There is a common misconception that you have to be over 59.5 before you can take a distribution from your retirement plan and not be hit with a 10% early withdrawal penalty.

What most people don’t know is that in section 72(t) of the tax code there is a little known provision that says if you leave your employer, after reaching age 55, in some cases you can take your money without paying the 10% penalty. Keep in mind, you have you quit, retire, be fired, etc. . . after age 55. If you leave service before 55 this little known provision does not apply to you.

By the way, if you leave service earlier, maybe you could roll the funds over into a new retirement plan, sponsored by a business of yours. Then if after age 55, you retire from your business, you will probably get the 10% savings.

Keep in mind for the above planning to work, you must have a valid business, and there must be a non-tax business for you to quite the business or leave service.

The SEC’s Office of Investor Education and Advocacy (OIEA) and the North American Securities Administrators Association (NASAA) recently issued a notice warning investors about fraudulent investments in self directed individual retirement accounts.

This is the dirty little secret of checkbook control and or self directed IRAs. There is a very good chance that you discovered the concept of self directed IRAs from an investment promoter. Now they sent you to someone to open up a self directed IRA. In fact the party opening the IRA could even be receiving either a commission for you to open the self directed IRA.

If that is the case, make sure you do your due diligence on the investment. My guess is that 90% of people who have created self directed investments have lost money. Sure a very large part of that could be due to the real estate melt down, but at the same time I’ve slowly come to the realization that a lot of people just aren’t sophisticated enough to manage their own investments.

Bottom line, if you take “checkbook control” over your retirement funds. Make sure you know what you are doing.

I’m of the opinion that there is going to be a lot of litigation in the coming years with self directed IRAs.  Investors jumped onto the self directed band wagon and made all sorts of flakey investments, but my guess is few of them had a clue about what they were doing.  A recent court case, In re: ENDEAVOUR HIGHRISE, L.P pretty much confirms the fact.

Since I’m not sured you readers will be as excited about the 65 pages of 10 point courier font as I was, I am going to spare you most of the gory details and get to the heart of the matter.

A number of self directed IRAs “invested” in a condo project that went bankrupt.  Now the bankruptcy trustee was suing the IRAs/IRA owners, trying to get some money, with a central question of the lawsuit being, “What is an IRA?”.

The judge pretty much decided that even though IRAs are not trusts, they should probably be treated as trusts in the case of lawsuits.  A fascinating result of this conclusion that will have all sorts of ramifications down the road was the judge constantly making reference to the custodial agent (Entrust Retirement Services, Inc.) as being a fiduciary.

This is fascinating because the Entrust affiliates, like most self directed custodians, take great pains to disclaim they are fiduciaries.  If a court makes a legal determination that the various custodians out there are in fact fiduciaries I think those “fiduciaries” are going to be in some deep doo doo.

Another interesting result was the judge’s determination that the IRA beneficiaries were proper parties to the lawsuit.  Even though he recited the familiar line that “a trust itself may not sue or be sued directly.”, with the norm being the trustee of the trust being sued, he also said the beneficiaries could be named in the suit as well.  I’m not sure the law is on the judge’s side on this one, rather I think the IRA owners really pissed the judge off and he twisted and turned the law to find a way to punish the IRA owners.  The judge did make a good point in that if he followed the wishes of the IRA owners who stated IRAs are merely personal property and can’t be sued, then an IRA and or its owners would never have to answer for any damages it caused.

The end result is there is now case law saying self directed custodians are fiduciaries, and IRA owners can be named in litigation involving their IRAs.

Yeah, yeah, I know.  I’m a broken record at this point.  I can only discuss 401k Roth conversions.  The reason is the payoff is simply too big to ignore, tax free wealth along with some of the strongest asset protection.

The downside to any Roth conversion is the price tag, you have to pay taxes on the value of the assets that you convert.  So. . . . what if I told you there is a loophole, actually its more like a massive black hole, that may in fact allow you to move your assets from your traditional account to the Roth account, with no taxes?

Yep, you heard me right, it appears the tax code will allow for IRA conversions and 401k conversions without an initial tax hit.  A full explanation is on subscription side of our blog.

For the last 2 years the big news trumpeted by the financial planning community was the ability to convert your traditional IRA to a Roth IRA.  A concept I believe is going to cause nothing but trouble for people.

Last week, the President signed a bill allowing for a much better alternative, the ability to convert your “traditional” retirement plan assets (think profit sharing and 401k plans) into Roth retirement plan assets.

There are a number of reasons this is so much better than an IRA Roth conversion.

The first is that IRAs are riddled with prohibited transaction issues, the IRAs are going to be considered fully distributed when people wake up.

