Home  Contact Us

I R A  FREQUENTLY ASKED QUESTIONS

What is an IRA?

An individual retirement account, or IRA, is the only kind of tax-advantaged retirement account that can be opened by virtually anyone. You can contribute up to $2,000 a year to an IRA, as long as you earn $2,000 a year or more. The money you invest may or may not be tax deductible, depending on how much you earn and whether you are married. Regardless of whether you can deduct the contribution from your annual income tax bill, the money you put into the account will grow tax-free until you start making withdrawals. Most people wait until they are at least 59 1/2 before they begin pulling money out of their IRAs, because the Internal Revenue Service usually levies a 10 percent "early withdrawal" penalty on money withdrawn sooner.

What does IRA stand for?

"IRA" is shorthand for an individual retirement account. You can contribute up to $2,000 a year to an IRA and your investment will grow tax-free until you begin taking the money out, usually after you reach age 59 1/2. Individual retirement accounts were created in 1974. As legend has it, the committee that was formulating the newfangled plan was struggling to come up with an acronym that would be easy for taxpayers to pronounce. The actuary working on the plan was named Ira Cohen, and his first name worked just fine.

What's the best type of financial institution to use for an IRA?

You can establish an individual retirement account (IRA) just about anywhere you wish. But before you open a new IRA account, first make sure you know which types of investments the financial institution allows its customers to make. Most investors establish their IRAs at a bank, brokerage firm, mutual fund company or insurance company. But while some of these institutions allow you to invest the money however you wish, others limit your selection or charge additional fees if you want to place money in something other than the types of investments offered through the financial institution itself. For example, if you want to use your IRA to invest in a particular mutual fund, make sure the institution will allow such an investment before you open the account.

What advantages does a 403(b) retirement plan have over an IRA?

A tax-sheltered annuity, or 403(b) plan, is a tax-deferred employee retirement plan that can be adopted only by certain tax-exempt private organizations and public schools and colleges. Employees are 100% vested in the plan and contribute only through salary reductions. A 403(b) plan boasts several features than can make it more attractive than an Individual Retirement Account (IRA). First, the ceiling for annual contributions can be as much as $10,500, which is much higher than the $2,000 limit for IRAs. Also, in plans of health, education or religious organizations, the 403(b) allows workers with 15 years of service to "make up" the years when they did not contribute their maximum through a catch-up provision. Beginning in 2002, an additional catch-up contribution of $1,000 will be allowed for workers age 50 and over. This catch-up will increase $1,000 each year after 2002 until reaching $5,000 in 2006. Finally, many tax-sheltered annuity plans allow participants to borrow from their plans; borrowing against an IRA is prohibited.

What is a conduit IRA?

Conduit IRAs are simply IRAs that result from rolling over a distribution from a qualified plan into a separate IRA that contains only rolled-over distributions from qualified plans, i.e. no other contributions from the IRA owner. A conduit IRA may be rolled over into the qualified plan of a subsequent employer, provided the receiving plan allows such transfers.

What is a Roth IRA?

The Taxpayer Relief Act of 1997 created a new type of individual retirement account called a Roth IRA. The new Roth IRA allows penalty-free withdrawals for retirees and for first-time homebuyers. Contributions to a Roth IRA are not deductible, but no taxes are paid on qualified distributions. To be qualified, a distribution must be made five taxable years after the first contribution to the account was made. In addition, the distribution must meet at least one of the following conditions:
1) The withdrawal is made after the account-holder reaches age 59 1/2;
2) The money, $10,000 or less, is used to purchase a first home;
3) The withdrawal is made because the account-holder becomes disabled, or
4) The distribution is made to a beneficiary after the account-holder's death.
It's important to note that the new tax law does not allow individuals to contribute more than $2,000 to all of their individual IRAs (with the exception of contributions to an educational account). Although restrictions on IRA investments have been relaxed, it's still impossible to put a lot of money into any type of individual retirement account unless you roll over money from an employer-sponsored 401(k) or similar account. 

Can I establish a Roth IRA regardless of how much I make?

A new type of individual retirement account, called a Roth IRA, was created by the Taxpayer Relief Act of 1997. Contributions to a Roth IRA are not tax-deductible, but penalty-free withdrawals can be made if the taxpayerís account has been open for at least five years, the taxpayerís age is at least 59 1/2 or the withdrawal is used to purchase a first home. Because the new Roth IRA was primarily created to help low- and middle-income people save, the law restricts the ability of upper-income taxpayers to open such an account. A maximum of $2,000 a year can be contributed to an account by single tax-filers with adjusted gross income (AGI) of at least $2,000 and less than $95,000 and joint filers with combined income of at least $2,000 and less than $150,000. The maximum contribution phases out for single filers with adjusted gross income between $95,000 and $110,000; and for joint filers, the phase-out affects those with AGI between $150,000 and $160,000.

How do I convert my current Individual Retirement Account into a new Roth IRA?

Generally, a taxpayer can convert his or her conventional IRA into a new Roth IRA if the taxpayerís adjusted gross income is less than $100,000 (for both single and joint filers). Any amount that would have been taxable as income when withdrawn from the existing account will be taxed. To convert to a Roth IRA , you must complete a Roth IRA Adoption Agreement and a Roth Conversion form. Be certain to indicate on the Roth Conversion form whether taxes are to be withheld from the IRA funds or will be paid from another source. Once the Roth Conversion IRA has been established, assets in the ordinary IRA will be moved to the Roth Conversion IRA. If you do not wish to convert the entire amount, you must indicate on the conversion form the exact security description and the amount of cash that is to be moved from the ordinary IRA.

How do I use money saved in my Roth IRA to pay for college?

Certain expenses for education qualify as penalty-free distributions from a Roth IRA. This is important since the penalty for early distribution of a Roth IRA is 10 percent. Qualified expenses include college tuition, fees, books, supplies, and room and board. However, that portion of the distribution consisting of earnings on prior contributions will be taxable since distributions from a Roth IRA to pay for higher education expenses do not qualifiy as totally tax free unless the account is more than five years old and the owner has attained age 59 1/2. Contributions to a Roth IRA are not tax deductible, but the principal and interest grow tax-free. Annual contributions to a Roth IRA are currently limited to $2,000.

What is a SEP-IRA?

A simplified employee pension (SEP) plan is a retirement plan used by many people who run a small business. A SEP is actually a special type of individual retirement account (IRA). As a result, itís often called a SEP-IRA.

What does SEP stand for?

SEP stands for simplified employee pension, a type of retirement plan that is popular among sole proprietors and owners of small businesses. A SEP is actually a special type of individual retirement account and is sometimes referred to as a SEP-IRA.

Can I invest in both a SEP and a traditional IRA?

If you are participating in a simplified employee pension (SEP) plan, the Internal Revenue Service will allow you to save even more money for retirement by allowing you to set up a separate Individual Retirement Account (IRA). The money you contribute to the IRA may or may not be tax-deductible, depending on how much you earn and whether youíre married or not. But even if you canít deduct the contribution on your income tax return, the investments inside the IRA will grow tax-deferred until you begin making withdrawals.

What is a spousal IRA?

The spousal IRA was created by Tax Reform Act of 1997. The spousal IRA allows the spouse of a participant in a qualified plan to make a deductible contribution to his or her IRA regardless of the other spouse's active participant status. A couple can contribute and deduct up to $2,000 per year on behalf of the non-active spouse. The deduction phases out between $150,000 and $160,000 of modified adjusted gross income.

What are the pros and cons of having large amounts of money in an IRA?

One of the biggest benefits of having an Individual Retirement Account (IRA) is that money in the account grows, tax-free, until you begin making withdrawals. The only trouble is, you can't really touch the money until you turn 59 1/2 unless you're willing to pay a stiff 10% penalty. So, in addition to having a retirement account to see you through your "golden years," also make sure you have other investments that can be quickly and easily tapped for cash while you're still young.

Is my IRA subject to the claims of my creditors in a bankruptcy proceeding?

