If your retirement investments are spread out over multiple individual retirement accounts (IRAs), it may make sense to treat these various accounts as one, a process known as "aggregating." Aggregation means treating several accounts as one, not actually combining them, and can allow for more efficient planning for distributions and more efficient investment strategy management.
Aggregating Different Types of IRAs
There are situations where aggregating IRAs is not allowed, and doing so can cause negative tax consequences and penalties. However, when IRA aggregation is permissible for distribution purposes, all of the traditional IRAs, SEP IRAs, and SIMPLE IRAs of an investor are treated as one traditional IRA, and all Roth IRAs are treated as a single Roth IRA.
The following are seven key aggregation rules for IRAs that could save you time and money.
IRA Aggregation Does Not Apply to the Return of Excess IRA Contributions
The IRA contribution limit for individuals is based on earned income. Individuals under 50 years of age can contribute up to $5,500 a year of earned income. Those older than 50 years of age are allowed an additional catch-up contribution of $1,000. The contribution limit is a joint limit that applies to the combination of traditional and Roth IRAs. When the IRA contribution is in excess of the $5,500 (or the $6,500 limit for people over 50), the excess contributions—including net attributable income (NIA), which is the growth generated by the excess contribution—must be returned before the IRA owner’s tax filing due date. Those who file their returns before the due date receive an automatic six-month extension to correct the excess contributions.
Mandatory Aggregation Applies to the Application of Bases for Traditional IRAs
Contributions to traditional IRAs are usually pre-tax. Thus, distributions from IRAs are taxable as income. In addition, distributions prior to 59.5 years of age are also subject to a 10% penalty. However, individuals may also contribute to a traditional IRA on a non-deductible basis with after-tax income.
Similarly, contributions to an employer-sponsored retirement plan can also be made on an after-tax basis (when it's allowed by the retirement plan) and potentially rolled over to an IRA where they would retain their non-deductible character. After-tax contributions to an IRA, but not the earnings thereof, may be distributed prior to 59.5 years of age without the customary 10% penalty.
Distributions from an IRA that contains after-tax contributions are usually prorated to include a proportionate amount of after-tax basis (amount contributed) and pre-tax balance (pro rata rule). Some IRA owners will choose to keep non-deductible IRA contributions in a separate IRA, which simplifies tracking and administration. However, that has no impact on distributions, because when applying the pro-rata rule, all of an individual’s traditional IRAs, SEP IRAs and simple IRAs are aggregated and treated as one. If an individual has contributed $700 to a non-deductible traditional IRA that has grown to $1,400, and they take a $500 distribution, one half of the distribution is returnable on a non-taxable basis, and the other half is taxable and subject to the 10% penalty if they are under 59.5 years of age. You can see why it's important to keep accurate records of transactions to document the taxable and non-taxable portions of the IRA.
Limited Aggregation Applies to Inherited IRAs
Inherited IRAs should be kept separate from non-inherited IRA accounts. The basis in the latter cannot be aggregated with the basis of an inherited IRA. In practice, it means that if an individual inherits two IRAs from different people, they must take the required minimum distributions (RMDs) for their two IRAs separately. They can only be aggregated if they are inherited from the same person. In addition, inheriting an IRA with a basis must be reported to the IRS for each person. (For related reading, see: Inherited IRA Distributions and Taxes: Getting It Right.)
Mandatory Aggregation Applies to Qualified Roth IRA Distributions
Qualified distributions from Roth IRAs are tax-free. In addition, the 10% early distribution penalty does not apply to qualified distributions from Roth IRAs. Roth IRA distributions are qualified if:
- They are taken at least five years after the individual’s first Roth IRA is funded,
- No more than $10,000 is taken for a qualified first time home purchase,
- The IRA owner is disabled at the time of distribution,
- The distribution is made from an inherited Roth IRA, or
- The IRA owner is 59.5 or older at the time of the distribution.
If an individual is taking a distribution and has two Roth IRAs, they cannot take the maximum distribution from each account. For instance, if a person takes a distribution for a first-time home purchase, they can only take a total of $10,000 from their two Roth IRAs, not $10,000 from each account.
Optional Aggregation Applies to Required Minimum Distributions
Owners of traditional IRAs must start taking required minimum distributions (RMD) every year, starting with the year in which they reach age 70.5. The RMD is calculated by dividing the IRA account's preceding year-end value by the IRA owner’s distribution period for the RMD year. An individual’s traditional, SEP and Simple IRAs can be aggregated for RMD purposes. The RMD for each IRA must be calculated separately; however, the owner can choose whether to take the aggregate distribution from one or more of their accounts. So, if an individual has a traditional, simple and SEP IRA, he would calculate the RMD for each of the accounts separately. He could then take the RMD from one, two or three accounts in the proportions that make sense for him.
One Per Year Limit on IRA to IRA Rollovers
If an IRA distribution is rolled over to the same type of IRA from which the distribution was made within 60 days, that distribution is excluded from income. Such a rollover can be done only once during a 12-month period. In this situation, all IRAs, regardless of type, must be aggregated. For instance, if an individual rolls a traditional IRA over to another traditional IRA, no other IRA-to-IRA (Roth or non-Roth) rollover is permitted for the next 12 months.
These are some of the more common IRA aggregation rules. Many of the problems that people may face with IRA aggregation can be avoided with proper documentation, so record-keeping is essential. Individuals can do it themselves or they can seek the help of a financial professional.
(For more from this author, see: Divorce and Retirement Accounts: What You Need to Know.)
Disclosure: The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Insight Financial Strategists LLC cannot guarantee that the information herein is accurate, complete, or timely, and makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.