Too many people don’t take their IRA and 401(k) paperwork seriously enough, and that leads to terrible consequences. Here are two recent cases that will surprise and shock a lot of people.
The first case involves an IRA owner who failed to notify the custodian that he moved. At least, the IRA owner’s new address didn’t make it to the custodian.
Most people know they can change IRA custodians when they want. What few people know is an IRA custodian can decide to stop being custodian of an account. Under conditions specified in the IRA documents that few people read, a custodian can close an IRA without any action by the IRA owner.
The most common provision says the IRA custodian can resign and close the account 30 days after notifying the IRA owner of the intention. That gives the IRA owner time to roll over the IRA to a new custodian. Typically, if the custodian doesn’t hear from the IRA owner within 30 days after the notice is sent, the account is closed.
A custodian closes an IRA by distributing the account balance, usually in the form of a check, and mailing it with a letter of explanation to the last known address of the IRA owner. The custodian also will send a Form 1099-R to both the IRS and the owner, listing the account balance as a distribution. The IRA owner will have to include that amount in gross income for the year, unless he or she is able to roll it over to a qualified retirement account within 60 days of the distribution.
In the recent case, the IRA owner moved, and the custodian didn’t receive notice of his new address. After some time passed, the custodian sent a letter to the owner at the last address on record. The letter said the custodian was resigning from the account, probably because there was a lack of activity in the IRA and lack of contact with the owner.
The letter, a subsequent distribution of the IRA, and a 1099-R all were sent to the last address and weren’t forwarded to the IRA owner.
But the IRS had the taxpayer’s current address and eventually sent him a letter assessing additional taxes for failing to include the IRA distribution in gross income.
After consulting with his CPA and doing a lot of paperwork, the IRA owner was able to roll over the shares of stock he held in the IRA to another IRA. The CPA then drafted a request that the IRS waive the 60-day requirement and accept the rollover as a tax-free transaction.
The IRS ruled in the IRA owner’s favor, so no additional taxes or penalties were due. To avoid the taxes, the taxpayer had to undertake a lot of work, pay his CPA’s fees, and incur a $10,000 fee the IRS charges to request a ruling.
The IRA owner incurred these costs because he didn’t notify the custodian of the new address and didn’t notice that he no longer was receiving any communications about the IRA from the custodian. That’s a simple paperwork snafu with significant consequences.
The second case involved a dispute over the inheritance of a 401(k) account between the deceased account owner’s second spouse and his children from the first marriage. Earlier in his career, the deceased owner had worked for many years at a firm that offered a 401(k) plan and had designated his children as the joint beneficiaries of the 401(k) account.
The firm was acquired by another firm for whom the owner was working at the time of his death. The assets from the 401(k) of the original employer were rolled over into accounts at the 401(k) plan of the new employer. The owner apparently failed to file a new beneficiary designation form with the new employer after the merger.
Under the rules of the new 401(k) plan, if a plan member failed to name a beneficiary the surviving spouse, if any, would be the sole beneficiary of the account. The plan administrator notified the widow that she was the sole beneficiary. The children filed a claim for the account with the administrator. The administrator denied the children’s claim and asked a court to decide who was the beneficiary.
The court ruled that the widow was the sole beneficiary.
The children argued that when the previous employer was acquired, all the plan terms and documents were merged into the new plan, including the beneficiary designation. But there was no evidence that the two firms intended to merge the plans. The new employer’s plan was a separate plan, and a new beneficiary designation form needed to be filed.
The deceased owner’s previous actions and the terms of his will indicated that he intended for his children to inherit all or most of his assets. But none of that matters when a retirement plan is concerned. All that matters is what the beneficiary designation form says. Since there was no beneficiary designation form filed with the new plan administrator, the rules established by the plan controlled.
