July Why Is April 1 the Required Beginning Date? What s Inside. Your inside source for IRAs and tax-favored savings plans

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1 I RA Your inside source for IRAs and tax-favored savings plans Your Inside Source for IRAs and Tax-Favored Savings Plans Volume 40, Number 7 July 2016 What s Inside Letter from the Editor Francis X. Krawiec, Executive Editor Documenting Disability Noteworthy Legal Actions First-Money-Out Rule Limits RMD Flexibility Planning Points Roth IRA Distributions in First Five Years Heard It On The Service Don Beideman, Director of Customer Service PMC s IRA Video Training Coffee Break Monthly Training Minute Spouse Beneficiary Rollover/Transfer/ Elect-to-Treat Why Is April 1 the Required Beginning Date? When IRAs first started in 1975, IRA owners were required to begin taking distributions by December 31 of the year they reached age 70½. This date is called the required beginning date (RBD). However, in 1984, the RBD was changed to April 1 of the year following the year the IRA owner reaches age 70½. The reason for this change really has nothing to do with IRAs. The required minimum distribution (RMD) rules apply to both IRAs and workplace retirement plans (WRPs). However, prior to 1984, one set of RMD rules applied to IRAs and another set applied to WRPs. Some of the rules were the same, but many of the rules were different. In 1984, in a move toward simplifying the rules, Congress mandated that the IRS develop one set of relatively uniform RMD rules for both IRAs and WRPs. One of the differences in the IRA RMD rules and the WRP RMD rules was the year for which an individual is required to begin taking distributions (i.e., the first distribution calendar year). For most WRP participants, the first distribution calendar year is the later of the year in which the individual reaches age 70½ or retires. Because an individual who is working beyond age 70½ may choose to retire at any time, WRP administrators have always had 90 days after the close of the first distribution calendar year (i.e., April 1 of the following year) to start paying distributions. For example, if employees suddenly retire on December 31, that year would be their first distribution calendar year. The plan administrator would have to start paying distributions by April 1 of the following year. For IRAs, the first distribution calendar year is the year the IRA owner reaches age 70½. The individual s employment status is irrelevant. Therefore, the 90-day extension is not needed for IRAs. However, because it would be impractical to change the RBD to December 31 of the first distribution calendar year for WRPs to make the rules more uniform, the IRS changed the RBD for IRAs to match the RBD for WRPs. Thus, IRA owners have until April 1 of the year following the year they reach age 70½ to begin taking RMDs PMC

2 Letter from the Editor Francis X. Krawiec, Executive Editor Documenting Disability Dear Reader, I am a proponent of the give-the-customers-more-than-they-expect philosophy of business. However, I also believe that sometimes a financial organization may make the rules for its customers more restrictive than necessary. For example, I know that many IRA sponsors require IRA owners who are under age 59½ and are asking for a distribution because they are totally and permanently disabled to provide documentation of their disability. I m sure the financial organizations have put such procedures in place to protect their customers from making a mistake, but requiring specific documentation for a disability distribution may be problematic for the IRA owner. It is not the financial organization s responsibility to decide whether an individual is disabled. A statement from the IRA owner indicating disability as the reason for the distribution (e.g., checking a disability box on an IRA distribution or withdrawal form) is sufficient. However, some financial organizations require additional documentation from the IRA owner to report the distribution as a disability distribution. Specifically, some financial organizations may require certification of disability from the attending physician. However, it may be inconvenient for the IRA owner to make an appointment with the doctor and have the doctor write the note. Some financial organizations may require a copy of the IRA owner s Social Security Disability Award Letter, awarding benefits due to total and permanent disability. However, the procedures for applying for Social Security disability benefits may be long and arduous and the IRA owner may be embroiled in that process and needs the IRA distribution funds before that process is complete. Although the IRS does not require financial organizations to receive a specific form of documentation proving the IRA owner s disability, the financial organization has the right to set such policy in place. It is important to know that if the financial organization requires documentation that the IRA owner is unable to provide, that doesn t mean the IRA owner cannot take the distribution or that such distribution will be subject to the IRS early distribution penalty. If the IRA owner does not satisfy the financial organization s disability documentation policy, the distribution may be taken, but it will be reported to the IRS as an early distribution, no known exception. The IRA owner may file IRS Form 5329 with his or her federal income tax return claiming the disability exception to the IRS early distribution penalty. Best Regards, July PMC

