Retirement Issues

<div class="Section1">One critical issue that clients may overlook when transferring Roth assets pursuant to a divorce settlement is the so-called “five-year rule” that applies to distributions from Roth IRAs.</div><br /> <div class="Section1"><br /> <br /> Typically, all withdrawals from a Roth IRA are taken on a tax-free basis. That includes both contributions and earnings on those contributions because the account owner pays taxes on the contributions before they are contributed.<br /> <br /> However, the distribution must be a “qualified distribution” for the earnings on after-tax contributions to receive tax-free treatment. A distribution is only “qualified” if it is taken after the five-year period beginning with the first tax year that the owner opened the Roth IRA and made a contribution to the account. This is known as the “five-year rule.”<br /> <br /> Distributions that are taken within five years of the date the account is opened will be subject to ordinary income tax to the extent that those distributions represent earnings on after-tax contributions. In other words, the contributions themselves will not be subject to tax a second time. The distribution could, of course, be subject to the 10 percent early withdrawal penalty if the client is not yet 59 ½ (unless another exception to the penalty applies).<br /> <br /> The IRS does not provide concrete information when it comes to understanding how the five-year rule applies when one spouse transfers a part of their Roth IRA assets to a former spouse as part of a divorce settlement. However, the IRS has offered guidance on how the five-year rule works when someone inherits a Roth IRA.<br /> <br /> When a client inherits a Roth IRA, they do not have to restart the five-year clock. The period that the original account owner had the assets in the Roth IRA transfers to the beneficiary. For example, if the original account owner had opened and funded the account three years prior to their death, the beneficiary only must wait two years before earnings on account contributions can be withdrawn tax-free.<br /> <br /> Most tax experts agree that these rules also apply when a client who owns a Roth IRA transfers those funds to a former spouse incident to divorce. The character of the account assets (as either after-tax contributions or earnings on those contributions) should also transfer to the former spouse. The amount transferred to the former spouse will also contain a pro-rata combination of contributions and earnings.<br /> <br /> It is also possible that a client could be impacted by the five-year rule if they have to withdraw Roth IRA funds sooner than expected because of a divorce. For example, the client may need the funds to pay for a new home or cover attorneys’ fees. Those funds may not always be tax-free if the account has been open for less than five years. It is also possible that early withdrawal penalties could apply unless the client qualifies for one of the exceptions to the<br /> 10 percent early distribution penalty.<br /> <br /> Once a divorce becomes final, each spouse can continue contributing to their own Roth IRAs as long as they satisfy the income restrictions that apply to Roth IRAs.<br /> <br /> </div>

<div class="Section1">Violating the “once per year” IRA rollover rule is an expensive mistake that cannot simply be corrected or waived. Because the IRS cannot waive a violation of the once-per-year rule, it’s especially important to pay close attention to avoid falling into the potential traps that can cause the client to violate the rule and incur significant tax consequences.</div><br /> <div class="Section1"><br /> <br /> Taxpayers can complete nontaxable rollovers between IRAs as long as the funds from the first IRA are deposited into the second IRA within 60 days. However, the taxpayer can only do this once in any 12-month period. If the taxpayer makes a second rollover within 12 months of the first rollover, the entire amount that was intended for rollover will be deemed distributed in a fully taxable transaction.<br /> <br /> If the taxpayer was not eligible to withdraw funds from the IRA because he or she had not reached age 59 ½, the taxpayer can also be subject to the 10 percent early withdrawal penalty on top of his or her ordinary income tax rates. The rollover can also trigger the 6 percent tax on excess IRA contributions if the mistake is not corrected on time.<br /> <br /> The rule applies to all IRAs—including traditional IRAs and Roth IRAs. It does not apply to rollovers between IRAs and employer-sponsored 401(k) plans. The rule also applies to all types of IRAs, so if the taxpayer has a SEP IRA, SIMPLE IRA or Roth IRA, the taxpayer is limited to one rollover per year across all types of accounts (Roth conversions do not count as rollovers).<br /> <br /> The one IRA-to-IRA rollover per year rule applies regardless of how many IRAs the taxpayer has. This represents a change from prior thinking, where many believed that taxpayers with multiple IRAs could complete one tax-free rollover <em>per IRA</em> per year. The IRS confirmed that this new interpretation will be enforced beginning January 1, 2015.