By Jeffery Levine, IRA Technical Expert
Follow Me on Twitter: @IRAGuru4EdSlott
Last Tuesday, Senator Orin Hatch of Utah introduced new IRA-related legislation to the Congressional floor. The purpose of the bill had nothing to do with taxes, as you might first suspect, but rather, was introduced in an effort to strip the Department of Labor (DOL) of some of its power over IRAs. In particular, the provision, part of the Secure Annuities for Employee (SAFE) Retirement Act of 2013, would remove oversight of the duty of care rules for IRAs from DOL and return them to the Treasury Department, which oversaw them until a 1978 executive order. The duty of care issue relates to the standard of care IRA advisors are held to when providing advice to clients.
For those not deeply familiar with IRAs, this may sound a little odd. After all, what does the Department of Labor have to do with retirement accounts anyhow? The reality of the situation, however, is that many federal and state organizations and entities have some sort of control, power or determination as to how IRAs are treated. Below is a brief list of some of these entities, but to be sure, this list is far from exhaustive.
Congress - Congress is the primary entity responsible for creating the federal laws that govern IRAs. These laws include everything from who has oversight over those helping individuals with their IRAs to how IRAs are taxed and at what amounts to who has to take required minimum distributions and how large those distributions must be. If you are unhappy with any of the rules for IRAs, or think they are a bit too complex, chances are it will take congressional action to make a change. On the other hand, if you happen to love the IRA rules and think they are just “oh-so-easy” to understand, you have Congress to thank.
The Department of Labor - As mentioned above, the Department of Labor has control over the duty of care rules applicable to IRAs. However, they also have the ability to affect IRAs and other retirement accounts in a very important way. The Department of Labor is actually the government entity responsible for determining what is, and what is not, a prohibited transaction.
Under the tax code, there are some things you simply cannot do with your retirement account, and these are known as prohibited transactions. Needless to say, prohibited transactions are a really bad thing. The entire IRA in which the prohibited transaction occurred is treated as having been distributed on January 1st of the year the prohibited transaction occurred, even if the prohibited transaction only involved a mere fraction of the account. That could lead to a significant tax bill, as well as the 10% penalty for those under 59 1/2 at the time.
Treasury Department/IRS - The Internal Revenue Service, or IRS, is a branch of the federal Treasury Department. Obviously, IRAs are affected by the IRS since it is the government body responsible for calculating and collecting your taxes. IRS, though, also serves another important function. Although Congress writes the laws that govern IRAs, it is IRS that is responsible for writing the regulations which explain those laws and issuing other guidance, such as notices, announcements and revenue rulings, that help clarify those rules and allow us to better understand how the laws work.
Individual states - States actually have a lot of say over IRAs for a variety of reasons and different state organizations are responsible for different aspects. For instance, it's up to each individual state to determine how much, if it all, they will tax IRA distributions. Similarly, it's up to individual states to determine if they will allow IRA deductions for IRA contributions on their state’s income tax return.
States also have control with a variety of other IRA related issues. For instance, state law determines whether or not IRAs receive creditor protection. States also generally have control over property law, so when you leave your IRA to certain beneficiaries, state law could have some say as to how those assets are passed. Plus, state laws cover when minor beneficiaries reach the age of majority and have control over certain inherited assets.