Individual Retirement Plans

<span style="font-weight: 400;">Final regulations released in 2024 offer significant flexibility when an account owner names multiple beneficiaries.  In these cases, when the original owner fails to take their full RMD prior to death, the beneficiaries can structure the RMD as they see fit.</span><br /> <br /> <span style="font-weight: 400;">In other words, the RMD can be distributed to any beneficiary.<a href="#_ftn1" name="_ftnref1">¹</a></span><span style="font-weight: 400;">  One single beneficiary could take the entire RMD or the RMD can be divided in any way among the multiple beneficiaries.  </span><br /> <br /> <b>Planning Point</b><span style="font-weight: 400;">: Because these distributions are fully taxable—and beneficiaries may be in different tax brackets.  It may be beneficial to allocate more of the RMD to beneficiaries in the lowest tax brackets.</span><br /> <br /> <span style="font-weight: 400;">Under prior law, many believed that each beneficiary was required to take their proportionate share of the total RMD, based on each beneficiary’s interest in the decedent’s retirement accounts.</span><br /> <br /> <span style="font-weight: 400;">A special rule now applies in cases where a decedent names multiple beneficiaries and also has multiple accounts.<a href="#_ftn1" name="_ftnref1">²</a></span><span style="font-weight: 400;">  For example, assume a situation where an individual has two IRAs.  If they wish to provide for multiple beneficiaries without each knowing what the other received, they could simply name different beneficiaries to different accounts.</span><br /> <br /> <span style="font-weight: 400;">The IRS has created a special rule for these situations.  The special rule applies if (1) the original owner dies before taking their full RMD for that year, (2) had multiple retirement accounts and (3) the beneficiary designations with for all of those accounts are not identical.</span><br /> <br /> <span style="font-weight: 400;">In this case, each of the individual’s accounts must distribute an amount that is proportionate to the entire account balance.  That’s true regardless of whether the original owner had taken part of their RMD for the year from one of the accounts.</span><br /> <br /> <span style="font-weight: 400;"><strong>Example:</strong> Assume Peter died with two IRAs, one valued at $100,000 and the other at $25,000.  He names his two children as equal beneficiaries to the $100,000 IRA.  He names his two nephews as equal beneficiaries to the $25,000 IRA.  He had not yet taken his annual RMD when he passed away.  Based on a total account balance of $125,000, 80% of the RMD must come from the $100,000 IRA and 20% from the $25,000 IRA.</span><br /> <br /> <b>Planning Point:</b><span style="font-weight: 400;"> It is fairly easy for each beneficiary to calculate how much the others inherited.  Because of this rule, clients with health issues or serious privacy concerns may wish to consider taking their RMD earlier in the year to reduce the risk that their account values and beneficiary choices will become generally known to all account beneficiaries.</span><br /> <p style="text-align: center;"><strong>Automatic Waiver for Beneficiaries</strong></p><br /> <span style="font-weight: 400;">Account beneficiaries who failed to take the original account owner’s RMD by December 31 would have been subject to the 25% penalty for failure to take the RMD on time.  Recognizing that beneficiaries who inherit accounts late in the year may face administrative and other difficulties, the final regulations retain the automatic waiver of the excise tax that applies in the case of an individual who had a minimum distribution requirement in a calendar year and died in that calendar year before taking their RMD.  </span><br /> <br /> The final regulations offer even more flexibility by extending the deadline for the beneficiary to take the missed RMD and be eligible for the automatic waiver. The new deadline is the later of (1) the beneficiary's tax filing deadline for the tax year that begins with or within the calendar year in which the individual died and (2) December 31 of the following calendar year.<a href="#_ftn1" name="_ftnref1">³</a><br /> <br /> <strong>1.    </strong>Treas. Reg. §1.401(a)(9)-5(c).<br /> <br /> <strong>2.    </strong>Treas. Reg. §1.408-8 (e)(4)<strong><b>.</b></strong><br /> <br /> <strong>3.    </strong>Treas. Reg. § 54.4974-1.

