determining when required minimum distributions must start and how to calculate them. An individual must receive at least a minimum amount from their IRA beginning with the year they turn 70 ½. In order to figure the amount for the required minimum distribution, the account balance as of December 31 for the preceding year is divided by the applicable distribution period or life expectancy factor for the individual.

In this case the individual client made the initial contribution in 2015 for year 2014. Since the account was opened in 2015, there is no account balance as of December 31 2014. Because there is a zero account balance as of December 31, 2014 there is no required minimum distribution due for 2015 from this account. The client will have to take required minimum distributions from this account in 2016 and for the following years.

Ask the Experts – March 24

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client mistakenly rolled over funds from his traditional IRA to his SIMPLE IRA. Is there a way to correct this error without incurring any penalties or tax liabilities?

Answer: Yes, he can later recharacterize the amount as a contribution to another traditional IRA assuming the contribution was made via a trustee-to-trustee transfer and the recharacterization was made by the due date (including extensions) of his tax return for the year in which the contribution was made. Additionally, your client must:

Include in the recharacterization transfer any income allocable to the contribution.
Report the recharacterization on his tax return for the year during which the contribution was made.
Treat the contribution as having been made to the second IRA on the date it was actually made to the SIMPLE IRA.

Also, your client must notify the trustees involved of the recharacterization, and supply the trustees with certain information, including:

The type and amount of the contribution to the SIMPLE IRA that is to be recharacterized.
The date the contribution was made and the year for which it was made.
Directions for the SIMPLE trustee to transfer the original contribution to the trustee of the traditional IRA.
The name of both trustees.
Any additional information needed to make the transfer.

Form 8606 should be used to report the recharacterization.

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Ask the Experts – March 18

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: Can my client roll over his traditional IRA into an HSA?

Answer: No, but he might be able to transfer a portion of his IRA to his HSA without incurring income tax liability by making a qualified HSA funding distribution.

A qualified HSA funding distribution is a way to fund an HSA with IRA money. It can be made from either a traditional IRA or Roth IRA to an HSA. Ongoing SEP IRAs or SIMPLE IRAs are not eligible. A SEP or SIMPLE IRA is ongoing if an employer contribution is made for the plan year ending within the tax year in which the qualified HSA funding distribution would be made.

The qualified HSA funding distribution must be made as a direct trustee-to-trustee transfer. The distribution is not included in the individual’s income, and it is not deductible. Only one qualified HSA funding distribution is allowed per individual.

The amount an individual can transfer from his IRA to an HSA in a qualified HSA funding distribution is limited to his general HSA contribution limit on the year. This limit depend on the type of HDHP coverage the individual has, his age, the dates he becomes eligible and ceases to be eligible to contribute. In 2014, for individuals with self-only HDHP coverage, an individual can contribute up to $3,300; for family coverage, up to $6,550. Any qualified HSA funding distribution reduces the amount that can be contributed to his HSA for that year.

The qualified HSA funding distribution is shown on Form 8889 in Line 10 for the year in which the distribution is made. Form 8889 is attached to the individual’s 1040 or 1040-NR.

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Ask the Experts – March 7

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers. Here’s the question of the day.

Question: My client earns too much (around $250,000) to make a Roth IRA contribution. Can he instead make a traditional IRA contribution and thereafter convert it to a Roth IRA?

Answer: Yes. While there are income limitations for making contributions to Roth IRAs, there are no such limitations for either a non-deductible contribution to a traditional IRA or a conversion of a traditional IRA to a Roth IRA.

Therefore, assuming your client doesn’t currently own an IRA, he could make a nondeductible $5,500 to a new traditional IRA, and thereafter convert it to a Roth IRA. This essentially results in a Roth IRA contribution.

However, if your client currently owns an IRA with pre-tax money, he should be careful not to trigger more tax consequences than he’d like.

For example, let’s say your client makes a $5,500 non-deductible contribution to his already existing traditional IRA with $49,500 pre-tax money. He pays taxes on the $5,500 contribution and his IRA is now worth $55,000, consisting of 90 percent pre-tax, and 10 percent after-tax contributions.

Here’s the problem: if he tries to convert $5,500 of the traditional IRA to a Roth, he will owe another taxes on an additional $4,950 income. This is because when an individual makes a distribution from an IRA with both pre- and after-tax money, the distribution consists of both pre- and after-tax money on a pro rata basis.

Therefore, if your client converted $5,500 from his traditional IRA to his Roth, only $550 would be with after-tax money, whereas $4,950 would be converted using pre-tax money—meaning he would owe taxes on an additional $4,950 of income. In the end, his $5,500 contribution would incur taxes on $10,450 of income ($5,500 + $4,950).

He could avoid the extra $4,950 of taxable income in the above example by making a deductible contribution to his traditional IRA (as opposed to a non-deductible contribution). If he does this, he will not pay income taxes on the original $5,500 distribution, but instead will owe taxes on the conversion. This tax result is identical to making an after-tax Roth contribution, but because of his income levels, he can only make a deductible contribution to a traditional IRA if he is not an active participant in an employer-sponsored plan.

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