Advanced Underwriting Consultants

Question of the Day – May 17

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Here’s the question of the day.

Question:  My client wants to re-title his IRA into the name of his living trust.  Is that a good idea?

Answer:  No, no, no!  It’s a terrible idea.

IRAs must be personally owned to qualify as IRAs.  Any attempt to transfer an IRA to someone else or to a trust will be treated as a complete disposition of the IRA—causing the entire account to be immediately taxable in most cases.  Furthermore, if the original IRA owner is younger than 59 ½, the entire account would also be subject to an extra 10% penalty tax.

This question usually arises when a client has done estate planning documents with an attorney, and has had a living trust drafted.  The attorney advises the client that, in order for the living trust to effectively help the client avoid probate, personally owned assets must be transferred into the trust.

While transferring assets that would otherwise be subject to probate into the trust makes sense, transferring qualified assets does not.  The transfer would be taxable as described above.  Furthermore, it is not necessary to transfer qualified assets into a living trust to avoid probate.  Probate can be avoided by naming a beneficiary for the account.  In fact, if desired, the living trust can be named the beneficiary of the account.  If that’s done, the account will pass smoothly to the living trust at the account owner’s death—without the need for probate.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – March 6

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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:  Can my client deduct the investment fees charged inside her variable annuity from her income taxes?

Answer:  No.

If investment fees are paid in cash or otherwise taken from an already-taxed source, they are potentially deductible—if the taxpayer itemizes, and to the extent all deductible miscellaneous expenses exceed 2% of AGI.

If the fees are deducted from an untaxed source—inside an IRA or nonqualified deferred annuity (NQDA) contract, for example—they are NOT tax deductible.  See Revenue Code Section 212.

Even though the internal amounts charged in an IRA or NQDA (including VAs) are not tax deductible, the IRS allows such amounts to be deducted from the pre-tax account without being included in the client’s taxable income.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – April 27

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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 sent a check into her personal IRA account on April 15, claiming a $5,000 income tax deduction on her 2011 tax return filed the next day.  The check bounced, as she found out on April 19.  Can she make good on the check now and still preserve her 2011 tax deduction?

Answer: Unfortunately, it’s too late.  The client needed to deposit good funds into her IRA by the tax filing deadline (April 17, 2012 for 2011 taxes).  Since that didn’t happen, no deductible IRA contribution is permitted for 2011.

There’s a private letter ruling on this kind of situation, where the IRS ruled that an IRA rollover check that was deposited within the 60 day window but bounced was not a proper rollover when the check was replaced later.

Since the client cannot make a contribution for 2011 after the deadline, she will need to file an amended tax return as well.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – November 3

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Question: My client has taken a distribution from an IRA, and is nearing the deadline for being able to re-deposit the money tax free under the 60-day rollover rule.  How rigid is the IRS’s deadline?

Answer: A taxpayer may make a 60-day rollover of an eligible rollover distribution if, after receiving the distribution, the amount is deposited into another eligible plan or IRA.  The taxpayer must make the rollover contribution by the 60th day after receiving the eligible rollover distribution.

The IRS may create a special extension to the 60-day requirement in cases where failure to meet the normal deadline is due to circumstances completely out of the control of the taxpayer.  Extensions are not routinely granted.

A recent Private Letter Ruling, PLR 201021040, gives one example where IRS waived the 60-day time period and allowed a deposit after 83 days to be treated as a tax-free rollover where the taxpayer proved he was erroneously advised by his financial advisor that he had 90 days to complete the transaction.

Under the facts of the PLR, Taxpayer A was the owner of an IRA with Custodian C and wished to do a rollover to Custodian D.  Taxpayer A consulted Financial Advisor B and was told he had 90 days to complete the transaction.  Taxpayer A has documentary proof of the erroneous advice given by Financial Advisor B.  In this case, IRS allowed the tax-free rollover even though the deposit into the new account was 83 days after withdrawal from the old account.

The IRS only grants waivers to the 60-day rollover requirement in limited circumstances.  Here’s what IRS itself says about waivers to the 60-day rollover period in Publication 590:

In determining whether to grant a waiver, the IRS will consider all relevant facts and circumstances, including:

  • • Whether errors were made by the financial institution,
  • • Whether you were unable to complete the rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error,
  • • Whether you used the amount distributed (for example, in the case of payment by check, whether you cashed the check), and
  • • How much time has passed since the date of distribution.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – November 1

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Question: My client’s spouse died earlier this year.  One of her assets is an IRA that she inherited from her late father.  The deceased was taking required minimum distributions (RMDs) based on her life expectancy when she died.  My client is now the beneficiary of that account.  What are the RMD requirements?

Answer: After the subsequent death of the original beneficiary, the inherited IRA account is payable to the new beneficiary named by the original beneficiary.

The stretch distribution period is the life expectancy of the original beneficiary, using the Single Life Table and the age she attained or would have attained on her birthday in her year of death, reduced by one (1) in each subsequent year.

