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Ruling to Remember: What NOT To Do When a Trust is the IRA Beneficiary

In Private Letter Ruling (PLR) 201425023, released by IRS on June 20, 2014, the IRS ruled that a surviving spouse who received IRA proceeds through a trust, which was the beneficiary of her deceased husband’s IRA, could not roll over the IRA funds she received because more than 60 days had passed since she received the funds. The IRS denied her request for more time to do the rollover because she didn’t provide sufficient proof of financial institution error. More importantly, the PLR is a good example of what not to do when a trust is the beneficiary of an IRA.

Facts of the PLR
IRA trust beneficiary“Ben” had an IRA and named a trust as the beneficiary of his IRA. The trustees of the trust were his two children. Ben’s wife “Ann” was the beneficiary of 25% of the assets of the trust. After Ben died, the entire proceeds of the IRA were paid to the trust as IRA beneficiary. The funds were deposited into the trust’s checking account. The PLR didn’t say who authorized the IRA distribution, but most likely Ben’s children as trustees ok’d the distribution.

Apparently, Ann had a problem with how the trust was interpreted and administered and started legal action against Ben’s children as co-trustees of the trust. Eventually, they worked out their differences. Ann and the trustees entered into a settlement agreement which said that the trust would attempt to establish a rollover IRA in Ann’s name for her 25% portion of the IRA funds that were distributed from the trust.

As a result of the settlement agreement, Ann opened an IRA in her name assuming that she would be allowed to roll over the amount she received from the trust. Shortly after the settlement agreement in October 2009, her 25% share of the IRA proceeds were paid from the trust and deposited directly (rolled over) into the IRA in Ann’s name. This distribution occurred after 60-days from when the entire IRA was distributed to the trust. Ann received a K-1 from the trust for 2009 showing a taxable distribution.

Ann must have realized that more than 60-days had lapsed since the IRA distribution was made from the trust, so she applied to the IRS for a waiver of the 60-day rollover period for financial institution error. While in the PLR request she referred to “financial institution error,” she really was blaming the trustees and their attorney for the delay, not the financial institution. Specifically, she claimed that the trustees and their lawyer had duties under state law to her as a beneficiary of the trust and that they failed to fulfill those duties.

She alleged that the trustees and their lawyer failed to fulfill their duties under state law when they allowed the entire IRA distribution to the trust. She also alleged that after the distribution, the trustees’ lawyer failed to timely inform the trustees and the IRA custodian of Ann’s rollover options as Ben’s spouse.

IRS Denies Waiver of 60-day Rollover Period
The IRS denied her request for a waiver of the 60-day rollover period. While not giving much detail, the IRS simply stated that the information and documentation that Ann submitted were insufficient evidence of financial institution error. So, the money she received from the trust and then rolled over to her own IRA was not eligible for rollover. As a result, the IRA distribution could not be treated as a tax-free rollover. It also likely created an excess IRA contribution.

Invalid Rollover Creates Excess IRA Contribution
In this case, Ann did the rollover before she requested the PLR. Either she assumed the funds were rollover eligible or she thought the IRS would give her a waiver of the 60-day rule due to the trustees and their lawyer’s alleged mistakes. She was wrong.

Without a 60-day waiver from IRS, the funds were not eligible to be rolled over to her IRA. The fact that she did roll over the money over means that the deposit is treated as a regular tax-year contribution for 2009. Assuming the deposit was more than $6,000 (the IRA contribution limit for 2009 for someone age 50+), then any amount above that is automatically treated as an excess IRA contribution. If an excess contribution is not timely removed by October 15 of the year after, it is subject to a 6% penalty each year until it’s corrected.

The 6% excess contribution penalty is reported on IRS Form 5329. If Form 5329 is not filed, the statute of limitations (normally 3 years) never begins to run adding more penalties and interest to an already costly situation.

Common Mistakes When a Trust is the IRA Beneficiary
While there are many good reasons to name a trust as the beneficiary of an IRA, the main reason is for control. If the IRA owner wants to control how the funds are paid out after he dies, a trust can do that.

