Minimizing Lifetime Taxes with Roth Conversions in Early Retirement

Minimizing Lifetime Taxes with Roth Conversions in Early Retirement

 

Minimizing Lifetime Taxes with Roth Conversions in Early Retirement

Moving into retirement is an exciting opportunity to live fully. It can be a time to travel, explore new hobbies, or spend time with grandchildren.

For many, this period at the start of retirement can also be an opportunity to provide additional financial security—and minimize lifetime taxes—by making partial Roth conversions.

 

The Retirement “Tax Valley”

Many retirees will be in a lower tax bracket early in retirement than they were just before retirement while they’re still working—or than they will be in later in retirement. To understand why, consider Jim and Susan (both age 61) who recently retired.

While working, Jim and Susan had a combined household income of $250,000. This put them right in the middle of the 24% tax bracket for a married couple. At retirement, Jim and Susan have the following assets:

  • $1 million (Jim’s IRA)
  • $1 million (Susan’s IRA)
  • $100,000 (Jim’s Roth IRA)
  • $500,000 (Taxable account – with a $300,000 cost basis)
  • $300,000 (Cash savings in bank accounts and CDs)
  • $800,000 (House – No Mortgage)

Jim and Susan will also have the following income in retirement:

  • $50,000 (Jim’s annual pension – starting at age 65)
  • $30,000 (Susan’s annual pension – starting at age 65)
  • $40,000 (Jim’s annual Social Security – Starting at age 70)
  • $35,000 (Susan’s annual Social Security – Starting at age 70)

 

In addition to that income, Jim and Susan will each have to start taking required minimum distributions (RMDs) out of their IRAs starting at age 72. Assuming they don’t make withdrawals from the IRA between now and age 72, and that the accounts grow at 7% annually over the next 11 years, they would each be worth about $2.1 million by age 72. They would each have an RMD of about $76,650 the year they turn 72 ($2,100,000 / 27.4).

This would potentially give them a taxable income at age 72 of about $308,300 from pensions, Social Security, and their RMDs. This puts them back at the top of the 24% tax bracket, and they could easily move up to the 32% tax bracket or higher.

However, in their first years of retirement, they could basically have no taxable income if they are using cash savings and the taxable investment account to fund their goals if they choose to do so. Is it a smart idea to minimize taxes this much during these early retirement years?

 

Strategic Roth Conversions Early in Retirement

Let’s say that Jim and Susan would have $0 taxable income in early retirement. Their modest interest, dividend, and realized capital gain income is offset by their $25,900 standard deduction.

If they each convert $65,000 annually from their IRA to their Roth accounts ($130,000 total), they will initially pay tax on that conversion primarily at the 10% and 12% rates, with just a little being taxed in the 22% bracket each year.

If they do this each year until age 72 when their RMD begins, they would have about $1,079,000 in each IRA, assuming 7% annual returns. This would reduce their initial RMD at age 72 by about half. Their taxable income at age 72 would be reduced by about $74,500 and their tax liability by about $17,880 since they were in the 24% tax bracket.

Much of the earlier conversions each year would have been taxed at 10% or 12% rates, resulting in less overall tax being paid during their lifetimes.

 

Protection Against Rising Tax Rates

The example above shows the benefits of Jim’s and Susan’s Roth conversions, assuming tax rates stay the same. If 10 years from now, tax rates on higher earners increase, they will have less income being taxed at those higher levels due to the smaller IRA balances and smaller RMDs.

They would also have about $1,000,000 in each Roth IRA by age 72, assuming a 7% rate of growth. This can be withdrawn tax-free if additional money is needed. This is always a benefit but especially so in a world where overall tax rates are higher.

 

Roth Conversions to Take Advantage of a Market Decline

In addition to the benefit of taking Roth conversions when in lower tax brackets, Jim and Susan can take advantage of market declines to make strategic Roth conversions.

Say a market decline in the first six months of the year produces the following negative returns:

-2% (Bonds)

-10% (Large US stocks)

-15% (Large international stocks)

-20% (Small US stocks, small international stocks, emerging market stocks)

This becomes a great opportunity for Jim and Susan to strategically move some of the small US, small international, and emerging market stocks from the IRA to the Roth accounts. Assuming the investments recover as expected, Jim and Susan can pay tax on the conversion when the prices are down and enjoy a significant tax-free recovery after the investments are in the Roth account.

