Tuesday, December 8, 2009

A Classic IRA Mistake

During my 20-plus years in this business, I’ve seen a lot of clients make mistakes in handling their IRAs. And the following e-mail from a reader is a good example of one of the more common ones: “I have an IRA with a brokerage house. During the year (looking to be conservative) I bought CD's at 6 different banks. I funded the CD's by writing checks from my IRA brokerage account to my IRA at the various banks (never holding the checks more than a minute). Now I have been told that because I wrote the checks as I described above, they’re taxable events, and I owe large amounts of income tax. One bank told me they would send me a form 5498 and that would solve the problem. Can you give me any advice?” My answer: “No doubt, you made a simple transaction very complicated. You should have used a "custodial to custodial" transfer. It's a straightforward one-or two-page form that all financial institutions use. But what's done is done ... The brokerage firm will issue a 1099-R that will show the checks you wrote as taxable distributions. A copy will go to the IRS, so you can't ignore it. I suggest that when you do your tax return, you include:
  • A letter that explains what you did.
  • Copies of the brokerage statement that shows the withdrawals.
  • Copies of both sides of the canceled checks.
  • Copies of confirmations from the banks showing when the money was deposited.
  • Your phone number and e-mail address so the IRS can get back to you if they have any questions.

Another thing … try to get all the banks to give you a form 5498. This shows that you made a rollover contribution to your IRA and include those with your letter to the IRS.” The lesson here is that before you move IRA or retirement plan money from one account to another think through the ramifications of what you’re doing. If you’re not sure, talk to your financial advisor or accountant. Otherwise a seemingly innocent transaction can turn into a kettle of worms. Best wishes, George P.S. I’m now on Twitter. You can follow me at http://twitter.com/efinancialwrite for frequent updates, personal insights and observations from my frequent travels around Costa Rica. If you don’t have a Twitter account, sign up today at http://www.twitter.com/signup and then click on the ‘Follow’ button from http://twitter.com/efinancialwrite to receive updates on either your cell phone or Twitter page.

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