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Poison Ivy: IRA Scenarios to Avoid Thumbnail

Poison Ivy: IRA Scenarios to Avoid

I got into some poison ivy and am suffering the consequences. It takes a few days for the welts to appear, but they are in full bloom. While I did take precautions before starting my yardwork (gloves, long sleeve shirt, etc.), in retrospect I could have been more careful. The frustrating part is, there isn’t a whole lot you can do once the swelling appears. Ice, some anti-itch spray, try not to scratch too much, and just methodically work through this incredibly uncomfortable irritation.

As I squirm and complain, I thought about what might qualify as poison-ivy equivalents for IRAs. What transactions or situations present themselves as non-life-threatening nuisances that must be dealt with? Here are 4 pain-in-the-tail IRA annoyances. Why four? Because 4 is an awkward and uncomfortable number for any list. (If I’m gonna suffer, we’re all gonna suffer.)

4 situations that present themselves as non-life-threatening nuisances that must be dealt with include: Having basis, excess IRA contributions, missed RMDs, and unexpected withholdings in an IRA rollover.

1. Having basis in an IRA.

How does one get basis (after-tax dollars) in an IRA? You could make a non-deductible contribution. You could roll over after-tax dollars (non-Roth) from a work plan into the IRA. Regardless of how the after-tax money arrived, it must be acknowledged. The pro-rata rule dictates that a person cannot cherry pick only the basis in an IRA and subsequently withdraw or do a Roth conversion with just those after-tax dollars. Until the entire account is withdrawn or converted, the ratio of after-tax vs. pre-tax dollars in all of a person’s IRAs, SIMPLE IRAs and SEP accounts must be accounted for. Even if an IRA owner has the means to separate the basis from the IRA via a “reverse rollover” to a work plan – you cannot roll after-tax or Roth dollars from an IRA to a 401(k) - this transaction still requires effort and the risk that something could go wrong. Basis in an IRA – it’s a lingering and prickly pest.

2. Excess IRA contributions and subsequent fix.

There is a myriad of reasons why an individual might contribute too much to an IRA. Maybe a person made a contribution, but then earned an unexpected bonus that pushed him over the income limits for a Roth. Maybe he rolled over dollars that were ineligible to be rolled over – like a required minimum distribution (RMD). Or maybe he just didn’t know the rules governing contribution limits. Nevertheless, the excess must be addressed. If the fix is made before the October 15 deadline, you must also consider the net income attributable (NIA). Or, you could recharacterize the contribution – along with the NIA. Corrections made after the October deadline come with a 6% penalty and the necessity to file IRS Form 5329. Nuisance, nuisance, nuisance.

3. Missed RMD.

Similar to excess contributions, there are a million reasons why a person might fail to take an RMD. Regardless of why the oversight happened, the error must be attended to. Withdraw the RMD. Complete Form 5329. Explain to the IRS what happened. Beg for mercy, and hope the IRS applies some soothing calamine lotion to the 25% penalty.

4. Unexpected withholding on a 401(k) rollover. 

Your plan custodian withheld the required 20% on a distribution? Now your 60-day rollover is only 80% of what was anticipated? Well, if non-qualified dollars are available, you could “replace” the withheld funds, complete a full 100% rollover, and retrieve the “missing” 20% from the IRS next year when filing your return. If a direct rollover had been initially requested, you could have avoided this whole brambly mess.

Now excuse me while I scratch and burn and scowl and wish I had been more careful.

By Andy Ives, CFP®, AIF®
IRA Analyst
Ed Slott and Company, LLC

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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.

Copyright © 2023, Ed Slott and Company, LLC Reprinted from The Slott Report, 05/24/23, with permission. https://www.irahelp.com/slottreport/poison-ivy-ira-scenarios-avoid, Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article. 
Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment adviser. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. This content is developed from sources believed to be providing accurate information and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional.