The IRA aggregation rule was created to limit the ability of taxpayers to take advantage of ‘abusive’ IRA tax strategies, by requiring that all IRAs are aggregated together to determine the tax consequences of a distribution from any of them.
The primary impact of the IRA aggregation rule is to determine how much of an IRA’s non-deductible contributions are treated as an after-tax return of principal when a taxable distribution occurs, whether as a withdrawal or a Roth conversion. Also, because all accounts have to be added together, the rule makes it very hard for many people to use the so-called “backdoor Roth contribution” strategy.
However, the IRA aggregation rule reaches much further than just the taxability of after-tax contributions in existing IRAs. Thanks to the recent Bobrow case, it now also applies to the limitation of no more than one 60-day rollover in any 12-month period. Though on the plus side, the IRA aggregation rules apply to required minimum distribution (RMD) obligations as well, allowing a distribution from any IRA to satisfy the RMD rules for all IRA accounts!.
Fortunately, though, the IRA aggregation rules do not apply when calculating substantially equal periodic payments (SEPP) under Section 72(t), reducing the danger that a withdrawal from one IRA could constitute a “modification” of the ongoing 72(t) distributions from another that would trigger a retroactive penalty. However, even in the case of SEPPs, the IRA aggregation rules will still apply in determining how much of a 72(t) payment constitutes a tax-free return of non-deductible contributions!.
Are you juggling multiple IRAs and feeling confused about how the IRS views them? You’re not alone. Many Americans save for retirement through various Individual Retirement Accounts (IRAs), but aren’t aware of an important regulation called the “aggregation rule” that could significantly impact their tax situation.
I’ve been studying ways to plan for retirement for years, and this rule often throws off even the smartest investors. So let’s talk about what the IRA aggregation rule is, how it affects your plans for retirement, and how to best handle it.
What Is the IRA Aggregation Rule?
Simply put, the IRA aggregation rule treats all your traditional IRAs as one big account for tax purposes. As David Cherill, a CPA and member of the American Institute of CPAs’ Personal Financial Planning Executive Committee, explains, “in the eyes of the IRS you have one IRA, no matter how many IRAs you have.”
IRAs, SEP IRAs, and SIMPLE IRAs are all affected by this rule. However, it doesn’t include 401(k)s and other employer-sponsored retirement plans. Additionally, it is important to note that this rule usually does not apply to traditional IRAs or Roth IRAs.
The aggregation rule becomes particularly important in three key situations
- When calculating taxes on Roth conversions
- When taking Required Minimum Distributions (RMDs)
- When dealing with non-deductible contributions
- When executing 60-day rollovers
How the Aggregation Rule Affects Roth Conversions
The aggregation rule can significantly impact the tax consequences of converting traditional IRA funds to a Roth IRA
Let’s say you have more than one IRA and one of them only has contributions that aren’t tax-deductible (after taxes). You might think that you can change that one IRA to a Roth and not have to pay taxes on the change. Unfortunately, the aggregation rule prevents this strategy.
Example:
Imagine you have two IRAs:
- IRA #1: $40,000 (all pre-tax money)
- IRA #2: $10,000 (all non-deductible contributions)
You want to convert just IRA #2 to a Roth IRA, hoping to pay no taxes since those contributions were already taxed.
However, the IRS views your total IRA balance as $50,000, with $10,000 (20%) being non-deductible contributions. So when you convert $10,000:
- Only 20% ($2,000) is considered non-deductible and tax-free
- The remaining 80% ($8,000) is considered taxable income
This pro-rata calculation has to be used for all distributions and conversions until all non-deductible contributions have been found.
How the Aggregation Rule Affects RMDs
Required Minimum Distributions (RMDs) are mandatory withdrawals from retirement accounts that generally begin at age 73 (previously 72 if you turned 72 before December 31, 2022).
When you have multiple traditional IRAs, the aggregation rule actually works in your favor for RMDs:
- You must calculate the RMD separately for each IRA
- But you can withdraw the total amount from any combination of your IRAs
For example, if you need to withdraw $20,000 in total from three different IRAs, you could take:
- $5,000 from IRA #1
- $15,000 from IRA #2
- $0 from IRA #3
This flexibility allows you to strategically choose which accounts to draw from based on investment performance, fees, or other considerations.
But be careful! This aggregation benefit doesn’t extend across different types of retirement accounts. If you have both traditional IRAs and employer plans like 401(k)s, you must take RMDs separately from each type of account.
Important Exceptions to Remember
There are several key exceptions to the aggregation rule that could trip you up if you’re not careful:
1. Inherited IRAs
If you inherit an IRA as a non-spouse beneficiary, those accounts are not aggregated with your personal IRAs. Additionally, IRAs inherited from different owners must be kept separate for RMD purposes.
2. Spouse’s IRAs
Even if you’re married and file taxes jointly, your spouse’s IRAs are never aggregated with yours. Each spouse must satisfy their own RMD requirements separately.
3. Employer Plans
As mentioned earlier, 401(k)s, 403(b)s, and other employer plans aren’t included in IRA aggregation. You must take RMDs from each employer plan separately.
4. Roth IRAs
Roth IRAs aren’t subject to RMDs for the original owner and aren’t aggregated with traditional IRAs for most purposes. However, they are included in the once-per-year rollover rule (more on that below).
The 60-Day Rollover Rule and Aggregation
About five years ago, the IRS tightened the rules around 60-day rollovers. Now, regardless of how many IRAs you have, you’re limited to just one 60-day rollover every 12 months. This limitation applies across all your traditional and Roth IRAs combined.
A 60-day rollover occurs when you withdraw funds from an IRA and redeposit them into another IRA within 60 days. If you attempt more than one such rollover within a 12-month period, the second transaction will be treated as a distribution and potentially subject to taxes and penalties.
Example:
If you take a distribution from a traditional IRA in January and roll it over to another traditional IRA within 60 days, that’s fine. But if you try to do the same with a Roth IRA in March of the same year, that second rollover would be disallowed, forcing the money out of the tax shelter entirely.
To avoid this pitfall, use direct trustee-to-trustee transfers when moving IRA money. These direct transfers aren’t subject to the once-per-year limitation.
Strategies to Navigate the Aggregation Rule
While you can’t avoid the aggregation rule entirely, there are some strategies that might help you manage its effects:
1. Use a Reverse Rollover for Roth Conversions
If your employer plan allows it, you could roll your pre-tax IRA funds into your 401(k) or other employer plan. This would leave only your non-deductible IRA contributions behind, which you could then convert to a Roth with minimal tax impact.
Using our previous example with $40,000 in pre-tax IRA #1 and $10,000 in non-deductible IRA #2:
- Roll the $40,000 into your employer’s 401(k)
- Convert the remaining $10,000 non-deductible IRA to a Roth
- Result: No taxes on the conversion since you’re only converting basis
2. Keep Careful Records of Non-Deductible Contributions
Use Form 8606 with your tax return to track all non-deductible contributions. This documentation is crucial for ensuring you don’t pay taxes twice on the same money.
3. Use Direct Transfers Instead of Rollovers
When moving IRA money between institutions, request direct trustee-to-trustee transfers instead of taking possession of the funds yourself. This avoids the once-per-year rollover limitation.
4. Strategic RMD Planning
Since you can take RMDs from any combination of your traditional IRAs, consider withdrawing from the accounts with the poorest performance or highest fees.
Bottom Line
The IRA aggregation rule is an important but often misunderstood aspect of retirement planning. Understanding how the IRS views your retirement accounts collectively can help you avoid tax surprises and penalties.
Remember these key points:
- All traditional IRAs are treated as one account for tax purposes
- Roth conversions are subject to pro-rata taxation based on all your IRAs
- You can take RMDs from any combination of your traditional IRAs
- You’re limited to one 60-day rollover per year across all IRAs
- Employer plans and inherited IRAs have different rules
If you’re managing multiple retirement accounts, I strongly recommend consulting with a financial advisor who specializes in retirement planning. The rules are complex, and the penalties for mistakes can be steep—including a 50% penalty on missed RMDs!
Have you encountered any issues with the IRA aggregation rule? What strategies have worked for you? I’d love to hear your experiences in the comments below.
The IRA Aggregation Rule And Pro-Rata Distributions Of Non-Deductible (After-Tax) IRA Contributions
When an IRA has received any non-deductible contributions, the distribution of those dollars is received tax-free as a return of (after-tax) contributions. The amount of any non-deductible contributions that have been made over time is tracked on IRS Form 8606.
The caveat, as noted earlier, is that when a distribution occurs from an IRA that includes non-deductible contributions, the calculation to determine how much of the distribution will be a return of principal must be done on a pro-rata basis under IRC Section 72(e)(8). (Unlike a Roth IRA, where under IRC Section 408A(d)(4)(B) distributions are presumed to come explicitly from after-tax contributions first.)
In the end, example 1b and the chart above it show how the IRA aggregation rule works when there are more than one IRA. Even a distribution comes from an account that was otherwise 100% funded with non-deductible after-tax funds, it still ends out being partially taxable if/when any other IRAs are aggregated into the calculation! And notably, the end result of this strategy in the example above is that the remaining $4,653 of after-tax funds not treated as being part of the withdrawal from IRA #2 have effectively be transmuted into after-tax contributions associated with IRA #1 (even though the contributions were never made to that account in the first place!)!.
Bobrow Commissioner, The Once-Per-Year IRA Rollover Rule, And The IRA Aggregation Rule
In the past, the IRA aggregation rules were mostly used to figure out the tax consequences of a distribution (or Roth conversion) that included contributions made after taxes. But thanks to the recent court case of Bobrow v. Commissioner, the IRA aggregation rule is now used in the context of the once-per-year IRA rollover rule, too.
