The great advantage of the Roth IRA over the traditional IRA is the potential for complete tax freedom for one’s savings. Note carefully the word “potential.” The IRS has several hoops for taxpayers to jump through before tax freedom is achieved. The most important of these is a five-year waiting period. The hoops have been arranged into a convenient flowchart by the IRS in its Publication 590, Individual Retirement Arrangements. The illustration here is adapted from the IRS version.

Even if the conditions are not met, the taxpayer may not owe tax or penalties on a withdrawal from a Roth IRA. That’s because withdrawals from ordinary Roth IRAs are treated first as a nontaxable return of after-tax contributions. However, an exception to this rule applies to Roth IRAs created by conversion from a traditional IRA or rollover from an employer’s plan. In those cases penalties may be triggered for early withdrawals.
See your tax advisors to learn more about how these rules may apply to your situation.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

IRAs have become a mainstay in many retirement portfolios, very often as receptacles for lump sum distributions from employer plans. Here are three private letter rulings that illustrate some of the complexities that may come with these accounts. The names in these otherwise true examples are fictitious.

How to fix a mistake

Believing himself eligible, Andy converted his traditional IRA to a Roth IRA on September 20. Late that year Andy received large, unexpected distributions of capital gains from his mutual funds. The gains were large enough to push Andy beyond the $100,000 AGI limit for conversions to a Roth IRA. He immediately told the IRA custodian to convert back to traditional status. Accordingly, Andy did not report the conversion on his Form 1040 that year.

Some years later, after the statute of limitations had closed for the year of the conversion and recharacterization, Andy was consolidating his retirement accounts. He discovered that the IRA custodian failed to follow his instructions regarding the recharacterization. So now it looks as if Andy did a conversion that he was not allowed to do and never reported it!

Andy contacted IRS, asking to be allowed to recharacterize the Roth IRA as a traditional IRA. IRS gave him the go-ahead, because (1) Andy took the initiative, contacting IRS before the Service identified the problem; (2) Andy had not made additional contributions to the account; (3) the error was the financial institution’s; and (4) Andy acted in good faith throughout. What’s more, there is no revenue loss to the government if the relief is granted, and no returns for closed tax years will be affected, as Andy did not report the original attempted conversion.

Don’t retitle the asset

In May 2006 Bob decided to diversify his IRA. He purchased two IRA annuities and took a cash distribution. On June 1 Bob and his wife used that cash to acquire a jointly held certificate of deposit. Bob claims that he told the bank officer that the money came from his IRA, and he thought that the joint CD also would be an IRA. If it wasn’t, he says, it was the bank’s fault, so he should be allowed to cure his faulty IRA rollover attempt now.

No, says IRS. There was nothing about the CD form that Bob and his wife signed that suggested it was an IRA, and it was unreasonable of him to think that it was. What’s more, qualified IRAs may not be owned jointly. The amount of the withdrawal transferred to the CD must be included in taxable income (and a penalty could apply if Bob is under age 59 ½).

Conversion to cash

The final ruling in this trio includes a mistake that is all too easy to make.
At age 56 Cindy began to receive regular distributions from IRA X in an amount intended to be substantially equal periodic payments for her life under IRC §72. As such, the distributions are exempt from the penalties for premature distributions.
At a later time, Cindy became nervous about the financial markets, and she worried whether she might exhaust her IRA too early in her retirement. She asked her custodian to move some of her money from stocks to FDIC-insured certificates of deposit, so as to minimize the risk of capital loss. Unfortunately, the company that was managing her IRA did not offer CD investments, so Cindy was advised to transfer the IRA money to another financial institution. She arranged for a trustee-to-trustee transfer of a portion of IRA X, as well as all of IRA Y, into a new IRA Z at a new company.
That happened in January. In May, when she went to the new IRA custodian to arrange for the transfer of the balance of IRA X, Cindy was told that the partial transfer might have constituted a modification to her series of periodic payments from the IRA. Why she wasn’t told about this earlier is not stated. Nevertheless, Cindy asks IRS to rule that the trustee-to-trustee transfer was not a modification of her annuity stream, or if it were, she asks to be allowed to take corrective action, to move money and related earnings around so as to negate fully any such modification.
No and no, rules IRS, taking a hard line. The nontaxable transfer of a portion of the IRA account balance to another retirement plan is a prohibited modification, and no corrective action is recognized by the tax law. Accordingly, all of her IRA distributions are subject to the 10% penalty tax, going back to when she began them at age 56.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Retirement planning intersects with other aspects of your financial planning. The most obvious examples are estate planning and planning for incapacity or illness. When taking a more comprehensive approach to your retirement planning, a brief survey of what elder law is all about may be beneficial. (A general understanding of elder law may be helpful, too, for those who now care for a spouse or relative with long-term needs.)

