Tag Archives: RMD

Self-Directed 401(k), Self-Directed IRA & Qualified Plan Information, Self-Directed Roth IRA

Required Minimum Distributions for 2011

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Question: Mom received two RMD letters one for her Roth IRA and one for her Roth 401k. As these are both Roth’s isn’t she exempt from mandatory distributions? Regardless she hasn’t owned the accounts for at least 5 years.

Answer: Regarding the RMD letters, your Mom does NOT need to take an RMD from her Roth IRA.  They centralized the process of sending out RMD letters this year, and someone erroneously failed to delete the Roth IRAs from the list.  I apologize for the error made by Quest IRA, Inc.  The only time you ever have to take an RMD from a Roth IRA is if the Roth IRA is an inherited IRA.

However, if your Mom has reached age 70 ½ she DOES have to take an RMD from her Roth 401(k).  Nothing in the 401(k) regulations exempts Roth 401(k)s from the mandatory distribution requirements.  As a 5% or more owner of the company, she cannot defer distributions as she could if she was just a worker bee.  The fact that she has not met the 5 year requirement to make it a qualified distribution doesn’t change the distribution requirements.  Essentially, her contributions and the profits will come out pro rata, so that if 75% of the money in her Roth 401(k) is her contribution and 25% is profit, then the taxable portion of her distribution will be 25% until she meets the 5 year requirement.

Let me know if you have any questions. Have a great day!

 

Self-Directed Roth IRA, Self-Directed Traditional IRAs

Can I Have a Roth Too, Please? Yes, You Can!!!

By H. Quincy Long

            Most people want a Roth IRA once they understand the tremendous tax benefits.  You do not receive a tax deduction for contributing money to a Roth IRA, but qualified distributions are TAX FREE FOREVER.  Essentially the concept of a Roth IRA is that you pay taxes on the “acorn” (the initial contribution) instead of the “oak tree” (the potentially large amount in the Roth IRA after many years of tax deferred accumulation).  This is especially beneficial in a truly self-directed IRA, which can invest in real estate, notes, options, private company stock, LLCs, limited partnerships and other non-traditional asset

            Unfortunately, there are income limits for contributing to a Roth IRA or converting money from a Traditional IRA to a Roth IRA.  For contributions, a married couple filing jointly may not contribute if they have Modified Adjusted Gross Income (MAGI) of more than $176,000 for 2009.  For single individuals the MAGI limit is no more than $120,000 for 2009 to be able to contribute to a Roth IRA.  The news is even worse if you want to convert assets from a Traditional IRA to a Roth IRA.  Whether married or single, you are not eligible to do a Roth conversion if your MAGI is more than $100,000.

            For people who exceed these income limits, it might at first appear that they are left out in the cold when it comes to Roth IRAs.  Fortunately, this is not actually true.  There are at least 3 ways in which a person who exceeds the income limits may end up with a Roth IRA.  The key phrase is “end up with” in the preceding statement.

            The first method of acquiring a Roth IRA if you exceed the income limits is to inherit one.  There is no age discrimination for contributing to a Roth IRA, unlike the Traditional IRA.  Anyone with earned income within the limits can contribute.  Earned income is generally income on which you must pay Social Security and Medicare taxes.  Passive or investment income, including rents, interest and dividends do not count as earned income, but it is not that hard to create earned income.  An elderly relative or friend may be able to help in your business in some way, for example, and your payment to them for their assistance would be earned income.  They may even be predisposed to name you as their beneficiary in the event of their death.

When a Roth IRA is inherited, the new account owner must take required minimum distributions from the IRA, unless the inheritor is a spouse.  Required minimum distributions are not required for the original account owner.  However, this does not mean that the balance in the account cannot be invested, and it is easy, at least with a self-directed IRA, to create income which exceeds the yearly required minimum distributions.  Even better, if the person who died had a Roth IRA for at least 5 tax years, distributions from the account are tax free, even if the inheritor is under age 59 ½.  There is never a 10% premature distribution penalty either, since the distribution is due to death.

            A second method to acquire a Roth IRA has to do with excess contributions.  Many people do not really know whether their income will exceed the limits when they make their Roth IRA contribution, especially if they contribute early in the year.  This is certainly true of self-employed persons.  So what happens if you make a mistake by contributing early and it turns out your income exceeded the MAGI limit for the year? 

If you take action before your tax filing deadline, including extensions (generally October 15), you can recharacterize the contribution to a traditional IRA as long as you are under age 70 1/2, along with all of the net income attributable (NIA) to the contribution.  You may also remove the contribution from the Roth IRA, along with any net income attributable.  In this case the only penalty which you might have to pay is on the income attributed to the contribution, not on the contribution itself.  If you remove the contribution after your tax filing deadline plus extensions, it is unclear from the regulations whether you must also remove the net income attributable from the Roth IRA.  A third choice is to leave the contribution in the Roth IRA and pay a penalty on the excess contribution.  In many circumstances this may be the wisest choice.