 

Additional Factors to Consider

There are several other factors for Jim and Susan to consider when making Roth conversions early in retirement.

When purchasing individual health insurance in retirement before Medicare begins, retirees may qualify for subsidies to reduce the cost of their premiums based on their taxable income. In Jim and Susan’s case, they have retiree healthcare from their employer that doesn’t qualify for tax subsidies, so this is not a factor.

Once Medicare Part B benefits start at age 65, there is an additional IRMAA premium cost when taxable income increases beyond a certain level. In 2022, this additional premium begins when income is above $182,000 for a married couple.

For retirees who expect to have money at the end to leave to an heir, Roth conversions can be an important part of an estate plan, as leaving Roth assets to heirs are significantly more valuable than leaving traditional IRA money to heirs.

 

Conclusion

While they won’t be a perfect solution for everyone, for the right families, Roth conversions early in retirement can be a powerful tool to minimize taxes over your lifetime and maximize overall expected wealth.

This can be one more tool to ensure the ability to make the most of retirement and really live fully!

 

 

 

Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source.  Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be taken as such. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. As always please remember investing involves risk and possible loss of principal capital and past performance does not guarantee future returns; please seek advice from a licensed professional.

 

 

Boeing Pension and Lump Sum Comparison – Should I Retire Early?

Boeing Pension and Lump Sum Comparison – Should I Retire Early?

 

Boeing Employee – Should I Retire Early?

Boeing employees nearing retirement age are facing a financial decision that will need to be made by November 30—one that could have a significant impact on their lifestyle in retirement.

 

Higher Interest Rates and the Lump Sum Pension Benefit

Boeing offers many employees the option at retirement to either receive a pension, providing monthly income for life, or to have a single lump sum deposited into a retirement account that can be invested and withdrawn as desired.

The amount of the pension benefit is based on several factors, including years of service with Boeing and average salary while employed.

When determining the lump sum benefit, the underlying interest rates are an additional factor to take into consideration. Higher interest rates will create a lower lump sum benefit, and lower interest rates will create a higher lump sum benefit. Boeing resets the interest rate used in the calculation once per year in November.

With the significantly higher interest rates we’ve seen in 2022, an engineer who may currently qualify to choose either a $5,000 monthly pension or a $1 million lump sum benefit may be looking at only $800,000 in lump sum benefit if they retire after November 30, 2022. The exact numbers will vary for each employee.

That $200,000 reduced benefit can be a significant incentive for employees who are planning to retire in the next few years to adjust their plans and retire early.

 

To Whom Does This Apply?

Not all Boeing employees have a pension as part of their benefits. Also, some employees are covered by unions that only offer the monthly pension and do not have a lump sum option.

Boeing engineers who are members of the SPEEA (Society of Professional Engineering Employees in Aerospace) union usually have a generous lump sum benefit compared with the monthly pension and may benefit significantly from comparing their options.

 

Financial Planning to Compare Options

The decision to take either the lump sum in retirement or the monthly pension is a significant one, and both contain risks.

With the lump sum, the employee is accepting the risk of the market and managing the money.

With the monthly pension, the guaranteed income provided to the employee will not increase with inflation. This year has been a good reminder that inflation can significantly reduce the purchasing power of that income.

Also, does it make sense for an employee who originally planned to retire in two years to give up on the years of additional earnings and savings? Can the employee afford to do so?

We help employees compare how a monthly pension or lump sum benefit will interact with other resources (Social Security, retirement accounts, real estate) to determine the ability to meet goals in retirement. We can also compare retiring in 2022 with delaying retirement and possibly receiving a reduced benefit in the future.

 

Deadline and Next Steps

Boeing employees wanting to claim the lump sum before rising interest rates potentially reduce benefits will have to retire and submit the request for a lump sum benefit by November 30, 2022.

