by Mat Sorensen | Oct 25, 2016 | Retirement & IRAs
The Retirement Improvements and Savings Enhancements Act (“RISE Act“) has drastic changes and provisions that effect self-directed IRA investors. From mandatory third-party valuations on all retirement account investment transactions to changing the 50% disqualified company rule to 10%, the bill has some significant changes that will negatively affect your ability to self-direct your account. There are some favorable provisions for IRA owners, however, the negatives greatly outweigh the positives.
Most Important Provisions
The bill sponsor is Sen. Ron Wyden (D-OR) who is the Ranking Member of the Senate Finance Committee and the Joint Committee on Taxation. Here’s a quick run-down of the most troublesome provisions that apply to self-directed IRA investors:
- Valuation Purchase/Sale Requirement. Mandatory Valuation Requirement for Private IRA (non-public stock market) Transactions: The new proposal seeks to require gifting valuation rules and standards for IRA transactions. This rule will force IRA owners to get a valuation before making any private investment. This valuation would include real estate, private company (e.g. LLC, LP, corporation), and note investments. The gifting valuation rules were created to value gifts where no value is set between a buyer and seller. mandating those same rules on actual transactions between an IRA and another unrelated party is unrealistic and unnecessary to establish actual fair market value.
- 50% Rule is Reduced to a New 10% Rule: Changes the 50% rule that states a company is a disqualified person to an IRA when it is owned 50% or more by disqualified persons (e.g. IRA owner and certain family). The new rule makes a company disqualified when owned 10% or more by disqualified persons.
- Roth IRAs Capped at $5M: Roth IRAs will be capped at $5M. Any amount over $5M must be distributed from the Roth IRA.
- Eliminate Roth Conversions: Traditional IRA funds cannot be converted to Roth IRA funds. Roth IRAs will be allowed only if the account owner makes initial Roth IRA contributions and only when they meet the Roth IRA contribution limits, which restricts high-income earners.
- Require RMD for Roth IRAs: Roth IRAs are currently not subject to required minimum distribution (“RMD”) rules because the amounts distributed do not result in tax. This rule will change and RMD will apply to Roth IRAs when the account holder reaches age 70 ½.
These proposals will have drastic impacts on self-directed IRA investors. The valuation requirement is perhaps the most dramatic as it will require valuations before an IRA can buy an asset and before it can sell an asset. Not only will this cause administrative issues and increased costs, but it will undoubtedly replace the ability of an IRA buyer or an IRA seller from transacting their IRA at the price and value they determine to represent the actual current fair market value of their investments.
I have written a detailed analysis of the bill which I plan to share with the Senate Finance Committee and the Joint Committee on Taxation. I welcome your input as a self-directed IRA investor and plan to advocate for common-sense rules that help self-directed investors take control of their retirement. My draft bill analysis can be accessed at the link below. Please send your comments to [email protected].
draft-rise-act-2016-analysis-by-mat-sorensen
by Mat Sorensen | Dec 1, 2015 | Retirement & IRAs, Uncategorized
If you are age 70 1/2 or older and if you have a traditional IRA (or SEP or SIMPLE IRA or 401k), you must take your 2015 required minimum distributions (“RMD”) by December 31, 2015. In short, the RMD rules require you to distribute a portion of funds from your retirement account to yourself personally. These distributed funds are subject to tax and need to be included on your personal tax return. Let’s take an example to illustrate how the rule works. Sally is 72 and is required to take RMD each year. She has an IRA with $250,000 in it. According to the distribution rules, see IRS Publication 590, she will need to distribute $9,765 by the end of the year. This equates to about 4% of her account value. Next year, she will re-calculate this annual distribution amount based on the accounts value and her age. Once you know how to calculate the RMD, determining the distribution amount is relatively easy. However, the rules of when RMD applies and to what accounts can be confusing. To help sort out the confusion, I have outlined some facts and fiction that every retirement account owner should know about RMDs. First, let’s cover the facts. Then, we’ll tackle the fiction.
Fact
- No RMD for Roth IRAs: Roth IRAs are exempt from RMDs. Even if you are 70/12 or older, you’re not required to take distributions from your Roth IRA. Why is that? Because there is no tax due when you take a distribution from your Roth IRA. As a result, the government doesn’t really care whether you distribute the funds or not as they don’t receive any tax revenue.