<br /> <br /> The once-per-year rule is not actually a calendar year rule. It applies on a 12-month basis. The taxpayer cannot, therefore, complete one rollover late in 2023 and another early in 2024 without penalty.<br /> <br /> Taxpayers who inherit IRAs from a deceased spouse must also watch out for the once-per year rule. If the taxpayer has executed another IRA rollover within the preceding 12-month period, that taxpayer cannot immediately roll the inherited funds into his or her own IRA. Instead, the surviving spouse must wait until 12 months have passed from the date of the previous rollover in order to avoid violating the rule.<br /> <br /> Taxpayers with certificates of deposits (CDs) that are actually registered as IRAs should also be advised of the rule when determining how to treat the matured CD funds—remembering that many taxpayer may not even realize that their CD investment is actually registered as an IRA in their name.<br /> <br /> The simplest way to avoid violating the once-per-year rollover rule is to move IRA funds via direct trustee-to-trustee transfer between financial institutions. These direct transfers accomplish the goal of consolidating accounts, but they are not treated as rollovers.<br /> <br /> Perhaps the most confusing aspect of the once-per-year rule is that it actually applies to distributions of IRA funds. It is the date when the taxpayer receives the distribution from the IRA that is actually relevant in determining whether 12 months have elapsed.<br /> <br /> If the taxpayer receives “distribution A” on November 15, 2024 and rolls it into another IRA on December 15, 2024, and later receives “distribution B” on November 20, 2025, the client can roll distribution B into an IRA on November 21, 2025 without violating the rule. That’s because more than 12 months have passed between her receipt of distribution A and distribution B.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> The once-per-year IRA rollover rule is complicated. For most clients, the best solution is likely to rely on direct transfers of IRA funds between accounts to avoid the serious tax consequences that one simple mistake can generate.<br /> <br /> <hr /><br /> <br /> </div>

<div class="Section1">The original SECURE Act sharply limited the distribution options for most IRA beneficiaries who inherit accounts in 2020 or thereafter. Surviving spouses are one of the few enumerated groups of individuals who continue to be eligible for taking inherited IRA distributions over their life expectancy post SECURE Act. However, as before the SECURE Act, surviving spouse beneficiaries have multiple options when it comes to determining how to treat an IRA that was inherited from a spouse. The choice the surviving spouse makes will impact the rate of distributions that must be taken from the inherited IRA—which, of course, can have a substantial impact on the survivor’s tax liability over the years. Because surviving spouses have a limited amount of time to make their election, it’s important to ensure that clients understand their choices—and the consequences of those choices.</div><br /> <div class="Section1"><br /> <br /> Surviving spouses can, of course, continue to treat the IRA as a beneficiary (inherited) IRA like any other designated beneficiary. They also have the option of rolling the inherited account balance into their own IRA or an employer-sponsored retirement account. As a third option, surviving spouses can elect to treat the inherited IRA as their own.<br /> <br /> Under proposed regulations related to the SECURE Act, however, the IRS has clarified that the surviving spouse has only a limited amount of time to elect to treat the IRA as their own.<br /> <br /> Under those proposed regulations, the surviving spouse must make the election before the later of (1) the end of the year in which the surviving spouse reaches their required beginning date or (2) the end of the year following the year of the original account owner’s death.<br /> <br /> The spouse beneficiary’s RMD obligations will depend on how they elect to treat the account. If the spouse treats the inherited IRA as an inherited IRA, the account will be registered in both the name of the deceased spouse and the surviving spouse (surviving spouse as beneficiary of deceased spouse). As an “eligible designated beneficiary,” the spouse beneficiary can take RMDs using their own life expectancy or the ten-year rule. The ten-year rule may be required under the terms of the IRA agreement or if the spouse beneficiary makes the election.<br /> <br /> Under the beneficiary IRA option, RMDs must begin by the later of (1) December 31 of the year after the year the original owner died or (2) the year in which the original owner would have been required to start taking RMDs.<br /> <br /> If the spouse beneficiary treats the inherited IRA as their own, they simply redesignate the account in their own name. RMDs are calculated based on the individual’s own life expectancy using the Uniform Lifetime Table.<br /> <br /> While the spouse beneficiary can roll over amounts to their own IRA, they cannot roll over RMDs. That means they could be subject to a pre-rollover RMD requirement if some time has passed since the original account owner’s death.