Advanced Underwriting Consultants

Question of the Day – May 28

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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 is 73, and she missed taking RMDs from her IRA for 2011 and 2012.  We just discovered the mistake.  What do we need to do with regard to past tax returns?

Answer:  If the client turned 70 ½ in calendar year 2010, she had until April 1, 2011 to take her RMD.  Her second RMD would have been due by December 31 of 2011, and the third one was due on or before December 31, 2012.

If the client fails to take the RMD by the deadline, the IRS imposes a special penalty tax of 50% on the amount that should have been distributed.  The penalty tax may be waived if

  • the taxpayer convinces the IRS that the failure to take the RMD was due to reasonable error, and
  • that reasonable steps are being taken to fix the problem.

A taxpayer applying for relief from the penalty tax must file IRS Form 5329 for the year in question and attach a letter of explanation. The instructions say that if the return is already filed, then Form 5329 can be filed separately for each year if it won’t otherwise change taxable income.

That means that for calendar year 2011, the client can file a Form 5329 by itself.

For calendar year 2012, if the client has not yet filed a final income tax return for the year, Form 5329 would be filed with the return.  If the return has already been filed for 2012, Form 5329 would be filed by itself.

To maximize her chances that the IRS will waive the penalty tax, the taxpayer will want to take the RMDs she should have taken in 2011 and 2012 before filing the Form 5329s.  That means the IRA distribution will show up as taxable on the calendar year 2013 return.

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 11

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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 73 year old client participated in a designated Roth account as part of her former employer’s 401K plan.  She left a substantial balance in the account when she retired earlier this year.  Is she required to take required minimum distributions (RMDs)?

Answer:  Yes.

The RMD rules that apply to regular 401K account balances also apply to designated Roth accounts.  If the client was not an owner of the company sponsoring the plan and retired from the plan-sponsoring employer this year, she must take an RMD from the account based on the December 31, 2012 designated Roth account balance.

The first RMD must be taken on or before April 1, 2014.

The client can avoid having to take post-2013 RMDs during her lifetime by rolling over the designated Roth account to a Roth IRA.  Roth IRAs have no RMD requirements while the taxpayer is still alive.

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 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:  My client is the beneficiary of her brother’s IRA.  The brother had begun taking RMDs prior to his death.  My client wants to stretch her IRA distributions.  What are her choices?

Answer:  If the decedent had reached the RBD at the time of death, a non-spouse beneficiary has the option to stretch over the longer of

  • the beneficiary’s life expectancy, calculated using the single life table factor for the year after the decedent’s death, and reducing that factor by one for each calendar year that elapses thereafter, or
  • the remaining life expectancy of the owner, determined using the age of the owner in the calendar year of his death, reduced by one for each calendar year that elapses thereafter.

Here’s an example of how the post-RBD stretch works:

Charlie, age 72, dies in 2013 with a sister, aged 74, named as beneficiary.  The Uniform Life Table factor for a 72 year old is 25.6.  The 12/31/2012 account balance would be divided by 25.6.  That amount would have to be distributed to the sister to satisfy Charlie’s RMD for 2013.  In 2014, the daughter will be 75 and the Single Life Table factor is 13.4.  Since the Uniform Lifetime Table factor for the decedent’s year of death minus one (24.6) is higher than the beneficiary’s Single Life Table factor, 24.6 will be used to calculate the 2014 RMD.  The beneficiary will subtract one from the 2014 factor to calculate the 2015 factor, and divide the 12/31/2014 account balance by 23.6 to calculate the 2015 RMD.

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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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 the beneficiary of a non-qualified deferred annuity (NQDA) inherited from her mother in 2008.  The client has not yet taken any distributions from the inherited account.  What are her RMD obligations?

Answer:  The non-spouse beneficiary of an NQDA generally has two options for taking distributions from the inherited account.  The first is that the beneficiary may take annual distributions based on the beneficiary’s life expectancy beginning in the year after the original owner died.

If that method is not chosen, the beneficiary must take a complete distribution of the account before the end of the fifth year after the original owner’s death.

It appears that the IRS will allow a tax-free transfer of an inherited NQDA to another NQDA account.  However, the new account is still subject to the RMD rules described above.

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 – September 30

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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’s the deadline for my client, who has inherited an IRA from a nonspouse, to elect to stretch out payments from the IRA based on the client’s life expectancy?

Answer: Under Treasury Regulations 1.401(a)(9)-3, a nonspouse beneficiary choosing to take payments based on the life expectancy method must begin payments by the end of the calendar year following the taxpayer’s death.

For nonspouse beneficiaries who inherit an IRA from a decedent who had not yet begun RMDs, the choice is usually between the stretch based on life expectancy, and complete distribution within five years.  Where the beneficiary does not choose the life expectancy method, complete distribution within five years is usually chosen.

The IRS, in Private Letter Ruling 200811028, said that even when a nonspouse beneficiary failed to elect stretch for several years after the taxpayer’s death, the beneficiary could still make a late stretch election.  The beneficiary would have to pay the 50% penalty tax for failure to take the prior RMDs due for the year after the taxpayer’s death and any following years.

Why would the beneficiary voluntarily pay such a hefty tax penalty?  In some cases, the value of preserving the option to pay out the IRA over the beneficiary’s life expectancy—and deferring taxes on those required payments—would more than offset the penalty tax on the undistributed RMDs.

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.