Here’s an example.  Say the original account owner, aged 90, died in 2010.  His daughter, age 60 in 2010, chose to treat the account as an inherited account.  Her first stretch distribution was due on or before December 31 of 2011.

In year 2011, the daughter is 61 and the factor from the Single Life Table is 23.3.  The account balance for 12/31/2010 is divided by 23.3 (equivalent to 4.29%) and that’s the RMD for 2011.

The daughter’s spouse is the beneficiary of the account.  The RMD for 2012 would be determined by using the daughter’s age of 61 in the year of death and the Single Life Table.  The factor for the daughter’s age in 2011 is 23.3.  For 2012, the account balance on 12/31/2011 would be divided by 22.3 and that’s the RMD.  For 2013, the factor would be 21.3, for 2020 the factor would be 14.3, and so forth.

Eventually, the factor would be less than one, and any remaining account balance would have to be distributed to the beneficiary in that year.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – October 14

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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 is divorcing her spouse, and they are in the process of splitting up a pension plan balance.  What are the tax consequences of doing so?

Answer: When a taxpayer withdrew funds from his IRA in order to satisfy a divorce judgment, he was required to include the distribution in his gross income.  The Tax Court also ruled the distribution was subject to the 10% penalty imposed on early IRA withdrawals.

The divorce judgment failed to meet the requirements of a qualified domestic relations order (QDRO).

Under the facts of the case, taxpayer was required to pay his ex-wife a specified amount of money pursuant to their property settlement agreement.  In an effort to comply with the agreement, he attempted to transfer funds directly from his IRA to his former spouse.  She, however, refused to accept the transfer over concern that the funds would be taxable to her when she eventually received distributions from her IRA.  Ultimately, ex-husband simply withdrew the money from his IRA and delivered it directly to his ex-wife.  He did not report the IRA withdrawal on his return.

The Tax Court noted that retirement plan distributions made under a QDRO are not currently taxable to the taxpayer making the transfer. However the Court rejected taxpayer’s contention that the divorce judgment was, in effect, a QDRO.  According to the Court, the judgment only directed that he make a specific cash payment to his ex-wife.  It did not order him to withdraw funds from his IRA.  In addition, husband didn’t actually transfer an interest in the IRA to his former spouse.  Instead, he merely took a withdrawal and paid the funds to her.

 

In general, qualified retirement plans must provide that plan benefits may not be assigned or alienated.  However, a plan may distribute, segregate, or otherwise recognize the attachment of any portion of a participant’s benefits in favor of the participant’s spouse, former spouse or dependents, if such action is mandated by a QDRO.

A QDRO is a judgment, decree, or order (including an order approving a property settlement) that relates to the provision of child support, alimony, or property rights to a spouse, former spouse, child or other dependent (“alternate payees”); is made under a state’s community property or other domestic relations law; creates, recognizes, or assigns the right to receive all or a portion of a participant’s plan benefits to an alternate payee; and clearly specifies,

  • the name and address of the alternate payee,
  • the amount or percentage of the benefit to be paid,
  • the number of payments or period over which the order applies, and
  • each plan to which the order applies.

Strictly speaking, a QDRO applies only to an employer-sponsored retirement plan such as a pension or profit-sharing plan, but Code Section 408 sets out similar provisions for IRAs.

A QDRO cannot provide an alternate payee with any form of benefit not otherwise available to the plan participant.

A QDRO may also specify that a former spouse of a participant be treated as the surviving spouse for purposes of survivor benefit requirements.  For this purpose, the former spouse will be treated as married to the participant for the requisite one-year period if such former spouse had been married to the participant for at least one year.

Under a QDRO, a spousal alternate payee (including a former spouse) is taxed like any other distributee of a qualified plan distribution.

The 10% premature distribution penalty which applies to qualified plan distributions taken prior to age 59-1/2 does not apply to payments made to an alternate payee pursuant to a QDRO.  This rule does not apply in the case of an IRA; distributions from an IRA not rolled over will be subject to the premature 10% distribution penalty.

If a spouse or former spouse of the participant receives a distribution under a QDRO, the rollover rules apply to such alternate payee as if the alternate payee were the participant. Thus, the alternate payee can avoid having to include such a distribution in his or her taxable income by rolling the money into an IRA within 60 days, or by asking the pension trustee to make a direct transfer.

For those helping clients make pension or IRA transfers pursuant to a divorce or separation, make sure it’s a QDRO.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – October 13

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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: I have a client who wants to access money from her IRA prior to age 59 ½.  How can she avoid the 10% premature distribution penalty on money she receives?

Answer: To avoid the penalty, many take distributions that are “part of a series of substantially equal periodic payments (sometimes called a SEPP) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of the employee and his designated beneficiary.”  See Revenue Code Sec.72(t)(2)(A)(iv).