<br /> <br /> Before rolling over the account balance, the spouse beneficiary must take a distribution if both of the following are true: (1) the rollover is occurring before the end of the ten-year period that applies to inherited IRAs and (2) the rollover is occurring after the spouse beneficiary reaches their required beginning date.<br /> <br /> The RMD amount is the RMD that would have been required for the years prior to the year of rollover had the spouse used the life expectancy distribution method instead of the ten-year rule (reduced by any distributions that the spouse beneficiary actually took during those years). Once the rollover is complete, further RMDs are calculated using the Uniform Lifetime Table.<br /> <br /> Although time is limited for a surviving spouse to elect to treat the IRA as their own, surviving spouses may continue to initially treat the IRA as a beneficiary IRA and later elect to roll the account funds into their own IRA. However, the surviving spouse may be subject to the RMD requirement discussed above because the survivor is not entitled to roll over RMDs into their own account.<br /> <br /> For spouse beneficiaries who are under age 59 ½, however, leaving the funds in a “beneficiary IRA” has an added benefit. Distributions will be exempt from the 10 percent early distribution penalty that would apply if the surviving spouse took a distribution from an IRA treated as their own. IRA custodians must elect “Code 4” in Box 7 of the taxpayer’s Form 1099-R.<br /> <br /> Spouse beneficiaries who elect to treat the account as their own have the ability to make contributions, convert funds to a Roth account or roll funds over under the traditional IRA rules.<br /> <br /> Once a taxpayer makes the decision to roll the inherited IRA into their own account or treat the inherited IRA as their own, they cannot later revoke those decisions. Beneficiaries who are uncertain may wish to initially register the inherited IRA as a beneficiary IRA and roll the funds over into their own account if the move is preferential from a tax standpoint.<br /> <br /> </div>

After the original SECURE Act was signed into law, taxpayers and advisors quickly realized that the inherited IRA had lost a key quality: the ability for beneficiaries to stretch the associated tax liability over their lifetime.  The IRS further limited the tax deferral benefit by releasing proposed regulations that require beneficiaries to take taxable distributions each year.  Now, many individuals are searching for alternatives to replace the so-called “stretch” IRA.<br /> <br /> <strong> </strong>Before the SECURE Act became law, inherited IRA beneficiaries could stretch the tax liability associated with these accounts over their own life expectancy.  Post-SECURE, only eligible designated beneficiaries (EDBs) have that option.  EDBs include (1) surviving spouses, (2) disabled or chronically ill beneficiaries, (3) beneficiaries who are not more than ten years younger than the original IRA owner and (4) the original IRA owner’s minor children (until they reach age 21).<br /> <br /> All other beneficiaries must empty the account within ten years of the original IRA owner’s death (paying ordinary income taxes on those distributions).  Before the IRS released proposed regulations, most experts believed that beneficiaries wouldn’t have to take RMDs during the first nine years, leaving the option of deferring all taxes until year 10.<br /> <br /> The regulations changed that rule for beneficiaries of IRAs where the original owner died after his or her required beginning date (the date RMDs began).  Those beneficiaries are also required to take annual RMDs during years 1-9 after the original IRA owner’s death.  Any remaining amounts must be distributed in year 10 (the IRS granted relief through 2024).<br /> <p style="text-align: center;"><strong>Roth Conversions</strong></p><br /> <strong> </strong>The SECURE Act regulations make Roth conversions more appealing for beneficiaries.  However, the SECURE Act also modified the rules governing inherited Roth IRAs.  Those beneficiaries will now be required to empty the account in ten years if they do not qualify as an EDB.<br /> <br /> Roth IRAs are still appealing despite the change because Roth IRAs are not subject to RMD rules during the original IRA owner’s life.  Roth IRA beneficiaries must take RMDs after the original owner’s death—but that owner will always be deemed to have died before their required beginning date because a Roth can never go into pay status because there is no required beginning date (i.e., the original owner did not have to take RMDs during life in the first place).<br /> <br /> Any Roth IRA beneficiary can wait until year ten to empty the account—allowing the funds to grow tax-deferred for another ten years.  Of course, those funds are nontaxable because the original account owner paid taxes on Roth contributions during life, but the earnings will be tax-free as well.<br /> <br /> It is possible to minimize the original owner’s tax liability by executing Roth conversions after retirement, when the taxpayer may have entered a lower income tax bracket.<br /> <p style="text-align: center;"><strong>The Charitable Remainder Trust Option</strong></p><br /> Clients might also consider establishing a charitable remainder trust (CRT) and naming the CRT as their IRA beneficiary.