By Andy Ives, CFP®, AIF®
IRA Analyst
Sometimes we get stuck in traffic, or a highway is closed, and we are forced to find an alternate route. I’m not talking about driving across someone’s front yard or going the wrong way on a one-way street. Think side roads and legal detours. While a main road may be blocked, that might not be the only way to reach your destination. The same holds true with certain IRA transactions. Here are a handful of creative “detours” that retirement account owners may be forced to take in order to reach their intended goal.
Backdoor Roth IRA. This is the classic workaround for anyone who makes too much money to contribute to a Roth IRA. Yes, there are contribution income limits which prohibit high earners from contributing directly to a Roth IRA. But these limitations can easily be overcome. High earners can make non-deductible contributions to a traditional IRA and then convert those dollars to a Roth IRA immediately thereafter. (There is no mandatory holding period before the conversion can be done.) Just be aware that the pro-rata rule will apply.
No Liquidity/RMD Aggregation. If an IRA owner holds an illiquid investment in his IRA, that is no excuse to avoid taking the required minimum distribution (RMD). The easiest “alternate route” is to take a distribution from another IRA. Assuming the IRA owner has another IRA, SEP or SIMPLE IRA that contains liquid assets, aggregation rules allow the RMD from the illiquid account to be taken from another IRA. Recognize that not all retirement accounts can be aggregated for RMD purposes. For example, an RMD for a 401(k) cannot be satisfied by taking a distribution from an IRA.
No Liquidity/RMD Conversion. Recently an advisor called and said his client was short by $24 with his IRA RMD. An illiquid investment prevented him from generating the cash to cover the shortfall. Additionally, he had no other IRA from which he could take the shortage from. The first idea was to make a contribution to the IRA, and then turn around and withdraw $24. But the retired IRA owner had no earned income, so a contribution was not allowed. The advisor mentioned that the client wanted to convert the entire IRA to his existing Roth. Ah-ha! A legal detour. Solution: The advisor converted the entire illiquid investment to a Roth. This resulted in a conversion of the remaining RMD of $24. But RMDs are not supposed to be converted. Oops. The $24 was now an excess contribution in the Roth. The existing Roth IRA had plenty of liquid investments. The $24 was then promptly removed from the Roth IRA as an excess contribution withdrawal. RMD satisfied, no penalties, legal workaround.
Estimated Taxes Underpayment. If it is late in the year and you find yourself behind in your estimated tax payments, take a distribution from your IRA and have 100% withheld. Taxes withheld are deemed to be paid in equally over all four quarters.
Taxes Withheld on Plan-to-IRA Rollover. Speaking of having taxes withheld, sometimes plan participants erroneously request a distribution (as opposed to a direct rollover) from their work plan with the intent of rolling over the dollars within 60 days. When the plan processes the distribution, there is a requirement to withhold 20%. In a situation like this, the account owner can make up the “missing” 20% with dollars from his own savings to complete a full 100% rollover. The 20% withheld will be a credit to the IRS that the taxpayer may be able to recoup at tax time.
Just because the sign says “Dead End” or “Road Closed” does not mean the journey is necessarily over. Legal workarounds exist for many retirement account transactions.
If you have technical questions you would like to have answered, be sure to submit them to mailbag@irahelp.com, to be answered on an upcoming Slott Report Mailbag, published every Thursday.
https://irahelp.com/slottreport/ira-transactions-detours-and-alternate-routes/