If you file for bankruptcy, your creditors may or may not be able to claim the assets of your individual retirement account (IRA). It depends primarily on where you live.
State law determines if IRAs are subject to the claims of creditors in a bankruptcy. Some states protect IRAs from the claims of creditors and others do not. But even in the same state, interpretation of bankruptcy law can vary from one court to another.
If youíre thinking of filing for bankruptcy, itís imperative that you consult a lawyer in the district where you live to find out how local courts would treat your IRA funds and other assets.

 

When must an IRA owner make his or her selection of the designated beneficiary?

You can select the designated beneficiary of your Individual Retirement Account (IRA) at any time. However, if you don't select a designated beneficiary by the time of the federally required distribution date -- April 1 of the year following the year in which you turn 70 1/2 -- you may only use your own life expectancy to determine the distribution period.

Should I name my spouse as the beneficiary of my Individual Retirement Account, or would it make more sense to name my child?

You can name whomever you wish as the beneficiary of your Individual Retirement Account (IRA). However, if you're married, there's at least one advantage to naming your spouse as beneficiary rather than a child. Under the tax code, a spouse can roll an IRA inherited from a deceased spouse into another IRA. This allows the surviving spouse more flexibility, because he or she can avoid minimum withdrawal requirements until age 70 1/2. This benefit is not available to a child who inherits an IRA from a parent.

Should I name my revocable living trust as beneficiary of my IRA?

If you have created a revocable living trust, you can name the trust as the beneficiary of your Individual Retirement Account. However, it may make more sense to use the trust only as a secondary, or "back-up," beneficiary-especially if you are married. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "In many cases, it is preferable to name a spouse or some other designated beneficiary as the primary beneficiary of your IRA. You can then name your revocable living trust as the contingent, or secondary, beneficiary. By using this succession of beneficiaries for your IRA, your spouse will have the spousal elections that are available upon the death of the IRA owner. If the owner and spousal beneficiary are killed in a common accident, then the revocable living trust can serve as a receptacle for the IRA proceeds." In other words, naming your spouse or other beneficiary as heir to your IRA can provide the beneficiary with more flexibility in choosing how the accountís assets will be used after youíre are gone.

Would it make sense to donate my Individual Retirement Account (IRA) to a charitable remainder trust?

Creating a charitable remainder trust (CRT) automatically entitles you to several tax benefits. But you can get some extra benefits if you donate your IRA to the trust. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "Another good idea if you want to make bequests to a CRT is to donate your IRA (or a portion of it) instead of your cash or other assets. Why? Because when you make a donation from your IRA, you avoid both the estate tax and the income tax on that money. That, in effect, leaves more for your family -- or the charity itself."

How much can I contribute to my IRA every year?

Although the Internal Revenue Service prohibits you from investing more than $2,000 a year in an Individual Retirement Account (IRA), it does not require a minimum investment. As a result, you can invest as little or as much as you like each year, as long as you don't invest more than $2,000.

Have the limits on the maximum amount that can be contributed to a spousal IRA changed?

In the waning days of the 1996 Congressional session, lawmakers approved a key change in the tax codes concerning Individual Retirement Accounts held by married couples. The change involves so-called "spousal" IRAs. In the past, the Internal Revenue Service has allowed two-earner couples to each contribute up to $2,000 a year to a retirement account. Families in which only one spouse worked could establish a spousal IRA, but the maximum contribution to the two accounts could not exceed a combined $2,250. The new law levels the playing field by simplifying the rules. Now, married couples can each contribute up to $2,000 a year to individual accounts -- for a total contribution of $4,000 -- regardless of whether only one spouse works or both of them do.

Is there a tax penalty if I contribute more than $2,000 to my IRA?

If you contribute more than $2,000 to an Individual Retirement Account (IRA), you will have to pay a penalty. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "If contributions (deductible or nondeductible) in excess of the amount allowed are made to an IRA, an excise tax equal to 6% of the excess contribution is imposed until the excess is withdrawn or used to reduce later yearsí contributions. This penalty can be avoided by withdrawing the excess amount plus interest earned before the due date for filing your tax return."

What is the deadline for making a contribution to an IRA?

You have until April 15, to make deductible or nondeductible IRA contributions for the previous year. You must make your contribution by April 15 even if you get an extension to file your return. If you are short of cash, you may borrow to make the contribution without jeopardizing the deduction. If an IRA deduction entitles you to a refund, you can file your return early, claim the IRA deduction, and if you receive the refund in time, apply it towards an IRA contribution before the due date.

What are the income limits on deducting contributions to an IRA?

Contributions to an Individual Retirement Account (IRA) may be fully deductible, partially deductible or non-deductible on your income tax return. It depends on a variety of factors. For the 2001 tax year: If your adjusted gross income is more than $63,000 ($43,000 for singles) and you are an active participant in an employerís pension plan, you cannot take an IRA tax deduction. However, you can make nondeductible contributions. If your adjusted gross is between $53,000 and $63,000 ($33,000 to $43,000 for singles), and you are an active participant in an employerís pension plan, you can take a partial deduction for your IRA contribution. If your spouse does not actively participate in an employerís pension plan, the spouse can deduct up to a $2,000 IRA contribution. In sum, the full $2,000 deduction is available to workers who are active participants in employer-maintained retirement plans only if their adjusted gross income (AGI) is below $33,000 for singles and $53,000 for joint filers. However, the non-active spouse can now deduct up to a $2,000 IRA contribution if the AGI of the couple is $150,000 or less and a reduced contribution for AGI between $150,000 and $160,000. The spousal IRA is not available for taxpayers with AGIs above $160,000 where on of the spouses is an active participant in an employerís plan.

Does the new tax law change the income thresholds for deductible contributions to an IRA?

Taxpayers who are covered by a retirement plan at work can deduct the full amount of a $2,000 contribution to an individual retirement account in 2001 if they file a joint return with modified adjusted gross income (AGI) of less than $53,000 or file singly with a modified AGI of less than $33,000. For every $1,000 over the income limit, the deduction amount is reduced by $200. The Taxpayer Relief Act of 1997 provides for a $1,000 annual increase in the limit through the 2002 tax year and larger annual increases after that to $80,000 for joint filers and $50,000 for individuals.

Does receiving Social Security affect my ability to make a deductible IRA contribution?

Social Security payments you receive could restrict your ability to deduct contributions to your IRA. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "If you are covered by a qualified pension plan where you work, Social Security benefits can affect your deductible contribution to an IRA. Deductibility of an IRA contribution depends on your adjusted gross income, which includes the taxable portion of Social Security benefits. So your Social Security can reduce the deductible portion of an IRA contribution."

What tax form do I use to report nondeductible IRA contributions?

If you have a nondeductible Individual Retirement Account (IRA), you must still report any contributions to it to the Internal Revenue Service. To do so, you must complete IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You must also file Form 8606 if you have received IRA distributions during the tax year and you have ever made nondeductible contributions to any of your IRAs. A Form 8606 must be completed and filed with the IRS even if you donít have to file a tax return for the year in question.

What will happen if I make a nondeductible contribution to my IRA and don't report it to the IRS?

If you make a nondeductible contribution to your IRA, you must report it by filing IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You face a $50 penalty if you don't file Form 8606, and failing to file could cause confusion between you and the IRS when you start withdrawing money from the retirement account in future. -- Laurence I. Foster

Am I allowed to mix deductible and nondeductible contributions in the same IRA?

Thereís no law that prevents you from mixing deductible and nondeductible contributions in a single Individual Retirement Account (IRA), but many experts advise against it. The main problem with using a single IRA for both deductible and nondeductible contributions involves taxes. When you eventually begin making withdrawals, calculating how much of each withdrawal is taxable and how much is not could be a nightmarish task.

Does it make sense to contribute to an IRA even if I can't deduct the contribution?

Even if you can't deduct your contributions to an Individual Retirement Account (IRA), opening one and funding it once a year might still make sense. The investments you make in the account still will grow tax-free until you start making withdrawals, usually after you reach age 59 1/2. However, you might be better off taking your after-tax dollars and putting them in other tax-advantaged investments that have no annual contribution limits, such as annuity contracts or tax-free municipal bonds.

Should I reimburse my IRA for fees deducted for annual administration?