<br /> <br /> The CRT is an irrevocable trust that will provide income to the beneficiary each year, whether for life or over a predetermined term of years.  The amount of income received is based on the value of the assets the client has passed to the CRT (the amount is re-calculated each year).  At the end of the term, the remaining account value is paid to a qualified U.S. charity (the CRT must be structured so that the charity receives at least 10 percent of the donor’s contribution).<br /> <br /> The account owner’s estate will receive an estate tax deduction for the charitable gift.  The CRT distributions to beneficiaries are taxed as ordinary income.  On the other hand, using the CRT to distribute funds over the beneficiary’s lifetime gives the assets more time to grow, so that the heir’s overall inheritance may be larger in the end.<br /> <p style="text-align: center;"><strong>Life Insurance</strong></p><br /> If the taxpayer has already passed their required beginning date and are taking RMDs, the taxpayer may be interested in purchasing life insurance to pre-fund the beneficiary’s tax liability.  Life insurance proceeds are received income-tax-free by the beneficiary.  While they may be included in the owner’s estate, the estate tax exemption in 2024 is $13.61 million per individual—meaning that most will not have to worry about federal estate taxes (state inheritance and estate taxes may apply).<br /> <br /> Those life insurance proceeds can help younger generations fund the tax bill that will apply during the period in which inherited IRA distributions must be taken.

<div class="Section1">Because student loans may prevent employees from contributing to employer-sponsored retirement plans, employees with student loans become less likely to receive the benefit of employer matching contributions. Beginning in 2024, employers have the option of treating employees’ qualified student loan payments as elective deferrals for purposes of an employer’s matching contribution program under the SECURE Act 2.0.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> Not all payments are eligible—so it’s important for employers to understand the details of what constitutes a qualified student loan payment.<br /> <br /> <hr /><br /> <br /> Typically, employers make matching contributions to employer-sponsored retirement plans based on the participant’s elective deferrals to the plan. For example, an employer may offer a 50 percent matching contribution up to 5 percent of the employee’s salary. So, for every dollar the employee contributes, the employer contributes an additional 50 cents—up to the compensation limit.<br /> <br /> Historically, employees have only received this benefit if they have the funds to contribute to the account.<br /> <br /> Beginning in 2024 and beyond, employers will also be entitled to make matching contributions to an employer-sponsored retirement plan based on an employee’s qualified student loan payments—even if the employee does not directly contribute to the retirement plan.<br /> <br /> Student loan repayments are only treated as contributions to the plan for purposes of qualification testing. Further, employers are permitted to either include these matching contributions with their general non-discrimination testing or test participants who receive these loan-based matching contributions as a separate group.<br /> <br /> The provision applies to any type of employer-sponsored deferral-based retirement plan, including 401(k)s, 403(b)s, SIMPLE IRAs and governmental 457(b) plans. Under the new law, the employer must treat the qualified student loan payment match in the same manner as the employer’s deferral-based matching contribution.<br /> <br /> Only payments that are classified as qualified student loan payments can be considered in the employer’s matching program. A qualified student loan payment is one that is made on a loan taken for the sole purpose of paying qualified education expenses for the individual, a spouse or someone who was the individual’s dependent at the time the debt was incurred. The loan must be for education provided during an academic period for an eligible student and the expense must be paid or incurred within a reasonable period of time before or after the debt was incurred.<br /> <br /> Qualified education expenses include tuition, fees, books, and other similar required expenses incurred by an eligible student. An eligible student is someone who is enrolled at least half-time (with at least six credit hours) in some type of program of study that is designed to lead to a degree, certificate or other type of recognized education credential at an eligible education institution.<br /> <br /> Expenses incurred for games, sports, hobbies, or non-credit activities do not qualify.<br /> <br /> The law does not specify whether the student must have graduated from or completed the program in order for the related student loan debt to qualify. Because the student loan matching program is entirely optional, it seems possible that the employer may be entitled to decide whether graduation is a requirement for receiving the benefit.<br /> <br /> </div>

