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A Trio of New IRA Developments

Three important pieces of news have hit the IRA scene.

Natalie Choate, 10/09/2009

Natalie Choate will be speaking at a location near you if you live in Atlanta (Oct. 23 and Nov. 3); San Diego (Oct. 24); Honolulu (Oct. 26); Baltimore (Oct. 30); New Orleans (Nov. 4); Chicago (Nov. 9 and May 4, 2010); Madison or Milwaukee, Wis. (Nov. 10); Hartford, Conn. (Nov. 17); Dallas (Nov. 19); Houston (Nov. 20); San Antonio (March 16, 2010); Boston (Nov. 23; April 26, 2010); Memphis (Jan. 22, 2010); Orlando (Jan. 28, 2010); Traverse City, Mich. (May 7, 2010); or Minneapolis (June 22, 2010). See all of Natalie's upcoming speaking events at www.ataxplan.com.

This month I'm skipping the usual question and answer format to spread the word about three important new developments: The rollover deadline for certain 2009 distributions has been extended until Nov. 30, 2009; a tax-saving idea based on the direct conversion of "NUA stock" to a Roth IRA has been attacked by the IRS; and the Department of Labor has concluded that taking trustees' fees for managing an IRA for a family trust is not a "prohibited transaction."

Rollover Deadline Extended for "Nonrequired 2009 RMDs"
As we all know (now), the minimum distribution rules were "suspended" for 2009. Specifically, there is no required minimum distribution for 2009 for any defined contribution plan or IRA. The suspension applies to both the plan owner (participant) and beneficiary.

However, some clients had a problem with this. For one thing, many individuals kept on taking their RMDs into early 2009 because they didn't hear about the new law. For another, many retirement plans kept right on paying "RMDs" into the year 2009, despite the new law, because the plan document required these distributions even if the law did not.

The IRS has now addressed these "nonrequired 2009 RMDs." A participant or surviving spouse (as beneficiary) who received a distribution in 2009 that would have been a required distribution under the normal rules but was not actually required to do so because of the one-year suspension can roll over that distribution to another plan or IRA, subject to just a few limits. Furthermore, the deadline for rolling over these "nonrequired 2009 RMDs" is the later of 60 days after the distribution or Nov. 30, 2009.

Now for the limits! This rollover extension will not help everyone who received a nonrequired 2009 RMD. Specifically,

* A nonspouse beneficiary cannot roll over any distribution received in 2009 or any other year. The IRS cannot waive this rule, even if the distribution was made against the instructions of the beneficiary or by mistake.

* A participant (or surviving spouse) cannot roll over into an IRA more than one distribution received from a particular IRA within 12 months. The IRS cannot waive this rule. So, a participant who took (say) three "nonrequired 2009 RMDs" in (say) January, February, and March of 2009 can roll only one of those distributions into a traditional IRA.

* The deadline extension applies only to these particular payments, i.e., "nonrequired 2009 RMDs." A participant or surviving spouse who took out more than what would have been his 2009 RMD and now wishes he/she hadn't done so, does not have an extended due date to roll those excess distributions back into a plan. (There may be some flexibility on this if the payments were part of a series of equal payments that included the "2009 RMDs.")

* Last but not least, the IRS has confirmed what was actually clear all along, namely, that the suspension of RMDs for 2009 does NOT allow an individual who is under age 59½ and who is taking a "series of substantially equal periodic payments" (to qualify for the § 72(t)(4) exemption from the 10 percent penalty on pre-age 59½ distributions), to quit taking his payments for the year 2009. The new law deals ONLY with required minimum distributions payable to participants over age 70½ or to beneficiaries. It has no effect whatsoever on distributions to someone under age 59½ (even if he or she is using the "RMD method" to calculate his/her "series" payments).

IRS Torpedoes NUA-to-Roth-Conversion Idea
Since 2008, participants have been permitted to roll money directly from a qualified plan to a Roth IRA, without the intervening step of rolling the money first into a traditional IRA (then converting the traditional IRA to a Roth).
This plan/Roth conversion option gave rise to the following planning idea: A retiring employee requests, from his employer's qualified plan, a lump sum distribution that includes appreciated employer stock. He directs that the LSD be rolled directly into a Roth IRA, as permitted by § 408A(e) (if he is eligible; that means having less than $100,000 of modified adjusted gross income if the conversion occurs before 2010. The effect of this "Roth conversion" is, according to the Code, that he is taxed as if he took the distribution outright, meaning (apparently) that he will be liable for current tax on only the plan's "basis" in the stock. The "net unrealized appreciation" in the stock is transferred into the Roth IRA without current tax?and then it is NEVER taxed, assuming that later distributions from the Roth IRA are taken as tax-free qualified distributions!

Based on the statute, this appears to work, BUT the IRS has just announced that (in the IRS view) it will NOT work. The IRS says this transaction will be taxed "as if" the LSD were transferred first to a traditional IRA; the hypothetical traditional IRA were the employee's only traditional IRA; and the traditional IRA were then transferred to the Roth IRA. Result says the IRS: The entire transfer is taxable (just like a plan-to-Roth conversion that did not include NUA stock) since there is no "NUA" deal for distributions either to or from a traditional IRA. 

