BOSTON – To the millions of Americans who own IRAs, 2005 may seem like most other years. But to accountants, estate attorneys and others who live, breath, eat and sleep IRAs, 2005 will go down as yet another banner year filled with new laws, court rulings, IRS Revenue Rulings and IRS Private Letter Rulings that dramatically affect America's most beloved retirement account.
What are the biggest changes affecting the 45.5 million American households and their $3.5 trillion-plus in IRA money? Here, according to Ed Slott's just-published IRA Advisor and his stable of experts, are the top rulings of the year.
1. 2005 legislation containing IRA provisions
The Katrina Emergency Tax Relief Act of 2005, or what some affectionately call KETRA, along with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) both have provisions that affect IRAs, says Robert Keebler of Virchow, Krause & Co.in Green Bay, Wis.
KETRA temporarily does away with the adjusted gross income (AGI) limit that usually applies to cash donations to charities. Typically, taxpayers can only deduct cash gifts to charities up to 50% of AGI. Under KETRA, however, donors get to deduct cash gifts made between Aug. 28, 2005 and Dec. 31 2005 up to 100% of their AGI. What's more, there's no phase-out of itemized deductions over 3% of AGI.
So how does this affect IRA owners? Keebler says IRA owners can make donations from their accounts up to the AGI limit by year-end. Yes, taking the money could trigger income tax. But the charitable deduction will serve as an offset, he says.
BAPCPA, meanwhile, has a much greater impact on IRA owners, says Keebler. Under that law, IRAs are shielded from creditors in bankruptcy proceedings. Keebler says professionals interpret the new law as creating two exemptions: one for rollover IRAs from employer-sponsored pension plans such as a 401(k) and another one for $1 million in traditional IRAs -- that's $1 million in contributions not the earnings on those contributions.
But lawyers for creditors see it differently, he says. They see only one exemption, one that protects IRAs up to $1 million -- period.
The courts will tackle this issue at some point. But in the meanwhile Keebler suggests that owners of large employer-sponsored retirement plans who are concerned about creditor protection need to look at their state laws before rolling from a "federally sheltered" employer's plan into an IRA.
If the plan is large enough, if the retirement money is exposed to creditors and if the state has weak IRA protection laws, it may be wise to leave the money in the employer's plan until the matter is resolved.
2. IRS Revenue Ruling 2005-36
Imagine taking a distribution (required or not) from an inherited IRA and then saying the IRA isn't yours anymore. Well, that's the upshot of the IRS' Revenue Ruling 2005-36, says Sy Goldberg, a senior partner with Goldberg & Goldberg in Melville, N.Y., member of the IRS Northeast Pension Liaison Group, and co-author of the "Consumer's Guide to the Retirement Distribution Rules."
Prior to this ruling, primary beneficiaries of inherited IRAs didn't have much flexibility. They either had to take a year-of-death required minimum distribution and take title to the IRA or they had to disclaim the IRA, passing it to the contingent beneficiary or beneficiaries.
Of note, primary beneficiaries often use IRA disclaimers to move assets from their taxable estate to another person's taxable estate to reduce potential estate tax bills and/or to create what's called a "stretch IRA" -- an IRA owned by a contingent beneficiary with a longer life expectancy. Creating a stretch IRA lowers the minimum distribution and extends the time the IRA gets to grow tax-deferred.
With the new ruling, which unlike an IRS Private Letter Ruling becomes available to all taxpayers, primary beneficiaries get to have their cake and eat it too. They can take a distribution and disclaim the IRA. And though it's complicated and shouldn't be done without the help of a professional, the primary beneficiary can either disclaim the entire IRA, a fixed dollar amount or a percentage of the IRA.
3. IRA trust ruling allows more post-death options
IRS' Private Letter Ruling 2005-37044 is among those PLRs issued in 2005 that people (though not necessarily strap hangers on the subway) are talking about, says Bruce Steiner, an attorney with Kleinberg, Kaplan, Wolff & Cohen in New York. That PLR confirms that an IRA can now be left to multiple trusts (one trust for each IRA beneficiary) which spring out of one master trust.
Heretofore, IRA professionals debated whether a trustee had the power to convert a conduit or pass-through trust to an accumulation trust, or vice versa, within nine months of the IRA owner's death. This ruling suggests that a trustee can do either: a conduit trust in which the required minimum distributions are paid to the beneficiary from the trust or an accumulation trust in which principal and income are allowed to accumulate rather than being paid out.
Steiner, though, says why anyone would create a conduit trust is beyond him. "It ignores the remainder beneficiaries," he says. "And it's not practical to create a plan that requires a PLR. The problem with a conduit trust is its inflexibility; it requires distributions. And if the object is to protect the money, a conduit trust doesn't do that."
4. New annuity ruling helps nonspouse beneficiaries
Goldberg says an IRS PLR ruling scheduled to be released Friday will help nonspouse beneficiaries of employer-sponsored retirement plans. In the past, nonspouse beneficiaries of an employer-sponsored retirement plan, such as a Keogh, had to liquidate the account and pay the tax on the entire distribution after the owner died.
With the new ruling, nonspouse beneficiaries will have the ability to purchase an annuity that distributes income based on the beneficiary's life expectancy. The nonspouse beneficiary can't roll the retirement plan into an IRA but can at least create a plan that mimics what the distribution from an IRA would have been.
5. PLRs allow executors to complete 60-day rollovers
Executors who have to work with IRAs in which the owner died before completing a rollover of an IRA distribution within the 60 days as required by law can sleep well in the wake of several PLRs in 2005.
According to Natalie Choate, author of "Life and Death Planning for Retirement Benefits," the IRS issued a number of PLRs granting executors the right to complete the rollover even though the 60-day window had lapsed. Choate says one thing these PLRs have in common is that they say mistakes can be corrected by an executor after an IRA owner's death. The 60-day rule may be waived in case of an error by an incompetent individual or by a financial institution, she says.