Always reimburse your IRA for administration fees. That way, your retirement account remains intact and you maximize the tax benefits of it. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver, Colo.), "If your annual fees are $25 and remain constant over 20 years, your IRA account is reduced by $500. But that is not your true cost since it ignores both the earnings those funds could have made if left in the account and the compounding effect. "For example, if you reimbursed your account each year for the $25 administration fee and those funds compounded at a long-term rate of 10 percent, your account balance would increase by approximately $1,430. Therefore, your true cost of administration when you include the 'lost opportunity cost' is not $500 but $1,430-almost 3 times as much." The bottom line: Always reimburse your IRA for administration fees.

Can I deduct the interest on a loan I get to make the contribution to my IRA?

If you borrow money to make a contribution to your individual retirement account (IRA), you cannot deduct the interest on the money that you borrowed. The Internal Revenue Service figures itís being generous enough by letting your IRA investments grow on a tax-deferred basis. It refuses to give you an additional tax break for finance charges you incur on a loan thatís needed to fund the investment.

How can I put mutual funds into an Individual Retirement Account (IRA)?

Most mutual fund companies have arrangements with a bank or trust company for people who want to put their mutual fund shares into an Individual Retirement Account (IRA). The bank or trust company is considered the "custodian" of the account, and will usually charge a modest $10 or $25 fee for its services. As an alternative, you can open a brokerage account IRA and purchase mutual funds within that. The process is similar to using a broker to buy funds normally, except that a single IRA custodian fee in the range of $25 to $50 will be charged. Some mutual funds offer IRA accounts directly. Whichever method you choose, write a separate check for your contribution. You can usually then deduct the fee on your income tax return, and youíll have that much more money growing tax-deferred inside your Individual Retirement Account.

 

Who can establish an IRA?

Anyone who earns money is eligible to establish an Individual Retirement Account (IRA). You can contribute up to $2,000 of your earnings a year. However, you cannot contribute more than you earn. For example, if you earn only $1,500, your contribution is limited to $1,500. An exception is made for a spouse who doesnít earn money. If you are married and one of you doesnít work, you can contribute an annual total of $4,000 into separate IRA accounts.

Can I establish a Roth IRA regardless of how much I make?

A new type of individual retirement account, called a Roth IRA, was created by the Taxpayer Relief Act of 1997. Contributions to a Roth IRA are not tax-deductible, but penalty-free withdrawals can be made if the taxpayerís account has been open for at least five years, the taxpayerís age is at least 59 1/2 or the withdrawal is used to purchase a first home. Because the new Roth IRA was primarily created to help low- and middle-income people save, the law restricts the ability of upper-income taxpayers to open such an account. A maximum of $2,000 a year can be contributed to an account by single tax-filers with adjusted gross income (AGI) of at least $2,000 and less than $95,000 and joint filers with combined income of at least $2,000 and less than $150,000. The maximum contribution phases out for single filers with adjusted gross income between $95,000 and $110,000; and for joint filers, the phase-out affects those with AGI between $150,000 and $160,000.

If I decide not to participate in my 401(k) plan, will I be eligible for a fully deductible IRA?

If you decide not to participate in a 401(k) plan thatís offered by your employer, you are still eligible for a fully deductible Individual Retirement Account (IRA) regardless of your salary as long as you do not actively participate in any qualified plan. If your spouse is an active participant and your combined AGI is$160,000 or more you cannot deduct your IRA contribution, even if you are not an active participant. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Youíre automatically considered an active participant in a pension plan if youíre eligible for a defined benefit plan-the traditional pension thatís fully funded by the employer. But in a defined contribution plan like a 401(k), youíre not considered an active participant unless you elect to contribute to the plan, your employer contributes to it on your behalf or your account is allocated part of the forfeitures (the nonvested part of someoneís account who terminates employment). "Thereís a very simple way to determine whether or not youíre an active participant in a pension plan: every January or February your employer sends you a W-2 form-the form stating your wages for the year just ended. Take a look at Box 15 on the W-2 form. If thereís no X in that box, you donít actively participate in a pension plan and the IRS wonít challenge you for taking a deduction for an IRA contribution."

Can I invest in both my companyís 401(k) plan and an Individual Retirement Account?

You can invest in a 401(k) plan and an Individual Retirement Account (IRA). However, depending on your salary, the money you contribute to your IRA might not be tax-deductible. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), under current law, if you participate in a qualified employer-sponsored pension plan like a 401(k), you can only deduct a $2,000 annual IRA contribution if you are single and earn less than $33,000 in 2001or are a married joint filer with a combined income of less than $53,000 in 2001. You qualify for a partial deduction on the IRA contribution in 2001 if you are single and earn between $33,000 and $43,000, or if you are a married joint filer and your combined income is between $53,000 and $63,000. Consult with your tax advisor to determine the exact deductible amount. Of course, even if you make a non-deductible IRA contribution, its earnings wonít be taxed until the money is withdrawn.

Can I invest in both a SEP and a traditional IRA?

If you are participating in a simplified employee pension (SEP) plan, the Internal Revenue Service will allow you to save even more money for retirement by allowing you to set up a separate Individual Retirement Account (IRA). The money you contribute to the IRA may or may not be tax-deductible, depending on how much you earn and whether youíre married or not. But even if you canít deduct the contribution on your income tax return, the investments inside the IRA will grow tax-deferred until you begin making withdrawals.

What can I invest my IRA money in?

You may invest your Individual Retirement Account (IRA) contribution in just about anything: Mutual funds, stocks, bonds, annuities, bank savings accounts, certificates of deposit, government bonds and investment trusts. IRAs are so flexible that the list of items that you cannot invest in is much shorter. Prohibited investments include life insurance contracts, collectibles and your own home.

Are municipal bonds a good investment for my IRA?

An Individual Retirement Account (IRA) is a great place to hold many types of investments, but municipal bonds are not among them. Municipal bonds are always free of federal income taxes, and often free of state and local taxes taxes for residents of the state of issuance. Capital gains, however, are taxable. Since they donít generate a lot of taxable income to begin with, thereís no sense putting them in a tax-deferred IRA. If you want to own municipal bonds, invest in them outside the IRA and put your taxable investments inside the account.

Are Series EE savings bonds a good investment for my Individual Retirement Account?

Investing in Series EE U.S. savings bonds makes sense for many people. However, you should not invest in EE bonds through your Individual Retirement Account (IRA). Series EE bonds are taxed by the federal government, but generally only when you redeem them several years in the future. The bonds are always exempt from state income taxes. Investments that are put into a traditional IRA automatically grow tax-deferred until withdrawal and investments put into a Roth IRA grow tax-free. For qualified educational expenses, Series EE bonds may be tax exempt.

Can an individual invest his or her IRA in collectibles?

Collectibles are among the few types of investments that are prohibited in an Individual Retirement Account (IRA). According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "If an individual invests his or her IRA in collectibles (works of art, rugs, antiques, metals, gems, stamps, most types of coins, alcoholic beverages, or any other tangible personal property specified by the IRS), the amount invested is treated as a distribution and will be taxed as current income. A 10% premature distribution penalty tax will also apply if the individual is under age 59 1/2."

Arenít certain types of coins allowed to be used as an investment in a self-directed IRA?

As a general rule, you canít invest in coins through an Individual Retirement Account (IRA). But there is an exception for self-directed IRAs concerning certain types of coins. According to J.K. Lasserís "Your Income Tax" (Macmillan General Reference), you can hold state-issued coins in a self-directed IRA. You can also use the account to invest in U.S. minted gold and silver coins, as long as the coins weigh one ounce or less.

 

Can I invest in both my companyís 401(k) plan and an Individual Retirement Account?

You can invest in a 401(k) plan and an Individual Retirement Account (IRA). However, depending on your salary, the money you contribute to your IRA might not be tax-deductible. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), under current law, if you participate in a qualified employer-sponsored pension plan like a 401(k), you can only deduct a $2,000 annual IRA contribution if you are single and earn less than $33,000 in 2001or are a married joint filer with a combined income of less than $53,000 in 2001. You qualify for a partial deduction on the IRA contribution in 2001 if you are single and earn between $33,000 and $43,000, or if you are a married joint filer and your combined income is between $53,000 and $63,000. Consult with your tax advisor to determine the exact deductible amount. Of course, even if you make a non-deductible IRA contribution, its earnings wonít be taxed until the money is withdrawn.