A brief overview
Elder law, which deals with issues affecting older adults, is a burgeoning specialty as the baby-boom generation deals with its own financial needs or those of retired parents. Elder law attorneys specialize in such matters as: estate and gift tax planning; relations between retirement plans and planning for heirs; and legal solutions to preserving wealth or minimizing taxes.

Elder law specialists also delve into the more esoteric areas of growing older, ones often little understood. These include: Medicaid trusts; long-term care insurance; veterans’ benefits; intrafamily and heirs’ disputes; business succession planning; living arrangement options; medical decision-making; age discrimination; and a host of others.

Many aspects of elder law involve family participation. For example, here are the major capacities in which you may serve when working with an elder law attorney.

Agent under a power of attorney (POA)
Powers of attorney are relatively well-known, for they apply to various stages of our lives. They give another party (an “attorney-in-fact,” or agent) the right to make financial or legal decisions for another (the donor of the power). However, not all POAs are alike. A durable POA gives authority to the attorney-in-fact beyond the period of a donor’s mental incapacity. A nondurable POA ends at that incapacity. A springing POA permits a donor to act on his or her own behalf until some specified event occurs, such as entry into a long-term care facility. Finally, many states have general POA laws that permit a donor—regardless of the type of POA selected—to authorize a full array of powers to the attorney-in-fact, or to be selective in the powers granted.

Guardians and conservators
Guardians and conservators are appointed by courts when a person of any age is unable to take care of himself or herself, and no POA is in effect. A person can petition a court to act in this capacity, but states vary as to when and if such an appointment may be made under state law. Therefore, having a POA in place may avoid the problem.

Representative payees
These have much less authority than an attorney-in-fact, guardian or conservator. Representative payees receive a person’s income, set up a fund and pay living expenses out of it. Both parties must agree to such an arrangement. It may be cancelled at any time. No court appointment is necessary. Only bill paying is permitted by the designated party. It usually works best for spouses who are somewhat incapacitated.

Agent for health care decisions
A durable power of attorney for health care (DPAHC), sometimes referred to as a health care proxy, is a document designating an agent to make health care decisions when the individual is unable to do so. The agent chosen has, generally, the same rights to request or refuse treatment that the donor of the power would have if he or she were capable of making and communicating his or her own decisions.

A DPAHC is different from a living will. There is no agent involved with a living will, but, rather, it is a document that specifies the kind of treatment that an individual wishes should he or she suffer an incurable or irreversible disease and physicians determine that the individual’s condition is terminal. A living will, then, has more narrow applicability than a DPAHC.

Resources
As you do your retirement and other planning, and want to find out more about elder law, the Internet is a good place to start. One Web site that may be helpful is: http://www.elderlawanswers.com. The site offers general information, similar to what you have read here, but in more depth.*

If you are looking for an elder law attorney, and neither your attorney nor his or her firm specializes in elder law, he or she may be able to make a referral to a practitioner in your area. Your local bar association may be able to furnish a list of elder law attorneys as well.

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In sum, elder law and its applications should be of interest to anyone looking beyond the mere financial aspects of retirement or preretirement planning. As a discipline, it addresses issues involving not only how much money you live on and preserve, but also how you live. Therefore, it is extremely important that the selection of an elder law attorney be an informed decision, based upon research and evaluation.

*ElderLawAnswers provides legal information only. It is not a law firm, does not give legal advice, and no attorney-client relationship exists between the site and any user.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

As you approach retirement, an extremely important decision awaits you. How do you take a payout from your retirement fund or funds?

One end of the spectrum offers a lump sum distribution, which you either take in hand or roll over into an IRA. At the other end of the spectrum lies the annuity. Annuities provide the security of a contract purchased from an outside provider that statistics say you can’t outlive. And in between are a variety of other options that may be available to you.

