|Permitted Roth Distributions||
Distributions, Transfers, Rollovers & Conversions
There are three ways to move IRA money, as follows:
Some ways have tax consequences while others do not. Continue reading to learn more.
Distributions occur whenever money is withdrawn from an IRA and the owner has an opportunity to spend it. A distribution is reportable to the IRS and carries possible tax consequences.
Required Minimum Distributions (RMD) – Traditional IRA: Because the government eventually wants to collect taxes it forces traditional IRA owners to take distributions by April 1 of the year immediately following the owner's 70½ birthday. Distributions are added to the owner's income and taxed at ordinary rates.
Why 70½, you ask? Why not 72 or 71? The IRS apparently enjoys mass confusion. Just be glad the geniuses at the IRS didn't pick a really weird number like 73 ¾. Anyway, individuals who turn 70½ in 2009 must take a distribution equal to or greater than their RMD by April 1, 2010. Subsequent RMD's must be taken by December 31 of each year.
RMD's affect Traditional IRAs only. Roth IRAs are not subject to the RMD.
The RMD (Required Minimum Distribution) is calculated by taking the previous 12/31 balance in the IRA and dividing it by the applicable factor from the appropriate life expectancy table. A person who turns 71 in 2004 and is taking a distribution would find the factor associated with his attained age in the year of distribution and divide it into his IRA balance as of the prior year end.
Most Recent Year End IRA Balance
Factor from appropriate life-expectancy table based upon attained age in year of distribution
The calculation is very easy and is explained more fully in a few pages. Again, IRA owners may take a higher distribution than is required, but they must at least take the required minimum.
Failure to take the RMD from a Traditional IRA: The IRS penalizes IRA owners who should have taken an RMD but did not. This Excess Accumulation Penalty is 50% of what should have been distributed. This is a serious matter.
RMD's do not apply to the Roth IRA. Individuals are never required to make a withdrawal from a Roth IRA, and instead may continue to make contributions for as long as they have earned income. Beneficiaries appreciate this Roth IRA feature.
Which Distribution Table Do I Use?
Uniform Lifetime Table III: This table is used 90% of the time. Look at the table to be sure that 26.5 is the factor for age 71. If not, find the correct table. It is used when the IRA owner turns 70½ and the beneficiary is . . .
Joint Life Expectancy Table II: This is used when the owner (living) has a sole spouse beneficiary (living) who is more than 10 years younger.
Single Life Expectancy Table I: Used only for calculating death distributions after the original owner has died.
Distributions and Withholding Taxes
It would be easy for an individual to take a distribution from a Traditional IRA, spend it, and then have no money to pay applicable taxes. To avoid this situation the IRS encourages custodians to collect taxes at distribution. This withholdingis merely a pre-payment of applicable taxes and is not to be confused with a penalty.
At least 10% of the amount distributed is withheld by the custodian unless the account owner signs a W-4P and checks the box that specifically directs that taxes not be withheld.
W-4P and Automatic Distributions: We ask individuals to sign a W4-P when setting up an automatic distribution. We remind them of their election by way of annual statement message that goes something like the following:
If you are set-up on automatic IRA distributions with us, we have your federal income tax withholding election on file. If you would like to change your instructions, contact us.
Withholdings do not apply to Roth IRA distributions. Roth IRA distributions are tax free. There is no tax liability triggered by a qualified withdrawal.
A transfer occurs when IRA funds are moved directly from one IRA at one financial institution into another IRA at another financial institution without the owner gaining control. In other words, only the custodian changes. This is the easiest and most reliable method to move IRA money. All transfer requests must be in writing with the customer’s signature. Customers who want to move money to SBSU should notify us and have an account ready to accept the transfer. SBSU acts as the custodian for all IRA accounts located at this institution.
SEP >> Traditional IRA money movement is coded as a transfer. Think of a SEP as a Traditional IRA on sterioids!
Transfers are unlimited. Unlike rollovers (to be explained), there is neither a time nor a quantity limit. Transfers are not reported to the IRS because the funds remain in the same type of account and the IRA owner has no opportunity to spend the money. Only the institution changes.
This is not a tax reportable event.
Transfers Due to Divorce or Legal Separation
An IRA may get split as part of a divorce decree or legal separation settlement. The IRS allows divorce settlement transactions to proceed free of tax implications as long as the money remains in a qualified plan. Here's what we need in order to initiate a transfer of IRA assets due to a divorce decree:
QEP's and Divorce: Money in a qualified employer plan, such as a 401(k), should be split into separate plan by the employer before being moved into an IRA. Because plan types are changing (QEP >>> IRA), the employer codes outgoing money as a distribution. We code the incoming money as a rollover contribution. The offsetting transactions cancel possible tax liability on the owner's tax return.