If I decide not to participate in my 401(k) plan, will I be eligible for a fully deductible IRA?

If you decide not to participate in a 401(k) plan thatís offered by your employer, you are still eligible for a fully deductible Individual Retirement Account (IRA) regardless of your salary as long as you do not actively participate in any qualified plan. If your spouse is an active participant and your combined AGI is$160,000 or more you cannot deduct your IRA contribution, even if you are not an active participant. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Youíre automatically considered an active participant in a pension plan if youíre eligible for a defined benefit plan-the traditional pension thatís fully funded by the employer. But in a defined contribution plan like a 401(k), youíre not considered an active participant unless you elect to contribute to the plan, your employer contributes to it on your behalf or your account is allocated part of the forfeitures (the nonvested part of someoneís account who terminates employment). "Thereís a very simple way to determine whether or not youíre an active participant in a pension plan: every January or February your employer sends you a W-2 form-the form stating your wages for the year just ended. Take a look at Box 15 on the W-2 form. If thereís no X in that box, you donít actively participate in a pension plan and the IRS wonít challenge you for taking a deduction for an IRA contribution."

If I have to choose between a 401(k) and IRA, which choice makes more sense?

If you have to choose between participating in a 401(k) or contributing to an Individual Retirement Account (IRA), a 401(k) is almost always the best choice. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "This decision is truly a no-brainer if your IRA contributions arenít tax deductible and/or your employer provides a matching contribution to your 401(k) plan. A 401(k) with an employerís match is a much better deal than an IRA that has no matching contribution and wonít reduce your current income tax bill. In fact, unless youíre uncomfortable with the 401(k) planís investment options, itís a better deal even if you donít have an employer match and your IRA contributions are fully tax-deductible. The reason: depending on your salary, a 401(k) plan may let you save up to $10,500 in the 2001 tax year. Your maximum annual IRA contribution is limited to $2,000. Itís also easier to save in a 401(k) plan than in an IRA and for a very simple reason: your 401(k) contributions are taken out of your paycheck automatically. Saving in an IRA requires a continuing conscious decision and self-discipline that many of us donít have. Another important potential advantage 401(k)s have over IRAs is that many 401(k) plans allow loans." Still, choosing an IRA would provide at least one distinct advantage over a 401(k): Withdrawals would be much easier. You canít withdraw money from a 401(k) plan before you reach retirement or terminate unless you qualify for an Internal Revenue Service-approved financial hardship claim or can access a plan loan. Such rules donít apply to IRAs. However, an early withdrawal from an IRA would still be subject to a 10% penalty as well as income taxes.

An IRA seems safer than a 401(k) plan. Can I switch my money from my 401(k) into an IRA?

An Individual Retirement Account (IRA) isnít really any safer than a 401(k) plan. In addition, a 401(k) plan provides several benefits that IRAs do not. You can usually contribute an amount thatís much higher than the $2,000 a year you can put in an IRA. Your 401(k) contribution also reduces your current taxes. Depending on what you earn, an IRA contribution might not do that. That said, the only way you can switch money from your 401(k) into an IRA is if you are getting a 401(k) distribution. That wonít happen unless you are leaving your job.

When I change jobs, how do I decide whether to leave my money in the company plan or switch it to an IRA?

If you have been participating in a company-sponsored retirement plan and decide to change jobs and you have at least $5,000, you can usually either leave your money in the company plan or roll it over into an Individual Retirement Account (IRA). Each choice has its advantages and disadvantages. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver, Colo.), "By moving former plan funds to an IRA, you are taking on the full responsibility of investing your funds -- or at least the responsibility of choosing money managers and monitoring their performance. You must also consider security. An IRA does not always enjoy the protection against creditors that is implicit in a qualified planís ERISA protection. State law defines the creditor protection given to IRAs.
"Many retirees elect to roll over their work-sponsored plans to increase their flexibility in investment choices. Their concerns include control over plan amendments, the necessity to deal with company pension departments which may be located outside the state where they reside and the loss of direct communication with the company because of retirement."
When faced with the decision "to roll or not to roll," your best bet is to meet with a financial planner who will help you clarify your objectives and guide you through the complexities of making this important investment decision. The more you know about your alternatives, the more comfortable you will be with your final decision.

Is there a dollar limit on how much 401(k) money I can transfer to an IRA?

Thereís no dollar limit on the amount of money you can have transferred from a 401(k) plan to a rollover individual retirement account. You can roll your entire 401(k) balance into the IRA, provided it contains no after-tax contributions. If your 401(k) contains some after-tax contributions, youíll have to take those contributions as a distribution. However, since you have already paid taxes on the money, you wonít have to pay taxes on them again. Good news! After 2001, the new Economic Growth and Tax Relief Reconciliation Act of 2001(fondly dubbed EGTRR 2001 by those in the know) will allow you roll over the after-tax contributions also.

If I roll my 401(k) money into a rollover IRA, what are the distribution requirements?

If you roll your 401(k) money into a traditional Individual Retirement Account, you will have to start taking money out of the rollover IRA no later than April 1 of the year after you turn 70 1/2. In other words, if you turned 70 1/2 in 2001, you would have to take your first distribution by April 1, 2002. However,this rule will not apply to your employer sponsored retirement plan accounts if you are still employed and do not own more than 5% of the company. IRAs must begin distribution even if your are not retired. (Rolling over into a Roth IRA requires you to pay taxes on the amount that you roll over, but there are no deadlines for taking distributions.)
The minimum you will have to withdraw depends on your life expectancy, which is determined by life expectancy tables published by the Internal Revenue Service. However, you can use the tables in one of two ways: You can calculate your minimum required distribution by dividing your account balance by the number of years remaining in your life expectancy, or by using your joint life expectancy with your spouse.
According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Itís worth doing the calculation both ways to see which is better for you. You come up with very different mandatory withdrawal amounts depending on whether you use one life expectancy or two. You must pay taxes on these mandatory distributions; you canít roll them into an IRA."

Why is it important to transfer money directly from a 401(k) account to a rollover IRA?

According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Thereís a very important difference between a rollover or "conduit" IRA and a regular IRA: A rollover IRA contains only money that originally came from a 401(k) plan, or other qualified pension plan. By keeping money from your 401(k) in a separate rollover IRA instead of in a regular IRA, you preserve your legal right to transfer it into another 401(k) plan at a future date. Thatís important because money you have in a 401(k) plan may be available for loans. IRA money can never be borrowed. Donít make additional contributions to your conduit IRA in the future or you lose the right to roll it back into a 401(k) plan. You can always save money in a regular IRA instead."

Can't I just have a check made out to me for the amount of my 401(k), and then deposit it in a rollover IRA within 60 days?

If you leave your job and decide that you don't want to leave your 401(k) plan there, the best and easiest way to transfer the money is to have the proceeds transferred into a rollover Individual Retirement Account (IRA). Many stock brokerage firms, mutual fund companies and other financial institutions offer rollover accounts and will handle nearly all of the paper work for you. The trustee of your old 401(k) plan will simply write out a check payable to the trustee of the rollover IRA. Technically, you can have your old employer's 401(k) plan deliver a check directly to you and still have up to 60 days to deposit the money in a rollover IRA. But if you do, your 401(k) distribution will be subject to a mandatory 20% withholding tax. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "This means that if your 401(k) account is worth $100,000, you'll get a check for $80,000. The tax is withheld just in case you change your mind about opening that IRA account. If you really do deposit $100,000 in an IRA within sixty days, then the $20,000 that was withheld will be refunded to you by April or May of the following year. "But in the meantime, you face a classic Catch-22 dilemma. How can you deposit $100,000, when all you received from your 401(k) plan is $80,000? Unless you happen to have a spare $20,000 lying around that you can add to your IRA deposit, you're going to be taxed exactly as if you had taken a $20,000 withdrawal. In other words, if you deposit only the $80,000 you received in the IRA, the government will add $20,000 to your taxable income for the year. The upshot is that you don't get a $20,000 refund. If you're in the 28% bracket, you get back only $14,400. If you're under age 59 1/2, you'll also owe a 10% early withdrawal penalty, so you get back only $12,400." The bottom line: If you're leaving your job, don't do anything with the money in your 401(k) plan until you have opened a rollover IRA. Then have your 401(k) plan administrator do a direct, trustee-to-trustee transfer into your new account.