Some distinctions and background
Not all types of plans are “true” retirement plans as defined by the IRS, even if they have the same effect or goal that you seek. For example, such arrangements as defined contribution money purchase pension plans and 403(b) retirement plans (plans that cover employees of public schools, tax-exempt organizations, etc.) are the real thing.

However, 401(k) and profit sharing plans technically are not.
Why the distinction? For one thing spousal consent is needed for true retirement plans before distribution can be authorized by a trustee or the named fiduciary. On the other hand, 401(k) and profit sharing plans, require no spousal consent for distributions. (Spousal consent to name or change a beneficiary is, however, required for all types of tax-qualified retirement plans.)

Many plans may be written to purchase an annuity on a default (automatic) basis. Similarly, many 401(k) and other types of plans may make this option available as part of the agreement signed by the employer and the employee.

Finally, it’s important to remember that some distributions are required by law. For instance, individuals are required to start at least a minimum distribution by the

April 1, following the year that they turn age 70 1/2, unless they are still working. If still working (and not 5% owners), they may defer initial distribution until the April 1 following the year that they retire.

Lump sum distributions
You may choose to take your accumulations in a single sum for a given tax year and pay tax in that year. In most instances, you will pay tax at your ordinary income tax rate on your lump sum.

Or, you can escape immediate taxation of your lump sum distribution by arranging for a direct rollover of funds from the retirement plan to an IRA or to an employer’s plan that will take the funds. (This approach avoids a mandatory 20% withholding tax on your payout if you receive it in hand.)

The annuity choice
Let’s say that your retirement plan does offer you the annuity option (either through the plan itself or by purchase through a third party). The annuity chosen may be fixed, meaning that you receive a payment of a predetermined amount of money periodically with a guaranteed benefit. A variable annuity provides for a fixed number of “accumulation units” that fluctuate according to the investments chosen. These are converted to “annuity units” at payout time to calculate the benefits paid.

From a tax standpoint, distributions from a retirement annuity plan generally include amounts that are tax free and represent the recovery of your cost (investment in the contract). Generally, the balance of the payment will be taxed. To find out more about the taxation of annuity payments, consult IRS Publication 575, available at www.irs.gov.
Single or multiple annuity accounts may be established with one or more providers.

Choices within choices
Accumulations can be distributed as a single sum (that lump sum again), in level premium payments or in flexible premium payments, regardless of whether a fixed or variable annuity is chosen. Among the most common settlement options:
• Straight life: This option calls for payment of a specific amount for the annuitant’s life only. Any money left unused reverts to the provider. No beneficiary is named.
• Life with period certain: This approach pays the annuitant for life, but if he or she dies during a period certain (e.g., 10 years, 20 years), a beneficiary will continue receiving periodic payments either as installment refunds or in a lump sum payout.
• Joint and survivor: Here the annuity is paid over the life of two individuals (usually spouses). When the first spouse dies, the annuity payments continue to be paid to the survivor at a predetermined amount that may be a full survivorship payment, or a one-half survivorship benefit or a one-third/two-thirds survivorship benefit.

Other retirement plan payout methods
Plans may offer other kinds of distribution options. For instance, installment payments may be allowed. Here, benefits are distributed from the plan in monthly, quarterly, semiannual or annual intervals.
• Fixed-dollar payments are recurring payments of a specified sum at regular intervals until the plan participant’s plan share is exhausted. The length of the payout period will depend upon the investment performance of the plan, but the amount will not change.
• Fixed-term payments are made at regular intervals over a predetermined number of years. The amount will change based on the balance available at the beginning of each year, but the term will not. The amount to be distributed is based simply on the beginning balance divided by the number of years in the payout period.
• Some plans contain default provisions that are effective when the participant fails to make a choice. For example, some plans will provide for payout as a joint and survivor annuity if the participant does not make a choice (or make it in time) or if there is a discrepancy that was unable to be resolved. In some cases the default provision may call for a lump sum payment.

Seek guidance
Before you make a choice about the form that you want your retirement benefits to take, you will want to talk to your advisors. In addition to tax and retirement planning issues, you will want to examine any estate planning implications of your choice. Taking the time to understand all your options and opportunities before you act will keep all your doors open.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.