If you’re feeling overwhelmed by assessing the pros and cons of this decision, reach out to us for your complementary personalized analysis. We can help you determine whether retiring now would provide you with a sustainable retirement that meets your lifestyle needs.

 

 

 

Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source.  Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be taken as such. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. As always please remember investing involves risk and possible loss of principal capital and past performance does not guarantee future returns; please seek advice from a licensed professional.

 

 

 

 

The Roth Rulebook

The Roth Rulebook

 

When preparing for retirement, it can be important to save money in different types of accounts to give you flexibility when it comes time to spend those funds. One of the most powerful and misunderstood types of accounts is the Roth. A Roth account is an after-tax retirement account that can be in the form of an IRA or an employer-sponsored plan such as a 401(k). The after-tax component means you pay tax on the front end when receiving the income, and in exchange, you can receive tax-free growth and tax-free withdrawals if you follow the rules of the Roth. There are three components to consider: contributions, conversions, and earnings. Contributions and conversions refer to the principal amount that you contribute or convert, while earnings refer to the investment growth in the account. There are contribution and eligibility limits set by the IRS each year, but today we will focus on withdrawing funds from a Roth IRA to maximize the after-tax benefit.

 

Roth Contributions

After you contribute to a Roth IRA, you can withdraw that contribution amount (principal) at any time without paying taxes or the 10% penalty. That is an often-overlooked fact that can come in handy.

Example: Ted is 38 years old and decides to open his first Roth IRA. He contributes $5,000 to the account immediately after opening it. Two years later, Ted finds himself in a financial bind and needs $5,000 for a car repair. One of the possible solutions for Ted is that he could pull up to $5,000 from his Roth IRA without paying any tax or penalty.

 

Roth Conversions

A Roth conversion is when you move funds from a pre-tax account such as a traditional IRA. You will owe income tax on the amount that you convert. This can be a powerful strategy to take control of when and how much you pay in taxes. There is no limit to how much you can convert.

When it comes to withdrawing money used in a Roth conversion, five years need to have passed or you need to be at least 59.5 years old to withdraw the conversion penalty-free. It is important to remember that each conversion has a separate 5-year clock.

Example: Beth is 50 when she executes a $40,000 conversion from her IRA to her Roth IRA in January 2020. In March 2025, Beth finds herself needing $40,000 for a home renovation. One of the possible solutions is that Beth could pull up to $40,000 from the conversion that she did over five years ago even though she is under 59.5.

 

Earnings

When it comes to withdrawing earnings from growth that has occurred after contributing or completing a conversion, you must wait until age 59.5 and five years need to have passed since you first contributed or completed a conversion. If you don’t follow both of those rules, then you could have to potentially pay income tax on the growth and a 10% penalty.

Example: With our previous examples above with Ted and Beth, even though they can withdraw their contribution and conversion respectively, neither of them can touch the earnings in their Roth accounts until they are 59.5 and have satisfied the 5-year rule.

 

Other Important Details

There are a few other exceptions that allow a person to avoid the penalty and/or income tax, such as a death, disability, or first-time home purchase.

For ordering rules, when a withdrawal is made from a Roth IRA, the IRS considers that money to be taken from contributions first, then conversions when contributions are exhausted, and then finally earnings.

 

Strategies 

  • Have a thorough understanding of the rules before withdrawing any funds from a Roth account.
  • Speed up the 5-year clock.
    • You can technically satisfy the 5-year clock in less than five years. You can make contributions for a previous year until the tax filing date (typically April 15th, but as of this writing, it may be April 18th in 2022). This means that a contribution on April 1st, 2022, could be designated to count toward 2021, and the clock will count as starting on January 1st, 2021. This shaves 15 months off the 5-year clock! Note: Conversions must be complete by the calendar year’s end (12/31), but you can still shave 11 months off the 5-year clock.
  • Start the 5-year clock now!
    • Even a $1 contribution or conversion starts the clock for you to be able to harness tax-free gains, so start as soon as possible.
  • After the passing of the SECURE ACT in 2019, most non-spousal IRA beneficiaries must now fully distribute inherited IRAs within ten years. This means that an inherited Roth IRA owner could potentially allow the inherited Roth to grow tax-free for up to ten more years and then withdraw those funds tax-free. If it fits into an individual’s financial plan, this can be a tremendous tax strategy to take advantage of.

