The ERISA consultants on the Columbia Management Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with a financial advisor in New Jersey is representative of a common inquiry involving the new 3.8% tax on Net Investment Income and qualified retirement plan and IRA assets. The advisor asked:
Do the Net Investment Income Tax (NIIT) rules affect assets saved in a qualified retirement plan or IRA? If so — how?
Highlights of Discussion
1. The NIIT rules do not affect contributions, conversions, or rollovers of, or earnings on, qualified retirement plan or IRA assets while they are held in the plan. However, withdrawals from these tax-favored accounts are included in the recipient’s taxable income when distributed, which could increase the individual’s modified adjusted gross income (MAGI) for NIIT purposes. Let’s define some terms.
• The 3.8% NIIT applies to the lesser of either:
— “Net Investment Income” OR
— the excess of MAGI over “the threshold amount”
• NII includes the following, reduced by allowable deductions:
— Interest
— Dividends
— Nonqualified annuities
— Royalties
— Rents
— Gain from the sale/disposition of certain property (capital gains)
— A trade or business considered a passive activity (under the passive loss rules) or trading in financial instruments or commodities/related derivatives
(Note that NII does not include distributions from qualified retirement plans or IRAs, among other items.)
2. MAGI, for this purpose, is adjusted gross income (e.g., Form 1040, Line 37) increased by the amount excluded from income as foreign earned income under section 911(a) of the Internal Revenue Code. (Note that MAGI does include distributions from qualified retirement plans or IRAs.) The MAGI threshold amounts are:
• $200,000 for single tax filers;
• $250,000 for married taxpayers, filing jointly; and
• $125,000 for married taxpayers filing separately.
Example
Tami, age 71, is a single taxpayer. She has $175,000 of investment income and a $100,000 required minimum distribution from her IRA.
MAGI
$175,000
$100,000
$275,000 (Total MAGI)
$200,000 (MAGI threshold)
$75,000 (Excess over MAGI threshold)
NII
$175,000
Lesser of = $75,000
$75,000 x 3.8% = $2,850 NIIT
Conclusion
Distributions from qualified retirement plans and IRAs—while not considered NII themselves — can affect the amount of one’s MAGI, which is also a key variable in the determination of NIIT. Taxpayers should consult their tax professionals regarding their personal financial situations. Financial advisors who are aware of the nuances of the NIIT are better positioned to support their clients.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2013 Columbia Management Investment Advisers, LLC. Used with permission.