Can I borrow from my IRA accounts?

One of the biggest disadvantages to investing in an Individual Retirement Account (IRA) rather than in a 401(k) or similar plan is that the Internal Revenue Service will not let you borrow against the built-up value of an IRA. Nor will the government let you use an IRA as collateral for a loan. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "IRAs cannot be borrowed against or used as collateral for a loan. Either of these is called a íprohibited transaction.í If you pledge all or part of your IRA as security for a loan or you borrow from your IRA, the amount pledged or borrowed is treated as a distribution that is taxable in that year. If this pledge or loan takes place before age 59 1/2, you will also owe the 10% premature distribution penalty." This may not be a disadvantage in the long run. Both IRAs and 401(k)s are primarily for retirement or meeting long-term objectives, such as education. Borrowing against a 401(k) jeopardizes its primary purpose.

What is a conduit IRA?

Conduit IRAs are simply IRAs that result from rolling over a distribution from a qualified plan into a separate IRA that contains only rolled-over distributions from qualified plans, i.e. no other contributions from the IRA owner. A conduit IRA may be rolled over into the qualified plan of a subsequent employer, provided the receiving plan allows such transfers.

What does it mean to roll over funds into an Individual Retirement Account?

When you get a lump-sum payment from a pension plan, 401(k) or other retirement plan, you will owe taxes on the money. However, you can defer those taxes if you "roll" the check into a rollover individual retirement account. Rollover accounts differ from conventional IRAs because the money invested in a rollover account comes from an existing retirement plan. By rolling the payout into the IRA, your investment can keep growing tax-free until you start making withdrawals. IRA rollovers must follow a strict set of Internal Revenue Service rules. You must deposit the check from your old pension plan into the rollover IRA within 60 days or else face some nasty tax consequences. Only pre-tax contributions are eligible to be rolled over, and the rollover account should be kept separate from any other IRA accounts you may hold. Ask a tax professional or financial planner for the details.

What are the technical aspects of an IRA rollover?

When you take money out of one retirement account, you can usually avoid any taxes and penalties on the money if you put the cash into a "rollover" Individual Retirement Account. That sounds simple enough, but you should know some of the technical aspects entailed in transferring funds from one retirement account to another. According to J.K. Lasserís "Your Income Tax" (Macmillan General Reference), "With a rollover you withdraw funds from an IRA and have 60 days to invest in another IRA. To avoid tax on a rollover from one IRA to another, these tests must be met: (1) The amount you receive from your old IRA must be transferred to the new plan within 60 days of your receiving it; and (2) a tax-free rollover may occur only once in a one-year period starting on the date you receive the first distribution."

What financial institutions can administer my IRA rollover?

There are a variety of financial institutions that can administer a rollover Individual Retirement Account (IRA). Banks and credit unions are two of them, but theyíre not always the best choice. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "While banks or credit unions may administer an IRA, you may be limited to their investments in savings accounts or certificates of deposit. Insurance on your account is limited to $100,000 by the FDIC. "Another alternative is to use an independent custodian, such as an investment firm or trust. With a self-administered IRA rollover, you can invest your money in CDs, Treasuries, commodities, unencumbered real estate, stocks, bonds, mutual funds, or limited partnerships. None of these investments is insured against loss due to market risk. However, most brokerage and investment firms carry insurance by the Securities Investors Protection Corp. (SIPC) covering a single clientís account for up to $500,000 in securities, of which $100,000 may be in cash."

Will the custodian of my IRA report my rollover to the IRS?

The Internal Revenue Service takes a keen interest in rollovers of money involving an Individual Retirement Account (IRA) and other retirement plans. Even if you cash out of a retirement plan and redeposit the funds into another IRA within the required 60 days, your custodian will report the transaction to the IRS. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "Many individuals are surprised when they receive a 1099-R from their custodian on a tax-free rollover. The practical reason, of course, is that the financial institution from which you received the funds directly cannot possibly know what you did with the funds after it made the distribution. You are required to report the rollover on your Form 1040 tax return and prove to the IRS that the funds were redeposited into another qualifying IRA account within the prescribed time limit."

Is there a dollar limit on how much 401(k) money I can transfer to an IRA?

Thereís no dollar limit on the amount of money you can have transferred from a 401(k) plan to a rollover individual retirement account. You can roll your entire 401(k) balance into the IRA, provided it contains no after-tax contributions. If your 401(k) contains some after-tax contributions, youíll have to take those contributions as a distribution. However, since you have already paid taxes on the money, you wonít have to pay taxes on them again. Good news! After 2001, the new Economic Growth and Tax Relief Reconciliation Act of 2001(fondly dubbed EGTRR 2001 by those in the know) will allow you roll over the after-tax contributions also.

If I roll my 401(k) money into a rollover IRA, what are the distribution requirements?

If you roll your 401(k) money into a traditional Individual Retirement Account, you will have to start taking money out of the rollover IRA no later than April 1 of the year after you turn 70 1/2. In other words, if you turned 70 1/2 in 2001, you would have to take your first distribution by April 1, 2002. However,this rule will not apply to your employer sponsored retirement plan accounts if you are still employed and do not own more than 5% of the company. IRAs must begin distribution even if your are not retired. (Rolling over into a Roth IRA requires you to pay taxes on the amount that you roll over, but there are no deadlines for taking distributions.)
The minimum you will have to withdraw depends on your life expectancy, which is determined by life expectancy tables published by the Internal Revenue Service. However, you can use the tables in one of two ways: You can calculate your minimum required distribution by dividing your account balance by the number of years remaining in your life expectancy, or by using your joint life expectancy with your spouse.
According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Itís worth doing the calculation both ways to see which is better for you. You come up with very different mandatory withdrawal amounts depending on whether you use one life expectancy or two. You must pay taxes on these mandatory distributions; you canít roll them into an IRA."

Why is it important to transfer money directly from a 401(k) account to a rollover IRA?

According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Thereís a very important difference between a rollover or "conduit" IRA and a regular IRA: A rollover IRA contains only money that originally came from a 401(k) plan, or other qualified pension plan. By keeping money from your 401(k) in a separate rollover IRA instead of in a regular IRA, you preserve your legal right to transfer it into another 401(k) plan at a future date. Thatís important because money you have in a 401(k) plan may be available for loans. IRA money can never be borrowed. Donít make additional contributions to your conduit IRA in the future or you lose the right to roll it back into a 401(k) plan. You can always save money in a regular IRA instead."

Can't I just have a check made out to me for the amount of my 401(k), and then deposit it in a rollover IRA within 60 days?

If you leave your job and decide that you don't want to leave your 401(k) plan there, the best and easiest way to transfer the money is to have the proceeds transferred into a rollover Individual Retirement Account (IRA). Many stock brokerage firms, mutual fund companies and other financial institutions offer rollover accounts and will handle nearly all of the paper work for you. The trustee of your old 401(k) plan will simply write out a check payable to the trustee of the rollover IRA. Technically, you can have your old employer's 401(k) plan deliver a check directly to you and still have up to 60 days to deposit the money in a rollover IRA. But if you do, your 401(k) distribution will be subject to a mandatory 20% withholding tax. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "This means that if your 401(k) account is worth $100,000, you'll get a check for $80,000. The tax is withheld just in case you change your mind about opening that IRA account. If you really do deposit $100,000 in an IRA within sixty days, then the $20,000 that was withheld will be refunded to you by April or May of the following year. "But in the meantime, you face a classic Catch-22 dilemma. How can you deposit $100,000, when all you received from your 401(k) plan is $80,000? Unless you happen to have a spare $20,000 lying around that you can add to your IRA deposit, you're going to be taxed exactly as if you had taken a $20,000 withdrawal. In other words, if you deposit only the $80,000 you received in the IRA, the government will add $20,000 to your taxable income for the year. The upshot is that you don't get a $20,000 refund. If you're in the 28% bracket, you get back only $14,400. If you're under age 59 1/2, you'll also owe a 10% early withdrawal penalty, so you get back only $12,400." The bottom line: If you're leaving your job, don't do anything with the money in your 401(k) plan until you have opened a rollover IRA. Then have your 401(k) plan administrator do a direct, trustee-to-trustee transfer into your new account.