<div class="Section1">Roth IRAs are funded with after-tax dollars to generate tax-free income later in life, usually during retirement. The funds can be withdrawn tax-free once the taxpayer reaches age 59 ½.</div><br /> <div class="Section1"><br /> <br /> The direct after-tax contributions can be withdrawn tax-free at any time, but any earnings may generate tax liability (although the 10 percent penalty is waived if the funds are used to pay qualified education expenses).<br /> <br /> IRC Section 529 education savings plans are also funded with after-tax dollars that are permitted to grow on a tax-free basis. Section 529 plan distributions are not taxed when received if the funds are used to pay for qualified higher education expenses (a 10 percent penalty on the earnings portion may apply if the funds are not used for qualified expenses).<br /> <br /> Each savings plan has annual contribution limits. In 2024, the maximum that a client can contribute to a Roth IRA is $7,000 ($8,000 if the client is at least 50 years old). The contribution limit for 529 plans is based on the annual gift tax exclusion amount (clients can contribute up to $18,000 in 2024, or $36,000 for married couples. Clients also have the option of contributing five years’ worth of contributions to the Section 529 plan in a single year (up to $90,000 in 2024).<br /> <br /> Unlike Roth accounts, 529 plans are regulated at the state level. Options for funding these plans can vary significantly depending upon the state rules governing the plan. For example, the rules governing contribution deadlines vary by state. State laws also limit the amount that can be accumulated within the 529 plan over a lifetime (the aggregate limit varies from state to state and can be somewhere between $235,000 and $529,000).<br /> <br /> Many clients may question why they would use a Roth IRA, which is primarily geared toward retirement savings, to fund their child’s education expenses. In the past, the primary pro-Roth argument was that it is always possible that a child will not attend college (or will receive a scholarship) so that the 529 plan funds will not be needed. Under the SECURE Act 2.0, taxpayers will be permitted to roll up to $35,000 in Section 529 plan dollars into a Roth IRA beginning in 2024.<br /> <br /> Taxpayers who earn more than $240,000 (married couples) or $161,000 (individuals) in 2024 cannot contribute directly to a Roth IRA. These taxpayers can execute Roth conversions to fund the account, but those conversions generate current tax liability.<br /> <br /> For clients who are eligible to contribute directly to a Roth based on the annual income limits, the Roth may be more attractive than the Section 529 plan. Roth contributions are not counted against the annual or lifetime gift tax exclusion or exemption—while 529 contributions are treated as gifts that count toward these limits.<br /> <br /> Other clients might be more attracted to the Roth option if they have already maxed out their annual 529 contributions based upon state limits and want to save more to cover future education costs. The Roth option can also be useful for clients who might want to use the funds for retirement expenses should the child not need the funds for educational expenses—for example, because the child has received a scholarship or an attractive financial aid package.<br /> <br /> Despite this, clients should remember that earnings on Roth contributions are taxable if they are withdrawn within five years of opening the account. Further, if the client has no earned income for the year, the Roth contribution option is not available, but the 529 plan may still be a viable savings solution.<br /> <br /> Many states also offer a state income tax deduction or credit for contributions to Section 529 savings plans—while no states offer a similar deduction for Roth contributions.<br /> <br /> The impact of using the Roth or 529 plan funds upon the student’s financial aid eligibility must also be evaluated. Roth accounts generally are not reported as assets for FAFSA purposes, while 529 plans can impact the child’s eligibility for need-based financial aid. On the other hand, the Roth distributions themselves are counted as income for FAFSA purposes.<br /> <br /> </div>

<div class="Section1">While most IRA contributions are made with pre-tax dollars and generate current tax liability when converted, it is also possible that the taxpayer’s IRA could contain nondeductible contributions—called the IRA “basis.” Taxpayers are not required to pay tax on IRA basis when converting to a Roth. Tax on conversion is instead applied on a pro rata basis so that only pre-tax dollars are taxed. For taxpayers with after-tax IRA funds, it may be possible to use exceptions to this pro rata rule to isolate basis and execute an entirely nontaxable Roth conversion.</div><br /> <div class="Section1"><br /> <br /> Most traditional IRA contributions are made with pre-tax dollars to reduce the taxpayer’s current taxable income. However, once a taxpayer’s income exceeds the annual inflation-adjusted thresholds, the tax deduction for the original IRA contribution is no longer available (i.e., the taxpayer is not able to make pre-tax contributions to the IRA). A taxpayer can, however, make nondeductible contributions to an IRA even when their income is too high to qualify for a tax deduction.