Tuesday, October 7, 2014

IRA Changes

Individual Retirement Accounts (IRAs) have been a popular savings vehicle for a long time (since 1974). They became more popular with the Economic Recovery Tax Act of 1981. Contributions made into an IRA were usually tax deductible (depending on your income level) and grew tax deferred until money was taken from the IRA. There were contribution limits (the smaller of 15% of taxable income or $1500 in 1974 and $5500 today for those under age 50). There are also penalties if the money was withdrawn before age 59 ½. No taxes were due on the earnings until payments were taken from the IRA; that payment was then taxed as ordinary income. There was also a “required minimum distribution” (RMD) at age 70 ½. Failure to withdraw your RMD was subject to a 50% penalty plus ordinary income tax on the amount that should have been withdrawn.

Since contributions were limited, one would think that IRA accounts have modest account values. However, rollovers from corporate benefit plans have been allowed. Such rollovers did not result in a taxable distribution from the benefit plan to the employee, and the rolled amounts could continue to grow tax deferred. The net result is that significant amounts (trillions) of dollars are now contained in IRAs. There have been some recent changes in IRA laws which warrant planning consideration. We discuss some of those below.

Asset Protection

In many states, IRAs were protected assets; i.e. they were not subject to attachment by creditors as long as the IRA was established under the Employee Retirement Income Security Act (ERISA). Such plans had an anti-alienation provision which prevents an employer or plan administrator from releasing benefits to a creditor. In July, 2014, the Supreme Court of the United States ruled that “inherited” IRAs were not protected from creditors. An IRA passed to a non-spousal heir was not protected because the non-spousal owner: 1) could not add to the account, 2)had immediate access to the entire account without penalty, and 3) was required to take annual distributions from the IRA regardless of age. There are still state considerations which may come into play, but the case does show that IRA creditor protection is worthy of planning.

Exemption from Required Minimum Distributions

As previously mentioned, IRAs are subject to a required minimum distribution at age 70 ½. However, there is an exception to that rule. An exemption is given to funds put into a deferred annuity. The IRA owner can purchase an annuity and defer the start of benefit payout until age 80. The purchase amount is limited to the smaller of 25% of the IRA or $125,000. That annuity is excluded in the calculation of the annual RMD amount. The basic intent was to allow the individual to provide guaranteed income protection later in life from the IRA holdings. While such a plan provides protection from minimum distribution requirements, the economic advisability warrants another complete analysis.

Temporary Withdrawals

Currently an IRA owner is allowed to withdraw from an IRA with no tax implications if the total amount withdrawn is replaced into the IRA within 60 days. Such a withdrawal is allowed once every 12 months and can be done from each IRA account. For example, an individual with two IRA accounts could do two such withdrawals and replacements every 12 months with no income tax consequences. That rule will change beginning in January, 2015. After that date, an IRA owner can make only one temporary withdrawal within 12 months from IRA accounts—regardless the number of accounts.

We, at Paragon Financial Advisors, assist our clients in management of their IRAs. If you have questions or concerns about your particular situation, please call us.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

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