Basic IRA Verbiage

In the world of retirement account and financial planning, there are many terms that are often used interchangeably, and at times incorrectly. This is actually the number one reason that people can get so confused when talking with a CPA, tax attorney, financial advisor, or custodian. For example, if I say “I want to transfer my IRA to another custodian,” that is drastically different from saying “I want to roll over my IRA to another custodian.” These are distinct actions that are reported to the IRS differently. Here are some terms to be familiar with when navigating your self-directed IRA.

Terms & Definitions

Distribution: An IRA distribution occurs when you pull funds out of the account for personal use. This is typically done after the age of 59 ½ , but truly can be done at any point in time. Distributions from any IRA will necessitate a 1099-R even if it is a tax-free distribution.

Transfer: The transfer of an IRA is relatively simple when it occurs between two accounts with similar tax treatment. For example, if I transfer my traditional IRA to a SEP IRA or another traditional IRA, there is unlikely to be any additional costs. Because they are the same tax style, this move is not reported to the IRS. This is important to keep in mind if you are considering moving funds between two different IRA companies, as it can be done as many times as you like while minimizing taxes and fees.

Rollover: The main distinction between a transfer and a rollover is that a rollover involves the relocation of funds from accounts of different types. Usually, this means that the account being rolled over is liquidated before the funds are moved to the new account. There are two types of rollovers, the first being the direct rollover, and the second being the indirect rollover (also known as the 60-day rollover).

Direct Rollover: The direct rollover consists of a direct transfer from a qualified account into an IRA. It is most commonly used when moving funds from an old employer plan (such as a 401k, 403B, 457, TSP, etc.) to an IRA. This movement differs slightly based on each custodian’s internal policies and procedures. Usually, the employer plan is first moved to a cash status. After this, the current custodian will cut a check made payable to the newly formed IRA. After that, the check is mailed to either the new custodian or the IRA holder to be deposited into the new IRA. This movement will create two tax forms, but will NOT be a taxable event if done properly. The two tax forms are a 1099-R and a 5498, which will effectively cancel each other out at the IRS level.

Indirect Roll Over: The indirect rollover, or 60-day rollover, occurs when the current retirement custodian sends the IRA holder funds directly prior to their transfer to a different account. Remember, in a direct rollover the check is made payable to the new IRA, not the IRA holder. Since the funds in an indirect rollover are made payable to the IRA holder, they will have 60 days from the time of constructive receipt (when funds were received) to deposit them into another retirement account before the rollover is treated as a distribution.

Conversion: A conversion occurs when funds are moved from a pre-taxed retirement account (such as a traditional IRA) to a Roth IRA. This is typically a taxable event and will generate a 1099-R from the traditional IRA. The amount converted can be subsequently added to your Modified Adjusted Gross Income (MAGI).

Fair Market Value (FMV): With self-directed IRAs, most custodians will require the account holder to provide a Fair Market Value every year of the investments in the account. This is simply informing the IRA custodian of the current value of the account holder’s private assets. For example, an IRA custodian has no idea what the property you bought with your IRA is worth. You have to provide that information to them. Keep in mind that you do not do this with public investments, because you are invested in assets that the big branded companies sold you.

UBTI/UBIT/UDFI: Unrelated Business Taxable Income is something that an IRA can produce when certain investments are made. This can apply to any type of retirement account depending on how the retirement account is invested. Typically, this will apply when the IRA is running a business, borrowing money (directly or indirectly), or owning personal property (such as a vehicle).

quote

Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes.

Warren Buffett
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