Confusing IRA situation; Help requested

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yankeefan4065
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Confusing IRA situation; Help requested

Post by yankeefan4065 » Mon Aug 06, 2018 4:46 pm

Hello All,

I'm trying to help a friend deal with a confusing IRA situation in which she may have gotten some bad advice. Here are the particulars:

1. She contributed to a Traditional Ira from 1986-1995. Most of those contributions were non-deductible; however, in 1987-1988 $1950 was deductible. The non-deductible portions were indicated on form 8606.

2. Fast forward to 2007: her tax preparer suggested moving her IRAs to one location----Prudential. He put the IRA in a variable annuity. From my understanding this should never have been suggested. However, she did it and the IRA (inside the annuity) was there until this month.

3. As an aside, she opened a Traditional IRA at Vanguard in 2014 and has contributed to that each year. All of the contributions are non-deductible and have been recorded on form 8606. (She was over the income limit to do a Roth). I had thought about a backdoor Roth but with the other IRA at Prudential I wasn't sure how to handle that and didn't want to confuse the situation and increase her tax burden.

4. This month her current adviser suggested getting out of the Prudential investment. She agreed. He suggested moving it to TIAA where she has her 403b. However, instead of moving it to a Traditional IRA he moved it into her 403b which is all pre-tax. I told her something didn't sound correct and she contacted her adviser. He researched it and suggested they both talk to her accountant about the best way forward, but the adviser did mention 3 possibilities:

5. Option A: Keep the money in the 403b and keep track of the basis for tax purposes. (I'm far from an expert but I don't understand this. The 403b is all pre-tax and a significant portion of the Traditional IRA is money that was non-deductible. She shouldn't owe tax on any of that. Isn't form 8606 only for IRAs?)

6. Option B: Transfer the non-deductible portion and open a Roth IRA (What are the tax implications?)

7. Option C: Call Prudential and ask for a letter of indemnity and return the funds to them.

Question:

1. What would be the simplest best option for her at this point? She doesn't want to owe tax on this account this year. I thought if they could transfer the money to a Traditional IRA at TIAA that would be best and then she could eventually move it to Vanguard.

2. Are any of the options described above sound? She values simplicity and peace of mind. The rest of her portfolio is good. (all indexed at a conservative equity/fixed ratio).

Thanks so much in advance. She'll probably be talking to her adviser tomorrow so I wanted to be able to share what the experts here think!

John

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Mon Aug 06, 2018 7:56 pm

One additional question:

For tax purposes when withdrawing from a Traditional IRA do you simply subtract the basis amount from the withdrawal amount to determine the taxable portion? Anything I’m missing?

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FIREchief
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Re: Confusing IRA situation; Help requested

Post by FIREchief » Mon Aug 06, 2018 8:06 pm

yankeefan4065 wrote:
Mon Aug 06, 2018 7:56 pm
One additional question:

For tax purposes when withdrawing from a Traditional IRA do you simply subtract the basis amount from the withdrawal amount to determine the taxable portion? Anything I’m missing?
Form 8606 outlines the correct procedure to calculate this.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Mon Aug 06, 2018 8:21 pm

Thanks....didn’t realize it was in Part 1 on the form

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Tue Aug 07, 2018 10:17 am

Wondering if anyone had further thoughts on this situation?

Thanks again

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House Blend
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Re: Confusing IRA situation; Help requested

Post by House Blend » Tue Aug 07, 2018 11:34 am

yankeefan4065 wrote:
Mon Aug 06, 2018 4:46 pm
5. Option A: Keep the money in the 403b and keep track of the basis for tax purposes. (I'm far from an expert but I don't understand this. The 403b is all pre-tax and a significant portion of the Traditional IRA is money that was non-deductible. She shouldn't owe tax on any of that. Isn't form 8606 only for IRAs?)

6. Option B: Transfer the non-deductible portion and open a Roth IRA (What are the tax implications?)

7. Option C: Call Prudential and ask for a letter of indemnity and return the funds to them.
I don't think Options A or B are options.

The basic problem is that one cannot roll the basis portion of a traditional IRA into a "qualified retirement plan" (401(k), 403(b), etc).