- RMD Can Be Taken From One IRA to Satisfy RMD for All IRAs: While each account will have an RMD amount to be distributed, you can total those amounts and can satisfy that total amount from one IRA. It is up to you. So, for example, if you have a self directed IRA with a property you don’t want to sell to pay RMD and a brokerage IRA with stock you want to sell to pay RMD, then you can sell the stock in the brokerage IRA and use those funds to satisfy the RMD for both IRAs. You can’t combine RMD though for 401(k) and IRA accounts. Only IRA to IRA or 401(k) to 401(k).
- 50% Excise Tax Penalty: There is a 50% excise tax penalty on the amount you failed to take as RMD. So, for example, if you should’ve taken $10,000 as RMD, but failed to do so, you will be subject to a $5,000 excise tax penalty. Check back next month where I will summarize some measures and relief procedures you can take if you failed to take required RMD.
- 401(k) Account Holder Still Working for 401(k) Employer: If you have a 401(k) with a current employer and if you are still working for that employer, you can delay RMD for as long as you are still working at that employer. This exception doesn’t apply to former employer 401(k) accounts even if you are otherwise employed.
Fiction
- RMD Due by End of Year: You can make 2015 RMD payments until the tax return deadline of April 15, 2016. Wrong! While you can make 2015 IRA contributions up until the tax return deadline of April 15, 2016, RMD distributions must be done by December 31, 2015.
- Roth 401(k)s are Subject to RMDs: While Roth IRAs and Roth 401(k)s are both tax-free accounts, the RMD rules apply differently. As I stated above, Roth IRAs are exempt from RMD rules. However, Roth 401(k) owners are required to take RMD. Keep in mind, you could roll your Roth 401(k) to a Roth IRA and thereby you would avoid having to take RMD but if you keep the account as a Roth 401(k) then you will be required to start taking RMD at age 70 ½. The distributions will not be subject to tax but they will start the slow process of removing funds from the tax-free account.
- RMD Must Be Taken In Cash: False. Required Minimum distributions may be satisfied by taking cash distributions or by taking a distribution of assets in kind. While a cash distribution is the easiest method to take RMD, you may also satisfy RMD by distributing assets in kind. This may be stock or real estate or other assets that you don’t want to sell or that you cannot sell. This doesn’t occur often but some self directed IRA owners will end up holding an asset they don’t want to sell because of current market conditions (e.g. real estate) and they decide to take distributions of portions of the real estate in-kind in order to satisfy RMD. This process is complicated and requires an appraisal of the asset(s) being distributed and partial deed transfers (or partial LLC membership interest transfers, if the IRA owns an LLC and the LLC owns the real estate) from the IRA to the IRA owner. While this isn’t the recommended course to satisfy RMD, it is a potential solution to IRA owners who are holding an asset, who have no other IRA funds to distribute for RMD, and who wish to only take a portion of the asset to satisfy their annual RMD.
The RMD rules are complicated and it is easy to make a mistake. Keep in mind that once you know how the RMD rules apply in your situation it is generally going to apply in the same manner every year thereafter with only some new calculations based on your age and account balances each year thereafter.
Click here for a nice summary of the RMD rules from the IRS.
by Mat Sorensen | Sep 15, 2015 | Retirement & IRAs
Have you rolled over your 401(K) plan or other employer based plan to a rollover IRA? Has someone told you that your rollover IRA in California isn’t protected from creditors. They’re wrong.
California Exemptions
Retirement plans are known for being great places to build wealth and they have numerous tax and legal advantages. One of the key benefits of building wealth in a retirement account is that those funds are generally exempt from creditors. However, some states have laws that protect employer based retirement plans (aka, ERISA Plans) more extensively than IRAs. California is one of those states as their laws treat IRAs and ERISA based plans differently (the California Code refers to ERISA based plans, such 401(k)s, as private retirement plans) .
California Code of Civ. Proc., § 704.115, subds. (b),(d), treats funds held in a private retirement plan as fully exempt from collection by creditors. “Private retirement plans” include in their definition “profit-sharing” plans. The most common type of profit sharing plan is commonly known as a 401(k) plan.
