Slott Report Mailbag: How Do I Set Up a Roth IRA For My Grandmother?

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

This week’s Slott Report Mailbag broadens the scope to issues that touch on IRAs, but also involve other forms of retirement accounts and retirement planning concepts. We look at 10-year averaging, required minimum distributions for employer plans and how to set up a Roth IRA for an older individual working a part-time job.

1. Can Form 4972 (10-year averaging) be used for IRA distributions or is it just for distributions from employer plans like 401(k)s?

Answer:
IRA distributions are taxed as ordinary income; there is no special tax treatment such as 10-year averaging. Accordingly, you cannot use IRS Form 4972 for any IRA distributions.

2. Ed:

I have some questions for you regarding the required minimum distributions (RMDs) for 401(k)s and I’m hoping you will be able to guide us.

Here is the situation:

My husband is the sole owner of a small roof and floor tile import business. He opened an individual 401(k) account in January of 2004. We have made contributions to the account every year since.
In December of 2009, he opened a Roth 401(k) account, but did not make a contribution to the account until April of 2012.

My husband turns 70 1/2 this year, so his 401(k) accounts are now subject to RMDs. The problem is that his Roth 401(k) is now only one year into the five years that are required before being able to make qualified withdrawals. Does age trump the five-year rule? Can we be forced to take a RMD from the Roth 401(k) account, which would be subject to taxes/penalties because the monies haven’t been in the account for at least five years?

I talked with a retirement account expert at TD Ameritrade, where we have our accounts. She advised/suggested the following:

1. Figuratively, lump together the two 401(k) accounts to get a grand total.
2. Calculate the RMD based on the grand total.
3. Take the RMD monies out of the Individual 401(k) account.
4. Then rollover the Roth 401(k) monies directly into my husband’s Roth IRA. The expert said that “theoretically” we could do this, referred to it as an “in-service distribution,” and said that the distribution would not be subject to taxes/penalties, even though the account hasn’t yet met the five-year requirement. We were also advised to consult a tax expert (EA, CPA).

Does the above scenario seem possible/appropriate/allowed to you?

Your insights would be much appreciated. Thank you for your time.

K. Davidson

Answer:
You must take a required minimum distribution from the 401(k) plan. A non-qualified distribution from the Roth 401(k) will be partially taxable (the earnings portion) and partially tax-free (the basis). The final regulations for Roth 401(k) accounts are very clear that the Roth account is a separate account. The 401(k) and Roth 401(k) funds cannot be commingled. You should take an RMD from the Roth account and an RMD from the “regular” 401(k) account. Make sure you take the Roth 401(k) RMD before rolling over the remaining funds to the Roth IRA. Any RMD amount that is rolled over becomes an excess contribution in the receiving account.

3.

Dear Mr. Slott:

I am reading your new book “How to Parlay your Roth IRA into a Family Fortune” and I am learning a lot.

I am especially interested in one point you made that made me think, and that is you could get your 80-year-old grandmother to fund a Roth IRA by hiring her to “shovel snow.” Could you share with me how you would do this? What kind of records would she need to keep so that the IRS would not consider this an audit exception? Would I need to do a W-2 form so that she could file on her income tax return that she has “earned” income? How much per year would she be able to “earn”?

Thank you,
Tom

Answer:
Anyone with bonafide compensation at any age can contribute to a Roth IRA as long as their total income does not exceed certain levels (e.g., $112,000 for someone who is single for 2013). IRS Form W-2 is filed only for employees. You should consult with your tax advisor on the best way to hire, pay, and report the wages for a relative.