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George F. Bearup, J.D. Senior Legal Trust Advisor

4-Jan-21

Duties of IRA Custodians

Take-Away: A 2020 Private Letter Ruling from the IRS is a helpful reminder that IRA custodians are treated differently from qualified plan administrators when it comes to their responsibilities to account owners.

Private Letter Ruling 2020033008 (May 18, 2020):

Facts: An IRA owner wanted to purchase a new home. He planned to use the proceeds from the sale of his existing home to make the new purchase. When the closing came for the purchase of his new home, his existing home was still listed for sale. The IRA owner’s real estate agent allegedly told him to take a distribution from his IRA to obtain the cash required to purchase the new home, with the intent to return the cash to his IRA as soon as his existing home sold. No real surprise, the IRA owner’s existing home did not sell during the 60-day IRA rollover period, causing the IRA owner to recognize the distribution in his taxable income. [IRC 408(d)(3).(A)(i)] It is not clear from the private letter ruling (PLR) but it is possible that the IRA owner also incurred a 10% penalty if he was under the age of 59 ½.

IRA Owner’s Argument: The IRA owner sought a waiver of the 60-day rollover limitation with regard to the distribution that he took from his IRA on the grounds of equity.[IRC 408(d)(3)(D); Revenue Procedure 2003-16.] In his request for the PLR from the IRS, the IRA owner tried to place the blame for his missing the 60-day rollover period on his real estate agent and his IRA custodian for not alerting him that the withdrawn funds had to be returned to his IRA within 60 days or the consequences that arise from failing to return the funds to the IRA within 60 days. The IRA custodian’s distribution request form stated that the owner requesting the distribution and signing the form understood that a 10% penalty tax and ordinary income taxes might apply to the distribution, but that form did not mention the 60-day IRA rollover period. The form also said that the IRA owner agreed to obtain legal and tax advice to make the determination of the consequences of a withdrawal from his IRA.

IRS’s Determination: The IRS was not sympathetic to the IRA owner’s claim of ignorance (or the blame that he tried placed on the IRA custodian.) Specifically, the IRS held that the missed 60-day rollover was not financial institution error.

  • The real estate agent was not responsible to provide advice on IRA rollover rules.
  • More to the point, neither are IRA custodians responsible for informing IRA owners about the 60-day rollover rule. “However, unlike a plan qualified under section 401(a), the Code does not impose a requirement on an IRA custodian to inform individuals of the rollover rules, and the failure of the realtor and the financial institution to provide this information does not rise to the level of financial institution error.”

The IRS categorized the IRA owner’s transaction as a short-term, interest-free loan to purchase a new home. With this observation the IRS then cited Congressional Committee Reports: “The Committee Report describing legislative intent indicates that Congress enacted the rollover provisions to allow portability between eligible plans including IRAs. Using a distribution as a short-term loan to cover personal expenses is not consistent with the intent of Congress to allow portability between eligible plans. Therefore, under the facts and circumstances presented in this case, the Service declines to waive the 60-day rollover requirement with respect to distributions of the [amount.]”

Qualified Plan Administrators: If the owner had withdrawn funds from a qualified plan account, like a 401(k) account, the result might have been different. Plan administrators, as fiduciaries, are required by law to inform distributees about the rules that apply to rollover-eligible distributions from the qualified plan. Plan administrators are the persons responsible for carrying out the plan provision, e.g. complying with the required minimum distribution rules. [IRC 401(a)(9); Treasury Regulation 1.401(a)(9)-4, A-5(b)(4).]That information that is required to be conveyed to the plan participant includes the income tax consequences that arise from distributions from a qualified plan that are not rolled over within 60 days of the distribution. A qualified plan has more than 30 requirements that it must meet to stay qualified. [IRC 401(a)(9).] In contrast, an IRA does not need to be qualified. The qualified plan administrator is the enforcer of all of the rules required for the plan to continue to be qualified, and since plan disqualification of the plan would be a disaster, plan administrators are extremely attentive to complying with these requirements and following all of the rules moreso than IRA custodians.

The Department of Labor notes that a qualified plan fiduciary is subject to standards of conduct because the fiduciary acts on behalf of plan participants in a retirement plan and their beneficiaries with the exclusive purpose of providing benefits to them. The fiduciary must carry out those duties prudently, and must follow the plan documents

Conclusion: This PLR is a good reminder that it is important to get good advice from people who know what they are talking about. Relying on the tax advice of a realtor trying to sell a home is not the source one would normally rely upon for the tax consequences that arise from a missed 60-day rollover. Under current law, IRA custodians are relieved of this obligation, but many IRA custodians take on that responsibility, even when the law is silent. Finally, back to the IRA owner in question, he apparently took a large enough distribution to purchase a new home with his IRA funds. That sizeable amount is all taxable income to the IRA owner. In addition, if he was under age 59 ½, he will also pay a 10% penalty on that distribution amount. Add to that the $10,000 IRS user fee for seeking a private letter ruling, and the legal fees he probably incurred to file the PLR request, and this became a very expensive home that he purchased.