Advisor Alert: Follow The Rules With IRAs

This week, we will talk about some unusual IRA rules.

Sometimes, federal law allows special benefits for military personnel. One of these special treatments that most people do not know about allows the beneficiary of military death gratuities and Service members Group Life Insurance to contribute funds to a Roth IRA or a Coverdale Education Savings Account.

This can be a good way to produce tax free income at a later date or help fund a college education for a child. Remember life insurance death benefits are not normally taxable.

The Roth contribution can be made without regard to normal annual contribution limits. If necessary at a later date, money if needed can be pulled out of this special Roth tax free without having to meet the regular Roth rules of five years and being 59½ or older. The contribution must be made by the end of the year following receipt of the benefit.

Now, let's talk about inherited IRAs. The I in IRA stands for individual. An IRA can never be jointly owned by spouses. They can be beneficiaries of each other's qualified funds. Upon death of one spouse, only a spouse can make the deceased IRA their own.

Children cannot do this. Both children, spouses and others can inherit an IRA. This inherited IRA will need to be titled properly and required minimum distributions (RMD) must be taken even though the beneficiary might not yet be 701/2. It is based on a beneficiary's age which might be must younger. This would mean the RMDs would be less.

The rule about whether a spouse should treat their deceased partners IRA as inherited or as their own would depend on the surviving spouse's age. If they are under 59½ they should treat it as inherited so if they need to pull money out for living expenses, they would not have to pay a 10 percent penalty on top of regular income tax rates. Once they reached 59½, they could then convert the IRA to their own. Then RMDs withdraws would be based on their age.

It is important to remember people transferring money from a deceased spouses IRA must be careful about the once per year rule. This rule says that you can only do one 60-day rollover every 12 months. This is when the IRA balance is sent directly to you.

The custodian is required to withhold 20 percent of the total for taxes and send you the balance of 80 percent. You have sixty days from receipt of the money to place it in a new IRA investment or the money is considered taxable and you will be taxed on the whole total.

It is important to remember, you must come up with the 20 percent withheld from another source and deposit the total. When you file your next income tax return, you will show the IRS that you followed the rule and they will refund the 20 percent. You are only allowed to do one every twelve months and this includes IRAs and Roth IRAs.

You must be careful if your deceased spouse had multiple accounts. The way to avoid this problem is to do trustee to trustee transfers. This is when the money is sent from the deceased spouse account directly to your new account. When done this way, there is no 60-day rule, no 20 percent withholding and you are not limited to one every twelve months.

IRAs are important retirement accounts, and it is important to follow the rules so that you do not have to pay unnecessary taxes.

Your Financial Future is written by certified financial planner Gary W. Boatman, MBA and CFP, who also wrote the book, “Your Financial Compass: Safe Passage Through The Turbulent Waters of Taxes, Income Planning and Market Volatility.” If there is an area that you would like to see discussed in the column, send your suggestions to [email protected].