Ask the IRA Gurus

 

By Natalie Choate

September 2011

Sometimes I get an IRA question to which I don't know the answer. That's when I turn to my nationwide circle of IRA experts. I call them the "IRA gurus." With their astounding collective experience and knowledge, they can often help. So keep those questions coming!

Question: Our client's father, "Homer," is in his 90s. Since he was 70 1/2, he had his IRA minimum distributions sent to him by monthly automatic transfer into his bank account. This had been arranged for him each year by his IRA provider. Last year, he moved closer to his son's (our client's) home because of some serious health problems and in the process moved his IRA to a different provider.

However, he neglected to reinstate the automatic sending of the required distributions. His health issues contributed to a declining ability to manage his affairs. As a result, he failed to take the required distributions for the year 2010. Homer's son helped him with his 2010 tax return, and had him file "Form 5329" as part of the return, reporting the missed distribution and requesting a waiver of the 50% penalty. Now, the IRS has just sent him a notice that the penalty is due--with no mention of the waiver request. Is there anything Homer can do at this point to avoid that penalty?

Answer: I don't have experience with this situation so I turned to my IRA gurus. These enormously knowledgeable and productive people manage to not only speak and write about retirement benefits, they also actively consult with, advise, and/or represent clients who have retirement benefit issues with the IRS. They had plenty of practical suggestions for Homer.

Barry Picker of Brooklyn, N.Y., author of Barry Picker's Guide to Retirement Distribution Planning, speaks nationally and actively practices in the retirement benefits tax area. He says, "The IRS response sounds like a computer-generated notice caused by the filing of the 5329. I've had this before. Don't pay; respond with a letter to the address on the notice explaining the situation and requesting the waiver. Chances are good you'll succeed."

Bob Keebler, CPA, of Green Bay, Wis., nationally known speaker and author of multiple publications dealing with the tax treatment of IRAs and Roth IRAs, heads his own accounting firm that specializes in helping individuals solve their IRA versus IRS problems. Bob has drafted more than150 successful IRS private-letter ruling requests in the retirement benefits area. He was succinct: "I agree with Barry!"

Denise Appleby, author of the invaluable Appleby IRA Quick Reference Guides, reminds the questioner that, "It's not enough to explain why you missed taking the minimum required distribution. You also must 'take steps to remedy the shortfall,' meaning that Homer must take the 2010 distribution now, in 2011, before asking the IRS to waive the penalty. Both steps are required before the IRS will consider granting a waiver." PAGEBREAK  

Ed Slott, publisher of the terrific Ed Slott's IRA Advisor newsletter, who trains financial advisors how to use retirement benefits expertise to expand their practices, agreed with all of the above: "I would have originally advised him to take the missed 2010 distribution immediately and file the 5329 not only asking for the waiver of the penalty, but also showing that he made up the missed distribution--that he took immediate corrective action upon discovering the error.

"Also state the reason for the oversight, which in this case is logical and, I believe, would warrant a waiver of the penalty. But now he has an IRS notice which must be answered. I would respond that the missed distribution was made up, state the reason for the honest oversight, ask for the penalty to be abated, and it should be abated. In addition, mention that before this, he had a perfect track record of never missing a required distribution because they were withdrawn automatically. Once IRS puts this all together, the penalty should be waived and he should be fine. However, it might take a few letters to get this resolved."

Steve Trytten, an estate-planning lawyer in Pasadena, Calif., with special expertise in retirement benefits (and my co-panelist on an upcoming "Retirement Benefits Myth-Busters" seminar), wonders whether the IRS rejection "is not a denial of the penalty waiver but instead an erroneous action based on older form instructions. The instructions to Form 5329 used to require full payment before a waiver could be considered. Several years ago, the instructions were revised to delete this requirement. Perhaps the next step is to resubmit the 5329 along with a copy of the current instructions and renew the request for waiver of penalty."

