The individual retirement account, or IRA, is a deceptively simple tax-advantaged savings vehicle that advisors must become proficient at working with to successfully serve clients, according to IRA consultant Ed Slott.

There are dozens of rules governing IRAs, particularly surrounding taxation, inheritance and distribution of IRA money, said Slott, president of Ed Slott and Company, at his firm’s Instant IRA Success workshop in Las Vegas last month. 

“Almost every advisor will say the same thing: We don’t give tax advice," he said. "But here’s the thing: You are tax advisors. ... If you’re touching an IRA, or a Roth IRA, you’re giving tax advice."

Presenters from Ed Slott and Company spent nearly four hours detailing 25 IRA rules they said advisors “must know,” covering relevant court cases and IRS policy statements that provide guidance for practitioners.

Here are 10 of Slott’s 25 “must know” rules for IRAs.

1. The Basics Of IRA Distributions

All traditional IRA owners face required minimum distributions (RMDs) by April 1 of the year that follows the year they turn 70 and one half.

“Because the IRS is keeping an eye out on RMDs, you want to be sure that your clients take theirs,” said Sarah Brenner, director of retirement education at Slott and Company. “Double-check IRA transactions by the end of the year." Also find out about accounts that they might have elsewhere, she added.

After the first RMD, all subsequent RMDs are required to be taken by the end of the year. So for someone who reached age 70 and a half in 2019, the account owner’s first RMD is required by April 1, 2020, and their second is required by Dec. 31, 2020. Thus, waiting until after Jan. 1, 2020 to take an initial RMD would lead to both distributions being taxed in one year.

RMD amounts are calculated using the IRS’s life expectancy calculations . While there are three different tables listing life expectancy that the IRS uses to calculate RMDs in certain cases, most IRA owners will use the Uniform Life Table, while most IRA beneficiaries will use the IRS’s Single Life Expectancy Table.

Failure to take a required minimum distribution triggers a 50 percent excise tax on the amount that went undistributed. In many cases, account owners and advisors have successfully petitioned for this penalty to be waived after the required distribution.

2. The Impact Of Rollovers, Transfers And QLACs

If a distribution is required for 2019, that distribution is calculated using the owner’s IRA balances as of Dec. 31, 2018, unless that account has an outstanding rollover on Dec. 31, 2018. Outstanding rollovers require the IRA balance to be adjusted. The same rules apply for transfers from one IRA to another.

“All those clients who hate taking RMDs, if they could, they would take a distribution in December, clean out their IRA, and then roll it over in January, which would leave the Dec. 31 balance as zero,” said Brenner. “The IRS is not going to let that happen.”

Assets in QLACs, or qualified longevity annuity contracts, are excluded from the RMD calculation. However, excess QLAC payments are added back for RMD calculations.

3. Aggregating RMDs

Many–but not all–RMDs can be aggregated. Owners of multiple traditional IRA and SEP IRAs can calculate RMDs from each account, add them together and take the distribution from any one or several IRAs. But spouses cannot aggregate their accounts together for the purpose of taking an RMD.

RMDs can be aggregated from IRAs that have been inherited from the same person, however, account owners cannot aggregate RMDs from accounts that they founded and own and those that they have inherited. RMDs from employer plans must come from each plan individually. Roth and traditional IRA RMDs must be aggregated separately. RMD calculated from one type of retirement account cannot be taken from a different type of account.

4. The Rules After An IRA Owner's Death

When an IRA owner dies before his or her required beginning date with living individuals named as beneficiaries, the entire inherited IRA must be withdrawn no later than the end of the year following the original IRA owner’s death.

Previously, an inherited IRA would default to the five-year rule—allowing beneficiaries to wait five years before distributions—even if a beneficiary was designated, as beneficiaries would have to elect to use the stretch IRA strategy, which extends the tax-deferred status of an inherited. Now, the stretch IRA is the default option, so most beneficiaries will never be subject to the five-year rule.

