Trying to Ease Tax Bite From Broker’s IRA Goof
Q: My stock broker got my individual retirement account in a terrible mess, and I am facing a huge tax bill and penalty.
When I retired, I had accumulated well over $100,000 in my company savings plan. I had already paid taxes on $60,000 of this amount. My stock broker insisted that the entire account had to be rolled over into an IRA. All went well for five years.
Then I cashed in the account and got my Form 1099 from the transaction. It shows that I owe taxes on the entire initial account, plus the interest it generated.
Must I pay taxes again on the $60,000? My broker is taking no responsibility for this mess.
Is there any place I can turn for help?
What is the IRS’ policy on such mistakes? --B. C. W.
A: Your first step is to calm down. Your situation, while not ideal, is not as horrible as you have been led to think.
Your next step is to contact qualified tax and legal experts who can explain your situation thoroughly and help you with any legal action against your broker.
This is what happened to you:
When you opened the IRA with your broker, you mistakenly included $60,000 of after-tax contributions you had made to your pension plan.
After-tax contributions are not eligible for being rolled over into an IRA, and when they are put into an IRA they are called “excess contributions” and subject to penalty.
Despite what your 1099 form says--it’s in error--you do not have to pay tax on the $60,000 a second time. You do owe taxes, as you might expect, on the remaining $40,000 and the interest generated by the entire account, which has never been taxed.
And you will be hit with a 6% penalty for each year you kept the $60,000 in the IRA.
According to my rough computations, this means that you will owe about $18,000 because of your broker’s bad advice. (This was computed at 6% multiplied by $60,000 by 5 years.)
What can you do about this?
Beyond talking to a good tax accountant or lawyer, you should be prepared to write an explanation to the IRS when you file your tax return detailing why the 1099 your broker sent is in error, and why you do not owe income taxes on the full distribution from your IRA.
You should not expect the IRS to waive its penalty because your broker gave you bad advice.
But perhaps your lawyer or accountant can determine if the statute of limitation on the penalty has already elapsed for some of the early years you held the account.
You should also consider the possibility of suing your broker for poor advice. But first, check the paper work you received when you opened the account. Did you sign forms that make you solely responsible for handling the account?
Again, a good lawyer can help you sort out your options, as well as determine the full extent of your damages.
Remember, you benefited from the tax-deferred interest build-up for five years, and that does offset some of the penalty.
How to Handle Savings Bonds Conversion
Q: Is it possible to convert my Series E savings bonds which have matured into Series EE bonds without having to pay income tax at the time of the transaction? --J. E . J.
A: No. You are not allowed a tax-deferred conversion of Series E bond proceeds into Series EE bonds. If you want to buy EE bonds, you must sell the E bonds and pay taxes on the proceeds. You are then free to use the remainder, or any part of it, to purchase EE bonds.
There is one possible tax-deferred conversion available to you. You may roll over proceeds from the E bonds into Series HH bonds. The only restriction is that these bond exchanges must be made in amounts of $500 or more. However, you may want to think twice before purchasing Series HH bonds.
Unlike Series EE bonds, whose interest is pegged to current rates, Series HH bonds pay a flat 6% interest, year in and year out.
Even in today’s sluggish market, you could earn more in an equally safe investment. But if you are absolutely determined to defer taxes on the Series EE bonds, then the Series HH is for you.
By the way, are you certain that your original bonds have completely matured? In many cases, the expiration dates on these bonds has been extended beyond the original maturity date. Check before you do anything rash.
Pending Acquisition Creates Stock Dilemma
Q: My company, which is now owned by a major retailer, will be sold to a large conglomerate. I have 11,000 shares of the retailing company’s stock in my 401(k) plan; the shares are now worth about half of what I paid for them.
When the acquisition is complete, I will have the choice of rolling my plan over into an IRA or cashing out completely and paying taxes on the distribution.
I am 15 years from retirement and can’t afford any more mistakes with my nest egg.
Should I sell out now, take my losses and try to find a better investment--or should I stick with the stock? --J. C.
A: This is a tough call, and you would be wise to gather other opinions before making your final judgment. Our experts recommend that you stick with the stock.
Granted, the stock has been a dog, and you’ve suffered. But that’s behind you, and you have to focus on the future.
Given the fact that the stock has slipped so, one can make an argument that it is more likely to rise than sink further.
But can you justify this conclusion based on your own knowledge of the company and its operations?
Do some research on the company. Get some analysis of the company’s outlook from one or more of the many stock brokerage houses that follow the stock to see what the so-called experts think.
Perhaps this retailer has a bleak future, and you would be wise now to bail out.
But perhaps the worst is behind it and it is poised for some big growth in the years ahead. Move cautiously; you would hate to compound your problems by acting in haste or out of anger.