Seymour "Sy" Goldberg, a well-known speaker and author on the tax treatment of retirement benefits, also tangles regularly with the IRS on behalf of clients. His stated, "The approach I use with respect to a penalty case in general is to respond to the IRS computer-generated penalty notice several times, and if that does not resolve the penalty issue, then I request an appeal to the local IRS Appeals Office. Based on the facts of this case, the penalty should be waived at either the IRS Service Center or the IRS Appeals Office."

Mike Jones, of Monterey, Calif., speaker, writer, and practitioner, and chair of the editorial advisory board for retirement benefits for Trusts and Estates magazine, concurs that if all else fails, Homer can "Exercise the right to go to IRS appeals with this. If that doesn't work, a suit for abuse of discretion could be needed; such suits are authorized by statute. Given the taxpayer's long history of compliance, it could be an abuse of the IRS' discretion not to waive the penalty."

I am a big fan of my IRA gurus. If they don't know the answer, there is no answer!

Natalie Choate practices law in Boston, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is fast becoming the leading resource for professionals in this field.

The views expressed are the author's.

The Pros and Cons of Custodial Accounts

Once you establish an UGMA or UTMA, the assets you gift cannot be retrieved.

Setting up a custodial account can be a savvy move for adults who want to gift their assets and help their children become financially independent. But there are many considerations -- and consequences -- to weigh before opening an account. Here are some key points to keep in mind.

1.       The account options: UGMA and UTMA. The two types of accounts you can use to gift assets to your youngster are called a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). Which one you use will depend on your state of residence. Most states -- with the exception of Vermont and South Carolina -- have phased out UGMA accounts and now only offer UTMA accounts. UTMA accounts allow the donor to gift most security types, including bank deposits, individual securities, and real estate. UGMA accounts limit gifts to bank deposits, individual securities, and insurance policies.

2.       There are no contribution limits. Parents, grandparents, other relatives, and even non-related adults can contribute any amount to an UGMA/UTMA at any time. Note that the federal gift tax exclusion is currently $13,000 per year ($26,000 for married couples). Gifts up to this limit do not reduce the $1 million federal gift tax exemption.

3.       The assets gifted are irrevocable. Once you establish an UGMA or UTMA, the assets you gift cannot be retrieved. Parents can set themselves up as the account's custodian(s), but any money they take from the account can only be used for the benefit of the custodial child. Note that basic "parental obligations," such as food, clothing, shelter, and medical care cannot be considered as viable expenses to be deducted from the account.

4.       Taxes are due -- potentially for both you and your child. Some parents may initially find custodial accounts appealing to help them reduce their tax burden. But it's not that simple. The first $950 of unearned income is tax exempt from the minor child. The second $950 of unearned income is taxable at the child's tax rate, which could trigger the need for you to file a separate tax return for your child. Any amounts over $1,900 are taxable at either the child's or the adult's tax rate, whichever is higher. Note that state income taxes are also due, where applicable.

5.       Your child will eventually gain complete control. Once your child reaches the age of trust termination recognized by your state of residence (usually 18 or 21), he or she will have full access to the funds in the account. Be warned that your child could have different priorities for the assets in the account than you do. Money that parents had earmarked as paying for college tuition could instead be used to purchase a sports car or fund a suspect business venture.

6.       It could impact financial aid considerations. For financial aid purposes, custodial assets are considered the assets of the student. If the assets in the account could jeopardize your child's chances of receiving financial aid, speak to your tax and/or financial professional. One of your options could involve liquidating the UGMA/UTMA and establishing a 529 account.

Before making any decisions about establishing a custodial account, be sure to talk to your tax and financial professionals.

This communication is not intended to be tax advice and should not be treated as such. Each individual's tax situation is different. You should contact your tax professional to discuss your personal situation.
© 2011 McGraw-Hill Financial Communications. All rights reserved.
Sept 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by James P Ellman, ChFC and Barry Mendelson, CFP, local members of FPA.