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10/21/06 - Important Legal Updates You Should Know About Your IRA

By: Investor Solutions, Inc.

It's refreshing to know that this year's congressional session hasn't been a total waste of time.  Apparently, retirement security, not just the war on terror, has been a central theme in government this year.  In fact, our congressional representatives have created sweeping changes in pension legislation.  But, it's not just pensions and 401k's that were impacted.   Here's what you should know about the recent legal reform as it pertains to your IRA. 

Retirement Plan Rollovers to Non Spouses

Previous to recent legislation, only spouses had the ability to rollover retirement plan assets (i.e. 401k, profit sharing, 403b, etc) into their own IRA or an Inherited IRA.  Surviving children or domestic partners were left out of the tax deferral deal; instead they were forced to take full a distribution of the account within five years of the decedent's death.  This, of course, had potentially huge tax ramifications for the non-spouse beneficiaries and the ability to "stretch" the money was non-existent.

The new law now allows for a child or other non-spouse beneficiary to roll funds directly from the company retirement plan to an Inherited IRA.   Notice the operative word:  directly. If the distribution goes to a non-spouse beneficiary's own IRA, to a non-IRA, or to the beneficiary first and then the IRA, the distribution becomes taxable and voids the "stretch IRA ability".   Account owners would be wise to cover their bases and include language in the beneficiary designation that reads something like: "My beneficiary is my son John Doe or the John Doe Inherited IRA, if he so directs."

Effective for distributions after 12/31/06, the rule will permit the funds to remain invested on a tax deferred basis and gives the beneficiary the flexibility to extend distributions and taxation over his/her lifetime. While the change in distribution rules is not the most optimal for domestic partners (same sex or otherwise), it's certainly a vast improvement over the draconian restrictions of before.  Ideally, everyone should have the ability to make the IRA their own after their spouse/significant other/domestic partner dies.

IRA's and Tax Refunds

Hoping to encourage higher savings and more banking, the Internal Revenue Service, as a result of the PPA legislation, will now allow taxpayers to use their federal tax refunds as direct deposits into their financial accounts, including IRA's.  This provision of the law will not be effective until January 2007, but it's just in time for the next tax filing season.  The feds will allow tax filers to deposit money from their refunds in up to three accounts.  However, the IRA must be already established before such a deposit will be allowed to be made.

The details of the law are still being ironed out, but we do know that the IRS FORM 8888 will be needed to file for direct deposit into your IRA.  Individuals will still be subject to the $4,000 annual contribution limit ($5,000 limit if over age 50).

IRA's and Charities

The last major update regarding IRA's impacts charitable gifting.  Congress has temporarily approved the ability of IRA account owners aged 70 ½ or older to donate cash directly from their IRA's beginning in 2006.  Charitably inclined IRA owners can donate up to $100,000 a year, and the good news is that the contribution counts toward the owners required minimum distribution (RMD) for that year.  While you do not get the benefit of a tax deduction, the distribution is not treated as taxable income to you.  This provision applies to outright IRA gifts to charities, but not to gifts made to foundations, donor advised funds or charitable annuities.

But, be cautious.  The donation must be made directly from your IRA to the charity.  This is simpler than the usual method: taking the distribution, giving the money to charity and then claiming the deduction for the donation. However, you are not allowed to touch the money during this transfer.  Most custodians should be able to accommodate this with a simple letter of instruction or internal form.  Unfortunately, unlike the other provisions of the Pension Protection Act, this feature expires at the end of 2007 so take advantage of it soon!

In summary, there are several changes in legislation that should positively impact IRA owners.  But, rest assured that these are not the last.  Our legislators have finally realized that Americans are not adequately preparing for retirement and they are trying to find fixes (albeit, minor ones) to influence greater financial savings.  Ultimately, however, it's not up to them-it's up to us to want to do it for ourselves.

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