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July 18, 2018

7 IRA Aggregation Rules Every Advisor Must Know


by Denise Appleby,CISP, CRC, CRPS, CRSP, APA

Being able to aggregate IRAs can allow for efficient distribution planning. However, applying aggregation when it is not permitted can cause tax complications for the IRA owner.

Multiple IRAs owned by an individual are treated as one IRA for certain distribution purposes. This is commonly referred to as IRA aggregation.

While IRA aggregation can allow for flexible and sometimes efficient distribution planning, aggregating IRAs when impermissible can cause adverse tax consequences and penalties for the IRA owner. As such, care must be taken to apply these rules only when allowed.

When aggregation is allowed for distribution purposes, all of an individual’s Traditional IRA, SEP IRA, and SIMPLE IRA are treated as one Traditional IRA. And, all of an individual’s Roth IRAs are treated as one Roth IRA.

Traditional IRAs cannot be aggregated with Roth IRAs for distribution purposes.

The following are seven aggregation rules for IRAs.

1.Return of Excess IRA Contribution: Aggregation Does Not Apply

An individual’s regular IRA contribution for the year is limited to the lesser of 100% of compensation or $5,500. An individual who is at least age 50 by the end of the year is permitted to make an additional catch-up contribution of $1,000.

All of an individual’s Traditional and Roth IRAs are aggregated and treated as one for the purpose of the regular IRA contribution limit.

Contributions in excess of this limit must be distributed as ‘return of excess contributions’ bythe IRA owner’s tax filing due date, plus extensions. Individuals who file their tax returns by the due date receive an automatic 6-month extension to correct the excess contributions.

The correction of excess contribution must include any net income attributable (NIA), which can be earnings or losses. Note: The NIA is not distributed as part of the correction, if the amount is distributed after the deadline.

The NIA is based on the performance of the investments held in the IRA to which the excess contribution was made, during the applicable computation period.

While IRA contribution limit applies on an aggregate basis to all the individual’s IRAs, the IRA aggregation rule does not apply for the purpose of correcting the excess contribution. Therefore, a correction of excess contribution can only be done from the IRA to which the excess contribution was made. Furthermore, the calculation of the NIA must be made on the performance of the investments held in the IRA to which the excess contribution was made.

2.Application of Basis for Traditional IRAs: Mandatory Aggregation Applies

The distribution of basis amounts from an IRA are tax-free and are never subject to the 10% early distribution penalty.

Basis is created in a Traditional IRA from nondeductible IRA contributions and rollovers of after-tax amounts from employer-sponsored retirement plans.

Generally, distributions from an individual’s Traditional IRA include a prorated amount of basis and pre-tax balance.

Some IRA owners choose to keep nondeductible IRA contributions in a separate IRA. But, that has no impact on distributions, because, when applying the prorata rule, an individual’s Traditional IRAs, SEP IRAs, and SIMPLE IRAs are aggregated and treated as one.

Tip: IRS Form 8606 is used to track basis for Traditional IRAs, and must be filed for nondeductible contributions. It must also be filed when an individual’s Traditional IRA balance includes basis, and a distribution or Roth conversion is made from any of the individual’s Traditional, SEP or SIMPLE IRA.

3.Application of Basis for Inherited Traditional IRAs: Limited Aggregation Applies

Multiple inherited IRAs are aggregated for basis purposes only if they are inherited from the same decedent.

Basis in a non-inherited IRA cannot be aggregated with basis in an inherited IRA.

Separate Forms 8606 must be filed in each instance where aggregation of basis is not permitted.

If an individual inherits multiple Traditional IRAs from different decedents, a separate Form 8606 must be filed in each case where basis was inherited from a decedent.

4.Qualified Roth IRA Distributions: Mandatory Aggregation Applies

A qualified distribution from a Roth IRA is tax-free, and is not subject to the 10% early distribution penalty.