 

Roth accounts can be incredible but also very confusing. As advisors, we figure out the best way to use these accounts to your advantage in terms of maximizing growth and minimizing taxes. If you have any questions about how you can best utilize a Roth account, please don’t hesitate to reach out to us. We are always happy to help you and those you care about!

 

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable; however, Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Nothing in these materials is intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Merriman does not provide tax, legal, or accounting advice, and nothing contained in these materials should be relied upon as such.

How Do I Correct Excess Roth IRA Contributions?

How Do I Correct Excess Roth IRA Contributions?

 

Co-written by: Scott Christensen & Katherine Li

 

Contributing to a Roth IRA is a great way to receive tax benefits for retirement savers. If you already do or are planning to take advantage of this tax savings vehicle, it is important to familiarize yourself with the rules that govern these accounts. The IRS has put in place strict limits regarding the amount that individuals can contribute to their Roth IRAs, as well as income limits for determining who qualifies.

 

If you are a single tax filer, you must have Modified Adjusted Growth Income (MAGI) under $140,000 in order to contribute to your Roth IRA. The amount you can contribute to your Roth IRA begins to phase out starting at a MAGI of $125,000; if your MAGI is greater than $140,000, you can no longer contribute to the Roth IRA. For those who file as married filing jointly, your MAGI must be under $208,000 in order to contribute. The phaseout range in this case applies to those with a MAGI between $198,000 and $208,000. The maximum IRA contribution in either case is $6,000 for those under 50 and $7,000 for those 50 and older.

 

As a result of these strict limits, it is easy for taxpayers to overcontribute. So what happens when taxpayers contribute in excess of their contribution limit?

 

For every year that your excess contribution goes uncorrected, you must pay a 6% excise tax on the excess contribution. In order to avoid the 6% tax penalty, you must remove the excess contributions in addition to any earnings or losses on that excess contribution by the tax filing deadline in April. To determine your earnings on your excess contribution, you can use the net attributable income (NIA) formula.

 

Net income = Excess contribution x (Adjusted closing balance – Adjusted opening balance) / Adjusted opening balance

 

Note: If you find that you have losses on your excess contribution, you can subtract that loss from the amount of your excess contribution that you have to withdraw.

 

Reasons for Overcontribution

 

  • You’ve contributed more than the annual amount allowed.
    • Remember that the $6,000 and $7,000 dollar maximum applies to the combined total that you can contribute to your Traditional and Roth IRAs.
  • You’ve contributed more than your earned income.
  • Your income was too high to contribute to a Roth IRA.
    • Unfortunately, single tax filers who make $140,000 or more and those who are married filing jointly who make $208,000 or more are unable to contribute to a Roth IRA.
  • Required minimum distributions (RMDs) are rolled over.
    • RMDs cannot be rolled over to a Roth IRA.
      • If it is rolled over to a Roth IRA, the amount will be treated as an excess contribution.

 

Removal of Excess Prior to Tax Filing Deadline

 

If you find that you have overcontributed prior to filing your tax return and prior to the tax filing deadline, you can remove your excess contributions before the tax filing deadline (typically April 15) and avoid the 6% excise tax. However, your earnings from your excess contribution will be taxed as ordinary income. Additionally, those who are under 59 and a half will have to pay a 10% tax for early withdrawal on earnings from excess contributions.

  • Keep in mind that it is your earnings that are subject to an ordinary income and early withdrawal tax, not the amount of your excess contribution.

 

If you find that you have overcontributed after filing your tax return, you can still avoid the 6% excise tax if you are able to remove your excess contribution and earnings and file an amended tax return by the October extended deadline (typically October 15). 

 

Recharacterization 

 

Recharacterization involves transferring your excess contribution and any earnings from your Roth IRA to a Traditional IRA. In order to avoid the 6% excise tax, you would have to complete this transfer process within the same tax year. It is also important to note that you can’t contribute more than your total allowable maximum contribution. Thus, you must make sure that you can still contribute more to your Traditional IRA prior to proceeding with recharacterization.