The IRS issued Revenue Ruling 2002-62, addressing rules governing this exception to the 10% penalty.  The ruling sets out three acceptable methods for determining payments under a series of substantially equal periodic payments:

(1) the required minimum distribution (RMD) method,

(2) the fixed amortization method, and

(3) the fixed annuitization method.

Each of the three methods requires use of a life expectancy table. The taxpayer can elect

  • the Uniform Lifetime Table,
  • the single life expectancy table, or
  • the joint and last survivor table.

Once chosen the table cannot be changed from year to year.

Methods (2) and (3) require the use of an interest rate assumption.  Revenue Ruling 2002-62 states that the interest rate used must not exceed 120% of the applicable mid-term rate for either of the two months preceding the month in which distribution begins.

Under the RMD method, the account balance is determined each year on a valuation date.  There is some flexibility in choosing the valuation date, but it is usually December 31.  The account balance is divided by the life expectancy determined from the applicable life expectancy table using the taxpayer’s age on the birthday falling within the distribution year. Using this method, there is a re-calculation of the payout each year.

Under the fixed amortization method, the initial account balance is determined.  That amount is amortized over the appropriate life expectancy using an interest rate not to exceed the limits set out above.  Once the initial payment is determined, it does not change but remains constant over the life of the arrangement.

Using the fixed annuitization method, an interest rate is selected (not to exceed the limits set out above) and using the appropriate mortality table, an annuity factor is derived.  The initial account balance is divided by the annuity factor and a payment determined.  Once determined, the payment does not change over the life of the arrangement.  The easiest way to get this number, in practice, is to ask a life insurance company for a quote.

Once a series of substantially equal periodic payments is commenced, it must continue for at least five years or until age 59-1/2, whichever comes last.  If the arrangement is terminated or the payments are changed prior to that time, the taxpayer will be assessed the 10% penalty plus interest for all payouts prior to the later of five years or age 59-1/2.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – October 4

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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: What is modified adjusted gross income (MAGI), and why is it important?

Answer: MAGI is used in many important decisions regarding IRAs.  For example, any taxpayer may make a traditional IRA contribution, but if the taxpayer (or spouse) is covered by an employer retirement plan, the deductibility of the contribution phases out at certain levels of MAGI.  Further, a taxpayer may be ineligible to make Roth IRA contributions if MAGI is too high.

Here are a few tips about MAGI, which are related to questions we often get asked.

  • MAGI is not reduced by deductible traditional IRA contributions
  • Capital gains are included in MAGI
  • MAGI can be reduced by contributing to 401(k) or 403(b) plans

Here’s a quick way to calculate MAGI using Form 1040.  Take the last number on the bottom of the first page of the return, “adjusted gross income,” and recalculate it by adding back in the following amounts:

  • IRA deduction
  • Student loan interest deduction
  • Exclusion of qualified savings bond interest shown on form 8815.
  • Tuition and fees deduction
  • Domestic production activities deduction
  • Foreign earned income exclusion
  • Foreign housing exclusion or deduction
  • Exclusion of employer-provided adoption benefits shown on Form 8839.

In addition, two special rules apply to Roth IRAs:  If the taxpayer does a Roth conversion during the tax year, the income reported as a result of the conversion is not included in MAGI for Roth IRA purposes.  Likewise, if the participant had to take a distribution from a traditional IRA in order to meet the RMD rules, the amount equal to the RMD is not included in MAGI for Roth purposes.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – September 29

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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: I believe that my client contributed too much to her IRA in 2010.  What are the penalties associated with the excess contribution?

Answer: For 2010, the maximum contribution an individual can make to a traditional and/or Roth IRA(s), if under age 50, is the lesser of $5,000 or earned income.  An individual age 50 or older may contribute the lesser of $6,000 or earned income.  A contribution greater than these maximums is excessive.

An excessive contribution will also result if an attempted rollover from another IRA or qualified plan proves invalid. A defective rollover could occur, for example, because the 60-day limit for rollovers was exceeded, a portion of the rolled amount was subject to minimum distribution requirements and thus not eligible for rollover, or for numerous other reasons. Of course, a properly executed rollover will not be considered an excessive contribution no matter how large in amount.

If a taxpayer does not make a corrective distribution, a 6% penalty tax will be imposed on the excessive amount, for the current year and for every subsequent year, until the excess contribution is eliminated.

A taxpayer can correct an excessive contribution, and thus avoid a 6% penalty tax, by taking a corrective distribution on or before the due date of his tax return, including extensions, for the tax year during which the excessive contribution was made.  To make a corrective distribution, the individual must withdraw the excess contribution plus any income attributable to the excess amount (or minus any loss so attributable).

The portion of the corrective distribution representing the return of the excess contribution itself is not included in taxpayer’s taxable income.  However, that part of the distribution which constitutes earnings, if any, on the excess contribution, will be taxed.  If taxpayer is under age 59 1/2, this taxable portion of the distribution will also be subject to the 10% early withdrawal penalty, unless an exception applies.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.