3 Noteworthy IRS Finalizes DRA Rollover Regs The IRS has adopted final regulations that amend the rollover rules associated with the tax treatment of distributions from designated Roth accounts (DRAs). These rules are essentially the same as those originally proposed in September A DRA is a separate account within a 401(k), 403(b) or governmental 457(b) plan that holds designated Roth contributions. As a result, if disbursements are made from an individual s DRA to the individual and also to the individual s Roth IRA or another DRA in a direct rollover, then pretax amounts will be allocated first to the direct rollover, rather than being allocated pro rata to each destination. The regulation also applies to a beneficiary of a DRA. These regulations generally apply to distributions on or after January 1, [T.D. 9769] MD Mandates Payroll Deduction IRAs Maryland became the latest state to mandate that most businesses must offer a payroll deduction IRA if not already offering another type of workplace retirement plan. Employees of a private-sector business that is affected by the law must start by contributing a yet-to-be-determined portion of their pay to an IRA. However, the employees are allowed to opt out of the program. The law creates the Maryland Small Business Retirement Savings Board to implement, maintain, and administer the new program and the trust, which will offer private-sector investments for the new IRAs. [Maryland SB 1007] Three IRA Owners Request PLRs Under Similar Circumstances In 2014, the IRA owners contacted a capital management company, Company A, to inquire about investing their IRAs in Fund B. The company assisted the IRA owners in completing the subscription agreements in a manner it believed was appropriate for an investment by an IRA. After completing the subscription agreements, the IRA funds were wired directly from their IRAs to the bank custodian of Fund B s assets, Trust Company C. Monthly financial statements from Company A identified the holder of the shares as (IRA owner s name) IRA. In March of 2015, it was discovered by Company A that Trust Company C was not acting as the IRA custodian for the IRA owners investments in Fund B. The IRA owners submitted letters to the IRS from Company A explaining its mistaken assumption that Trust Company C was the custodian of the IRAs, and assuming responsibility for the error. In its letter, Company A stated that it has notified other investors who intended to invest their IRAs in Fund B and that it will revise its subscription agreements to ensure the error does not recur. The IRS granted all three requests to allow additional time for the distribution amounts to be rolled over to IRAs. [PLRs , and ] Proposals Made to Expand HSAs Several bills propose expansion of the Health Savings Account (HSA) rules. The Health Savings Account Expansion Act of 2016 (S. 2980) proposes to increase the HSA contribution limits, expand the list of qualified medical expenses, and decrease the penalty for nonqualified distributions from 20% to 10%. Another bill (H.R. 5445) would allow both spouses to make catch-up contributions to the same HSA, allow certain expenses incurred prior to establishment of an HSA to be treated as qualified expenses, and raise the HSA contribution limit. A third bill (H.R. 5452) would allow individuals eligible for Indian Health Service aid to qualify for an HSA. The Veterans TRICARE Choice Act (H.R. 5458) would provide for coordination between the TRICARE program and eligibility for making contributions to an HSA. Errata In the front-page article of last month s IRA Insider, Eugene Keogh should have been identified as a U.S. Representative. July PMC