 

Apply the Excess Contribution to Next Year

 

You can offset your excess contribution by lowering the amount of your contribution the following year by the excess amount. For example, say that you contributed $7,000 to your Roth IRA when the maximum amount that you could contribute was $6,000. The next year, you can offset this excess amount of $1,000 by limiting your contribution to $5,000. You are, however, still subject to the 6% excise tax due to the fact that you were unable to correct the excess amount by the tax filing deadline, but you won’t have to deal with withdrawals. 

 

Withdraw the Excess the Next Year

 

If you choose to withdraw the excess the following year, you will only have to remove the amount of your excess contribution, not any earnings. However, you will be subject to a 6% excise tax for each year that your excess remains in the IRA.

 

These rules can be confusing to navigate which is why we recommend involving your tax accountant or trusted advisor in these situations. We are happy to connect you with a Merriman advisor to discuss your situation.

 

 

Sources:

https://www08.wellsfargomedia.com/assets/pdf/personal/goals-retirement/taxes-and-retirement-planning/correct-excess-IRA-contributions.pdf

https://www.nerdwallet.com/article/investing/excess-contribution-to-ira

https://investor.vanguard.com/ira/excess-contribution

https://www.fool.com/retirement/plans/roth-ira/excess-contribution/

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.

 

Summer Jobs and Loving Grandparents

Summer Jobs and Loving Grandparents

 

One of the great things I get to experience as a financial advisor is that many of my clients have achieved such good financial security that they are able to help their relatives financially. One of the best examples is grandparents wanting to help their grandchildren. The usual starting place for grandparents is helping to build an education nest egg, usually in a 529 plan.

When their grandchildren get older, my clients will often pose the question of how to help them out without just giving them money directly. Below is a typical conversation. Loving parents can be interchanged with loving grandparents with the same effect.

 

Client: Eric, our wonderful 20-year-old granddaughter just finished her second year of college and is doing very well. We are so proud of her. We want to help put her in a better financial position for after college, but her parents do not want us to spoil her. Is there anything we can do for her?

Eric: Does she have a summer job or work while at school?

Client: Yes, she is working at a local nursery tending the plants over the summer. She loves the job as she is a biology major.

Eric: Great! One way you could help her is to fund a Roth IRA for her.

Client: Really?! She can have a Roth IRA?

Eric: Yes. Since she has earned income, she can contribute to a Roth IRA.

Client: How much can she contribute?

Eric: She can contribute up to the amount of income she makes with a maximum of $6,000. Let’s say she makes $2,500 over the summer; she could contribute that amount to a Roth IRA.

Client: That is very interesting. Why would she want a Roth IRA?

Eric: There are a lot of reasons, but the big one is that she will have an account that will grow tax free; and by starting at such a young age, she will have extra years for it to grow until her retirement.

Client: I don’t think many 20-year-old kids these days are really that interested in retirement accounts.

Eric: That’s true, but I like to show the miracle that is compound interest and how small deposits made now can turn into large amounts of money in 45 years at retirement. If your granddaughter were to invest $3,000 for the next five years and earn 7% interest until age 65, she would have over $387,000.

Client: That’s amazing! But still, thinking about retirement is a difficult concept for young people.

Eric: True. Another great aspect of a Roth IRA is that it can help with a first-time purchase of a home. There are certain rules in place to allow contributions, including up to an additional $10,000 of a Roth, to be used for the first-time purchase of a home. A Roth account has a great amount of flexibility.

Client: That is wonderful!

Eric: I have helped many grandparents with making contributions to their grandchildren’s Roth IRAs. Some grandparents will match the contributions their grandchild makes to their Roth IRA to incentivize them to save money. Others will just make the entire contribution as a reward for working a part-time job. Either way, the grandchild will benefit. It ends up being a wonderful legacy that can be used by the grandchild to further their financial situation. Also, it can teach them the benefits of saving money. When they start careers down the road and can fund their 401k, they will have already experienced the benefits, and the education and experience can put them on a great path to financial security. I have received rave reviews from people who have put one of these plans into motion and have seen the benefits.