5. What If There’s No Designated Beneficiary?

If no beneficiary is named, or if an estate or other non-human entity is named on an IRA’s beneficiary form, then the rules for distributions are guided by the life expectancy of the deceased IRA owner.

If the deceased IRA owner dies after his or her required beginning date, then the longest possible distribution period for that IRA in 2019 is 15.3 years.

For example, if an IRA owner turned 70 and one-half in 2018, dies in June 2019 and has no designated beneficiary, then the IRA can be paid out over his or her remaining single life expectancy of 16.3 years as calculated by the IRS. The first RMD must be taken by Dec. 31, 2020, and the distribution should be calculated using the 15.3 years remaining on his or her life expectancy.

6. Creditor/Bankruptcy Protection Of IRAs

Unlike ERISA-covered retirement accounts like 401(k)s, IRA creditor and bankruptcy protection is typically determined at the state level. However, in 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act added IRAs and Roth IRAs, and any account exempted from federal income tax, to a list of assets exempt from any bankruptcy estate.

There is a limit of over $1.2 million on the amount of contributed IRA assets exempted from bankruptcy estates, and all rollovers from company defined contribution plans are also exempted and not counted towards the limit.

“It’s unlikely that anybody would have that much money in their IRA if you’re just looking at contributions and earnings,” said Andrew Ives, IRA analyst at Slott and Company.

Court rulings have supported bankruptcy protections for IRA rollovers in transit as well.

Slott and Company warned that in several cases, failure to comply with rules for qualified retirement plans and prohibited transactions within IRAs led to court rulings that resulted in a loss of bankruptcy protection in an IRA. Furthermore, inherited IRAs are typically not protected in bankruptcies.

7. A Year Of Death Distribution

Beneficiaries must take any required distribution not taken by an IRA’s owner in the year of their death. Year of death distributions are not paid to an estate unless the estate is named as the beneficiary.

The beneficiary is responsible for paying taxes on the year-of-death distribution as well.

8. Medicaid Treatment Of Retirement Accounts

Because Medicaid is administered by individual states, the treatment of retirement assets may vary from state to state and an IRA’s assets may count against a client’s Medicaid eligibility and distributions, even required minimum distributions, may be treated as income.

Advisors should be particularly wary of Roth IRAs, which Slott and Company referred to as a “Medicaid trap.” In most cases, a Roth account’s assets will be counted against an individual’s Medicaid eligibility.

“If you have a client on Medicaid who wants to do a conversion to a Roth, be very careful,” said Ives. “It could effect things down the road for him or her.”

9. IRAs and Wills

IRAs generally don’t pass through wills. Slott and Company warned that IRAs should almost never change hands via a will, as it is preferable for IRAs to pass via beneficiary forms.

If an IRA is left to pass through a will, then there is no designated beneficiary for the account and it cannot be used in the stretch IRA strategy. Slott pointed out that it’s roughly the same state of affairs caused by naming an estate on the account’s beneficiary forms.

1.0 Roth 5-Year Rule Confusion

There are actually two different five-year rules governing Roth IRAs: one for penalty-free distributions, the other for tax-free distributions.

The first rule for penalty-free distributions only applies to Roth IRA conversions and the 10 percent early withdrawal penalty. The penalty applies if the current account owner is under 59 and one-half years old and is trying to withdraw funds from a Roth IRA that were converted from a traditional IRA within the last five years. This rule was instituted to prevent account holders from using Roth conversions to avoid the 10 percent early withdrawal penalty from their traditional IRAs.

“You have to wait it out,” said Brenner. “If you have a client that does multiple conversions, the five-year rule starts anew for each conversion. You could have multiple five-year waiting periods if they’ve done multiple conversions, but if the client is 59 and one half, you don’t have to worry about this.”

The second rule, for income-tax-free distributions from a Roth account, covers a five-year period from the moment a client’s first Roth IRA is established. It never restarts for additional Roth IRA contributions or conversions from a traditional IRA to a Roth account. After holding a Roth account for five years, even with a balance of just one dollar, the account owner can take tax-free distributions from the account.