Individual Retirement Accounts (IRAs) have been around since they were created by the Employee Retirement Income Security Act (ERISA) of 1974 (Code §408). Roth IRAs, which were created by the Taxpayer Relief Act of 1997, began in 1998 (Code §408A). However, the rules relating to them are continually changing due to cost-of-living adjustments, court decisions, and IRS guidance. Here are some new considerations for 2018 and beyond.
When IRAs began, the maximum contribution was $1,500 per year, and there was no additional amount permitted as a “catch-up” for those age 50 and older. At that time, they were not serious retirement savings vehicles because of the low contribution limit. But things have changed. For 2018, the maximum contribution is $5,500, plus a $1,000 catch-up amount for those who will be at least 50 years old by the end of 2018 (Notice 2017-64). These limits were unchanged since 2013. But for 2019, the contribution limit will be $6,000, plus a $1,000 catch-up amount (Notice 2018-83).
A married person with a nonworking spouse can contribute up to the annual limit for an IRA for the nonworking spouse (assuming the working spouse has earned income at least equal to the contribution amounts). These are called the Kay Bailey Hutchison spousal IRAs.
Deductions for IRAs are permissible for those who are active participants in a qualified retirement plan only if modified adjusted gross income (MAGI) is below a set limit (with a partial deduction allowed for MAGI within a phase-out range). The MAGI limits for 2019 are higher than in 2018 due to COLAs.
Roth IRA contributions are also limited or barred, depending on MAGI; these amounts differ from limits on traditional IRA deductions for active participants. This is so regardless of active participation in a qualified retirement plan.
Timing for Making Contributions
The deadline for making 2018 contributions is April 15, 2019. This deadline applies even if an individual obtains a filing extension for Form 1040.
Contributions can be made using federal income tax refunds. All that is needed for this is to direct the Treasury to send the refund to a specific account; this is done on Form 1040. The refund can be applied for 2018 contributions (assuming that the return is filed early enough for the refund to be deposited by April 15, 2019) or for 2019. If an individual wants to apply some or all of a refund to more than one acceptable type of account (e.g., savings, checking, health savings account), file Form 8888, Allocation of Refund (Including Savings Bond Purchases). It is highly advisable to inform the account’s custodian or trustee about the year to which the contribution relates.
A distribution from IRAs fully funded through deductible contributions is treated as ordinary income includible in gross income. A distribution is not taxable if there is a qualified rollover (Code §408(d)(1) and (3)). A distribution is considered a qualified rollover distribution if the entire amount is directly transferred to or deposited in an IRA (or other eligible retirement plan) within 60 days of the distribution.
If the distribution is taxable and the owner is under age 59½, a 10 percent penalty applies unless an exception can be used (Code §72). One such exception is being disabled at the time of the distribution. Disability for this purpose means being unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.
In one recent case, a taxpayer who was under age 59½ and received an IRA distribution of over $43,000 claimed he was exempt from the 10 percent penalty because of disability. However, the Tax Court rejected his claim (Totten, TC Summary Opinion 2019-1). Although he submitted evidence of having a serious illness at the time of the distribution, it did not amount to a disability. He continued to work and earn income as an employee as well as an independent contractor. While the illness may have been an impediment, it did not prevent him from engaging in “substantial gainful activity.”
Inherited IRAs and Bankruptcy
In 2014, the U.S. Supreme Court held that heirs who inherited IRAs could not protect the assets in the accounts under the federal Bankruptcy Code when they filed for bankruptcy (Clark v. Rameker, S.Ct., 573 U.S. 122 (2014)). Now, a U.S. district court decision has indicated that there may be protection for heirs under state bankruptcy rules in some locations (Arehart, BC-DC ID, 1/10/19).
The case involved an individual who inherited an IRA from his mother and later filed for bankruptcy protection. When he filed for bankruptcy, the IRA was valued at over $78,000 and he claimed it was an exempt asset under Idaho bankruptcy law. The trustee in bankruptcy disagreed, but the U.S. Bankruptcy Court in the District of Idaho agreed that the exemption applied to the inherited IRA.
Under Idaho law, inherited IRAs are exempt because it comports with Idaho policy to protect the retirement income of its citizens. The court, noting that the state legislature “painted with a broad brush,” concluded that retirement income means income not only from qualified retirement plans (e.g., profit-sharing and 401(k) plans), but also from IRAs and Roth IRAs. The court noted that the legislature did not choose to amend its statute following the Supreme Court decision referenced earlier.
A number of states, including Florida and Texas, specifically exempt inherited IRAs under state bankruptcy rules. Last year, the U.S. Bankruptcy Court for the Northern District of New York held that an inherited IRA was not exempt from creditors under New York law (In re Todd, Bankr. ND NY, 3/23/18).
Qualified Charitable Distributions (QCDs)
IRA owners who are age 70½ or older can avoid tax on withdrawals by making a qualified charitable distribution (Code §408(d)(8)). The annual limit on QCDs is $100,000. QCDs, which were made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015, offer significant tax and other benefits:
• Benefit charity without itemizing. Those who claim the standard deduction instead of itemizing can reap a tax benefit (explained next) for charitable giving. No deduction is allowed for a QCD, but the charity receives the money and the individual has served his/her charitable inclinations.
• Reduction in AGI. The distributions are not included in adjusted gross income. As such, an individual may be entitled to take advantage of various exclusions, deductions, and/or credits where eligibility is limited by AGI.
• RMD credit. A QCD qualifies as a required minimum distribution (RMD). Thus, a person age 70½ or older who must take an RMD can avoid tax on it (up to the $100,000 limit) by making a QCD.
• Savings on Medicare premiums. The surcharge on Medicare premiums for higher-income individuals is based on modified adjusted gross income. To the extent MAGI can be reduced through a QCD, there can be savings on Medicare premiums for Parts B and C.
IRAs have been around for nearly half a century and continue to be valuable tools in providing retirement income and creating tax breaks. But changes may be coming. Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 (H.R. 1994), which passed the House Ways and Means Committee on April 2, 2019, is a measure that would make a number of favorable changes to IRAs, including repealing the maximum age for traditional IRA contributions (currently age 70½), raising the RMD age to 72, and allowing a 10 percent penalty exception for distributions on account of the birth of a child or adoption. A companion bill was introduced in the Senate Finance Committee on April 1, 2019.
Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink and senior consultant to Citrin Cooperman & Company.