How Many IRAs Should You Have?

In a recent column I mentioned that I have nine IRAs, causing some to ask why on earth anyone would have that many IRAs. Which leads to this column: How many IRAs should someone have?

Generally, the fewer the better: Fewer accounts to track, fewer required minimum distributions to compute, fewer beneficiary designation forms to fill out. But despite the dream of simplicity, most people end up with multiple accounts.

Start with the IRAs you cannot combine: If you have a Roth IRA and a traditional IRA, they obviously must be in separate accounts. If you own an IRA you established for yourself and an inherited IRA, those cannot be combined. In fact, you cannot combine an IRA you inherited from one decedent with an IRA you inherited from another decedent.

If you have a business that contributes to a SEP-IRA, the SEP-IRA must be separate from your other traditional IRAs.

That's it (I think) for the legally mandated separate IRAs.

Keep Rollover and Contributory IRAs Separate? An IRA that has received no contributions other than rollovers from qualified retirement plans is called a "rollover" IRA. An IRA to which you have ever made any "regular" (i.e., annual-type nonrollover) contributions is called a "contributory" IRA--even if it also contains one or more rollovers from qualified plans.

There are three reasons offered for keeping your rollover IRAs "pure" and uncontaminated by "regular" contributions--but only one of those reasons is valid!

Not a valid reason: Once upon a time, a rollover IRA was the only type of IRA that could be "rolled over" into a qualified plan--but that rule was repealed in 1992.

Also not a valid reason: Some people mistakenly think that if they make aftertax (nondeductible) contributions to a separate IRA, they can later withdraw those contributions from that particular separate IRA tax-free. Sorry, it doesn't work that way. For purposes of determining what portion of any IRA distribution is considered a tax-free return of the individual's nondeducted contributions, all of that individual's IRAs (whether rollover or contributory) are considered to be one giant single IRA. And the proportion of the distribution that is tax-free is based on the portion of the combined balance of all of the person's IRAs that is represented by aftertax contributions.

So, nowadays there is absolutely no tax difference between these two types of IRAs--but federal bankruptcy law does distinguish, which leads to the valid reason: There is an unlimited bankruptcy exemption for (noninherited) rollover IRAs. The exemption for "contributory" IRAs is very generous but not unlimited. It's possible some states' creditor exemption laws make similar distinctions. So someone who has an eye on potential creditors might therefore want to keep his or her rollover IRA(s) "pure" (not "contaminate" them with any regular contributions).

Different IRAs for Different Death Beneficiaries? In some cases, it's desirable to have separate IRAs payable to different beneficiaries. Someone who is leaving an IRA partly to charity and partly to human beneficiaries might consider having separate IRAs, one payable to the human beneficiaries and one payable to the charities. That way, the desire of the human beneficiaries to use the life expectancy payout method for their share of the IRA money is not put at risk by having nonindividual beneficiaries on the same account.

It is perfectly possible to name both humans and charities as beneficiaries on the same IRA, and obtain the life expectancy payout for the individual beneficiaries, for example by establishing "separate accounts" after the participant's death or simply paying off the charities before the "beneficiary finalization date." But those approaches do have deadlines, and there is always the risk that litigation or mistake or some other cause could result in missed deadlines. Naming only individual beneficiaries on a separate IRA established for them, while naming charities on a different IRA, avoids this risk.

Similarly, if you have multiple beneficiaries who can't get along with each other, you might want to leave each one his or her own separate IRA.

Investment Reasons to Have Separate IRAs? If you are subject to taking RMDs, and you have an IRA investment that you think has a real risk of becoming worthless, keep it in a separate IRA. That way, if it does radically shrink in value, your RMD from that particular IRA will be the RMD computed in the usual way or the total value of the account if less. At least you will benefit from your lost investment by having a reduced RMD!

I recommend avoiding any investment that has a high potential of causing a prohibited transaction. If you ignore this advice, then I recommend keeping the potentially PT-causing investment in an IRA separate from your other more traditional IRA investments. The occurrence of a PT disqualifies the entire account. If a PT does occur, it is better to have only the separate IRA holding the PT-causing investment disqualified than to lose qualification for all IRA assets.

If you hold annuity contracts, it is likely that the insurers who issue the contracts will set up each contract as a separate IRA. Or maybe you just like to have accounts with multiple financial institutions to get the benefit of advice or other advantages each one may offer.

Where to read more: Natalie Choate's book Life and Death Planning for Retirement Benefits (7th ed. 2011) discusses: The requirements for Roth IRAs (Chapter 5); post-death deadlines for cleaning up a beneficiary designation (¶ 1.8); prohibited transactions (Chapter 8); rules for inherited IRAs (Chapter 4). Regarding the rules for rollovers from IRAs into qualified plans, see ¶ 2.6.02(H) of Life and Death Planning for Retirement Benefits or § 402(c)(8)(B)(iii)(iv)(v) and (vi) of the Code.

Now available in electronic edition! By popular demand, Natalie Choate's book Life and Death Planning for Retirement Benefits has been published in an electronic version. The e-book edition gives you the entire book in word-searchable format, plus two additional chapters (on life insurance and annuities in retirement plans) that were left out of the print edition for reasons of space. Live links to cross-referenced book sections and most cited tax sources. Access anywhere you have an Internet connection. Visit http://www.retirementbenefitsplanning.com to subscribe or learn more.