<div class="Section1">Tax-free rollovers ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4008">4008</a>) may be made from one SIMPLE IRA to another SIMPLE IRA at any time, but a rollover from a SIMPLE IRA to a traditional IRA is permitted only in the case of distributions to which the 25 percent early distribution penalty does not apply ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3709">3709</a>).<a href="#_ftn1" name="_ftnref1">¹</a> During the two year period that the 25 percent penalty is imposed, such a transfer would be treated as a distribution from the SIMPLE IRA and a contribution to the other IRA that does not qualify as a rollover contribution.<a href="#_ftn2" name="_ftnref2">²</a> To the extent that an employee is no longer participating in a SIMPLE IRA plan and two years have expired since the employee first participated in the plan, the employee may treat the SIMPLE IRA account as a traditional IRA.<a href="#_ftn3" name="_ftnref3">³</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;408(d)(3)(G).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Notice 98-4, 1998-1 CB 25.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; General Explanation of Tax Legislation Enacted in the 104th Congress (JCT-12-96), p.&nbsp;141 (the 1996 Blue Book).<br /> <br /> </div></div><br />

<div class="Section1">An endowment contract is a policy under which a person is paid a specified amount of money on a certain date unless he or she dies before that date, in which case, the money is paid to a designated beneficiary. Endowment proceeds paid in a lump sum at maturity are taxable only if the proceeds are more than the cost of the policy. To determine the cost, subtract any amount previously received under the contract, and exclude from income the total premiums (or other consideration) paid for the contract. Include the part of the lump sum payment that is more than the cost in income.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> If no nondeductible contributions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3656">3656</a>) have been made by the taxpayer to any traditional individual retirement plan, the portion of the death benefit of an endowment contract equal to the cash value immediately before death is included in gross income as a federal income taxable distribution. The balance is federal income tax-free as proceeds of life insurance under IRC Section&nbsp;101(a). If the death benefit is paid in installments, the amount representing life insurance proceeds is prorated and recovered tax-free under IRC Section&nbsp;101(d).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> If nondeductible contributions to any such individual retirement plan have been made, it would seem that a portion of the cash value of the contract should be treated as a recovery of basis and, as such, nontaxable ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3671">3671</a>).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRS Pub. 17 (2019).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.408-3(e)(2).<br /> <br /> </div></div><br />

<div class="Section1">Prior to TRA &rsquo;84, the IRC provided for the issuance of retirement bonds.<a href="#_ftn1" name="_ftnref1">¹</a> These bonds were issued by the U.S. government, with interest to be paid on redemption. Sales of these bonds were suspended as of April&nbsp;30, 1982.<a href="#_ftn2" name="_ftnref2">²</a> Subsequently, the Treasury Department announced that existing bonds could be redeemed by their holders at any time without being subject to an early distribution penalty ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3677">3677</a>).<a href="#_ftn3" name="_ftnref3">³</a> Existing bonds also can be rolled over into other individual retirement plans under rules applicable to rollovers from individual retirement plans ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4004">4004</a>).<a href="#_ftn4" name="_ftnref4">⁴</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;409, as in effect prior to repeal by TRA &rsquo;84.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Treasury Release (4-27-82).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Treasury Announcement (7-26-84).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; IRC &sect;&nbsp;409(b)(3)(C), prior to repeal.<br /> <br /> </div></div><br />

<div class="Section1">The penalty under IRC Section 72(t) will not be applied if, as a result of applying an acceptable method of determining substantially equal periodic payments, an individual depletes his or her account and is unable to complete the payouts for the required duration period under IRC Section 72(t)(4).<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   Rev. Rul. 2002-62, 2002-2 CB 710, §§ 2.03(a) and 3.<br /> <br /> </div>

<div class="Section1"><em>Editor&rsquo;s Note: <em>See</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3691">3691</a> for a discussion of the substantial changes the SECURE Act made to the distribution rules governing IRAs inherited by non-spouse beneficiaries. The rules below apply to tax years beginning before 2020.<div class="Section1"><br /> <br /> Prior to 2020, the minimum distribution requirements that applied after the death of an IRA owner depended on whether the IRA owner died before (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3688">3688</a>) or after (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3689">3689</a>) the required beginning date.<br /> <br /> Distributions generally were treated as having begun in accordance with the minimum distribution requirements under IRC Section&nbsp;401(a)(9)(A)(ii). If distributions irrevocably (except for acceleration) began prior to the required beginning date in the form of an annuity that meets the minimum distribution rules, the annuity starting date would be treated as the required beginning date for purposes of calculating lifetime and after death minimum distribution requirements.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.401(a)(9)-6, A-10; Treas. Reg. &sect;&nbsp;1.408-8, A-1.<br /> <br /> </div></div><br />

