Roth IRA in Trust – One for the textbook!
As a successor trustee, beginning in 2002, for my aunt and uncle’s Trust I’ve been trying to sort out various legal aspects of the Trust for the past 10 years. My Uncle passed away in December 2000 and my aunt passed away in February 2007. Unfortunately what I’m about to share with you is a classic textbook example of why it is so important for the grantors of the Trust to fully inform not only the trustees, but the successor trustees as well of all aspects pertaining to the Trust at the time the Trust is created, as well as amended.
As legal counsel has advised there are three parts to the Trust I’ve been dealing with, the Credit Shelter, the Marital and the personal share belonging to my late aunt. Prior to his death my uncle had named the Trust as the beneficiary for his Roth IRA.
We have received conflicting information from legal and tax counsel regarding the disposition of the Roth IRA due to several factors:
1. I did not personally become aware of the Roth IRA’s existence until sometime in 2006, missing the five year time frame for distributions.
2. My aunt never took distributions from the Roth IRA during her lifetime.
3. The proceeds from the Roth IRA were ultimately transferred to the Trust in November 2010. However, when the money was transferred to the Trust it was put into the Marital Trust, which legal counsel has indicated was incorrect. Counsel is stating the distribution should have gone into my aunt’s personal share of the Trust.
Consequently, I’m trying to sort out the issue of the potential 50% penalty and whether it applies to the entire Roth IRA distrubution or does it apply to the RMD’s that were not taken or perhaps a combination. And then of course we have the question of the Roth IRA assets not being distributed to the Trust until November 2010, some 45 months after my aunt’s passing.
A 1099R was issued for the 2010 tax year indicating the distribution was from a Roth IRA. Subsequently form 5390 was submitted to the IRS with a letter of explanation regarding the distribution indicating that my aunt was not of sound mind for a number of years regading her finances and the trustees were unaware of the existence of the Roth IRA until sometime in 2006.
Needless to say your expertise in this area would be extremely helpful as I indicated we seem to have conflicting information at this point in time.
Permalink Submitted by Alan Spross on Mon, 2012-04-30 20:34
If we assume that the trust was not considered a qualified trust, most likely because it missed the deadline to present the trust docuements to the Roth custodian, it makes things more simple.
Since a Roth owner is deemed to have passed prior to the required beginning date, a non qualified trust beneficiary triggers the 5 year rule for Roth RMDs. I think you meant to indicate that Form 5329 (not 5390) was filed requesting that the IRS waive the 50% penalty, which under the above circumstances would have been 50% of the Roth IRA value. Usually, the IRS will waive the penalty provided that the RMD or in this case the full balance of the Roth had been distributed.
Of course, the Roth was fully qualified and therefore the lump sum distribution would not have been taxable. But you never heard from the IRS regarding the penalty waiver?
Permalink Submitted by Scott Rivard on Mon, 2012-04-30 23:00
As of today 04/30/2012 we have not received a response from the IRS. I must be mistaken, but I thought it was form 5390 that we did file in April 2011. Our legal counsel has stated that we’d probably not receive a response until 2 years and 10 months have elapsed from the filing date. While I realize this is a bit of a unique situation, I’m surprised that both legal and tax counsel have not provided me a definitive answer regarding this matter.
Permalink Submitted by Scott Rivard on Mon, 2012-04-30 23:13
Alan, Sorry for any confusion it was form 5329 that was filed in 2011.
Permalink Submitted by Bruce Steiner on Tue, 2012-05-01 03:28
What does the trust say as to where the Roth IRA goes?
Someone must have known about the Roth IRA. Perhaps the lawyer who prepared the trust agreement who presumably asked uncle and aunt about their assets. Perhaps the lawyer who handled uncle’s estate and prepared the estate tax return. Perhaps the accountant who showed the income from the conversion on uncle’s income tax return for the year of the conversion. Perhaps whoever was receiving uncle’s mail after he died.
Why didn’t uncle simply name aunt as the beneficiary of the Roth IRA? Why did they create all of this complexity?