4 Legal Actions First-Money-Out Rule Limits RMD Flexibility Starting for the year an individual attains age 70½, a lifetime required minimum distribution (RMD) must be paid to a Traditional, SEP or SIMPLE IRA owner for each distribution calendar year. Note that it is the year in which the IRA owner attains age 70½, not the date he or she attains age 70½. Most participants in a workplace retirement plan (WRP), such as a 401(k) plan or a pension plan, may delay starting distributions from the WRP until the year they actually retire if that is later than the year in which they attain age 70½. RMDs and Rolling Over a Distribution Even though an IRA owner has reached his 70½ year, the IRA owner is still permitted to move his IRA funds from one organization to another by way of a transfer or rollover. However, if choosing to take a distribution and then roll over the funds within 60 days, the IRA owner must be mindful that if he has not satisfied his RMD, all or a portion of the distribution is not eligible for rollover. This rule is sometimes referred to as the first-money-out rule because the first distribution for the year counts toward the RMD. Example: In January 2016, Raul requested a $10,000 distribution from his Traditional IRA with the intention of rolling over the funds to a Traditional IRA elsewhere. Raul will attain age 70½ in November He had not yet satisfied his $1,000 RMD for the year. Raul should have retained the $1,000 RMD, leaving only $9,000 eligible for rollover within 60 days of receiving the distribution. Even though Raul s 2016 RMD deadline is April 1, 2017 (the RMD deadline for the first distribution calendar year is April 1 of the year after the 70½ year), and even though he had not attained age 70½ at the time of the January 2016 distribution, the first-money-out rule dictates that he must satisfy his RMD first, and roll over no more than $9,000. Consequences if RMD Rolled Over When making a rollover to an IRA, the IRA sponsor will usually have the IRA owner complete an IRA Rollover Election form, which usually contains language warning the customer that the RMD is not eligible to be rolled over. But all too often, the IRA owner inadvertently rolls over the RMD amount. If the IRA owner rolls over an RMD amount, the ineligible amount is still treated as a taxable distribution from the distributing IRA. Because the RMD amount is not eligible to be treated as a rollover, the ineligible amount is instead treated as a regular contribution to the receiving IRA. The IRA owner will now have an excess contribution because an individual may not make a regular contribution to a Traditional IRA starting with the year age 70½ is attained. In addition, an excess contribution is subject to an IRS 6% penalty if not timely corrected. RMD May Be Transferred The first-money-out rule that prohibits IRA owners from rolling over an RMD does not apply to transfers between Traditional, SEP and SIMPLE IRAs. An IRA owner who is in or past his 70½ year can request that the entire balance of his IRA, including the RMD amount for that year, be transferred to another IRA. However, the IRA owner must remember to satisfy the RMD by the applicable deadline. July PMC

5 Roth IRA Distributions in First Five Years Planning Points Roth IRAs have been available since However, they are still relatively new. Baby boomers who are now reaching the standard Medicare application age of 65 were already 46 years old then! Let s get a better working knowledge of the advantageous characteristics of Roth IRAs by examining (and debunking) some of the more popular myths about these valuable retirement accounts but, first, a little background on how distributions from a Roth IRA are treated. Ordering Rules Roth IRAs can contain three types of funds: (1) tax-year contributions, (2) conversion funds, and (3) earnings. When distributions are made from any of an individual s Roth IRAs, the funds are distributed in that order, treating all of the individual s Roth IRAs as if they were one Roth IRA. So, in general, none of the conversion funds are distributed before all of the tax-year contributions have been distributed, and none of the earnings are distributed until all of the tax-year contributions and conversion funds (if any) have been distributed. Myth #1 Distributions may not be taken from a Roth IRA until the owner has had a Roth IRA for at least five years. The truth is: Funds in a Roth IRA are available to the owner at any time, at any age, and for any reason. Myth #2 All distributions from a Roth IRA during the first five years will be taxable. The truth is: (1) Distributions of tax-year contributions during the first five years are never taxable, regardless of the age of the recipient or the reason for the withdrawal. (2) Distributions of conversion funds during the first five years are never taxable, regardless of the age of the recipient or the reason for the withdrawal; however, the IRS 10% early distribution penalty may apply. (Please read Myth #3.) (3) Distributions of earnings during the first five years are always taxable. Myth #3 All distributions from a Roth IRA during the first five years will be subject to an IRS 10% penalty. The truth is: (1) Distributions of tax-year contributions during the first five years will not be subject to the IRS 10% early distribution penalty, regardless of the age of the recipient or the reason for the withdrawal. (2) Distributions of conversion funds during the first five years (a separate five-year period applies to conversions made in separate years) will be subject to the IRS 10% early distribution penalty only if the funds were taxable when converted and the recipient is under age 59½ at the time of the distribution and does not qualify for an exception to the IRS 10% penalty (e.g., disability, etc.). (3) Distributions of earnings during the first five years will be subject to the IRS 10% early distribution penalty only if the recipient is under age 59½ at the time of the distribution and does not qualify for an exception to the IRS 10% penalty (e.g., disability, etc.). Myth #4 For a Roth IRA distribution to be tax-free and penalty-free, the distribution must be a qualified distribution. The truth is: All qualified distributions from a Roth IRA are tax-free and penalty-free. However, many distributions that are not qualified distributions are also tax-free and penalty-free. (Please refer back to Myths #2 and #3.) July PMC