Trusts are also often named as the IRA beneficiary for creditor protection purposes. In light of the June 2014 Supreme Court’s ruling in the Clark case where the court ruled that inherited IRAs are not protected in bankruptcy under federal law, more IRA owners may consider naming a trust as the beneficiary of their IRA to protect the money from the beneficiaries creditors.

Trusts by themselves are complicated. The IRA required minimum distributions rules are complicated too. When you mix the two by naming a trust as the IRA beneficiary, problems often occur. Below are some common mistakes that are made after an IRA owner dies with a trust as the beneficiary.

Paying Out Entire IRA to Trust
After the IRA owner dies, paying out the entire IRA to the trust should NOT be done, unless the trust says so. Only the required minimum distribution (RMD) needs to be paid to the trust, not the entire balance. If the entire IRA balance is paid to the trust (a nonsposue beneficiary), the trust cannot roll over the funds back into an IRA. The entire IRA distribution will be taxable.

After the IRA owners dies, the IRA should simply be retitled (transferred) into an inherited IRA for the trust, the same that would be done for any nonspouse IRA beneficiary. For example, the IRA could be retitled: “Jane Doe Family Trust as beneficiary of Jane Doe IRA” or something similar that identifies the deceased IRA owner and the trust as beneficiary.

Naming Family Members as Trustee of a Trust
Naming family members as trustee of trust has potential benefits and pitfalls. Family members will usually know the family dynamics and needs of the trusts’ beneficiaries and may be in better position to know when to make distributions than a third party trustee such as a bank that doesn’t know the family history. This is especially true in an accumulation (discretionary) trust where the trustees have to decide when to pay the IRA funds to the trust beneficiaries or retain them inside the trust.

One of the primary potential pitfalls is that the family members probably don’t have expertise in acting as a trustee and ideally should seek advice from professionals. If a disgruntled trust beneficiary questions whether the trustees are doing their job correctly, it certainly could cause friction in the family to say the least.

In PLR 201425023, it’s wasn’t clear whether the decedent’s children as co-trustees made a mistake, but the fact that the entire IRA balance was paid to the trust is suspect. One of the trust’s beneficiaries, the decedent’s wife, initiated legal action against the trustees which resulted in a settlement agreement. The odds that the settlement agreement caused problems in their family are pretty high.

Advisor Action Plan

  • Encourage trustees of a trust to not distribute any IRA funds without first getting professional advice.
  • Do not make a total distribution from the IRA to the trust after the IRA owner dies. Only the RMD needs to be paid out.
  • After the IRA owner dies, make sure the IRA is set up as an inherited IRA with the trust as beneficiary of the decedent.
  • Tell surviving spouse beneficiaries that whenever applying for a 60-day rollover waiver, doing a spousal rollover before the PLR request is received is risky. If the IRS denies the waiver, then an excess contribution will likely happen in the surviving spouse’s IRA.
- By Beverly DeVeny and Jared Trexler

What A Younger Spouse Should Do When Inheriting an IRA

Richard has an IRA and has named his wife Diane as the beneficiary. Richard dies unexpectedly at age 52. Diane is 50. What should she do with Richard’s IRA?

This is a case when the spouse should probably remain a beneficiary of the IRA. Here's why.

A beneficiary does not have to pay the 10% early distribution penalty on amounts withdrawn from the inherited IRA. If Diane needs to use IRA funds for any reason, she can take as much or as little as she wants and only pay income tax on the amounts she withdraws. She will not owe the 10% penalty. If Diane moves the inherited IRA into her own name, however, she will owe the penalty - unless one of the exceptions to the penalty applies.

A spouse beneficiary does not have required minimum distributions (RMDs) until the deceased account owner would have been 70 ½. Diane will have no RMDs until Richard would have been 70 ½ - 18 years from now. If she does not need any funds from the IRA, she can leave them in the account to continue to grow and compound, tax deferred.

Once Diane reaches the age of 59 ½, when she will no longer be subject to the 10% early distribution penalty on funds in her own retirement account, she can move the inherited IRA into an IRA in her own name. There is no deadline for a spouse to do this. She can make the IRA her own even if she has regularly taken funds out of the account.

Diane should be sure to make the funds her own before the year Richard would have been 70 ½. Here's why.