IRA to IRA Rollovers: This occurs when an IRA owner takes possession of IRA funds but later re-contributes the money back into the same type of IRA. This is the worst possible way for a customer to transfer IRA money because of the 60-day rule and the 12-Month rule. SBSU requires a Rollover Certification whenever an individual wants to move money into SBSU from another retirement plan and handle them money in the process.
The 60-Day Rule means that an IRA owner who takes possession of funds from one IRA must complete the rollover to another IRA within 60 days. Otherwise, the distribution is subject to taxes and/or penalties. The 60-day clock starts the day after withdrawal and ends the day after deposit. The IRS may waive this rule for reasons beyond the control of the IRA owner, such as a natural disaster.
12-Month Rule: One rollover per 12 month period is allowed (not once per calendar year). A second rollover within 12 months of a previous rollover is looked upon as an excess contribution by the IRS. This usually results in stiff taxes and penalties with interest, and a very unhappy IRA owner.
Non-Spouse Beneficiary: A QEP >> IRA direct rollover is allowed for a non-spouse beneficary only if the IRA is set up as an inherited IRA. The custodian must make the check payable to the bank, not the beneficiary. Checks made out to the beneficiary are not eligible. A non-spouse beneficiary cannot co-mingle inherited IRA funds with personal IRA money.
QEP >> ROTH: This is allowed as of 2007. It is helpful when some funds in a QEP consist of after-tax contributions. The contribution is coded as a rollover, not a conversion and appears in box #2 of the 5498. Contrast this with IRA-to-Roth conversion that appears in box 3 of the 5498 (described in more detail later in this module under Conversions) . The owner generally puts pre-tax contributions in Traditional while after-tax contributions go to a Roth.
Taxes will result if either of the above rules are violated; first at ordinary tax rates, and then applicable penalties.
Qualified Employer Plan (QEP) Rollover to IRA
May a person who has quit a job move his or her 401(k) or other qualified plan into an IRA?
Yes, is the short answer. Funds from any qualified employer-sponsored plan may be rolled over to a Traditional IRA without tax consequences. The following QEP's may be rolled into an IRA:
SBSU always uses a Rollover Certification questionnaire to clarify the exact source of rollover funds. We cannot accept money into an IRA unless it is from a source listed above. Otherwise, the mistake may cause significant tax problems for the owner.
Starting in 2007 QEP money may be rolled directly to a Roth IRA. In prior years the money had to roll into a traditional IRA before being rolled to a Roth.
Qualified Employer Plan (QEP) Rollover to IRA Continued ....
There is a good way and a bad way to transfer money from a QEP into an IRA. The good way is discussed first.
Direct Rollover is the best way to move money from a QEP to an IRA at SBSU. With a direct rollover the money is sent directly from one custodian to another. The owner does not have an opportunity to take the money and run. The 60-day rule and the 12-month rule do not apply when funds are moved in this manner.
Indirect Rollovers take place when funds from a QEP are payable to the owner, who then becomes responsible to complete the rollover. This type of rollover subjects the owner to all sorts of rules and restrictions, including the 60-day and 12-month rules. In addition, the owner must pay 20% withholding taxes at the time of distribution, and then make up the taxes from his own pocket when he completes the rollover. Otherwise, the 20% withheld for the government gets counted as a distribution. This method has obvious problems.
In summary it is better to choose Transfer(IRA to IRA) or Direct Rollover (Employer Plan to IRA) when moving retirement money around.
The bank may loan money to individuals who have chosen the indirect rollover method to make up the 20% employer withholding on the distribution. However, the bank may not use the IRA as collateral.
A conversion occurs when traditional IRA funds are rolled into a Roth IRA at either the same or different financial institution. This is a taxable event to the IRA owner, who must report the IRA distribution as taxable income.
There are certain restrictions on conversions, as follows:
Partial conversions are allowed. However, the taxability of the partial conversion inherits the taxability ratio of all pre and post-tax contributions to the traditional IRA.
Starting January 2008, money from a QEP may be rolled directly into a Roth IRA, subject to the $100K MAGI limit (which expire 2010).
A conduit IRA is nothing more than another IRA that is separate from any other IRA. It is used as a place to park QEP money. For example, a person with a 401(k) may change jobs and may want the opportunity to roll funds from his old 401(k) into a different QEP at his new job. The conduit IRA allows him to do just that. It also preserves certain unlimited bankruptcy protection on Qualified Employer Plan money ( QEP's can't be confiscated due to bankruptcy).
A Conduit IRA must remain pure. It cannot become contaminated with other types of IRA money or with other contributions. Otherwise, it may become ineligible for rolling the funds back into another employer-sponsored plan. SBSU will not allow anything other than the original rollover funds into a conduit IRA and will not allow the owner to make a contribution to a conduit IRA.
We recommend you contact a tax or financial professional to discuss options and limitations when converting from one plan type to another.