Individual Retirement Accounts (IRAs) and Roth Individual Retirement Accounts (Roth IRAs) provide flexible tax-sheltered retirement options. This flexibility comes with a complex systems of rules. Here is a quick review of some important rules affecting IRAs. Roth IRA rules will be reviewed in a subsequent post.
Deadlines for IRA Contributions
Contributions can be made up till the un-extended due date of your tax return for the year you desire to make the deduction. So, if your tax return is first due (no extensions allowed for calculating the deposit date) on April 15th of 2014 for tax year 2013, you have until April 15, 2014 to make the contribution to your IRA and you will still be able to take the deduction for tax year 2013 (Code Sec. 219(f)(3)).
Tax-Free Rollovers from One IRA to Another
By definition, a “rollover” is when you actually make a withdrawal from your IRA and then place the withdrawn funds into another IRA. You can withdraw all or part of your IRA any time you want, once a year, and even use the money for other purposes in-between, so long as the funds are re-deposited into another IRA no later than 60 days from the date of withdrawal. While not necessarily a sound financial idea, this means that IRA monies can, in essence, be “borrowed” for 60 days without any penalty whatsoever, except any cost charged by the IRA administrator to effect the withdrawal (Code Sec. 408(d)(3)(A)).
The IRS may waive the 60-day rule if an individual suffers a casualty, disaster, or other event beyond his reasonable control, and not waiving the 60-day rule would be against equity or good conscience (Code Sec. 408(d)(3)(I)), but don’t plan on this automatically being granted unless specific conditions are met.
Automatic Waiver of 60-Day Rule
The IRS will automatic wave the 60-Day rule if the failure to re-deposit the funds is caused by financial institution error. The requirements for automatic waiver are:
• The financial institution received the funds on behalf of the taxpayer before the 60-day rollover period expires;
• The taxpayer followed all of the financial institution’s procedures for depositing the funds into an eligible retirement plan within the 60-day period (including giving instructions to deposit the funds into an eligible retirement plan);
• Solely due to the financial institution’s error, the funds are not deposited into an eligible retirement plan within the 60-day rollover period;
• There would have been a valid rollover, if the financial institution had deposited the funds as instructed; and
• The funds are actually deposited into an eligible retirement plan within one year from the beginning of the 60-day rollover period (Rev Proc 2003-16, 2003-4 CB 359, Sec. 3.03).
Trustee-to-Trustee Transfers of IRA Funds
By definition, direct, trustee-to-trustee transfers aren’t rollovers because the transferred funds are not within the direct control and use of the taxpayer (Rev Rul 78-406, 1978-2 CB 157). As a result, direct, trustee-to-trustee transfers aren’t subject to income tax, aren’t reported on your return, and aren’t subject to the once-a-year limit that applies to IRA rollovers.
Transfers from Qualified Plans to an IRA
You can make a tax-free rollover of an eligible rollover distribution from a qualified plan your IRA (Remember a “rollover” means you withdraw and take control of the funds and then within 60-days you deposit the funds in an IRA) (Code Sec. 402(c)(1), Code Sec. 408(d)(3)).
One thing to be aware of when taking funds from a Qualified Plan to place in your IRA is that if you do a “rollover” (i.e. take possession of the funds) the plan administrators are required by law to withhold 20%, which you can get back when you file your tax return so long as you make the deposit within the required 60 days (Code Sec. 3405(c). Note a big difference here. Trustee-to-trustee transfers from your qualified plan to your IRA are not subject to mandatory 20% withholding (Code Sec. 408(d)(3)(A)(ii)). Therefore, unless you have a real good reason to be using the money during the 60 days, it would be in your best interest to transfer trustee-to-trustee from your Qualified Plan instead of rollover, since your transfer will be made without the 20% mandatory withholding.
Special Rules for Basis IRAs
Special rules apply if you deposit more than you can deduct during the tax year into your IRA account. For example, the standard limit for tax year 2013 is $5,500 per taxpayer. Let’s assume you want to put in extra money so you’ll be better prepared for retirement, so you put $10,000 into your IRA. You can deduct $5,500 on your tax form. The difference of $4,500 gets added to your basis for the year. So, if you only make the deduction amount every year, you will never have a basis. But, each year you add more than the deduction, you add, and it accumulates, basis to your IRS. This comes into play when you withdraw funds.
Why is this important? Non-basis IRA funds accumulate tax free. Basis IRA funds do not. The standard rule for tax purposes is if you withdraw for use funds from your IRA and your IRA has basis, each withdrawal is considered to have both a basis and a non-basis components. If you are retired, the non-basis component is tax free, but the basis component is subject to income tax at whatever rate you are paying when you are retired.
Since a rollover is by definition a withdrawal, a rollover from an IRA with a basis, even if re-deposited in another IRA within 60-days, would be subject to tax on the basis portion. However, under a special rule, if you leave in your IRA an amount equal to at least your basis, the rolled over amount can be made tax free (Code Sec. 402(c)(2), IRS Publication 590, 2013, pg. 23).
Still Confused About Your IRA Options?
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