Diane, as a beneficiary, would have to use the Single Life Table for calculating her RMDs from the inherited IRA. The RMDs would be larger each year than they would be if Diane owned the account and used the Uniform Lifetime Table. As a result, Diane would be paying more in income tax each year, and she would be depleting the account at a faster rate than she would have to if the account was an owned account.

Plus, Diane’s beneficiaries of the inherited account would not be able to use their own life expectancies at Diane’s death. Instead, they would have to continue using Diane’s life expectancy. Her beneficiaries would be successor beneficiaries - a beneficiary’s beneficiary. They would not be an original beneficiary. As a result, the annual distributions would almost certainly be larger, the beneficiaries would owe more in income tax each year, and the account would be depleted at a faster rate.

- By Beverly DeVeny and Jared Trexler

Slott Report Mailbag: Can I Mix Pre-Tax and Post-Tax Money in the Same IRA?

This week's Slott Report Mailbag discusses IRA basis and the ever-popular question about Roth IRA and IRA distributions' tax status. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.


ed slott IRA questions
Send questions to [email protected]
I currently have two Traditional IRAs, which were funded from rollovers from 401(k) and 403(b) accounts, and opened in 2013. I want to contribute to a Traditional non-deductible IRA for 2014 with after-tax funds then convert it to a Roth. My broker says I can’t mix pre-tax and post-tax money in an IRA. But if I file IRS Form 8606 will it show my basis for what I contributed to the Traditional IRA? Can you help?

Michael from New Jersey

You can mix pre-tax and post-tax money in the same IRA. It doesn’t matter because under the pro-rata tax rule, all of your non-Roth IRAs are considered one IRA for tax purposes. You cannot convert just your nondeductible IRA contribution to a Roth IRA tax-free because you have other IRA money that contains pre-tax funds. Form 8606 will show your basis but it will also show you how a distribution from any IRA will be taxed. A portion of each distribution will come from your pre-tax dollars and a portion will come from your after-tax dollars.


Good afternoon,

I am 44 years old and rebuilding my primary residence from Hurricane Sandy. To pay off my existing mortgage I am taking out all of my contributions from my Roth IRA and Traditional IRA. I opened my Roth IRA in April 1999 for 1998 contributions and my Traditional IRA contributions were all non-deductible because I contributed to 401(k).

Question: for my Roth, if I take my contributions only as a distribution do I pay any tax? For my Traditional IRA do I just pay the 10% early distribution penalty if I just take out my contributions? And if I take out my full balance on a deceased Beneficiary IRA do I have to pay ordinary income tax? Are all my tax statements correct if I take distributions from all three IRA accounts? I am keeping all gains in the Roth and Traditional IRA.

All annual Roth IRA contributions can be withdrawn at any time without tax or penalty. For your Traditional IRA, despite the fact that all of your contributions were nondeductible, you cannot just withdraw those contributions tax-free. The earnings on those contributions are taxable. Under the pro-rata tax rule a portion of any distribution will be from your after-tax contributions and a portion will be from your pre-tax earnings. The 10% penalty will apply to the taxable amount of your IRA distribution. The withdrawal of funds from a beneficiary IRA will be taxable, but no 10% penalty because it’s due to death. In your Traditional IRA and the Beneficiary IRA, you cannot keep all gains in those accounts to reduce or avoid taxes.

- By Joe Cicchinelli and Beverly DeVeny

QLACs Shift From Tax Code Theory to Consumer Reality ... Soon

In response to my post last week on the IRS announcement of final regulations for Qualifying Longevity Annuity Contracts (QLACs), a number of Slott Report readers inquired about their availability. Here’s what some of them had to say:

“Do you know which companies are currently offering QLACs?”
“I searched the internet for QLACs and couldn’t find one company that has one.”
“I called four companies to inquire about QLACs. Two of them said they don’t have any available and two of them didn’t even know what I was talking about!”

So what’s the deal? Quite simply, the final QLAC regulations that were released by IRS on July 1, 2014 are in effect already - they were effective beginning the next day, July 2, 2014 - but that doesn’t mean that insurance carriers already have products that conform to the new IRS specifications.