6 Heard It on the Hotline On IRS Form 1099-R, is code 4, death, used for a distribution paid to a beneficiary of a deceased Roth IRA owner? No. For distributions paid to a beneficiary of a deceased Roth IRA owner, use either code T Roth IRA distribution, exception applies or code Q qualified distribution from a Roth IRA. Code T is used if the distribution is being taken before the end of the initial five-year period or use code Q if the five-year period has been satisfied. We are converting a Traditional IRA to a Roth IRA internally for an IRA owner who is under age 59½. Should we report the distribution using code 2 early distribution, exception applies on IRS Form 1099-R? Yes. The funds that are being converted should be reported as a code 2, early distribution, exception applies, on IRS Form 1099-R, because it is known that the funds are being moved directly to a Roth IRA. A conversion is one of the exceptions to the IRS 10% early distribution penalty. May an HSA trust or custodial agreement restrict HSA distributions to pay or reimburse only the HSA owner s qualified medical expenses? No. The HSA trust or custodial agreement may not contain a provision that restricts HSA distributions to pay or reimburse only the HSA owner s qualified medical expenses. Only the HSA owner may determine how the HSA distributions will be used. Therefore, distributions may be used to pay or reimburse qualified medical expenses or for other nonmedical expenditures, which may be subject to federal income tax plus the 20% IRS penalty. An IRA owner died after his required beginning date (RBD) in 2016 and the two beneficiaries set up separate inherited IRA accounts in July Must the decedent s undistributed required minimum distribution (RMD) amount be distributed to the beneficiaries before the separate accounts are established? No. The RMD may be transferred with the other IRA funds into the separate inherited IRA accounts. However, each beneficiary must take the RMD amount that he or she is responsible for by December 31. Paying the funds from the inherited IRAs will generally ensure that the distributions are properly reported as having been paid to the beneficiaries. Does the 60-day rollover rule apply to a direct rollover from a workplace retirement plan (WRP)? No. A direct rollover from a WRP is not subject to the 60-day rollover rule because the individual never has constructive receipt of the distribution. In March of 2015, an HSA owner made a 2014 contribution of $3,300 and a 2015 contribution of $3,350 to his HSA. His 2015 IRS Form 5498-SA shows a total of $6,650 in Box 2. Is this correct? Yes. The instructions for IRS Form 5498-SA state that Box 2 Total Contributions Made in 2015 include any contributions made in 2015 for 2014 in addition to contributions made in 2015 for July PMC

7 One of our customers works for the American Red Cross. He was sent to Mississippi in March for three weeks providing aid to those affected by severe storms and flooding in a federal disaster area. He is saying that his 2015 tax-filing deadline is now July 15, If he makes a 2015 IRA contribution after April 18, 2016, but before the July 15, 2016 deadline, how do we report the 2015 contribution? You would report the 2015 contribution on the 2016 IRS Form 5498 by showing the amount contributed in Box 13a, Postponed Contribution; in Box 13b Year, enter 2015 ; and in Box 13c Code, enter FD. An individual has been making contributions to a Roth IRA for several years. Now he wants to convert funds from his Traditional IRA to a Roth IRA. Must the Roth IRA conversion funds be deposited to a separate Roth IRA or may the converted funds be added to the Roth IRA that consists of contributions? Funds being converted from a Traditional IRA may be added to the Roth IRA that consists of Roth IRA contributions. However, some financial organizations policies may not allow this. For those financial organizations, the converted funds may need to be put into a separate Roth IRA. May Traditional IRA tax-year contributions be made to a SEP IRA? Yes. SEP IRAs are Traditional IRAs that accept employer contributions. However, some financial organizations allow only SEP contributions to be deposited to a SEP IRA. Your Service Don Beideman, Director of Customer Service PMC s IRA Video Training Professional IRA training for your whole staff is just $ (for a limited time). No travel. No scheduling conflicts. No lost productivity. Your staff can be trained at any time, at their very own desk, with PMC s six high-quality video tutorials covering every aspect of IRA rules (to include free reproducible outlines for each video) with guaranteed immediate results. To take advantage of our limited time offer of these acclaimed video tutorials at this affordable discounted price, you must order by September 2, Order today by simply calling me at or visit us at pmc-corp.com and click Training. Just one more way we make YOU the expert! July PMC