Note that if you were counting on paying tax only on the plan-basis portion of the conversion, and NEVER paying tax on the NUA portion, you end up MUCH WORSE under the IRS's interpretation--you have to pay ordinary income tax on the ENTIRE Roth conversion, with NO WAY to resurrect your favorable long-term capital gain treatment for the NUA portion. Yes, if you don't want to pay tax on the entire conversion, you can "recharacterize" the conversion--but the effect of that is to dump the entire distribution into a traditional IRA (the eventual distributions from which will all be taxed as ordinary income). There is no way to get the stock back into the QRP so you can "do it over" as a lump sum distribution of employer stock (and salvage the long-term capital gain treatment for the NUA portion).

Bottom line: Someone might challenge the IRS on this and might even win. But DON'T use this idea unless you are prepared for the possibility that you may end up owing ordinary income tax on the entire lump sum distribution AND forfeiting your "NUA" deal forever.

DOL Blesses IRA Payment to Trust
The Department of Labor  has just issued an "Advisory Opinion" clearing up a question that troubled some planners, namely, whether using a family member as trustee of a trust named as beneficiary of an IRA could cause "prohibited transaction" problems for the IRA because of the trustee's fees. Here's the background, and the conclusion of the new opinion.

As part of his estate plan, Seymour Goldberg proposes to leave his IRA, at his death, to a trust for the benefit of his grandson Cole. Following Seymour's death, Seymour's son Jason (Cole's father) will be sole successor trustee of the trust. The DOL assumes that the trust is a "see-through trust" for minimum distribution purposes (with Cole as the sole "designated beneficiary"), though this presumably makes no difference with regard to the question at hand.

The IRA would be the sole asset of the trust. Jason, as trustee, would have broad investment powers over the IRA. The trustee would be required to withdraw from the IRA, each year, the annual required minimum distribution under § 401(a)(9), and will be able to withdraw additional amounts in the trustee's discretion. As trustee, Jason would be entitled to receive from the trust "statutory trustees' commissions" under New York law. These commissions are based on the size of the trust fund and are intended under New York law to provide reasonable compensation to the trustee for services.

Tax Code § 4975(c) generally prohibits certain transactions between an IRA and a disqualified person. The penalty for engaging in such a "prohibited transaction" is that the IRA ceases to be an IRA--it is deemed to be entirely distributed as of the first day of the taxable year in which the PT occurs. § 408(e)(2).

The Department of Labor was asked whether paying distributions from the IRA to the trust, and using such distributions to pay trustees' commissions to Jason as trustee, would constitute a PT. The DOL said no, even though the DOL concluded that Seymour, Jason, Cole, and the trust itself are all DQPs. Essentially, the DOL says that the trust is the named beneficiary of the IRA; any payment from the IRA to the trust is a payment to the beneficiary of the IRA; and payments to the participant or beneficiary, in accordance with the IRA's terms and if otherwise permitted by the Tax Code, cannot be a PT. The decision by a beneficiary (including a trust that is a beneficiary) to take a distribution from the IRA is not a "fiduciary" decision within the meaning of the PT rules.

Any limits or quibbles by the DOL here? The DOL does mention that a trustee's decision to take an IRA distribution that is not a required distribution either under the tax law or under the terms of the trust is "reviewable" under fiduciary standards generally applicable to trustees--but that is outside the scope of the DOL's authority. That is something for state law applicable to trustees and beneficiaries generally. The DOL also hints that a fiduciary who provides investment advice to an IRA owner could have a PT if he causes the IRA owner to take a distribution and "transfer the proceeds to a vehicle which would benefit the fiduciary.

But those speculations are far afield. Basically, the planning community can take comfort in the knowledge that IRA distributions to a trust named as beneficiary will not be attacked as "prohibited transactions" merely because the distribution is used by the trust to pay the trustee's fee.

Resources: For the extension of the 60-day rollover deadline, see IRS Notice 2009-82, 2009-41 I.R.B. *** (9/24/09). For the original NUA-to-Roth conversion idea, see Jones, Mike, "Do Roth IRA Conversions Offer a Brand-NUA Opportunity?," Steve Leimberg's Employee Benefits and Retirement Planning Email Newsletter (www.leimbergservices.com), Archive Message #390, 11/1/2006. For IRS position on the NUA-to-Roth conversion idea, see IRS Notice 2009-75, 2009-39 I.R.B. 436 (9/8/09). For full details on NUA stock in employer plans, see Chapter 2 of Life and Death Planning for Retirement Benefits (6th ed. 2006; $89.95 plus shipping; www.ataxplan.com). For more on Roth IRA conversions, see Chapter 5 of Life and Death Planning for Retirement Benefits or see Natalie Choate's Special Report, "Roth-Ready for 2010!," which may be downloaded for $39.95 at www.ataxplan.com. For DOL Advisory Opinion 2009-02A (9/28/09), visit www.dol.gov/ebas/regs/aos/ao2009-02a.html.

The purpose of this column is to provide general educational information for investment professionals. Natalie cannot give advice regarding specific clients or actual matters. Thus, only hypothetical questions, seeking general information, can be answered. Questions that involve real people or real matters will not be answered. E-mail your questions to advisorquest@morningstar.com

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