While the final QLAC regulations closely resemble the proposed regulations that were initially released back in February 2012, there are a number of changes insurance carriers will need to and/or want to incorporate into their products before they are actually released and made available for purchase.

That’s why - at least to the best of my knowledge - for now, QLACs exist in theory only.
If you think a QLAC may make sense as part of your plan, though, there is some good news. Over the past few years I’ve spoken with a number of insurance company executives who indicated they had full intentions of offering QLACs once the final regulations were released. Supposedly, some of those companies even began to work on QLAC products based on the proposed regulations which, given their similarity to the final regulations, will likely require only minimal tweaking before being finalized. Plus, many companies already offer products that are substantially similar to QLACs.
Put all of that together, and it’s likely that in the not too distant future QLACs will go from tax code theory to consumer reality.

2014 Retirement Guide Helps You Save and Stretch Wealth

- By Jeffrey Levine and Jared Trexler

You Can't Convert a Non-Deductible IRA Contribution Tax-Free in Most Cases

converting non-deductible IRA
You want to make a contribution to a Roth IRA for 2014. As long as you’re working and have compensation (earned income) you can potentially make a Roth IRA contribution of up to $5,500 if you’re under age 50 or $6,500 if you’re age 50 or older this year. However, remember that there’s an income limit for making a Roth IRA contribution. Certain higher income individuals aren’t allowed to make a Roth IRA contribution for the year.

For 2014, if you’re married and filing jointly, and your combined income (what the IRS calls modified adjusted gross income or MAGI) is $191,000 or more, you can’t make a Roth IRA contribution. If you’re single, the MAGI limit for 2014 is $129,000. But there’s a strategy to allow high income individuals to get around the income limits for contributing to a Roth IRA. This loophole is sometimes called a “backdoor Roth IRA conversion.”

There are no income limits to convert IRA money to a Roth IRA, so any high income person can do a conversion. There’s also no income limit to make a traditional IRA contribution, but typically high income individuals can’t take a tax-deduction for it because they participate in a company retirement plan and their income is too high. That leaves you with making a non-deductible traditional IRA contribution, which is allowed.

Generally, when you convert IRA money to a Roth IRA, the conversion is taxable. Some folks have been told that you can simply make a non-deductible traditional IRA contribution and then convert that contribution to a Roth IRA tax-free. In most cases, this strategy does not work because of the pro-rata tax rule.

Under the pro-rata tax rule, if you have other IRAs, including SEP and SIMPLE IRAs, you must look at all the balances of all your non-Roth IRAs when figuring the taxable part of any IRA money you convert to a Roth IRA. It doesn’t matter if your nondeductible IRA contribution was made into a separate IRA either; the rules look at all of your IRAs as one IRA.

When one of your IRAs has nondeductible money in it (also called after-tax funds), then each dollar withdrawn from any of your IRAs will contain a percentage of tax-free funds (the nondeductible funds) and taxable funds (the deductible funds and earnings) based on the percentage (pro-rata portion) of after-tax funds to the entire balance in ALL your IRAs.

So, if you have other IRA money when you make a nondeductible IRA contribution, you can’t just convert that contribution tax-free. You report your after-tax contributions on IRS Form 8606. This form must also be filed with your tax return when you do a Roth conversion.

2014 Retirement Guide Helps You Save and Stretch Wealth

- By Joe Cicchinelli and Jared Trexler

IRS Regulations Bring QLACs to Life

QLAC retirementYesterday, July 1, 2014, the IRS released the Final Regulations for "qualifying longevity annuity contracts" (QLACs). Thanks to these regulations, you will now be able to purchase certain annuity contracts that can be excluded from the fair market value you use to calculate your required minimum distribution (RMD).

Ultimately, the purpose of the regulations is to make it easier to invest a portion of your retirement savings in annuities that won’t begin to pay benefits until a more advanced age - beyond 70 ½ - the age at which RMDs must generally begin. Doing so obviously reduces the number of years for which you’ll likely receive an income stream, but it also helps to maximize the amount of income you can receive in later years for a given premium. The Summary of Comments and Explanation of Revisions that was released with the Final Regulations offered the following:

"For example, if at age 70 an employee used $100,000 of his or her account balance to purchase an annuity that will commence at age 85, the annuity could provide an annual income that is estimated to range between $26,000 and $42,000."