Client: What about her brother who is 16 years old and working at a grocery store?

Eric: Even better—more time to grow, although an adult will have to act as custodian on the Roth IRA until the age of majority.

Client: How do we get started?

Talk to your Merriman Wealth Advisor if you are interested in looking at Roth IRA options for your children or grandchildren. We can help with the custodial set up and investment recommendations.

 

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Nothing in this presentation in intended to serve as personalized investment, tax, or insurance advice, as such advice depends on your individual facts and circumstances. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.

 

 

How to Report Your 2020 RMD Rollover on Your Tax Return

How to Report Your 2020 RMD Rollover on Your Tax Return

 

Following the stock market decline early in 2020, Congress passed the CARES Act on March 27, providing relief for individuals and businesses impacted by the pandemic. One of the provisions was a suspension of 2020 Required Minimum Distributions (RMDs). Individuals who hadn’t taken a distribution yet were no longer required to do so.

For individuals who took a distribution early in 2020, they were given the opportunity to “undo” part or all of that distribution by returning funds to their IRA by August 31, 2020.

 

Tax Forms for IRA Rollovers

Some taxpayers who took advantage of this rollover to undo that RMD may be surprised to get tax forms reporting the withdrawal.

Example 1: Kendra turned 75 in 2020 and had a $30,000 RMD at the start of the year. She took her distribution on February 1, 2020, with 10% tax withholding ($27,000 net distribution and $3,000 for taxes). She didn’t “need” the distribution as Social Security and other income covered her entire cost of living. Because she didn’t need the money, she returned the full $30,000 to her IRA on June 15, 2020.

In January 2021, Kendra was surprised to receive a Form 1099-R since she returned the entire amount and knew she shouldn’t owe taxes on it. The Form 1099-R reported a $30,000 distribution from her IRA in Box 1 and $3,000 in Box 4 for tax withholding. Box 7 reports code 7 for a “normal distribution.”

 

How to Report the 2020 Rollover

Since Kendra returned the entire $30,000 withdrawal listed on her tax return, it won’t be included in her taxable income. However, she will need to report both the withdrawal and the rollover on her tax return.

In her case, the full $30,000 will be reported on line 4a of Form 1040, with $0 reported on Line 4b. She will also write “Rollover” next to line 4b. In her case, the $3,000 that was withheld for taxes will still be reported with other tax withholding and will impact her ultimate refund or balance due.

How to Report a Partial Rollover

Example 2: Jane turned 76 in 2020. She also had a $30,000 distribution that she took on February 1, 2020, with 10% tax withholding ($27,000 net after $3,000 for taxes). On June 15, 2020, she returned $12,000 to her IRA instead of the full $30,000.

In January 2021, she received a 1099-R that also reported a $30,000 distribution from her IRA in Box 1 and $3,000 in Box 4 for tax withholding. Box 7 reports Code 7 for a “normal distribution.”

In Jane’s case, she will also report the full $30,000 on line 4a. She will report $18,000 on line 4b ($30,000 original distribution minus $12,000 returned to her IRA in 2020). She will also write “Rollover” next to line 4b. The $3,000 withheld for taxes will still be reported with other tax withholding as usual.

 

Form 5498

Taxpayers who returned some or all of their distribution in 2020 will receive Form 5498. They likely will not receive this form until May 2021—after the April 15 tax filing deadline. This form will be used to report the amount returned to the retirement account in 2020 and verify the rollover reported on the 2020 tax return. The taxpayer does not need to wait (and should not wait) for the Form 5498 before filing their taxes. This is simply an information form so the IRS can verify what was reported on the tax return.

 

Exception from the Usual Rule

It’s important to remember that all of these rollovers are a one-time exception in 2020 from the usual rule. Typically, this type of rollover can only be done once per rolling 365-day period and must be completed within 60 days of taking the withdrawal. Also, RMDs are generally specifically prohibited from this type of rollover.

 

Conclusion

Individuals who returned RMDs in 2020 to avoid having to include the withdrawal in their taxable income will still receive a tax form showing the distribution and will have to report it on their tax return. When reported correctly, the amount returned will be excluded from their income as intended.

 

 

 

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.