When I change jobs, how do I decide whether to leave my money in the company plan or switch it to an IRA?

If you have been participating in a company-sponsored retirement plan and decide to change jobs and you have at least $5,000, you can usually either leave your money in the company plan or roll it over into an Individual Retirement Account (IRA). Each choice has its advantages and disadvantages. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver, Colo.), "By moving former plan funds to an IRA, you are taking on the full responsibility of investing your funds -- or at least the responsibility of choosing money managers and monitoring their performance. You must also consider security. An IRA does not always enjoy the protection against creditors that is implicit in a qualified planís ERISA protection. State law defines the creditor protection given to IRAs.
"Many retirees elect to roll over their work-sponsored plans to increase their flexibility in investment choices. Their concerns include control over plan amendments, the necessity to deal with company pension departments which may be located outside the state where they reside and the loss of direct communication with the company because of retirement."
When faced with the decision "to roll or not to roll," your best bet is to meet with a financial planner who will help you clarify your objectives and guide you through the complexities of making this important investment decision. The more you know about your alternatives, the more comfortable you will be with your final decision.

Can my Section 457 plan account balance be rolled over into an IRA?

Section 457 plans are nonqualified,as a result, funds cannot be rolled over into an Individual Retirement Account (IRA). Proceeds from a Section 457 may only be transferred to another such plan. If you have a Section 457 plan and are leaving your government job to work in private industry, you have two choices. First, you can take the planís balance in a lump sum and pay ordinary income taxes on the distribution. Or, you can leave the balance with your previous employer until a predetermined date. If you choose to leave the Section 457 plan where it is, you avoid current income taxes and the balance will continue to grow tax-deferred. You can continue to manage the investments just as if you were still employed, but you cannot make any additional contributions. Beginning in 2002, participants may roll their 457 plan distributions to any other tax favored plan including IRAs and if the plan documents allow it, qualified plans, other 457 plans or TSAs.

 

What are the tax benefits of an IRA?

Setting up an Individual Retirement Account (IRA) to save for your golden years is beneficial for several reasons. First, you can contribute up to $2,000 a year to an IRA and -- depending on your income and marital status -- deduct the contribution on your income tax return to lower the amount of taxes you owe. Whether the contribution you make is deductible or not, the money you invest will grow inside the account tax-deferred until you begin making withdrawals. This effectively means that youíll have more and more money working for you, year after year. As an added bonus, you can invest the money just about any way you wish. If you wait until you are at least 59 1/2 and retired before you start pulling money out of the IRA, you get yet another tax break. Since your tax bracket will probably be much lower when you retire than it was when you were working, a smaller portion of the withdrawals you make will be gobbled up by the Internal Revenue Service. IRAs arenít as attractive as 401(k) plans and many other retirement programs because of the $2,000 per year limit. But if you donít qualify for one of those other plans, or if you want to supplement your savings, setting up an IRA can be a great choice. For more information, you can consult IRS Publication 590 <http://www.irs.ustreas.gov/prod/forms_pubs/pubs/p590toc.htm>, Individual Retirment Arrangements. You can download it <http://www.irs.ustreas.gov/prod/forms_pubs/pubs.html> from the IRS Web site or order by calling 1-800-TAX-FORM (829-3676).

How can I calculate my IRA deduction?

You can make an IRA contribution up to the amount of your earned income or alimony received. However, not all IRA contributions are deductible. Contributions to Roth IRAs or education IRAs are never deductible. To determine your deductible contribution, subtract your AGI (assume it is $56,000 and your married filing jointly) from the top of the phaseout rage, $63,000 in 2001, divide by $10,000 and multiply the result by $2,000. $63,000-$56,000 = $7,000, $7,000 / $10,000 = .7 and finally, .7 x $2,000 = $1,400, the maximum deductible contribution. Remember, you should always consult with your tax advisor to make certain your calculations are correct.

Do I have to itemize deductions on my income tax return to take advantage of the IRA deduction?

One of the most overlooked benefits of investing in an Individual Retirement Account is that you can take a deduction for your contribution without itemizing your tax return. No complicated paperwork is involved, but you must file Forms 1040 or 1040A rather than 1040EZ. -- Laurence I. Foster

What are the income limits on deducting contributions to an IRA?

Contributions to an Individual Retirement Account (IRA) may be fully deductible, partially deductible or non-deductible on your income tax return. It depends on a variety of factors. For the 2001 tax year: If your adjusted gross income is more than $63,000 ($43,000 for singles) and you are an active participant in an employerís pension plan, you cannot take an IRA tax deduction. However, you can make nondeductible contributions. If your adjusted gross is between $53,000 and $63,000 ($33,000 to $43,000 for singles), and you are an active participant in an employerís pension plan, you can take a partial deduction for your IRA contribution. If your spouse does not actively participate in an employerís pension plan, the spouse can deduct up to a $2,000 IRA contribution. In sum, the full $2,000 deduction is available to workers who are active participants in employer-maintained retirement plans only if their adjusted gross income (AGI) is below $33,000 for singles and $53,000 for joint filers. However, the non-active spouse can now deduct up to a $2,000 IRA contribution if the AGI of the couple is $150,000 or less and a reduced contribution for AGI between $150,000 and $160,000. The spousal IRA is not available for taxpayers with AGIs above $160,000 where on of the spouses is an active participant in an employerís plan.

Does the new tax law change the income thresholds for deductible contributions to an IRA?

Taxpayers who are covered by a retirement plan at work can deduct the full amount of a $2,000 contribution to an individual retirement account in 2001 if they file a joint return with modified adjusted gross income (AGI) of less than $53,000 or file singly with a modified AGI of less than $33,000. For every $1,000 over the income limit, the deduction amount is reduced by $200. The Taxpayer Relief Act of 1997 provides for a $1,000 annual increase in the limit through the 2002 tax year and larger annual increases after that to $80,000 for joint filers and $50,000 for individuals.

Does receiving Social Security affect my ability to make a deductible IRA contribution?

Social Security payments you receive could restrict your ability to deduct contributions to your IRA. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "If you are covered by a qualified pension plan where you work, Social Security benefits can affect your deductible contribution to an IRA. Deductibility of an IRA contribution depends on your adjusted gross income, which includes the taxable portion of Social Security benefits. So your Social Security can reduce the deductible portion of an IRA contribution."

What tax form do I use to report nondeductible IRA contributions?

If you have a nondeductible Individual Retirement Account (IRA), you must still report any contributions to it to the Internal Revenue Service. To do so, you must complete IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You must also file Form 8606 if you have received IRA distributions during the tax year and you have ever made nondeductible contributions to any of your IRAs. A Form 8606 must be completed and filed with the IRS even if you donít have to file a tax return for the year in question.

What will happen if I make a nondeductible contribution to my IRA and don't report it to the IRS?

If you make a nondeductible contribution to your IRA, you must report it by filing IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You face a $50 penalty if you don't file Form 8606, and failing to file could cause confusion between you and the IRS when you start withdrawing money from the retirement account in future. -- Laurence I. Foster

Is there a tax penalty if I contribute more than $2,000 to my IRA?

If you contribute more than $2,000 to an Individual Retirement Account (IRA), you will have to pay a penalty. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "If contributions (deductible or nondeductible) in excess of the amount allowed are made to an IRA, an excise tax equal to 6% of the excess contribution is imposed until the excess is withdrawn or used to reduce later yearsí contributions. This penalty can be avoided by withdrawing the excess amount plus interest earned before the due date for filing your tax return."

