Avoid These Common IRA Compliance Mistakes
By Agatha Schmidt, CISP, SDIP, CHSP
Running a compliant IRA program is a significant responsibility for most financial organizations that administer IRAs. Knowing the rules, creating policies to support those rules, training staff to understand them, and making sure that procedures are followed, are key elements to ensuring a compliant program. With the ever-changing retirement legislative and regulatory landscape, the high rates of turnover caused by the “Great Resignation,” and the possibility of IRS audits, financial organizations face a higher risk of incurring costly mistakes.
Ascensus consultants conduct compliance reviews throughout the country in order to help financial organizations recognize errors and identify ways to mitigate their risks. This article will explain some of the more common compliance mistakes that Ascensus consultants have discovered.
Missing Required Plan Documents
An IRA is not officially an IRA unless it is properly established. The IRS requires three documents to establish an IRA: a plan agreement, a disclosure statement, and a financial disclosure. Financial organizations must provide these documents to all IRA owners. Although financial organizations may have a written procedure to support this requirement, there have been instances where an organization could not prove that the IRA owner received a copy of the opening documents.
Financial organizations could face a penalty of $50 for each required document (up to $150 for each IRA) that they fail to provide. To avoid this penalty, financial organizations must keep copies of signed documents or copies of signed acknowledgments that the IRA owner received the required documents.
There are also document amendment requirements. From time to time, IRA plan agreements and disclosure statements must be amended for new guidance or newly enacted legislation. Financial organizations must provide clients with amended plan agreements and disclosure statements when required by the IRS. Failure to provide proof of this may result in another $50 penalty, per document, per IRA. A financial organization that administers one thousand IRAs, for example, could pay up to $100,000 in penalties for failing to provide both the plan agreement and disclosure statement amendments.
Incorrect IRS Reporting
Filing annual information returns is the closest contact that most financial organizations will have with the IRS. Improper reporting not only leads to compliance issues, but may draw unwanted attention from the IRS. To avoid an IRS audit and potential penalties, it is imperative to eliminate or minimize reporting errors.
Some of the most common reporting errors are caused by issues with the financial organization’s core transaction processing system or by inadequate training of staff. For example, if a core processing system contains incorrect transaction codes, then the wrong distribution code could be reported on Form 1099-R or an amount could be reported in the wrong box on Form 5498. Reporting issues can also occur when staff misunderstand which codes to use and end up reporting a transaction incorrectly (e.g., treating a nonreportable transfer as a reportable rollover). The IRS does not view faulty system programming or human errors as valid reasons for incorrect reporting.
Withholding Failures
Withholding is another common topic of concern that appears in compliance reviews. It goes without saying that the IRS’ main goal is to collect tax revenue, so failure to properly follow certain federal tax withholding requirements may result in the following penalties.
Failure to provide IRA owners the required withholding notice – $100 penalty for each failure, up to a maximum of $50,000 per calendar year
Failure to retain proper records to report withholding – $50 penalty per IRA
Failure to withhold 10% if the IRA owner does not make an election or failure to withhold an amount as directed by the IRA owner – the financial organization is liable for payment of the amount that should have been withheld
These monetary penalties can quickly add up. As withholding is another point of close contact between a financial organization and the IRS, financial organizations should review their withholding procedures and provide proper training to their staff as needed to ensure compliance with federal (and state, if required) withholding requirements.
Incorrect Beneficiary Payouts
Beneficiary determination and paying out death distributions is a complex component of an IRA program, and recent changes in beneficiary payout rules makes it more challenging. Incorrectly reporting death distributions is another common issue that Ascensus consultants discover. And although errors can generally be corrected, a substantial number of corrections may draw the IRS’ attention and trigger an audit.
During some compliance reviews, Ascensus found that death distributions were reported in the wrong name and tax identification number. Once an IRA owner is deceased, assets are generally moved from the decedent’s IRA to the beneficiary’s inherited IRA. If the beneficiary distributes those assets, the distribution should be reported on Form 1099-R in the beneficiary’s name and Social Security number (SSN) . This rule also applies when a required minimum distribution (RMD) is not satisfied by the IRA owner before death. When this occurs, the beneficiary must satisfy the RMD by December 31 of the year of death. The financial organization must report the RMD under the beneficiary’s name and SSN—not under the decedent’s name and SSN.
Take Action to Minimize Errors
Compliance mistakes may result in possible financial liabilities. They may also pose a reputational risk for the financial organization. With required document amendments on the horizon, and new withholding forms and requirements recently released by the IRS, financial organizations should take a proactive approach to ensure that their IRA programs remain compliant. Investing in IRA training, conducting regular internal audits, and ensuring that forms and documents are up-to-date, can go a long way to accomplish that goal.