The other is that you can’t borrow money from an IRA, you can with the Roth.  If you run out of money and can’t pay the taxes due on the Roth conversion, just borrow it out of the retirement plan, in a non tax manner of course.

Another is asset protection.  Some states have limits on the asset protection provided to IRAs, that is if they haven’t engaged in a prohibited transaction and thus lost all asset protection.  401ks typically have much higher levels of asset protection and a single prohibited transaction doesn’t cause them to lose their exempt status.

If someone tries to talk to you about converting your IRA to a Roth, ask them about converting your profit sharing plan to a Roth account plan.  If they don’t know what you are talking about, move on.

The laws regarding IRAs are very complex.  Even more complex are the laws dealing with trusts as beneficiaries of IRA accounts.  The rules are so complicated you probably don’t want to even mess with them unless you are dealing with an attorney who specializes in the subject.

That means those of you who have living trusts, don’t blindly name the living trust as the beneficiary of your IRA.  If you do, there is a good chance that the IRA is going to have to be distributed over the life expectancy of your oldest beneficiary.  A result the younger kids and grandkids aren’t going to be thrilled about.

Not only that, but in most of the marketed stand alone retirement trusts, the account is going to have to make distributions each and every year whether the kids want the money or not.  In short, most trusts do nothing but create a headache for IRA distributions.

One type of trust that makes a whole lot of sense is something we call the Family Owned Retirement Trust — FORT, get it?

With this type of trust, the IRA assets can be commingled and invested together for the whole family, you don’t have to set up 15 different trusts.  Additionally you don’t have to make distributions each and every year.  If the family doesn’t need income, no big deal, it doesn’t have to be distributed.

Another great aspect of the FORT is that it lives up to its namesake, it is protected from adversaries.  If you go to my resources page I’ve got a complete section on the asset protection of inherited IRAs, its mostly bad news.  With the FORT, the retirement plan assets are protected.

The moral to the story is the next time you are filling out a beneficiary designation for your retirement plan don’t list a trust as the beneficiary unless you have a specially created trust specifically for that purpose.

Earlier in the month I pointed out an article on the subject of if the IRS can take away your IRA.

For some reason people seem to be astounded and incensed the IRS can take away their retirement plan.  Keep in mind the IRS has some pretty strong powers, in particular the power to levy (legal speak for take away), “upon all property and rights to property” a taxpayer has.

Since an IRA is property of the taxpayer the IRS has the right to levy on that asset.  Don’t think this is true?  Here is a memo talking about how the IRS can take away your IRA.

The key point to keep in mind is the phrase used in the memo about how the IRS can , “step into the shoes of the taxpayer and acquire whatever rights to the property the taxpayer possess”.  There are a number of strategies to use with IRAs that curtail the rights the IRA owner has, and thus curtail the rights of anyone who tries to take them away as well.

The other day I was talking with a friend, and they told me they were a bit irritated at their CPA.  It seems my friend asked the CPA a “basic” tax question and the CPA said they were going to have to research the subject and of course charge my friend for the research.

My friend was upset because he felt the CPA knew, or should, know the law and was just gouging him.

In fact this is a complaint I get all the time from people who expect me to know every aspect of the tax code.  What people don’t realize is that in many cases there are exceptions to the exceptions as well as contradictory cases and laws.

Lets use the creditor protected status of inherited IRAs as an example.   Courts all across the country have come to opposite conclusions about the protected status.  Some courts say inherited IRAs are exempt from the claims of creditors, other courts say inherited IRAs are not protected assets.

Lets put a microscope on the bankruptcy court district for San Diego.  There is a decision back in 2003 saying inherited IRAs don’t have asset protection.  However in August of 2010 a judge in the exact same court said inherited IRAs are protected in bankruptcy.

Why the difference?  The realistic answer is 2 different judges with 2 different opinions.  The other big difference is the different ways the debtors tried to have their IRAs exempt in bankruptcy.

Under the bankruptcy code debtors are allowed to claim that certain assets are “exempt”, that is to say that creditors can’t take those assets away.  So if you have a $500K IRA and it is considered exempt, you can go bankrupt, wipe out your debts, leave bankruptcy and still have a $500K IRA available to start over.   The challenge is that while bankruptcy is federal law, the bankruptcy law says that states can require debtors to use the state law when determining what is and isn’t exempt.

Oh yeah, in the case of certain assets, no matter what the state law says about exemptions, federal law might “trump” the state laws.  Such is the case of exempt status of IRAs in bankruptcy, you are supposed to use state law unless federal law is better.

Starting to get confused?  Good that means you’re human.

In the 2003 case the debtor claimed their inherited IRA was exempt using the state law exemptions, Section 703.140(b)(10)(E) .

