Where’s the Value in a Conduit IRA?

By Stephanie Swanson, CIP, CHSP

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You rarely hear the term “conduit IRA” anymore. Once a more common part of retirement savings portability, the conduit IRA has become a retirement savings relic. Increased portability between IRAs and employer-sponsored retirement plans has mostly diminished their purpose—to hold retirement plan assets until future rollovers back to retirement plans. So is there a need to offer a conduit IRA product? As the usefulness of a conduit IRA continues to decline, you may find it more beneficial to focus on growing other parts of your IRA program. Still, some of your clients may find the few remaining conduit IRA benefits of value.

What Is a Conduit IRA?

Sometimes called a “rollover IRA,” a conduit IRA is a Traditional IRA that holds only retirement plan rollover assets. These Traditional IRAs were established to temporarily hold retirement plan rollover assets, such as savings in a 401(k) or profit sharing plan. By segregating the assets, the IRA owner can later move the savings back to another retirement plan and retain certain tax benefits. If the IRA owner makes other types of IRA contributions, such as regular IRA contributions, the IRA loses its conduit status.

The conduit IRA became less important when the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) expanded portability. Since 2002, individuals can roll over pretax Traditional IRA assets into an eligible retirement plan if allowed by the plan, regardless of whether the IRA assets are maintained as conduit IRA assets. Because of this, many individuals commingle their retirement assets. But some may wish to retain their retirement plan rollovers in a conduit IRA to help identify and track their savings. Some may keep the assets separate to preserve potential income averaging and capital gains tax treatments (if eligible).

Identifiable Retirement Plan Assets

Some savers keep their retirement plan assets separate in a conduit IRA for their own recordkeeping. Keeping them separate also may benefit those who seek bankruptcy protection. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, certain qualifying assets can be exempted from an individual’s estate for bankruptcy protection. IRA assets are protected up to $1.28 million (subject to adjustment every three years). Retirement plan asset exemption is unlimited, even after being rolled over to an IRA. Those with more than $1.28 million in plan assets could roll the assets over to a conduit IRA to more easily track for this purpose.

Capital Gains and Income Averaging Tax Treatments

Capital gains and income averaging are federal tax treatment options only available to certain retirement plan distribution recipients. These special formulas are used to figure a separate tax on the distribution and may result in a smaller tax for the recipient. IRA distributions do not qualify for these tax treatments. These tax treatments remain available for retirement plan assets in a conduit IRA that are later rolled back over to a retirement plan and subsequently distributed from that plan because they were not commingled with other IRA assets.

Capital gains tax treatment is available for the portion of a lump-sum distribution attributable to plan participation before 1974. Income averaging, which the IRS calls the “10-year tax option,” allows eligible individuals to determine their tax using tax rates that were in effect for single taxpayers in 1986. These tax treatments are explained in IRS Form 4972, Tax on Lump-Sum Distributions.

Value Is in Customer Service

Not many will find value in the dying conduit IRA. Few circumstances require its use, and those circumstances only affect plan participants who are in their 80s-90s. The real value your organization can offer is great customer service. You can provide conduit IRA benefits without sacrificing resources in promoting a product that many will not need. An individual can create a “conduit” IRA simply by opening a new IRA with his retirement plan rollover and otherwise not contribute to it. If your clients ask about the benefits of a conduit IRA, educate them as you feel comfortable and encourage them to seek competent tax advice. By doing so, you’ll help your clients understand whether they will benefit from a conduit IRA.