The onslaught of boomers entering their retirement phase is in full swing. As a result, IRAs will unquestionably become the nexus for distribution of a retiree's nest egg. With more than $4 trillion dollars (and growing) of market value in IRA accounts, and nearly 40 percent of U.S. households utilizing their IRA accounts, it is imperative to know the rules and regulations. IRS Publication 590, which covers Traditional IRA, Roth IRA and SIMPLE IRA regulation, is 108 pages of scintillating reading. We have chosen a few issues for further review:
- Buying foreign securities in an IRA precludes the account holder from recovering any foreign tax withholding. For example, you own Nokia, and Finland withholds tax on the dividend the stocks pays to you. The income would not have created any taxable income in the IRA; as a result, there is no ability to claim a credit for the withholding at the source. In contrast, foreign holdings bought in taxable accounts can claim a refund of foreign withholding by filing IRS Form 1116.
- Using an IRA to skirt the wash-sale rules has finally been ruled on by the IRS. Previously, in order to declare a loss on a stock sale, account holders may have received advice that they could purchase the same stock in their IRA or Roth IRA within 30 days of the sale in order to maintain their position in that holding and claim the loss. Revenue Ruling 2008-5 now clearly states that buying identical stock in their IRA to recreate their original position before the 30-day time period elapses, or buying stock within 30 days of the date they plan to sell the stock in their brokerage account, will cause the loss to be disallowed.
- Buying real estate in an IRA as a diversification technique has become more prevalent. It is a very complex undertaking, and can result in big problems if not done correctly. Only certain IRA custodians offer the ability to invest in real estate within a self directed IRA. As the IRA is a tax deferred account, the benefits of owning property (such as ability to deduct property taxes, claiming capital gains tax rates on appreciation and the ability to deduct depreciation) are forgone. In addition, the account holder cannot personally provide services to the property within the IRA, prompting the need to hire intermediaries for the job of finding tenants, collecting rent and performing maintenance and repairs. These extra expenses must come from within the IRA, as well - therefore sufficient cash must be maintained within the account. Insurance and taxes need to be paid from within the IRA as well - personal funds cannot be added to the account in order to satisfy these expenses. If any of these rules are violated, the whole IRA could be disqualified, resulting in ordinary income tax on the full account balance. If the account holder is under the age of 59 1/2 , a 10 percent penalty may apply to the balance as well.
- Beginning in 2007, tax refunds were allowed to be directly deposited to IRAs. This was received as a great idea, but the basic issues of timing and maximum deductible contributions can potentially create problems. The refund can be delayed and arrive after the April 15 deadline. There can be an adjustment to the amount of the refund, causing problems with the intended deduction if a tax return is mailed and completed before the funds are actually deposited to the IRA. Additionally, if a tax refund is made with direct deposit to an IRA and there is qualification for a tax rebate check, per the recent Economic Stimulus legislation, the check could also be automatically deposited to that same IRA account. Fortunately, the IRS will allow for withdrawal of the unintended tax rebate amount deposit without tax or penalty as a result of announcement 2008-44.
While there is no shortage of additional potential pitfalls within the IRA, we chose to highlight these four areas. The distribution phase of life's savings is of utmost importance. By being an advisor who is proficient in navigating the intricacies of the IRA, you can avoid some disastrous results.
Mark A. Cortazzo, CFP is senior partner with MACRO Consulting Group in Parsippany, N.J.