If you leave the money in your Roth IRA, you are required to pay a penalty of 6% of the amount of the excess contribution for each year that the excess remains in the Roth IRA.  For example, if you make an excess contribution $4,000 to a Roth IRA and your MAGI exceeds the limit, your penalty is only $240 for each year the excess remains in the account.  This is the penalty regardless of how much money you make in the Roth!  Since the penalty only applies for as long as the excess contribution remains in the Roth IRA, you will no longer have to pay the penalty if you qualify for a Roth in a future year and do not contribute or if you remove the contribution.  Once you have a Roth IRA, the account may continue to be invested regardless of your current year income. 

            Finally, in 2010 the $100,000 MAGI limit for converting assets from a Traditional IRA to a Roth IRA is eliminated.  Although a person who exceeds the MAGI limit will still not be able to contribute to a Roth IRA, in 2010 and future years anyone may convert assets in a Traditional IRA to a Roth IRA, no matter what their income level.  The amount converted is generally added to your taxable income for the year of conversion to extent it exceeds any non-deductible contributions in the account.  For conversions in the year 2010 only, however, the person converting has the choice of paying 50% of the taxes on the conversion in 2011 and the other 50% in 2012.  You have 3 years to pay taxes on Roth conversions done in 2010!

            As I always say, there are worse things than not qualifying for a Roth IRA, such as qualifying for a Roth IRA!  Whether by inheriting a Roth IRA, through an inadvertent excess contribution, or by conversion in 2010, even those who are fortunate enough not to qualify for a Roth IRA due to income exceeding the MAGI limit may end up with a Roth IRA.  Even a small Roth IRA can be built into a large IRA with careful investing, which means that even the wealthy can have a substantial amount of tax free retirement income.

Self-Directed Roth IRA, Self-Directed Traditional IRAs

What’s in a Name? – Why It’s Important to Name a Beneficiary for Your IRA

By H. Quincy Long

             Many people probably don’t think too much about how important it is to name a beneficiary for their IRAs.  However, as my family recently found out, ignoring this important detail when setting up your IRA can be costly from a tax perspective.

             I recently received a distribution check from an IRA of my father, who passed away last year.  My father was a very careful planner, so I was quite shocked at his lack of tax planning with his IRA.  When setting up his IRA he named his estate as the beneficiary of the IRA (this is equivalent to not naming a beneficiary at all).  This meant that when he passed away the estate had to be probated, even though the IRAs were the only assets requiring probate in his estate.  IRAs that have named beneficiaries are generally non-probate assets, meaning that they pass directly to the beneficiaries instead of passing through a will.  That was the first problem. 

The larger problem came because of the lack of choices he left us by naming his estate as beneficiary.  In a Traditional IRA, required minimum distributions must begin no later than April 1 of the year after the IRA owner turns age 70 ½.  This is known as the required beginning date.  My father died before his required beginning date.  Since his estate is a non-individual beneficiary, the IRA had to be distributed within 5 years, or by December 31, 2011.  If my father had died after his required beginning date without having a named individual beneficiary, the yearly required minimum distributions would have been based on his remaining life expectancy in the year of his death reduced by one for each year following the year of his death. 

In contrast, the choices available to our family had my father simply named beneficiaries would have been much more favorable.  Assuming my father wanted his wife and 3 sons to split the IRA in the same percentages he listed in the will, he could have named us specifically instead of requiring the distribution to be made through his estate.  If the IRA was not split into separate IRAs by September 30 of the year following the year of his death, then required minimum distributions would have been based on the remaining life expectancy of the oldest beneficiary, which was of course his wife.  As his wife is a few years younger than he was, this certainly would have been a large improvement over taking the entire IRA over the next 5 years.

Had my father named the 4 of us as beneficiaries specifically, an even better plan would have been to separate the IRAs into 4 beneficiary IRAs with each of us as the sole beneficiary prior to September 30 of 2007 (the year following his death).  In his wife’s case this would mean that she could choose to take all the money out within 5 tax years, leave the IRA as a beneficiary IRA, thereby allowing her to take distributions without penalty even if she was under age 59 1/2, or she could have elected to treat the IRA as her own.  In the case of his sons, we could have

taken the IRA over 5 years or we could have stretched the distributions over our life expectancy.  For example, in my case I could have elected to take the distributions over the next 39 years instead of all at once!

Since I expected nothing from my father’s estate and have no critical need for the funds, I would have taken the longer distribution period.  Instead I must add the distribution check to my taxable income for this year, which in my tax bracket means a substantial bite out of the money for taxes.  Since I am reasonably good at investing in my self-directed IRAs, having the ability to stretch the distributions out over 39 years would have meant an inheritance of many times what I will end up with after taxes because I had to take it all within 5 years.

The problem is even worse for my father’s wife, who will have an extraordinarily large tax burden this year, since she chose to take her share of the IRA out all at once instead of over a 5 year period.  While I am certainly grateful that my father thought of me in his will, simply naming specific beneficiaries would have made his legacy worth so much more to his family. 

Don’t let it happen to your family!  Review your IRA beneficiary designations, and if you haven’t already done so, name your beneficiaries.  Your family will be glad you did.