<br /> <br /> These nondeductible contributions form the “basis” in the IRA and can be converted (or withdrawn) tax-free (unlike traditional, deductible contributions, which are taxed when converted). After-tax funds that are rolled over from another retirement account will also be added to the account’s basis.<br /> <br /> In other words, it’s entirely possible that the taxpayer could have both pre-tax dollars and after-tax dollars in the traditional IRA. Taxpayers can’t “pick and choose” which dollars to convert to a Roth.<br /> <br /> The pro rata rule requires that a taxpayer include all IRA assets (both pre-tax and after-tax contributions) when determining the taxes due on a Roth conversion. For example, assume a taxpayer has $20,000 worth of nondeductible IRA assets and zero pre-tax dollars in the account. If the taxpayer converts the entire $20,000 to a Roth, the taxpayer will owe no tax on the conversion because no portion of the converted assets represent pre-tax (deductible) contributions.<br /> <br /> On the other hand, if the account contains both pre-tax and after-tax dollars, a proportionate percentage of each dollar converted will be taxable (so pre-tax contributions are taxed and after-tax contributions are not taxed again upon conversion. If the account contained $20,000 in nondeductible contributions and $10,000 in pre-tax contributions, 1/3 of the amount converted would be taxable under the pro rata rule.<br /> <br /> If the taxpayer can isolate the after-tax contributions (i.e., the account’s basis) so that no pre-tax dollars remain in the account, it’s possible to execute a tax-free Roth conversion. A few workarounds do exist to allow the taxpayer to remove pre-tax funds from the IRA and reduce (or eliminate) the need to calculate tax on conversion under the pro rata rule.<br /> <br /> Making a rollover from an IRA to an employer-sponsored 401(k) or retirement plan is perhaps the most widely used “exception” to the pro rata rule. Only pre-tax IRA contributions can be rolled into the employer-sponsored plan. This strategy can allow the IRA owner to remove pre-tax contributions from the IRA, isolating the IRA to solely after-tax contributions that can be used to execute a tax-free Roth conversion.<br /> <br /> Note, however, that the IRA-to-401(k) rollover strategy only works if the taxpayer has access to an employer-sponsored retirement plan that accepts IRA rollovers.<br /> <br /> Taxpayers who have reached age 70 ½ may wish to consider the qualified charitable distribution strategy. Once the taxpayer reaches age 70 ½, a transfer made directly from the IRA to a qualified charity (generally, 501(c)(3) organizations, but not donor-advised funds, foundations or charitable gift annuities) will count toward the taxpayer’s RMD and is entirely nontaxable. Only pre-tax contributions can be transferred via the QCD strategy.<br /> <br /> Taxpayers who are eligible to fund an HSA also have the option of rolling pre-tax IRA dollars into an HSA. The taxpayer can only execute one IRA-to-HSA transfer in a lifetime—and the amount transferred is limited to the annual HSA contribution limit for the year.<br /> <br /> </div>

<div class="Section1">Distributions from traditional retirement accounts are subject to harsh penalties on top of ordinary income taxes if the account owner takes a distribution before reaching age 59 ½. While several exceptions to the IRA early withdrawal penalty exist, most of those exceptions are not particularly helpful for those who merely need access to their funds because of an unexpected cash shortfall. On the other hand, one exception is available to all IRA owners, regardless of their circumstances and regardless of the purpose for the distribution. Taxpayers can structure a series of substantially equal periodic payments (SOSEPP) to gain access to their retirement funds without penalty—and for any reason.</div><br /> <div class="Section1"><br /> <br /> SOSEPPs are exempt from the 10 percent early distribution penalty that applies to traditional retirement account distributions prior to age 59 1/2. The IRA owner can set up a series of equal periodic payments (whether the payments are made monthly, quarterly or even annually) and avoid the penalty as long as the SOSEPP remains in place for the longer of (1) five years or (2) the date the recipient reaches age 59 1/2. If the SOSEPP is ended or modified prior to that time, the penalty applies (plus interest).<br /> <br /> The SOSEPP payment is calculated based on one of three different options (the fixed annuity option, the fixed amortization option or the RMD option) that mimic a draw-down of the account over the owner’s life expectancy. The most commonly used options are based on the individual’s life expectancy and an interest rate that has historically been based on the federal mid-term rate in effect for either of the two months prior to the start of the SOSEPP schedule (the rate could not exceed 120 percent of that federal mid-term rate).<br /> <br /> Beyond those rules, taxpayers are able to structure their payments using a single life expectancy or joint life expectancies of the IRA owner and designated beneficiaries.