What If You Were Told You Are Not Part of An Employer Retirement Plan But You Really Were?
By Timothy P. Bogert, CLU, ChFC, LIC, AIF®
Member of Ed Slott's Master Elite IRA Advisor GroupSM
I like to ask clients “If what you thought to be true turned out not to be true, when would you want to know? Since the beginning of mankind, people have been told things that turned out not to be true. The World is Flat. Radio has no future (Lord Kelvin 1897). The horse is here to stay, but the automobile is only a novelty – a fad. (Advice from a president of Michigan Savings bank to Henry Ford’s lawyer. Horace Rackham). What if you were told you are not part of an employer retirement plan but you really were? What could be the implications?
John, who was single, had never been told he was participant in his employers’ retirement plan. His W2, which contains a box that should be checked if he is a participant in a retirement plan, was not checked. John, who is only in his 20’s diligently made tax deductible contributions to his IRA for several years.
Toward the end of 2015, John called me to say he just found out he was a participant in his employer’s plan, but when he received his 2015 W2, you guessed it, the “Retirement Box” still wasn’t checked. His employers seemingly “minor error” turned out to be a major headache for John. See, Johns income each year was too high to make a tax deductible IRA contribution while also being a participant in an employer retirement plan ($61,000 - $71,000 for singles like John or $98,000 - $118,000 for married filing jointly for 2016).
Please note, there are several potential errors on the part of an employer who doesn’t properly communicate to an employee that he or she is a participant in a retirement plan, but that is beyond the scope of this article. I will deal with the problems and potential solutions to Johns situation.
What to do? John had made deductible IRA contributions for several years that, as it turned out, he was not allowed, and his “deductible” contributions reduced the amount of income taxes he paid for those years. On top of this, it was too late to recharacterize his IRA contributions for several of these prior years without a Private Letter Ruling from the IRS at a cost to John of $10,000 PLUS legal fees and, there are not any guarantees they will agree to John’s request for leniency. None of this was Johns fault, but now we had to search for any available solutions.
The portion of the tax code that deals with IRA contributions is 61 pages long (there is another section just as lengthy that deals with distributions) and is full of things we can’t do but thankfully, also things we can do. So what can John do?
Since John's situation occurred over several years, different rules apply.
Contributions made prior to 2015
It was too late to recharacterize these as Roth IRA’s. To correct these years will require John to amend his tax returns, pay the taxes and penalties on the income that he took the deduction for, and file the form 8606 (indicating the IRA’s were not deductible) with each return
Contribution made in 2015
In this case, John has a couple of options
1) He can remove these prior to October 17, 2016 plus any earnings attributed to these contributions. Earnings would be taxable and since John is under age 59½, a 10% penalty would apply. John will need to inform his custodians since there will be special reporting on the 1099-R. What can be a bit confusing is that the 1099-R will be for 2016 but any income would be taxable for 2015. Many custodians will calculate the earnings but if not, IRS Publication 590-A has a worksheet for calculation.
2) John can recharacterize his 2015 contribution as a Roth IRA assuming his income was below $116,000. The contribution is treated as though it were originally made to a Roth IRA.
Either option John chooses would require his 2015 income tax return to be amended if already filed.
*Note that if John takes no action by October 17, the monies will have to stay in the account as an after tax contribution and must be reported on Form 8606 for 2015. In other words, after October 17, 2016, his 2015 contribution would be treated the same as his pre 2015 contributions are.
So although not all of Johns options are great and will cost him some money, at least they were discovered now and not ten or twenty years from now when the cost of the solutions would be magnified.
But, there is some really good news for John. He got married this year. On top of that, if they file a joint income tax return and their modified adjusted gross income (MAGI) is below $184,000 he will be able to make a full Roth IRA contribution.
I remind my clients that retirement plans do two things, they postpone the tax and the tax calculation. If we choose to postpone the tax (Regular IRA) we want to postpone them as long as possible. When what we think to be true (contributions are deductible) turns out not to be true (contributions are not deductible), we want to know ASAP!
About the author: Timothy P. Bogert, CLU, ChFC, LIC, AIF® has practiced values based financial planning for over 35 years. Tim has appeared on PBS with Ed Slott over 20 times, and has been quoted in the Wall Street Journal and Detroit News.
Tim’s specialty is helping people and businesses locate money they are losing unknowingly and unnecessarily. This money can now be used more efficiently to help accomplish their financial goals without changing their lifestyle. Tim’s credentials include Certified Life underwriter (CLU), Charted Financial Consultant (ChFC), Licensed Insurance Counselor (LIC) and Accredited Investment Fiduciary (AIF®).
Tim and Kim live on a farm in Lapeer Michigan and have been married for 38 years. Tim and Kim have 13 children 7 of which are adopted, 4 with special needs.
Securities offered through LPL Financial, Member FINRA/SIPC.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Content Citation Guidelines
Below is the required verbiage that must be added to any re-branded piece from Ed Slott and Company, LLC or IRA Help, LLC. The verbiage must be used any time you take text from a piece and put it onto your own letterhead, within your newsletter, on your website, etc. Verbiage varies based on where you’re taking the content from.
Please be advised that prior to distributing re-branded content, you must send a proof to email@example.com for approval.
For white papers/other outflow pieces:
Copyright © [year of publication], [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] Reprinted with permission [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] takes no responsibility for the current accuracy of this information.
Copyright © [year of publication], Ed Slott and Company, LLC Reprinted with permission Ed Slott and Company, LLC takes no responsibility for the current accuracy of this information.
For Slott Report articles:
Copyright © [year of article], Ed Slott and Company, LLC Reprinted from The Slott Report, [insert date of article], with permission. [Insert article URL] Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article.
Please contact Matt Smith at firstname.lastname@example.org or (516) 536-8282 with any questions.