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 In This Update:
  • Q of the Month:
    Do I Only Have to Use the 5-Year Rule Once?
  • Key Focus:
    Contributing to Retirement Accounts Reduces Taxes
  • Ruling to Remember:
    The 60-Day Rollover Window

 Resources  Expert


?? Question of the Month: Do I only have to use the 5-year rule once?

Q: Does the establishment of ANY Roth IRA start the clock on the 5-year rule? For example, a 40-year-old establishes a Roth IRA in January 2007. In March 2012, he establishes another Roth IRA, which contains funds converted from a Traditional IRA. Could he withdraw those converted funds and not pay a penalty tax?

A: There are two 5-year rules, one for tax-free distributions and one for penalty-free distributions. The 5-year rule for tax-free distributions starts when the first Roth IRA was established in January 2007. That Roth IRA can be used to satisfy any additional Roth IRAs established. Once five years pass and the other qualifications for a qualified distribution are met (age 59 1/2, death, disability, first-time home buyer), all distributions are tax-free. A non-qualified distribution of earnings in the Roth account will be subject to income tax and the 10% early distribution penalty, if applicable. Converted funds in a Roth IRA have their own 5-year rule. If the account owner is under age 59 1/2 and the converted amount has been held for less than five years, then the distribution is subject to the 10% penalty. Each conversion has its own 5-year holding period.


2012 IRA Strategies to Gain New Business


Prohibited Transaction Relief

The February issue of Ed Slott's IRA Advisor Newsletter goes through several examples of prohibited transaction relief for IRA owners who signed broker indemification agreements. The relief comes after a pair of Department of Labor Advisory Opinion Letters (discussed in the newsletter) reinforced that such agreements would be considered an extension of credit between an IRA owner and his or her IRA.

Also in the February issue: a court case that brought attention to the 10% penalty exception for unemployed individuals and another case that delved into the age 55 penalty exception.


Inside Ed Slott's IRA Advisor Newsletter

Prohibited Transaction Relief for IRA Owners Who Signed Broker Indemification Agreements

  • IRS Announcement 2011-81
  • Extension of Credit Between an IRA and an IRA Owner
  • Advisory Opinion Letter 2009-03A
  • Advisory Opinion Letter 2011-09A
  • IRS Announcement 2011-81
  • Advisor Action Plan

10% IRA Penalty Exception for Unemployed Individuals

  • Recent Case Brings Attention to Unemployed Penalty Exception
  • Facts of the Case
  • The Court’s Decision
  • Health Insurance Exception for Unemployed Persons
  • When the Unemployed Exception Won’t Work
  • Medical Exception Alternative

Age 55 Penalty Exception; Court Rules that Employee Fails to Meet the Requirements

  • Gail Marie Watson V. Commissioner
  • Facts of the Case
  • The Court’s Decision
  • 3 Common Age 55 Exception Mistakes

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February Key Focus

Contributing to Retirement Accounts Reduces Taxes

One of the best ways to legally avoid current income taxes is by contributing to an employer-sponsored retirement plan such as a 401(k) or 403(b). While it’s too late to make any contributions to those plans for last year, you have until April 17, 2012 to set up and fund a new IRA or add money to an existing one and have contributions count for 2011. The last day to contribute for the prior year is generally April 15, BUT in 2012 the 15th falls on a Sunday and the 16th is Emancipation Day, a holiday in the District of Columbia that affects tax filing deadlines.

Eligibility to deduct contributions made to Traditional IRAs depends on a somewhat complex formula that considers your income, your retirement coverage at work and, if applicable, your spouse’s retirement coverage. If neither you nor your spouse participates in an employer-sponsored retirement plan, then all of your Traditional IRA contributions will be deductible. However, if either one of you is covered by a retirement plan at work, phase-out ranges based on the amount of your modified adjusted gross income (MAGI) for the year could limit your IRA deductibility. You will know if you are considered to have particpated in your employer’s plan by checking your W-2 form for the year in question. If the “Retirement Plan” box is checked, then you have participated. If it is not, then you haven’t, simple, right?

Go here to view 2012 IRA and tax tables for phase-out ranges

The same contribution deadline for Traditional IRAs also applies to Roth IRAs. While you get no immediate income tax benefit by making a Roth IRA contribution, the growth will be tax-free when withdrawn, provided certain conditions are met. And while there are no deductibility phase-outs to deal with, the amount of your MAGI will determine whether you qualify to make a contribution.

Keep in mind that you must have earned income at least equal to the amount you wish to contribute to either a Traditional or Roth IRA. If you don’t qualify to make a deductible contribution to a Traditional IRA because of the income limitations, consider making a non-deductible contribution. The money in the Traditional IRA will grow tax-free until withdrawn. Also, special rules allow an individual with little or no earned income to use their spouse’s compensation to make an IRA contribution. You can view IRS Publication 590 for additional information on this topic.

Go here to read the entire article and search “Tax Season Week” for full 2012 tax season information. Also search the hashtag #TaxSeasonWeek on Twitter for tax season updates.

Ruling to Remember

Private Letter Ruling 201205021

“John,” a 70-year-old taxpayer, wanted to rollover an IRA distribution into three separate IRAs. He successfully completed two of those rollovers to two different financial institutions. The remaining funds were slated for a third IRA at a third financial instituation.

However, John’s best laid plans didn’t come to fruition. His financial advisor incorrectly completed the rollover forms by failing to check the correct box to indicate his intention to establish a rollover IRA. As a result, the funds were deposited into a non-IRA account.

John immediately requested a waiver to the 60-day rule. IRS normally looks at 1) errors committed by a financial institution; 2) inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error; 3) the use of the amount distributed; 4) the time elapsed since the distribution occurred.

John’s information was consistent with the assertion that his failure to accomplish a timely rollover was due to an error by his financial advisor. IRS waived the 60-day rollover requirement and granted 60 more days from the issuance of the ruling letter to contribute the intended amount to a rollover IRA.

Aside from the obvious financial institution error, there is an important lesson to learn. One distribution taken from an IRA CAN be split into rollovers to different IRAs. The one-rollover-per-year rule is not an issue since there was only one distribution. Despite the financial instutition error, John would NOT have been granted the extension if he had taken three distributions on three different days.

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