<br /> <br /> In recent years, the required interest rate for calculating SOSEPP amounts has been extremely low. In other words, the taxpayer’s payments were typically much lower than needed because of the low interest rate assumptions that were in place, so that the SOSEPP payment method was not useful for many individuals. Further, the IRS has updated life expectancy tables so that the SOSEPP would have been calculated using a longer life expectancy—which further reduced the SOSEPP payments if the SOSEPP was calculated using the annuity or amortization methods.<br /> <br /> The IRS released guidance in Notice 2022-06 that allows payment schedules beginning in 2022 and thereafter to use an interest rate that is as high as 5 percent (or the taxpayer can elect to use the old rules, meaning using 120 percent of the federal mid-term rate in effect for either of the prior two months).<br /> <br /> SOSEPPs that begin in 2022 could also be adopted using either the old life expectancy tables or the new life expectancy tables (it was unclear whether the client can opt to use the new 5% interest rate along with the old life expectancy tables, which would produce the highest SOSEPP amounts).<br /> <br /> This change provides an opportunity for plan participants to adopt the SOSEPP option and receive a higher periodic payment. Unfortunately, taxpayers with existing SOSEPPs are not permitted to modify their interest rate to take advantage of larger SOSEPPs.<br /> <br /> Taxpayers with existing SOSEPs who use the RMD distribution method (which does not rely on an interest rate) can switch to the new IRS life expectancy tables without being treated as if they “modified” the SOSEPP (in fact, they were required to switch beginning in 2023).<br /> <br /> </div>

<div class="Section1">Nearly every taxpayer is familiar with the concept of rolling funds from an employer-sponsored 401(k) into an IRA. The strategy is a common one for taxpayers once they are no longer employed by the company sponsoring the 401(k)—and can also give the taxpayer more control over the management of their retirement funds. On the other hand, rollovers from IRAs into company-sponsored 401(k)s are relatively rare. There are situations in which executing a “reverse rollover” from an IRA into a 401(k) can be advantageous, especially for those who are interested in minimizing their RMD obligations upon hitting their required beginning date.</div><br /> <div class="Section1"><br /> <br /> Taxpayers should first understand that a 401(k) plan is under no obligation to accept rollover contributions. While all 401(k)s must allow taxpayers to transfer funds out of the 401(k) into an IRA, the reverse is not true. So, before considering the reverse rollover strategy, the taxpayer should check with their plan sponsor to determine whether rollovers are accepted in the first place.<br /> <br /> Further, while taxpayers may be entitled to roll pre-tax IRA dollars into a 401(k), the IRS does not allow taxpayers to roll nondeductible or Roth IRA contributions back into a company-sponsored 401(k). In situations where the IRA contains both deductible and nondeductible contributions, the deductible contributions can be segregated and rolled over into the 401(k).<br /> <br /> While the benefits of a traditional 401(k)-to-IRA rollover are fairly clear, the benefits of executing a reverse rollover are less obvious. For the right taxpayer, the reverse rollover can allow the taxpayer to avoid taking required minimum distributions (RMDs) once the client reaches their required beginning age (which is currently age 73).<br /> <br /> Under the “still working” exception for 401(k)s, the taxpayer is not required to begin taking RMDs even after reaching the required beginning date if the taxpayer continues to work for the employer that sponsors the plan. Note, however, that the taxpayer can only take advantage of the still working exception if the client does not own more than 5 percent of the company and the plan allows delayed RMDs. The rules governing IRAs do not allow for delayed RMDs even if the taxpayer continues to work after reaching their required beginning date.<br /> <br /> An IRA-to-401(k) rollover can also help minimize tax liability if the taxpayer decides to execute a Roth conversion. Under the “pro rata rule,” the taxpayer must consider both deductible and nondeductible IRA contributions that exist as of December 31 of the year of conversion when funding a backdoor Roth using the conversion strategy.<br /> <br /> If the IRA contains pre-tax dollars and after-tax dollars, at least a portion of the amount converted will be taxed in the year of conversion. However, if the taxpayer rolls all pre-tax funds into the 401(k) during the year of conversion, the Roth conversion will be nontaxable (similarly, if the taxpayer rolls a portion of the pre-tax dollars into the 401(k), a smaller portion of the amount converted will be taxable).<br /> <br /> Taxpayers who are interested in taking a loan from their retirement plan may also be interested in the reverse rollover option. 401(k)s can allow participants to take loans from the plan, while IRAs do not offer a similar option (however, it is important to check with the specific 401(k) because 401(k)s are not required to offer plan loans).<br /> <br /> As with any strategy, there are potential downsides that the taxpayer should consider before executing the reverse rollover. Both IRAs and 401(k)s impose a 10 percent penalty for early withdrawals. Each type of plan allows for exceptions that can allow the taxpayer to avoid the penalty in certain situations.