Permalink Submitted by Scott Rivard on Tue, 2012-05-01 13:21
All very good questions you ask regarding the various professionals involved in this matter. My aunt lived in Alabama and I live in upsate New York and was originally a secondary trustee, who later became a primary trustee in July 2002, two years after my Uncle’s passing.
You’d have to understand my Uncle in order to understand why he named the Trust as beneficiary. He was a retired orthropedic surgeon, who decided he knew best how to structure his estate, even though he had the largest and best known law firm in Huntsville, Alabama advising him. Unfortunately, for everyone involved I’m sure he would not listen to their best advice.
My Aunt passed away in February 2007 and was not only a very private person, but over at least the last 10 years of her life not always thinking clearly in matters of her finances and personal estate. In fact she shared very little information with me as a trustee or my brother as the other trustee.
So that brings us to today with thr Roth IRA, sitting in the Marital Trust, with legal counsel telling me that it should be part of my Aunt’s personal share of the Trust. The current value of the Roth IRA is approximately $195,000.00. Once again RMD’s were never taken by my Aunt as far as I know and the money was not transferred to the Trust until November 2010.
The Fidelity sent out the required 1099R showing the distribution as coming from a Roth IRA and subsequently the accountant prepared and I filed a 5329 with the IRS along with a letter of explanation requesting they waive any possible tax penalties due to my Aunt’s lack of awareness and mental state in regards to tax issues relating to the Roth IRA. On line 53 of the 5329 the accountant had listed on Additional Tax – $97,384.00, which in retrospect I totally disagree with in that this was a Roth IRA, NOT a traditional IRA. Legal counsel has advised that she believes any penalty would be assessed on 50% of the RMD’s for each year form 2001 to 2007 when my Aunt passed. As I stated,unfortunately for me and the beneficiaries this matter has become a case study for the Ed Slott book on “Things NOT to do with a Roth IRA.”
Permalink Submitted by Bruce Steiner on Tue, 2012-05-01 13:33
Alabama? The trust you describe is common in a community property state where revocable trusts are commonly used, notably California, but not in a common law (non-community property) state such as Alabama. It’s not surprising that lawyers in Alabama and New York would have to struggle to deal with it.
I’m not familiar with Huntsville, but there are some excellent tax and trusts and estates lawyers in Birmingham, Alabama, as well as many here in New York.
If your uncle was an orthopedic surgeon, his estate was probably large enough that it’s worth taking a closer look to see that everything was or is done to complete the administration, and to see that the beneficiaries’ estate planning is in better shape.
Permalink Submitted by Scott Rivard on Tue, 2012-05-01 13:59
I’m simply trying to get some guidance on this matter from your organization, as I know Ed Slott is the recognized national leader when it comes to IRA’s and taxation issues and knows far more on this topic than most, if not all, estate planning attorneys, as well as accountants. As I mentioned I’ve already received conflicting information from legal counsel and the accountant who prepared the estate tax filing and subsequently the 5329 filing. Since taxes have already been paid on a Roth IRA contribution and the money grows tax free and subsequently all distributions are tax free, I disagree with the accountant who feels there’s a 50% penalty on the entire amount of the Roth IRA ($195,000.00), approximately $97,500.00. Once again, legal counsel is saying the 50% would be applicable to the RMD’s that were never taken between 2001 and 2007 when my Aunt passed. In addition, I would assume the IRS could levy an additional penalty for the period from 2007 to November 2010 when the money was finally distributed to the Trust.
Would you suggest at this point I contact Ed’s office directly on this matter, since I am receiving conflicting advice? And yes the estate was large enough that over $240,000.00 was paid in federal estate taxes in 2007.
Permalink Submitted by Alan Spross on Tue, 2012-05-01 22:10
There is probably many issues involved with the trust administration, but the Roth IRA seems like a fairly simple situation:
1) The Roth IRA did reach qualification status before it was distributed, that means that the entire amount distributed to various trusts is tax and penalty free in the year distributed.