Many of the most important aspects of QLACs remain unchanged from the proposed regulations that first introduced them back in 2012 (You can read one of my initial posts on the topic here). That said, there are a couple of key changes that, on the whole, make QLACs more attractive and increase the likelihood that one may play a role in your retirement planning at some point.

Here are some of the highlights of the QLAC Final Regulations:
  • You will be able to exclude the value of a QLAC from your RMD calculations, allowing you to keep a greater portion of your IRA (or other retirement account) intact longer.
  • Payments from QLACs will have to begin no later than the first day of the month after you turn 85.
  • You will be limited as to how much of your retirement savings you can invest in a QLAC. The limit will be the lesser of $125,000 or 25% of your applicable retirement account assets. The 25% limit will apply on an individual plan basis, except for IRAs, BUT the $125,000 is a cumulative limit for all QLACs in all retirement accounts. For IRAs, the 25% limit will apply to the prior year-end total of all IRAs (not including Roth IRAs).
  • The limits will apply separately to each spouse when each spouse has their own retirement accounts.
  • QLACs cannot be variable or equity-indexed annuity contracts, though insurance may offer contracts with cost-of-living adjustments.
  • QLACs cannot offer any cash surrender value. So if you buy one, just be sure you won’t be needing that lump-sum of money anytime soon!
Perhaps the biggest difference between the proposed regulations of 2012 and the final regulations released yesterday relate to the potential death benefit options. Initially, the only QLAC death benefit option was going to be an income stream paid out over the life of the beneficiary (the size and start date of the payments were to vary depending on whether the beneficiary was a spouse or non-spouse designated beneficiary). That’s still an option under the final regulations, but an additional return-of-premium option is also now possible.

These, of course, are the death benefit options allowed to be offered by a QLAC under the final regulations, but that doesn’t mean that every QLAC will do so. It’s likely that insurance companies will begin to introduce annuity products that meet QLAC specifications in the near future, so if it sounds like a strategy that may make sense for you, keep your eyes and ears open and consider speaking with a qualified professional who can help you evaluate your options.

2014 Retirement Guide Helps You Save and Stretch Wealth

- By Jeffrey Levine and Jared Trexler

Exceptions to the Once-Per-Year IRA Rollover Rule

once-per-year IRA rollover rule exceptionsThere is a one-rollover-per-year rule that applies to IRA distributions. IRA-to-IRA or Roth IRA-to-Roth IRA rollovers are subject to the once-per-year rule. The account owner can only rollover IRA funds once every 12 months. The 12-month period is a full 12 months.

For example, if you received your IRA distribution in November that you rolled over within 60 days, you are not eligible to do another rollover from that IRA until the following November. The 12 months starts when you receive the IRA distribution, not when the distribution is actually rolled over, for example 60 days later.

In 2014, this once-per-year rule applies to each of your IRAs separately. For example, let’s say you have two different IRAs with two different financial institutions; you can roll over one distribution from each of them. But this rule will change next year.

On January 28, 2014, The Tax Court ruled in the Bobrow case that the once-per-year rollover rule applies to all of a person’s IRAs collectively, not to each of his IRA accounts separately. Based on the Court’s ruling, the IRS announced in March 2014 that this rule change will not start until 2015.

Direct transfers between IRAs (where you don’t control the funds) are not subject to the once-per-year limit and can be done an unlimited number of times.

While the once-per-year rollover rule applies to most IRA-to-IRA or Roth IRA-to-Roth IRA rollovers, there are some exceptions. The three types of rollovers listed below are not subject to the once-per-year rule. Like direct transfers, they can be done an unlimited number of times within a year:
  1. Roth conversions - IRA funds can be converted to a Roth IRA as many times as you like during the year.
  2. Rollovers from employer plans to IRAs - Distributions from your employer retirement plans, such as a 401(k) aren’t subject to the once-per-year rollover limit.
  3. Rollovers from IRAs to employer plans - Some employer retirement plans allow you to roll over your pre-tax IRA funds into your company’s retirement plan. If that’s the case, you can roll over as a many distributions as you like.

- By Joe Cicchinelli and Jared Trexler