IRAs, on the other hand, are only exempt from creditors up to an amount “necessary to provide for the support of the … [IRA owner, their spouse and dependents] … taking into account all resources that are likely to be available…” In other words, the exemption protection for IRAs is “limited”. California Code of Civ. Proc., § 704.115, subdivision (e).
McMullen v. Haycock
Notwithstanding the limited creditor protections for IRAs outlined above, the California Court of Appeals has ruled that rollover IRAs funded from “private retirement plans” receive full creditor protection as if they were a fully protected private retirement plan under California law. McMullen v. Haycock, 54 Cal.Rptr.3d 660 (2007). In McMullen v. Haycock, McMullen had a judgement against Haycock for over $500,000. McMullen attempted to get a writ of execution against Haycock’s IRA at Charles Schwab. In defending against the writ of execution, Haycock claimed that the entire IRA was a rollover IRA funded and traceable to a private retirement plan and thus fully protected from collection as a private retirement plan. Haycock relied on California Code of Civ. Proc., § 703.80, which allows for the tracing of funds for purposes of applying exemptions.
Haycock lost at the trial court level but appealed and the appellate court found in his favor and ruled that his rollover IRA was fully protected from the collection of creditors as the funds in the rollover IRA were traceable to a fully exempt private retirement plan (e.g. former employer’s 401(k) plan).
As a result of McMullen v. Haycock, California IRA owners whose IRAs consist entirely of funds rolled over from a private retirement plan of an employer are fully protected from the collection efforts of creditors. IRAs that consist of individual contributions and are not funded from a prior employer plan rollover will only receive limited creditor protection. It is unclear so far how an IRA would be treated that consists of both private retirement plan rollover funds and new IRA contributions. Presumably, the Courts will trace the funds and separate out the private retirement plan rollover IRA portions from the regular IRA contributions and the regular IRA contributions would then receive the limited protection. Unfortunately, there is no case law or guidance yet as to rollover IRAs with mixed rollover and regular IRA contributions.
McMullen v. Haycock was a big win for IRA owners with funds rolled over from a private retirement plan and one that should be kept in mind when planning your financial and asset protection plan.
by Mat Sorensen | Feb 10, 2015 | Retirement & IRAs, Uncategorized
President Obama’s latest budget proposal seeks to address once policy issue: the federal government wants more money. That fact is, American wealth is being concentrated into retirement accounts and the government wants more of it than it already receives. Here’s three proposals from the President’s budget proposal that would weaken the current benefits of saving for retirement.
In an effort to halt so called “Back-Door” Roth IRAs, President Obama’s budget proposal would eliminate the ability to convert “after-tax” dollars in a traditional IRA or employer based plan to Roth. You could still convert “pre-tax” dollars that are in a traditional IRA or employer plan to Roth. For example, a traditional IRA with pre-tax dollars could be converted to a Roth IRA as their is tax due on this conversion and the IRS wants your money. However, many high-income earners who could not contribute to a Roth IRA have instead made “after-tax” contributions to their retirement plan (where they receive no deduction) and they have been able to convert those amounts to Roth dollars with no taxes on the conversion (since the dollars are after-tax) under what has become known as a “Back-Door” Roth IRA. Click here for a prior article I wrote on the “Back-Door” Roth IRA.
Other bad ideas found in the budget include imposing required minimum distributions (RMD) on Roth IRAs. RMDs have never applied to Roth IRAs because taxes have already been paid on the funds but the new proposal would require RMD on Roth IRAs when the account owner reaches 70 1/2 in a manner similar to traditional IRAs.
And finally, the budget proposal would limit the ability to contribute to a retirement account once your retirement account values exceed approximately $3.4M. The account could still grow but no new contributions would be allowed. This would be a first of its kind rule as total account success has not been a restriction in your ability to contribute into the most popular retirement accounts like IRAs and 401(k)s. While most people don’t need to worry about exceeding $3.4M in their retirement account, setting a ceiling on account growth seems to be a dangerous precedent.
Want to know the good news, President Obama has never had a budget approved. Not even when his party controlled both houses of Congress.
by Mat Sorensen | Dec 16, 2014 | Retirement & IRAs
In 1986, Congress allowed individual retirement accounts (IRA) to invest in precious metals bullion. Since then, many IRA owners have purchased and held precious metals bullion coins and bars in IRAs as a hedge against inflation and to diversify their retirement assets.