One also needs to understand that for tax purposes, she has only one traditional IRA -- all of them are combined, along with their basis.

Perhaps best explained with an example that has actual numbers:

IRA1: $50K in non-deductible contributions, $100K balance.
IRA2: $20K in non-deducible contributions, $30K balance.

So you have, in effect, one IRA with $70K basis and $130K balance. If you do a rollover to a 403(b) from either or both accounts in any combination you like, up to $60K, the (combined) basis will remain untouched. If you roll $50K in, your two IRAs will have a combined balance of $80K and a basis of $70K.

However, it sounds like your scenario, in the context of this example, was more like rolling $100K into the 403(b) plan. Absent Option C working out, I'm pretty sure that the $100K in the 403(b) is and must be treated as 100% pretax.

What I'm not sure about is what happens to the traditional IRA(s), and whether (in this hypothetical example) they retain the $70K basis, even though the account balances now add up to $30K. Of course this is suboptimal, as it means being exposed to (eventual) double taxation on the the $40K that should not have been rolled to the 403(b).

This may be a job for Alan S.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Tue Aug 07, 2018 12:06 pm

Thank you so much for that response. I was afraid of it being taxed twice. She did call Prudential to see if she could simply move it back as if nothing happened but she indicated that they said it wasn't as simple as that and it would probably be simpler to fix it on the TIAA end.

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House Blend
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Re: Confusing IRA situation; Help requested

Post by House Blend » Tue Aug 07, 2018 12:22 pm

Another idea: Based on the age of her IRAs, it is plausible that she has already celebrated, or will soon be celebrating, her 59.5th birthday. This brings with it the potential for in-service rollovers out of her 403(b) plan.

In that case, if the speculation is correct in my hypothetical example that the full $70K basis stays with the IRAs, then another option to be made whole and avoid the double taxation would be to roll $40K from the 403(b) plan to the trad IRA (or whatever amount would bring the account balance to roughly match the total basis), and then convert the entire IRA to Roth.

If her 59.5th birthday is, say, in 2020, then that would suggest continuing to make non-deductible IRA contributions but hold off on converting until 2020 when she can do a rollover that results in an IRA balance in line with its basis. For each additional year that you have to wait for age 59.5, some of the advantage of doing this is lost, but it's always better than wasting $40K of excess basis.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Tue Aug 07, 2018 12:29 pm

She'll be turning 56 next month. If I'm understanding you correctly you do not think she will be able to move that money from the 403b to a Traditional IRA even though it's only been a week or so. The fact that it was moved there automatically made it pre-tax?

Thank you again.

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House Blend
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Re: Confusing IRA situation; Help requested

Post by House Blend » Tue Aug 07, 2018 12:39 pm

yankeefan4065 wrote:
Tue Aug 07, 2018 12:29 pm
She'll be turning 56 next month. If I'm understanding you correctly you do not think she will be able to move that money from the 403b to a Traditional IRA even though it's only been a week or so. The fact that it was moved there automatically made it pre-tax?
Unless TIAA or Prudential are willing to unwind the transaction, I think any amounts in the 403(b) are automatically going to be pretax, and rollovers out of your current employer's plan generally are not allowed until age 59.5 is attained.

However, if she also has a 403(b) account from a *former* employer, those dollars are probably rollover-eligible today, and could be used to soak up any leftover basis in the trad IRA.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Tue Aug 07, 2018 12:45 pm

Unfortunately she does not have a second 403b. Outside of hiring an accountant is there any way of finding out if your speculation about the "basis" staying at "70k" (or whatever hers is) is accurate?

Many thanks.

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House Blend
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Re: Confusing IRA situation; Help requested

Post by House Blend » Tue Aug 07, 2018 12:54 pm

I've sent a pm to Alan S.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Tue Aug 07, 2018 1:17 pm

Thanks so much for your help! My friend just told me her advisor at TIAA is currently working on it. Hopefully they’ll just unwind it. I shared your comments with her so she is aware of the particulars of the situation.

Alan S.
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Re: Confusing IRA situation; Help requested

Post by Alan S. » Tue Aug 07, 2018 7:08 pm

This is a messy situation due to the lack of clear IRS guidance, and there are several inter related issues.