Does the new tax law change the rules for deductible contributions for married couples who participate in an employer-sponsored retirement plan and also have an Individual Retirement Account?

The Taxpayer Relief Act of 1997 loosened the restrictions on so-called spousal IRAs. Under the new law, an individual is not automatically considered a participant in an employer-sponsored retirement plan merely because his or her spouse is covered by such a plan. The spouse who isnít covered can make a deductible $2,000 IRA contribution, provided the coupleís modified adjusted gross income is less than $150,000. The deduction is reduced by $200 for every $1,000 over the $150,000 limit and phases out entirely at a modified AGI of $160,000.

Can I deduct the interest on a loan I get to make the contribution to my IRA?

If you borrow money to make a contribution to your individual retirement account (IRA), you cannot deduct the interest on the money that you borrowed. The Internal Revenue Service figures itís being generous enough by letting your IRA investments grow on a tax-deferred basis. It refuses to give you an additional tax break for finance charges you incur on a loan thatís needed to fund the investment.

Will the custodian of my IRA report my rollover to the IRS?

The Internal Revenue Service takes a keen interest in rollovers of money involving an Individual Retirement Account (IRA) and other retirement plans. Even if you cash out of a retirement plan and redeposit the funds into another IRA within the required 60 days, your custodian will report the transaction to the IRS. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "Many individuals are surprised when they receive a 1099-R from their custodian on a tax-free rollover. The practical reason, of course, is that the financial institution from which you received the funds directly cannot possibly know what you did with the funds after it made the distribution. You are required to report the rollover on your Form 1040 tax return and prove to the IRS that the funds were redeposited into another qualifying IRA account within the prescribed time limit."

According to the new tax laws, when must you begin withdrawing money from your IRA?

Distributions from an Individual Retirement Account (IRA) are required to begin by April 1 of the year following the tax year during which you reach age 70 1/2. If you do not start receiving distributions at that time or you receive an insufficient distribution after this date, a penalty tax of 50% applies to the difference between the amount you should have received and the amount you did receive. According to J.K. Lasserís "Your Income Tax" (Macmillan General Reference), the IRS may waive the penalty for insufficient withdrawals if they are due to reasonable error and if steps have been taken to remedy the situation. You must submit evidence to account for shortfalls in withdrawals and how you are rectifying the situation. The IRS has indicated that examples of acceptable reasons for insufficient withdrawals includes erroneous advice from the sponsoring organization or other pension advisors or that your own good faith efforts to apply the required withdrawal formula produced a miscalculation or misunderstanding of the formula.

What tax form will I receive if I receive pension plan, annuity or insurance distributions?

If you receive a distribution from a pension plan, annuity or insurance contract, the company that makes the payment will send you a Form 1099-R. This form also is sent when your receive payments from a profit-sharing plan, Individual Retirement Account (IRA), or other tax-favored retirement program.

What is meant by a premature distribution from a retirement plan?

When you withdraw money from a retirement plan earlier than the age required by the Internal Revenue Service (59 1/2), the money you receive is known as a premature distribution and is subject to a 10% penalty unless you qualify for an exception to the penalty.

Does the IRS still impose a 15% penalty on excess distributions from an IRA?

Older taxpayers who want to make relatively large withdrawals from their Individual Retirement Accounts got a lucrative tax break when Congress suspended the 15% penalty on so-called excess withdrawals. The Tax Relief Act of 1997 later repealed it entirely.

How will taxes be calculated if I make a lump-sum withdrawal from an IRA that includes both taxable and nontaxable contributions?

If you have made both tax-deductible and nondeductible contributions to your Individual Retirement Account (IRA) and then decide to make a lump-sum withdrawal, some of the money you pull out will be taxed and the remainder will not. Hereís an example, from "The Price Waterhouse Personal Tax Adviser" (Irwin Professional Publishing, Burr Ridge, Ill.): You have had an IRA for 10 years and now you want to make a lump-sum withdrawal. For the first eight years you made tax-deductible contributions of $2,000 each year. Your total deductible contributions: $16,000. During the last two years, you also contributed $2,000 annually, but those were nondeductible contributions. Your total nondeductible contributions: $4,000. The money you invested in the IRA generated $10,000 in profit. So altogether, you have $30,000 in the account. If you make a lump-sum withdrawal, you do not owe tax on the $4,000 in nondeductible contributions you made earlier. However, you do owe tax on the $16,000 in deductible contributions made to the account, and you also owe tax on the $10,000 in profits your investments generated. So, you are taxed on $26,000 of your $30,000 withdrawal.

What is the tax treatment of an IRA at the death of its owner?

Some complicated tax issues can arise if you die while thereís still some money left in your Individual Retirement Account. If your IRA proceeds are payable to your spouse, he or she can take the proceeds outright or may roll over the IRA account, or any part of it, into his or her own IRA account. Your spouse may also delay distribution until December 31st of the year you would have turned 70 1/2. The rollover should be direct from one account to the other. If your spouse takes the proceeds outright, no 10% penalty tax will be assessed even if the spouse is under age 59 1/2, although income taxes will be due. If the spouse rolls the proceeds directly over into an IRA of his or her own, the money from the IRA account will continue to grow tax-deferred until withdrawals begin. When the spouse eventually dies too, the assets will pass to the heirs and be subject to income taxes and (depending on the size of the estate) federal estate taxes. If the beneficiary of the IRA is not the spouse, the beneficiary may not rollover the distribution to his or her own IRA and is taxed on the distribution.

Who pays the taxes due on my IRA when I die?

When you die, your beneficiaries will pay the income tax due on distributions from your Individual Retirement Account (IRA). According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "In the event a deceased IRA ownerís account is subject to estate taxes, the beneficiary of the IRAís assets may deduct the federal estate taxes. This can be done in a lump sum or over a period of time as funds are withdrawn up to the amount of the estate tax paid on the IRA benefits. It should be noted that the deduction is of use only if the beneficiary has sufficient deductions" to itemize rather than take the standard deduction.

Can my IRA continue compounding tax-deferred after my death?

Contributing to an Individual Retirement Account (IRA) can provide you with some important tax breaks. By carefully choosing your beneficiary, you can ensure those tax breaks will keep flowing even after you die. According to "The Question and Answer Book of Money and Investing" (Adams Publishing, Holbrook, Mass.), "If you do not need to substantially deplete your IRA during your retirement, you may want to keep the tax shelter intact as long as possible for your benefit and your heirsí. Your IRA does not necessarily have to terminate at your death. Your beneficiary can maintain the IRA and retain some of the benefits of tax deferral. That is, the beneficiary must make a minimum systematic withdrawal over his or her life expectancy, but the remaining funds continue to compound tax-deferred. The rules concerning IRAs are complex, and they change frequently. Two major changes occurred in 2001, alone. Therefore, you should consult with an accountant or other tax professional before you make any significant move.

How are nonqualified Roth IRA distributions taxed?

For nonqualified distributions, contributions are always considered to be withdrawn first and come out tax-free, the earnings come out next and are taxed at ordinary income rates. If the owner is under 59 1/2, there is an additional 10% penalty on the taxable withdrawal unless certain conditions are met. Qualified distributions are tax and penalty free. A qualified distribution is a distribution, from a Roth IRA that has existed at least five years, to the Roth IRA owner who is at least 59 1/2.

How can I use my Roth IRA account to transfer assets free of estate taxes?

A Roth IRA may be useful in lowering estate taxes. This is accomplished by converting a large IRA to a Roth IRA and paying the associated income tax. For example, if an IRA account worth $1 million is converted to a Roth, which requires payment of income taxes on the transfer. The tax is $400,000 if the bracket is 40%. Paying the tax lowers the gross estate by $400,000, and the estate tax by $220,000 in 2001 and $200,000 in 2002, assuming the payer is in the highest estate tax bracket.

 

What are the rules for withdrawing from an IRA?

The rules for withdrawing money from an Individual Retirement Account (IRA) are similar to those guiding withdrawals from many other retirement plans. Most IRA investors donít start making withdrawals until they reach 59 1/2. If you withdraw money earlier, youíll get hit with a 10 percent penalty unless you qualify for a rare exception. Withdrawals are taxed at your individual tax rate, which will probably be lower after you retire than when you are working.