<div class="Section1">An IRA offers tax-free build up on contributions. The earnings on a traditional IRA are tax deferred to the owner; that is, they are not taxed until the owner begins receiving distributions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3671">3671</a>). The earnings on a Roth IRA may or may not be taxed upon distribution ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3673">3673</a>). Like a trust that is part of a qualified plan, an individual retirement account is subject to taxes for its unrelated business income ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3974">3974</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4098">4098</a>).<div class="Section1"><br /> <br /> Tax deferral is lost if an individual engages in a prohibited transaction ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3980">3980</a>) or borrows under an individual retirement annuity. The loss occurs as of the first day of the tax year in which the prohibited transaction or borrowing occurred.<a href="#_ftn1" name="_ftnref1">¹</a> For an account established by an employer or association of employees, only the separate account of the individual loses its deferred status.<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Prohibited transactions include: borrowing money from the IRA, selling property to it and using IRA assets for personal use or as security for a personal loan. Additionally an IRA is prohibited from investing in collectibles (e.g. artwork, antiques, stamps) and life insurance.<br /> <br /> <hr><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;408(e); Treas. Reg. &sect;&nbsp;1.408-1.<br /> <br /> </div></div><br />

<div class="Section1">The IRS has ruled that interest paid on amounts borrowed to fund an IRA is not allocable to tax-exempt income ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3652">3652</a>). Therefore, the deduction of such interest is not subject to the general prohibition against deducting interest incurred or carried to purchase tax-exempt assets.<a href="#_ftn1" name="_ftnref1">¹</a> Because such interest is &ldquo;on amounts borrowed to buy or carry property held for investment,&rdquo; it would seem that it should be classified as &ldquo;investment interest expense&rdquo; and the deduction limited.<div class="Section1"><br /> <br /> Interest paid on money borrowed to buy property held for investment is investment interest. Such interest is deductible but generally limited to the taxpayer&rsquo;s net investment income for the year.<a href="#_ftn2" name="_ftnref2">²</a> Generally, interest incurred to produce tax-exempt income is not deductible.<br /> <br /> Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which the taxpayer did not materially participate (other than a passive activity).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Let. Rul. 8527082. <em><em>See</em> </em>IRC &sect;&sect;&nbsp;163(a), 265.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;163(d).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; IRS Publication 550 (2018).<br /> <br /> </div></div><br />

<div class="Section1">Sequence of returns risk is a market volatility issue surrounding the order in which returns on a taxpayer’s investments occur when the taxpayer is taking distributions or withdrawals from the portfolio.</div><br /> <div class="Section1"><br /> <br /> Essentially, if a greater proportion of low or negative returns occur during the early years of retirement, when taxpayer is taking withdrawals, the taxpayer’s overall returns are going to be lower than if those negative or low returns occurred at a later point in the taxpayer’s (and the investment’s) lifetime. Mathematically, this is because the withdrawal of a fixed dollar amount from a portfolio when the portfolio value is down requires the liquidation and distribution of a larger percentage of the portfolio than would be required when the portfolio value is high. These early low (or negative) returns and distributions have a larger impact on the compounded value of the portfolio if they occur in early years. Negative returns could even cause a portion of the principal investment to be lost.<br /> <br /> Even if the return is simply lower than average in the early years while distributions are being taken, the investment will generate an overall lower return because the investment will gain less value early on, meaning there will be a lower account value to generate growth even in later, higher return periods.<br /> <br /> When the taxpayer is making withdrawals from his or her investment accounts, the risk of outliving the retirement assets is magnified when negative returns occur in early years.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> Financial planners modeling sequence of returns risk for their clients can illustrate the potential impact of (1) reducing market volatility of the overall portfolio, (2) reducing withdrawal amounts in early years or delaying withdrawals from the portfolio in down markets, and (3) maintaining a balanced portfolio so that withdrawal amounts can be paid from assets with a stable asset value rather than from selling volatile assets in a depressed market – as strategies to mitigate the potential impact of sequence of returns risk.<br /> <br /> <hr /><br /> <br /> </div>

<div class="Section1">Distributions from traditional and Roth IRAs are not subject to the 3.8 percent net investment income tax (also known as the Medicare contribution tax) imposed under the Affordable Care Act. The tax equals 3.8 percent of the lesser of a taxpayer’s net investment income for the taxable year, or the excess (if any) of the taxpayer’s modified adjusted gross income for the year, over a threshold amount ($200,000 for a taxpayer filing an individual return and $250,000 for a taxpayer filing jointly).<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> IRC Section 1411 specifically excludes distributions from both traditional and Roth IRAs and other qualified plans from the definition of “net investment income.”<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> While taxable distributions from traditional IRAs are not subject to the net investment income tax, they do increase a taxpayer’s modified adjusted gross income (MAGI) for the year. A higher MAGI may expose taxpayer’s other investment income (or increase taxpayer’s exposure) to this 3.8 percent tax. Planners should consider the effect of an IRA distribution on a client’s MAGI and exposure to the net investment income tax.<br /> <br /> <hr /><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRS Publication 550 (2018).<br /> <br /> </div>