<br /> <br /> Those exceptions vary based on whether the account is a 401(k) or an IRA, so taxpayers should carefully examine the various exceptions to determine whether they may need to take advantage of a particular exception in the future. For example, taxpayers can avoid the early withdrawal penalty for IRA distributions used to buy a first home, but the first-time homebuyer exception is not available for 401(k) early withdrawals.<br /> <br /> Taxpayers should also consider the various investment options available under each type of plan. IRAs tend to allow for a wider variety of investments, especially if the taxpayer is interested in nontraditional retirement investments, such as cryptocurrency and real estate. 401(k) investments are limited by the plan itself and tend to contain more traditional investment classes.<br /> <br /> 401(k)s also offer stronger creditor protection (protection offered for IRA funds can vary from state to state).<br /> <br /> </div>

<div class="Section1">Clients who are interested in alternative or non-traditional investment strategies often wish to use their retirement funds for those investments. The IRS limits the types of investments that can be made within the traditional IRA structure. For many, a self-directed “checkbook control” IRA can provide a investment tool that allows the account owner to have a greater degree of control over retirement investment choices, all while minimizing custodian involvement and the red tape associated with traditional self-directed IRAs.</div><br /> <div class="Section1"><br /> <br /> A checkbook control IRA is an IRS-approved retirement account structure that allows the account owner to make independent investment decisions. Like self-directed IRA owners, owners of checkbook control IRAs can investment in non-traditional assets, such as bitcoin, precious metals and real estate.<br /> <br /> To form a checkbook control IRA, a self-directed IRA LLC is first formed. The LLC establishes a checking account like any other business entity. However, the LLC is funded using the IRA funds—which are then transferred to the checking account. With the advice of tax counsel, the IRA owner can become the managing member of the LLC and retain signature authority over the checking account (i.e., “checkbook control”).<br /> <br /> The checkbook control can allow the IRA owner to act more quickly when making an investment. Despite this, the owner is prohibited from receiving assets—and any distributions must be properly processed through the IRA custodian, who is required to report the distribution.<br /> <br /> The key to preserving tax-preferred treatment is to ensure that the IRA investments never revert directly to the IRA owner, but always back to the IRA itself.<br /> <br /> A recent U.S. Tax Court case<a href="#_ftn1" name="_ftnref1">¹</a> illustrates the substantial risks associated with maintaining a checkbook control IRA. In this case, the taxpayer used a third-party service provider to purchase American Eagle coins with the IRA and stored them at home. She first directed her IRA custodian to form a single-member LLC (of which she was the managing member) and to transfer her IRA funds to the LLC’s bank account.<br /> <br /> She used the bank account to purchase the coins (using records to establish the LLC as the legal purchaser). While the IRA custodian filed a Form 5498 to report the value of the IRA assets, the court found that the custodian had no role in the management of the LLC, the purchase of the coins or administration of the LLC/IRA.<br /> <br /> The court found that, under IRC Section 408(a), an IRA must be administered by an IRA trustee that is a bank or IRS-approved custodian. While the court did recognize the legality of the checkbook control IRA structure, it found that the IRA owner cannot have “unfettered control” over IRA assets without negative tax consequences. More specifically, the court found that the custodian’s role in the self-directed IRA structure included maintaining custody over the assets, maintaining records, and processing the actual transactions involving the IRA assets.<br /> <br /> The IRA owner, on the other hand, can only permissibly act as a conduit or agent for the IRA custodian. Personal control over the IRA assets resulted in deemed distribution treatment in this case—because the IRA owner took physical possession of the coins in her own home and failed to purchase the coins directly through the IRA.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> While it’s difficult to know how far the Tax Court will go in applying deemed distribution treatment to any particular transaction, it’s always a good idea to exercise caution—and note that Congress and the IRS have been paying close attention to self-directed IRAs generally in recent months.<br /> <br /> Any client who is interested in the checkbook control IRA structure should be extremely cautious and be sure to involve the IRA custodian in order to avoid deemed distribution treatment.<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>.   <em>McNulty v. Commissioner,</em> 157 TC 10.<br /> <br /> </div>