This white paper summarizes the legal requirements for purchasing and holding precious metals bullion in an IRA. The focus of this white paper is on the legal requirement that a bank remain in physical possession of precious metals bullion that is held in an IRA.
As a background, collectibles are prohibited from being held in an IRA.[1] A collectible is tangible personal property such as a stamp or coin, metal or gem, wine or a work of art.[2] In form and substance, collectibles are much different than traditional IRA investments like stocks, bonds, and certificates of deposit that offer no benefit of aesthetic value, personal use or consumption. The general theory behind the prohibition on investing in collectibles is that tax-deductible IRA assets should not be used, displayed, or enjoyed by an IRA owner before retirement or early distribution. If an IRA purchases or holds a collectible, then that asset is distributed from the IRA and the assets are deemed to be a collectible. A distribution typically results in taxes and penalties assessed to the IRA owner.
Congress created a very limited exception to the prohibition on holding collectibles in an IRA when it exempted certain precious metals bullion coins and bars from the definition of a collectible.[3] Section 408(m) of the Internal Revenue Code states:
(3) Exception for certain coins and bullion.–For purposes of this subsection, the term “collectible” shall not include –
(A) any coin which is –
(i) a gold coin described in paragraph (7), (8), (9), or (10) of section 5112(a) of Title 31, United States Code[4],
(ii) a silver coin described in section 5112(e) of Title 31, United States Code[5],
(iii) a platinum coin described in section 5112(k) of Title 31, United States Code[6], or
(iv) a coin issued under the laws of any State, or
(B) any gold, silver, platinum, or palladium bullion of a fineness equal to or exceeding the minimum fineness that a contract market (as described in section 7 of the Commodity Exchange Act, 7 U.S.C. 7) requires for metals which may be delivered in satisfaction of a regulated futures contract[7],
if such bullion is in the physical possession of a trustee described under subsection (a) of this section.
This white paper seeks to clarify the final paragraph of the subsection that requires a “trustee” to be in “physical possession” of precious metals bullion held in an IRA.
A “trustee” is a “bank…or such other person who demonstrates to the satisfaction of the Secretary [of the U.S. Treasury] that the manner in which such other person will administer the [IRA] will be consistent with the requirements of this section.”[8] A “bank” is defined as: (1) any bank; (2) an insured credit union; and (3) a corporation which, under the laws of the State of its incorporation, is subject to supervision and examination by the Commissioner of Banking, or other officer of such State in charge of the administration of the banking laws of such State.[9]
To be considered “a trustee,” an entity must be a bank, a credit union, a trust company or any other regulated entity supervised and examined by the banking commission of the state in which it is established. If an entity does not fit within a category above, it cannot be a “trustee” of IRA assets.[10]
Notably, the IRS has issued guidance on the issue of whether two non-bank entities could store precious metals bullion that is held in IRAs.[11] In deciding this issue, the IRS noted that the “limited exception” that allows IRAs to invest in bullion coins and bars “applies only if a certain type of bullion is in the physical possession of the IRA trustee.” The IRS then concluded that bullion stored by a non-bank, and not by a trustee, would be considered collectibles and treated as a distribution from the IRA and subject the IRA owner to taxes and penalties.
As a corollary to the “trustee” requirement, a “trustee” must be in “physical possession” of acceptable precious metals bullion. Unlike the term “trustee,” the Internal Revenue Code does not define what “physical possession” means.
To accurately interpret what “physical possession” means, a three-step approach is required. First, the term “physical possession” must be given its ordinary and common meaning. Second, since an investment in precious metals is a very limited exception to the general rule that collectibles are prohibited from being held in an IRA, the language in this exception must be narrowly construed so that the exception does not “swallow the rule.”[12] Third, interpretation of the term “physical possession” must take into account, and be in harmony with, the legislative intent of the exception that allows IRAs to invest in precious metals bullion coins and bars.
Black’s Law Dictionary is an authoritative source of legal definitions that is useful in obtaining the meaning of physical possession, and distinguishing it from “constructive possession” of tangible personal property. Physical possession describes the actions of “a person who knowingly has direct physical control over a thing.”[13] In contrast, constructive possession describes the actions of “[a] person who, although not in actual possession, knowingly has both the power and the intention at a given time to exercise dominion or control over a thing, either directly or through another person or persons.”[14] A trustee is in physical possession of precious metals bullion if it has actual, physical control over such bullion. Constructive possession does not amount to physical possession because a trustee is merely exercising custodial control over the bullion, as opposed to being in actual, physical possession of the bullion.