(E) A payment under a stock bonus, pension, profitsharing, annuity or similar plan or contract on account of illness, disability, death, age, or length of service. . .

When the judge analyzed the law they came to the conclusion that while the IRA in the heads of the original owner might have fit that definition, once the original owner died and passed the IRA to the new beneficiary, the inherited IRA was no longer similar to a pension, profit sharing, or annuity payment.  Thus the inherited IRA was not exempt in bankruptcy.

In the August 2010 case the debtor’s attorney initially claimed the state exemption for the inherited IRA, but when the bankruptcy trustee put them on notice they were going to try to contest the exempt status of the inherited IRA, the debtor switched to the federal exemptions.

The reason for the switch is the federal laws merely require the plan to be a “retirement plan” and that it is exempt from the relevant sections of the tax code.  The judge in this case determined that the plan was a retirement plan in the hands of the original owner, and its status as a retirement plan stuck with it when it became an inherited IRA.  Thus the judge determined that inherited IRAs are exempt under the federal exemptions.  (By the no one brought up the issue as to if the IRA was still qualified under the code.  That is going to be a very big issue in the years to come.)

So what is the take away from this lesson?  Reasonable minds disagree and this area of the law is far from settled.  There is no binding precedent.  There could be 2 different debtors in San Diego going bankrupt, with the exact same IRAs inherited from the exact same person, getting different judges in bankruptcy, with one keeping their inherited IRA, the other losing their inherited IRA.

The law is not as black and white as people think it is, there are all sorts of nuances based upon everyone’s different situation.  If you have an inherited IRA, or any IRA for that matter, you need to establish a plan on how to protect it before some tragic event causes you to have to consider its protected status in bankruptcy.

When you start talking about Roth IRAs, people start salivatating.  The reason is earnings grow in a completely tax free environment within the Roth.  Because of the completely tax free treatment there are all sorts of “interesting” concepts being promoted by professional advisors on how to supercharge your Roth.

The challenge is these ideas create a kind of of “Gresham’s Law” in the tax planning realm, bad tax advice makes it harder to provide good tax advice. When people are told they can move all their profits to a completely tax exempt entity, they typically aren’t interested in such exciting topics as the home office deduction or the ability to write off their aspirin.

Compounding the challenge is the fact it normally takes the government a number of years to crack down on the too good to be true concepts.

Case in point is the government action against an attorney in St. Louis.  Back in July of 02 the IRS approved an investigation into the attorney.  The government was of the opinion that the attorney promoted concepts (schemes?) which involved taxpayers establishing Roth IRAs and through various means, moving hundreds of thousands, and in one case, millions of dollars into the Roths in a very short time period.  That is Supercharging!

Finally, on Friday September, 17th, 2010, 8 years after the initial investigation a court finally ordered the attorney to stop talking about the Roth concepts.  In fact the court order permanently banned the attorney from advising on the “establishment of any other Individual Retirement Account based arrangement.”

So what occurred over the 8 year gap?  A number of clients are in a world of hurt with the IRS.      One was hit with 285,000 in taxes.  Another was hit with $3 million in taxes.   Not sure if he was a client of the attorney or not, but a St. Louis radio personality was hit with a $500K fine just for trying to supercharge their Roth. . . the radio personality estimates the structure saved him about $1,000.00 in taxes.

I know its a jungle out there, I also know it is hard to determine who to trust.  If you are presented with some incredible sounding tax strategy, sure it might work, but the best way to protect yourself is to request a formal opinion from the IRS or at the very least have a disinterested 3 party tax attorney give you a written legal opinion.  Yes, both of the above are going to cost you money, but the bills will probably be a lot less than the bill the IRS will present you if you did something wrong.

Every morning I get updates on the latest rulings and changes to the tax code.  More and more it seems that requests to fix failed IRA rollovers are taking over the IRS update world.

My guess is 2 factors are contributing to the large number of rulings:

1.  People are getting older and thus needing to access their IRA funds.
2.  Due to market turmoil more people are shifting assets around.

Without further ado, here are this weeks rulings.

201037038 — The IRA owner moved funds from her IRA to a non-IRA account.  The IRA owner said she thought the account she moved the funds into was an IRA account but couldn’t provide any proof that was her intention.  IRS did not allow the IRA owner to fix her IRA.

201036026 — IRA owner was depressed and confused about her finances as her husband had recently died and her son was deployed in IRA.  IRS allowed the IRA to be fixed.

201036029 — IRA owner was taking prescription medicine that caused confusion when he made a rollover.  IRS allowed him to fix his IRA rollover.

Remember, we have a full page devoted to IRS rulings allowing (or not allowing) people to fix their failed IRA rollovers.