How is the minimum withdrawal from my IRA calculated?

Internal Revenue Service guidelines state that minimum distributions from an IRA must be taken in regular periodic installments over a specified number of years. The timeframe for these distributions canít exceed your own life expectancy, or the joint life expectancy of you and your spouse. The annual payments are calculated by dividing the balance of the ownerís account at the end of the prior calendar year by the life expectancy of the owner, or the joint life expectancy of the owner and his or her spouse if the resulting life expectancy is greater, as determined for that distribution year. Since calculating minimum withdrawals is a complicated task, itís best to get the help of an accountant or other qualified expert to make them for you.

According to the new tax laws, when must you begin withdrawing money from your IRA?

Distributions from an Individual Retirement Account (IRA) are required to begin by April 1 of the year following the tax year during which you reach age 70 1/2. If you do not start receiving distributions at that time or you receive an insufficient distribution after this date, a penalty tax of 50% applies to the difference between the amount you should have received and the amount you did receive. According to J.K. Lasserís "Your Income Tax" (Macmillan General Reference), the IRS may waive the penalty for insufficient withdrawals if they are due to reasonable error and if steps have been taken to remedy the situation. You must submit evidence to account for shortfalls in withdrawals and how you are rectifying the situation. The IRS has indicated that examples of acceptable reasons for insufficient withdrawals includes erroneous advice from the sponsoring organization or other pension advisors or that your own good faith efforts to apply the required withdrawal formula produced a miscalculation or misunderstanding of the formula.

What happens if I donít start taking money out of my retirement account at age 70 1/2?

If you donít start taking money out of your retirement account by the time you reach age 70 1/2, youíll be hit with some extremely serious tax penalties. The Internal Revenue Service will slap you with a 50 percent excise tax on the difference between what you withdrew (if anything) from the account and what you should have withdrawn. On top of that, youíll owe additional excise tax for each year you fail to make the required distribution. For example, if you should have taken $9,000 from the account but didnít take out a cent, you would owe the IRS $4,500 for that yearís requirement. If you fail to make the required distribution for the following year,assume itís $8,000, you will own another $4,000 for that year. And on top of all that, youíll owe regular income taxes on each withdrawal as well!

What is meant by a premature distribution from a retirement plan?

When you withdraw money from a retirement plan earlier than the age required by the Internal Revenue Service (59 1/2), the money you receive is known as a premature distribution and is subject to a 10% penalty unless you qualify for an exception to the penalty.

How can I take distributions from my IRA penalty-free prior to my reaching the age of 59 1/2?

In recent years Congress has added new ways to pull money out of your Individual Retirement Account (IRA) before you turn 59 1/2 and avoid paying the 10% early-withdrawal penalty.
1) Beginning in 1998, you can take distributions of up to $10,000 from your traditional or Roth IRA to buy, build or rebuild a first home without having to pay the 10% additional tax on early withdrawals.
2) You can also take distributions from your traditional IRA for qualified higher education expenses without having to pay the 10% additional tax.
3) If you are disabled, you can pull as much money as you wish out of your IRA at any age and the early-withdrawal penalty will be waived.
4) You can withdraw funds to pay pay health insurance premiums for yourself and family after the loss of a job and a minimum of 12 consecutive weeks of unemployment compensation.
5) You can use the money to pay deductible medical expenses (i.e., those in excess of 7.5% of the participantís or IRA ownerís adjusted gross income for the year).
6) Under an adjudicated domestic relations order in settlement of a divorce. 7) If you die before reaching 59 1/2, your beneficiary or estate can receive the IRA proceeds without paying the 10% penalty and will not owe income taxes until distributions begin. This exception wonít do you any good -- after all, youíll be gone -- but it would provide a nice tax break for your heirs.
8) You can start withdrawing the money early and avoid the penalty if you make withdrawals in "substantially equal" payments at least annually, either over your life or the joint lives of you and another beneficiary. People who utilize this exception are usually in dire financial straits and must follow a complex set of rules developed by the IRS. If they donít follow those rules to the letter, theyíll be hit with a 10% penalty on all their early withdrawals plus accrued interest.

What is a Qualified Domestic Relations Order (QDRO)?

A QDRO is a court-ordered disposition of marital property specifically addressing the assets in a qualified retirement plan, such as a pension account or 401(k). The QDRO creates an alternate payee and assigns the alternate payee the right to receive plan benefits payable to the plan participant. The participantís spouse, former spouse, or dependent may be designated as the alternate payee. IRAs, on the other hand, are adjudicated by divorce decree and subject to state law. Qualified plan assets are protected under ERISA (Federal law) and must be distributed according to the QDRO.

How can I transfer part of my retirement plan assets to my former spouse without paying taxes on the withdrawal?

A court ordered disposition of qualified plan assets under a QDRO will not result in a taxable transaction. A QDRO is a court-ordered disposition of marital property specifically addressing the assets in a qualified retirement plan, such as a pension plan or 401(k). The QDRO creates an alternate payee and assigns the alternate payee the right to receive plan benefits payable to the plan participant. The participantís spouse, former spouse, or dependent may be designated as the alternate payee. The QDRO allows the plan administrator to make the distribution. If the retirement plan assets are in an IRA, the division and distribution must be adjucated by the court and a distribution order made. Otherwise the distribution may be deemed a withdrawal subject to penalty and taxes.

How will taxes be calculated if I make a lump-sum withdrawal from an IRA that includes both taxable and nontaxable contributions?

If you have made both tax-deductible and nondeductible contributions to your Individual Retirement Account (IRA) and then decide to make a lump-sum withdrawal, some of the money you pull out will be taxed and the remainder will not. Hereís an example, from "The Price Waterhouse Personal Tax Adviser" (Irwin Professional Publishing, Burr Ridge, Ill.): You have had an IRA for 10 years and now you want to make a lump-sum withdrawal. For the first eight years you made tax-deductible contributions of $2,000 each year. Your total deductible contributions: $16,000. During the last two years, you also contributed $2,000 annually, but those were nondeductible contributions. Your total nondeductible contributions: $4,000. The money you invested in the IRA generated $10,000 in profit. So altogether, you have $30,000 in the account. If you make a lump-sum withdrawal, you do not owe tax on the $4,000 in nondeductible contributions you made earlier. However, you do owe tax on the $16,000 in deductible contributions made to the account, and you also owe tax on the $10,000 in profits your investments generated. So, you are taxed on $26,000 of your $30,000 withdrawal.

Can I use five-year averaging on a lump sum distribution from my Individual Retirement Account?

Five-year averaging has been repealed.

Does the IRS still impose a 15% penalty on excess distributions from an IRA?

Older taxpayers who want to make relatively large withdrawals from their Individual Retirement Accounts got a lucrative tax break when Congress suspended the 15% penalty on so-called excess withdrawals. The Tax Relief Act of 1997 later repealed it entirely.

Can I make penalty-free withdrawals from an IRA to buy medical insurance?

Losing your job is bad enough, but those problems can be compounded if your medical insurance disappears along with your paycheck. Since 1997, some workers who lose their jobs have been able to make penalty-free withdrawals from their Individual Retirement Account (IRA) to defray the cost of buying medical coverage. According to J.K. Lasserís "Your Income Tax" (Macmillan General Reference), "After 1996, unemployed individuals who have received unemployment benefits under federal or state law for at least 12 weeks may make penalty-free IRA withdrawals to the extent of medical insurance premiums paid during the year. The withdrawals may be made in the year the 12-week unemployment test is met, or in the following year. However, the penalty exception does not apply to distributions made more than 60 days after the individual returns to the work force." Self-employed persons -- who are ineligible for unemployment benefits -- now can also make penalty-free withdrawals from an IRA to pay their insurance premiums.

 

PROFESSIONAL PARALEGAL PROVIDERS
1600 Sawtelle Blvd., Suite 101
Los Angeles, California 90025

Tel: (310)268-1060

Fax:(310)268-1686

© 2003 PPP.  All rights reserved.