A distribution is qualified if it meets the following two requirements:

i.The distribution is made five or more years after the individual’s first Roth IRA contribution or conversion. And,

ii.The distribution is made under one of the following circumstances:

a)The owner is at least age 59½ at the time the distribution is made.

b)The distribution is made for qualified first-time homebuyer purchase. This is limited to a lifetime amount of $10,000.

c)The IRA owner is disabled when the distribution is made.

d)The distribution is made from an inherited Roth IRA.

This five-year period starts with the first Roth IRA contribution that the individual makes. For instance:

·Assume that the individual’s first Roth IRA contribution was made to Roth IRA # 1 in 2010.

·Assume too, that the individual converted an amount to Roth IRA #2 in 2017.

Even if a distribution is made from Roth IRA #2 in 2018, the 5-year period for determining if that distribution is qualified starts January 1, 2010, when Roth IRA #1 was first funded.

5.Required Minimum Distributions: Optional Aggregation Applies

IRA owners must start taking required minimum distributions (RMD) for the year in which they reached age 70½ and continue for every year after. An RMD for a year is determined by dividing the IRA’s preceding year-end fair market value by the IRA owner’s distribution period for the RMD year.

The RMD rules do not apply to Roth IRA owners.

An individual’s Traditional, SEP and SIMPLE IRAs can be aggregated for RMD purposes.

While the RMD for each IRA must be calculated separately, the aggregate amount can be taken from one or more of the individual’s Traditional, SEP or SIMPLE IRAs, if the IRA owner so chooses.

6.Inherited IRAs:Limited Aggregation Applies

Beneficiaries must take RMDs from the IRAs that they inherit. This includes inherited Roth IRAs. An exception applies to a spouse beneficiary who elects to treat an inherited IRA as his/her own. Under this exception, the RMD rules would apply as if the spouse was the original owner of the IRA.

If an individual inherits multiple Traditional IRAs from one decedent, the RMD for those inherited IRAs can be aggregated and taken from one or more of the inherited Traditional IRAs, if the beneficiary so chooses. This same aggregation rule applies to Roth IRAs that are inherited from the same decedent.

RMDs for inherited IRAs cannot be aggregated with RMDs for non-inherited IRAs, and RMDs inherited from different decedents cannot be aggregated.

7.One Per Year Limit on IRA to IRA Rollovers: Mandatory Extended Aggregation Applies Among Roth and Traditional IRAs

A distribution from an IRA is excluded from income, if the amount is rolled over to the same type of IRA from which the distribution was made, within 60 days of receipt. Such a rollover can be done only once during a 12-month period.

Unlike all the other cases where aggregation applies by IRA ‘type’ (among non-Roth IRAs or among Roth IRAs), this requires aggregation of all an individual’s non-Roth and Roth IRAs.

Therefore, if an individual performs an IRA to IRA rollover between two Traditional IRAs, that individual is not permitted to perform another IRA to IRA rollover from any other type of IRA -whether Roth or non-Roth for the next 12 months.

Any rollover that breaks this rule is considered an ineligible rollover and creates an excess contribution in the receiving IRA, if the amount exceeds the regular IRA contribution limit that applies to the individual.

These are only some of the aggregation rules that apply to IRAs. Others not covered include aggregation rules for substantially equal periodic payments programs, and those that apply to Roth IRAs when the owner is not eligible for a qualified distribution. These are beyond the scope of this article.

Proper Record Keeping Is Essential

Proper record keeping is essential for accurate tax reporting. For example, failure to file IRS Form 8606 could result in tax-free amounts being treated as taxable.

Ultimately, the responsibility for record-keeping rests with the IRA owner. But of course, IRA owners often depend on the professionals with whom they work to provide education and support that can help them perform accurate record keeping.

You can help your clients by providing them with an annual updated status and/or checklist for these items. Affected clients should ensure that the information is related to any party that is responsible for preparing their tax returns.

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