Every financial organization that offers IRAs—whether or not IRAs are a main focus of the business—should regularly monitor IRA rules and regulations. After all, IRAs are part of a constantly changing legislative environment. And with staff turnover becoming the norm, financial organizations are at an increased risk for errors within their IRA programs, making IRA compliance an ongoing mission. Those organizations that do gamble with noncompliance risk IRS audits, monetary penalties, and, ultimately, jeopardizing the tax-deferred status of their clients’ IRAs.
For better control over IRA compliance, financial organizations need to be most diligent about three main areas within their IRA programs that are subject to IRS scrutiny: documents, withholding, and reporting.
IRA compliance affects every IRA and begins as soon as one is opened. At the time they open an IRA, IRA owners must receive a current plan agreement and disclosure statement, as well as a financial disclosure. The plan agreement is the contract stating the terms of the IRA, and the disclosure statement is the nontechnical version of the plan agreement. The disclosure statement explains the IRA rules in such a way that the general public is more apt to understand. The financial disclosure shows the IRA owner the projected growth of IRA assets (based on specific assumptions). It includes any fees or penalties that the financial organization may assess against the IRA.
IRA administrators must have IRA owners sign and date these opening documents or an acknowledgement that they received copies of the opening documents. The financial organization should retain copies of the signed documents or the signed acknowledgements.
According to IRS guidance, anytime new legislation affects IRA rules, financial organizations generally must amend the plan agreement and disclosure statement used for existing IRAs (amendments to financial disclosures are not required). Financial organizations then must retain proof that amendments were sent to IRA owners.
Opening Document Penalties
If a financial organization does not have proof that it provided each of the required opening documents or sent amendments as required, it will incur a $50 penalty per failure. This can be costly. For example, if an IRS audit of 50 IRAs found that a plan agreement, disclosure statement, and financial disclosure were not given for each when opened, that financial organization would owe $7,500 in penalties.
The IRS has specific rules for withholding on IRA distributions, some of which depend on whether the recipient is a U.S. citizen/resident alien or a nonresident alien.
One rule that applies to all recipients is that they be given the option to apply withholding or waive withholding. To ensure that this is done, the IRS requires financial organizations to provide all IRA distribution recipients a withholding notice using IRS Form W-4P, Withholding Certificate for Pension or Annuity Payments, or a substitute Form W-4P.
In addition, financial organizations must provide withholding notices to IRA owners at certain times during the year according to the frequency of the distributions. If an IRA owner is taking distributions quarterly or more frequently (e.g., monthly distributions), financial organizations need only provide the notice once per year at a reasonable time before the first payment each year. If an IRA owner is taking distributions less frequently than quarterly (e.g., once per year), financial organizations must provide the notice no more than six months before each distribution. The person receiving the notice must have enough time to sign and return an election. Financial organizations must retain proof that these notices were provided in a timely manner.
Financial organizations also are responsible for remitting the collected withholding amounts to the IRS and as such, keeping the necessary records to report them accurately to the IRS.
As with other areas of compliance, the IRS assesses penalties for not following the withholding rules. If a financial organization fails to withhold or obtain a recipient’s signed election not to withhold, the financial organization is responsible for the amount that should have been withheld.
There are two other potential withholding failures. Financial organizations that do not give proper notices to IRA distribution recipients will incur a $10 penalty for each instance. Financial organizations that do not keep records to report withholding accurately to the IRS are subject to a $50 penalty per IRA for which proper records were not kept.
IRA reporting is the key to a checks-and-balances system for IRAs. To lessen the chances of an audit—and to avoid penalties—financial organizations need to keep up with IRA reporting requirements, even if outsourcing their IRA administration and reporting. Financial organizations should remember that ultimately, they are responsible for any penalties imposed.
Failure to timely submit an IRS Form 5498, IRA Contribution Information, to the IRS, an account statement to the IRA owner, and a fair market value statement to the IRA owner all result in a $50 penalty per failure to the financial organization. A tiered penalty structure applies to IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., failures, with fines as high as $100 per return.
The IRA marketplace is expected to grow dramatically each year. It behooves any financial organization to ensure that its IRA program is in compliance. This means analyzing current IRA procedures, making sure IRA staff understands IRA requirements, and addressing possible deficiencies. A financial organization with an IRA program that checks out like it should is not only protecting itself from failed audits and hefty fines, but is protecting its clients and their accounts, which after all, is the ultimate customer service.
About the Author – As a technical writer at Ascensus, Lisa Walker researches and writes about various IRA topics for Ascensus’ online and printed publications and education materials, including Ascensus workshops and webinars, the IRA Institute, the IRA Reference Service, Retirement Central®, and the Retirement Plans Bulletin. Lisa started with Ascensus in 2005 and has earned the Certified IRA Services Professional (CISP) designation from the Institute of Certified Bankers. She holds a Bachelor of Arts degree in English from South Dakota State University.