2) Roth RMDs are another matter. A Roth owner is deemed to have passed prior to the required beginning date and when a non qualified trust is the named beneficiary, the 5 year rule applies. The entire balance was distributed, but due to extenuating circumstances this occurred after the 5 year rule deadline. This triggers the potential 50% excess accumulation penalty which has nothing to do with taxation of the Roth. It instead is a severe penalty for failing to take the RMDs in time. The IRS will usually waive this penalty if the 5329 is filed and the situation is corrected. Since the entire Roth was distributed, there is nothing further to do than to wait to see if the IRS waives the penalty due to “reasonable cause”. It sounded like there was reasonable cause, so there is unlikely to be a penalty levied.
If the 5329 was filed correctly and this is just a matter of securing confirmation from the IRS that the penalty has been waived, the IRS should be contacted to confirm the status.
Permalink Submitted by Scott Rivard on Tue, 2012-05-01 22:33
1. Are you in agreement with legal counsel that the 50% penalty is applicable to the RMD’s that were never taken?
2. Or are you of the opinion the 50% penalty is applicable to the entire Roth IRA?
3. Or possibly a third option that the 50% penalty is not only applicable to the RMD’s that were never taken, but also any investment gains on the account after my Aunt’s passing in February 2007 to November 2010 when the Roth IRA was ultimately distributed to the Trust?
Sorry to keep asking for clarification, but this has not only been confusing for me, but our legal and tax counsel as well, who’ve provided differing opinions. Ed and your organization are nationally known as “the answer person / people” in matters pertaining to IRA’s so I was hopeful you could answer this most troubling question.
If you think I should call Ed direct or another member of the staff at this point for a definitive answer, please provide the best number to call. Thank you for your continuing assistance in this matter.
Permalink Submitted by Alan Spross on Tue, 2012-05-01 23:22
1) Yes, but it is also true that the IRS will waive the penalty for “reasonable cause”, particularly when unique circumstances, or health problems are part of the reason. The IRS is also more likely to waive the penalty when the taxpayer (trust) self reports the omission on Form 5329 as opposed to the IRS initiating action.
2) Yes, under the 5 year rule it would be. Now if the trust was qualified for look through treatment and RMDs were taken using the life expectancy of the oldest trust beneficiary, a case could be made that the penalty should only apply to the life expectancy RMDs that would have been due through 2010 instead of the entire balance. 2009 RMDs were waived, so 8 years of RMDs were delinquent. But this argument is moot if the trust was not qualified and to become qualified it would have to meet the conditions listed on p 36 of Pub 590. One of those requirements was to submit the trust to the Roth custodian by 10/31/2001. Under the circumstances that probably did not happen.
3) No merit in this. RMDs are always based on the actual value, either the prior 12/31 value if life expectancy was used (see above) or the requirement to totally drain the account by the end of the 5 th year after death (12/31/2005). That would include the affect of any gains or losses included in the account balance.
Do you have a copy of the 5329 that was filed. It would be interesting to see what the stated “reasonable cause” was?
Who was the trustee of the trust from 2000-2005, your aunt? Was what her mental and physical condition during those years?
Permalink Submitted by Alan Spross on Wed, 2012-05-02 02:13
Unless there is a specific need for a definite answer due to a need to distribute these assets, I would go with legal counsel and not follow up with the IRS. If no word in 18 months, it’s a good sign the IRS has agreed to the waiver.
I can’t tell you if the IRS typically issues a notification of waiver, or their silence simply means that the waiver has been granted.
Permalink Submitted by Bruce Steiner on Wed, 2012-05-02 02:20
This forum can be useful for providing general information, but not for providing specific legal advice. Your lawyer can give you specific advice based upon the facts, and your objectives.
Commissions of $38,000 are modest for a $5 million estate. The issue is not the amount of the commissions, but rather their performance.
Why didn’t the lawyers prepare the estate tax return? In most cases, the lawyers prepare the estate tax return, especially in larger estates.
Permalink Submitted by Scott Rivard on Wed, 2012-05-02 02:36
That’s an excellent question regarding why legal counsel did NOT prepare the tax return as opposed to the accountant, one we’ll probably never know. But then under the circumstances there are many unanswered questioned regarding the estate. This is why I stated at the very beginning this is a textbook case for Ed to cite in how NOT to do estate planning and the consequences related to IRA’s, especially Roth IRA’s. Thank you very much for your assistance in this matter.