The once-per-year IRA rollover rule states that when a distribution occurs from an IRA and it is rolled over within 60 days (under the normal rollover rules), another rollover cannot occur for the next 12 month period (measured from the day the distribution occurred). In the original interpretation of these rules – and as previously explained in IRS Publication 590 – the Service had interpreted this rule to mean that no additional rollovers could occur from either the IRA that the distribution came from, or the IRA that the new funds went to. However, if the taxpayer had another entirely separate and unrelated IRA, that IRA could still engage in another rollover. And some people had actually used this rule to chain together multiple IRA rollovers (where IRA #2 repays IRA #1, then IRA #3 repays IRA #2, then IRA #4 repays IRA #3, etc.), effectively extending themselves a long-term “temporary” loan.
However, in the Bobrow case, the Tax Court reviewed the strategy (after Bobrow made a mistake in executing it, raising the attention of the IRS in the first place), and declared that the IRA aggregation rule under IRC Section 408(d)(3) should apply for the purposes of the once-per-year rollover rule, not just in the context of calculating the pro-rata tax consequences of an IRA distribution.
As a result of the court’s ruling, the IRS declared in IRS Announcement 2014-15 that starting in this current year of 2015, any IRA distribution-and-60-day-rollover from any IRA will render all of the taxpayer’s IRAs ineligible for another 60-day rollover in the next 12 months! Notably, since the IRA aggregation rule only applies to IRAs and not employer retirement plans, a distribution-and-60-day-rollover from an employer retirement plan does not trigger this rule, but any other IRA distribution-and-rollover does. In addition, it’s important to remember that a trustee-to-trustee transfer is not treated as a 60-day rollover, and consequently there is still no limit on the number of trustee-to-trustee “rollover” transfers that can occur within a year. But for any situation where the taxpayer actually takes possession of the money as a distribution, and then rolls the funds over within 60 days, the IRA aggregation rule applies to render all IRA accounts ineligible for another 60-day rollover for the next 12 months!
IRA Aggregation Explained: How Many IRAs Become One
FAQ
What are IRA aggregation rules?
Essentially the IRA aggregation rule makes you treat all of your IRA accounts as one big pot of money. This rule says that you can’t put $6,500 into an IRA that you can’t deduct (after taxes) and then only convert that amount to avoid taxes.
How to avoid IRA aggregation rule?
Pitfall #1: IRS Aggregation Rule If an individual has pre-tax IRA’s we typically recommend that they rollover those IRA’s into their employer sponsored retirement plans which eliminates all of their pre-tax IRA balance and then open the opportunity to execute this backdoor Roth IRA contribution strategy.
Can I max out my 401(k) and also contribute to an IRA?
Key takeaways Anyone eligible can contribute to an employer’s 401(k), but income limits apply to Roth IRAs. Since both accounts have annual contribution limits and potentially different tax benefits, contributing to both could boost your annual savings amount and potentially reduce your tax bill, now and down the road.
What is the RMD aggregation rule?
RMD aggregation allows account owners to combine their Traditional IRA and 403(b) plan RMDs, calculating the total amount due from their combined accounts but withdrawing it from one or more of those accounts. However, 401(k) plans and 457(b) plans require separate RMDs, which must be withdrawn from their respective accounts and cannot be aggregated. Spouses also cannot aggregate their IRAs; .
What is the IRA aggregation rule?
However, not everyone is aware of a crucial component of IRA regulations called the “aggregation rule. ” Essentially, if you have multiple IRAs, this rule treats them as a single IRA for tax purposes. This can be especially important to understand when performing Roth conversions or planning for required minimum distributions.
What is the aggregation rule?
The aggregation rule plays a crucial role in managing tax treatment related to retirement savings. The Internal Revenue Service stipulates that all of your IRA accounts (except Roth accounts) are treated as a single entity for calculating conversion taxes or minimum distributions.
What is the aggregation rule in a Roth IRA conversion?
The aggregation rule precludes you from converting only the non-deductible contributions. Instead, the IRS considers all of your IRAs as a single unit when you perform a Roth conversion. For example, imagine you have $40,000 in one IRA and another $10,000 in a separate account that was funded entirely with non-deductible contributions.
What is the IRA aggregation rule in Bobrow v Commissioner?
Bobrow v. Commissioner, The Once-Per-Year IRA Rollover Rule, And The IRA Aggregation Rule: In the past, the IRA aggregation rules were mostly used to figure out the tax effects of a distribution (or Roth conversion) that included contributions made after taxes. But thanks to the recent court case of Bobrow v.
Does IRA aggregation apply if a distribution is already 100% taxable?
As when a distribution is already 100% taxable, there’s no pro-rata formula to apply, and if applicable at all the 10% early withdrawal penalty would apply to the entire account anyway. However, as soon as an IRA has any non-deductible (i.e., after-tax) contributions included, the IRA aggregation rule is immediately relevant.
Does the aggregation rule apply to IRA rollovers?
The IRA aggregation rule has been adopted to apply to traditional IRA rollovers as well. The once-per-year IRA rollover rule mandates that when money is rolled from one IRA to another, an additional rollover cannot occur for another 12 months.