As an example, if an IRA custodian were to delegate to a non-bank the responsibility of storing precious metals bullion in its custody, the “physical possession” requirement would not be met because the non-bank, and not a trustee, is in actual, physical control of bullion held in an IRA. Therefore, an IRA custodian (or any other trustee) should not delegate storage of bullion in an IRA to any party who itself does not qualify as a “trustee.”
Courts that are called upon to interpret the meaning of “physical possession” in Section 408(m) would be required to narrowly interpret that term because that term is included within an exception to the general rule that collectibles should not be held in IRAs. A narrow interpretation of the modifier “physical,” next to and in connection with the term “possession,” naturally yields a finding that a trustee must have direct physical control over bullion.
For example, if an IRA custodian leases depository space from a non-bank, and precious metals bullion stored within the leased space is exclusively handled and stored by non-bank’s employees, the IRA custodian cannot be said to be in physical possession of the bullion. This is because the non-bank’s employees maintain physical control of the bullion. Put simply, a literal and narrow interpretation of physical possession would lead to the conclusion that the IRA custodian’s metaphysical control over its leased space is not tantamount to physical possession.
Lastly, the legislative intent in requiring “physical possession” of bullion by a trustee must be examined. Section 408(m) is a very limited exception to the general prohibition on holding collectibles in an IRA. It allows an IRA to invest in certain precious metals that are unlike traditional investments because they are tangible items that are portable, durable, and liquid. These unique characteristics of bullion coins and bars underscore the need to require a regulated or Treasury-approved entity store this type of IRA asset. Without such a requirement, bullion could come into the IRA owner’s possession or be stolen – without a trace of evidence – prior to retirement or early distribution.
In conclusion, to avoid the possibility of otherwise acceptable bullion being deemed a “collectible” by the IRS (and, by extension, treated as a distribution from the IRA), the prudent course for IRA custodians, third-party administrators, and IRA owners is to deposit bullion into the custody and safekeeping of a precious metals depository that meets the Internal Revenue Code’s definition of a “bank” (i.e., a bank, credit union, or trust company). Storing in any other manner invites uncertainty to retirement planning, and it raises the distinct possibility that the retirement assets will be forfeited based on the decision to store bullion outside the physical possession of a trustee.
[1] 26 U.S.C.A. § 408(m)(1)
[2] 26 U.S.C.A. § 408(m)(2)
[3] 26 U.S.C.A. § 408(m)(3)
[4] Respectively refers to the one ounce ($50 face value), one-half ounce ($25 face value), one-fourth ounce ($10 face value), and one-tenth ounce ($5 face value) Gold American Eagle coins distributed by the United States Mint.
[5] Refers to one ounce Silver American Eagle coins distributed by the United States Mint.
[6] Refers to any platinum bullion and proof platinum coin distributed by the United States Mint.
[7] The minimum fineness requirement of each metal is as follows: Gold = 995 parts per 1,000 (99.5%); Silver = 999 parts per 1,000 (99.9%); Platinum = 999.5 parts per 1,000 (99.95%); Palladium = 999 parts per 1,000 (99.95%)
[8] 26 U.S.C.A. § 408(a)(2)
[9] 26 U.S.C.A. § 408(n)
[10] A nonbank may approved as a “nonbank trustee” if it is approved by the US Treasury upon demonstrating, among other things, that it is experienced in discharging fiduciary duties. See, 26 C.F.R. § 1.408-2(e)
[11] I.R.S. P.L.R. 200217059 (Apr. 26, 2002)
[12] See, e.g., In re Woods, 743 F.3d 689, 699 (10th Cir. 2014) (“we are guided by the interpretive principle that exceptions to a general proposition should be construed narrowly.”)
[13] Black’s Law Dictionary, 606-607 (5th Ed. 1983).
[14] Black’s Law Dictionary, 1163 (6th Ed. 1990).
About the Author:
Mat Sorensen, Esq. is a partner at KKOS Lawyers in its Phoenix, AZ office. Mat is the author The Self Directed IRA Handbook
Scott B. Schwartz, Esq., contributed to the content of this paper.