8 Coffee Break We were talking during our coffee break, and this question came up: In December of 2015, Mary contributed $5,500 to her IRA at our financial organization. Now, she is telling us that she had previously contributed $5,500 for 2015 at another financial organization. She said that she already filed her 2015 federal income tax return and she claimed only $5,500 as an IRA contribution. If she corrects the excess contribution by withdrawing the second contribution plus the net income attributable to it by October 15, 2016, will the net income attributable be taxable for 2015? The Answer: Yes. Because the $5,500 contribution that is being corrected was made in 2015, the earnings attributable to the excess contribution will be taxable for Please Join Us... Submit a question to the IRA Insider and if it appears in the Coffee Break, we will send you your very own IRA Insider coffee mug. Send your question to: pmc@pmc-corp.com. Put Coffee Break in the subject line. If we use your question, in addition to sending you an IRA Insider coffee mug, we will acknowledge your contribution in this space. Get breaking news, timely reminders and important dates. It s FREE! Sign up pmc-corp.com, click Early Warning . July PMC

9 Monthly Training Minute July 2016 Spouse Beneficiary Rollover/Transfer/Elect-to-Treat Most of the time when an IRA owner dies, the owner s spouse is the beneficiary of the deceased IRA owner s funds. At any time, a spouse beneficiary may treat the decedent s IRA as his or her own. Often, a surviving spouse beneficiary will immediately roll over, transfer, or elect to treat the IRA funds as his or her own. However, if the spouse does not treat the IRA as his or her own IRA, the funds will remain in an IRA titled in the spouse beneficiary s name, as beneficiary of the deceased spouse s name. Automatic Elect-to-Treat There are two ways that a spouse beneficiary may automatically elect to treat the IRA as his or her own. If a spouse beneficiary makes a contribution to the decedent s IRA after the owner has died, or if a spouse beneficiary fails to take the required death distribution on a timely basis in any year following the year of the IRA owner s death, the IRA is automatically treated as the spouse beneficiary s own IRA. Affirmative Election: Moving the IRA Funds to the Surviving Spouse The IRA sponsor may retitle the deceased IRA owner s account in the spouse beneficiary s name, or the funds may be transferred to an IRA in the spouse s name. If the IRA funds are staying within the same financial organization, the funds are typically moved directly from the decedent s IRA to the spouse s IRA as a nonreportable transfer. A spouse may also transfer the funds into an IRA in the spouse s own name at another financial organization. The other way the spouse beneficiary can move the funds is to take a death distribution and then roll over the eligible portion to an IRA in the spouse beneficiary s name following the regular rollover rules. It is important to note that once the spouse beneficiary moves the IRA funds to an IRA in his or her own name, the surviving spouse loses the option to use the death distribution rules, and the funds may not be put back in an IRA titled in the name of the spouse beneficiary, as beneficiary of the decedent PMC Published by Your Inside Source for IRAs and Tax-Favored Savings Plans The IRA Insider newsletter is published monthly by PMC, 839 Lincoln Avenue, Suite 2, West Chester, PA Phone pmc@pmc-corp.com. Subscription rates: Online - $139 per year; Printed copies by First Class mail from West Chester, PA - $159 per year. Entire contents are copyrighted. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Articles appearing in the IRA Insider may not be reproduced, in whole or in part, without the express written permission of the publisher.