First, the date of the distribution from the IRA determines the pre tax and basis available in the IRA. This is not like the usual IRA distribution situation where any transaction up to year end affect what was distributed. In this case, the actual date of the distribution applies. Therefore, the first thing to do is determine if IRA basis was in fact rolled into the 403b. Houseblend correctly described that pre tax amounts in all owned IRAs are deemed to be rolled into the 403b before any basis is included under a special exception to the pro rata rules for IRA distributions.

Now let's suppose that some basis was actually rolled into the 403b. The IRS has stated in RR 2014-9 that the 403b plan should then distribute back out of the plan the amount of basis plus any earnings, but since this ruling was issued for the benefit of the plan and not the participant, there is no additional guidance about 1099R reporting and coding. EPCRS outlines most plan corrective actions, and while this generally would fall under "excess amounts", EPCRS does not address rollover issues such as this.

So I am improvising from here. The basis was not eligible for rollover to the plan and therefore is an excess amount to be distributed back out. No telling how that 1099R will be coded, but most likely as a corrective distribution it will not be eligible for rollover back to the IRA. However, other than the earnings, the amount returned should not be taxable or pro rated with any other amounts in the plan. Earnings returned will be taxable and possibly be subject to penalty depending on the 1099R coding. The end result of all this is that the 403b holds no basis, and the IRA basis was distributed via the 403b tax free. Technically, the IRA basis that was distributed should be reported as such on Form 8606 which will reduce the IRA basis and only the pre tax amount distributed reported as a direct rollover to the 403b. This will differ from the 1099R and require an explanatory statement so the IRS will understand what is being reported.


Now, suppose the 403b plan is NOT notified. The plan will continue to assume that the entire rollover was pre tax money as required. That would end up with that IRA basis in the 403b improperly where it will be treated as pre tax with eventual double taxation. But if the plan is notified of the error and the excess is distributed out of the plan tax free (except for earnings on the excess) double tax will be avoided.

Since it is not clear exactly how the 403b plan will react if notified, or how the IRS will react to the tax return, nothing here is certain.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Tue Aug 07, 2018 7:39 pm

Alan, thank you very much for that detailed explanation. My friend greatly appreciates all of the information!

GrowthSeeker
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Re: Confusing IRA situation; Help requested

Post by GrowthSeeker » Tue Aug 07, 2018 9:06 pm

Why not roll everything except the basis portion into the 403b; and then move (convert) all the basis portion into a Roth?
Future non deductible tIRA contributions can become backdoor Roth contributions.

What I don't know is did something get done incorrectly when she put a mixture of deductible and non-deductible IRA money into that Prudential annuity account? (I don't know).
Just because you're paranoid doesn't mean they're NOT out to get you.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Tue Aug 07, 2018 9:19 pm

The basis was rolled into the 403b along with the earnings. Hopefully the basis can get moved out. It’s pretty confusing trying to follow all of it . The money in the Prudential annuity (IRA), as far as I know, was all done correctly.

Thanks for responding.

yankeefan4065
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Re: Confusing IRA situation; Help requested

Post by yankeefan4065 » Fri Aug 10, 2018 5:17 pm

*UPDATE*

My friend heard from her advisor at TIAA and he (along with his director) came up with a few options as well as an additional one not mentioned yet.

1. Leave the funds in the pension in the rollover source (I read this to mean just leave them in the 403b). I have no idea why this is an option because there is definitely basis in those funds which may mean double taxation. Alan S. said they do not belong there.

2. Ask Prudential to send a letter of indemnity requesting funds back. My friend had already called and Prudential said that is not automatically a given and would have to go through a "process" to get approval. (they even said it would be easier to handle it on TIAA's end)

3. Open an IRA with TIAA and then transfer the funds to the IRA. This would be the best option; however, it was mentioned, that as soon as the non-basis money (earnings) went in there it automatically became pre-tax.

I told her at this point before doing anything it may be easier to just contact an advisor from Garrett planning that was mentioned earlier or Ed Slott's company (mentioned on another message board) that deals with retirement and IRA issues.

Any final thoughts on any of this? Anyone heard of Ed Slott's company?

Thanks again,
John

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