Bryant - Course 5. Retirement Planning & Employee Benefits. 5. Other Tax-Advantaged Retirement Plans Flashcards
It really does not matter whether you are two months, two years, or even 20 years away from retirement: It is never too early or too late to start planning, and planning for retirement may yield rich dividends.
A good retirement plan would be one that offers maximum benefits and minimizes taxes. There are some factors, however, which should be taken into consideration before opting for a retirement plan such as distribution options, investment options, or others.
The Other Tax-advantaged Retirement Plans and Keoghs module, which should take approximately six hours to complete, will discuss the different retirement plan options and explain the usage, advantages and disadvantages of each plan type.
Upon completion of this module, you should be able to:
* List the different kinds of retirement plans,
* Explain the usage and utility of each of these plans,
* State the advantages and disadvantages of the plans,
* Highlight the tax implications of the plans, and
* Explain how they can be implemented and what their requirements are.
Module Overview-
A retirement plan offers financial security for people after retirement. Most retirement plans allow savings to grow tax free, which is an added incentive. There are different retirement plan options. Some of these options are Traditional IRA, Roth IRA, Simplified Employee Pension (SEP) plan, SIMPLE IRA, Tax Deferred Annuity (TSA) or 403(b) plan, and Keogh plan.
A Traditional IRA is a type of retirement savings arrangement under which investment earnings are tax deferred. In some cases, the contribution is tax deductible.
A Roth IRA is a form of IRA under which contributions may be made up to a specified limit on a nondeductible basis, but withdrawals may be tax free under certain conditions.
A SEP is an employer-sponsored retirement plan that allows an employer to make contributions to their own as well as employees’ retirement accounts.
SIMPLE IRAs are employer-sponsored plans too. Tax-deferred contribution levels are significantly higher in this plan than they are for Traditional and Roth IRAs.
A TSA or 403(b) plan is a tax deferred employee retirement plan that is restricted to certain tax-exempt organizations and public school systems.
A Keogh plan is a qualified, tax-deferred retirement savings plan that is set up for a non-incorporated business entity such as a sole-proprietor or partnership. It differs from other qualified plans only in how the owner or partner is treated regarding contribution limits and distributions.
To ensure that you have a solid understanding of Other Tax-advantaged Retirement Plans and Keoghs, the following lessons will be covered in this module:
* Traditional IRA
* Roth IRA
* Simplified Employee Pension (SEP)
* TSA or 403(b) Plan
* SIMPLE IRA
* HR 10 Keogh Plan
Section 1 - Traditional IRA
A traditional IRA (IRA stands for either individual retirement account or individual retirement annuity) is a type of retirement savings arrangement under which IRA contributions, up to certain limits, and investment earnings are tax-deferred. This means that interest earned and gains received inside the traditional IRA are free of federal income tax until withdrawn from the IRA.
Traditional IRAs are primarily plans for individual savings, rather than employee benefits. However, their features are important because they fit into an employee’s overall retirement savings plan and therefore influence the form of employer retirement plans to some degree.
Employers can sponsor traditional IRAs for employees as a limited alternative to an employer-sponsored qualified retirement plan. Employers who have a qualified plan can also sponsor a deemed IRA as part of the qualified plan, to provide an additional form of retirement savings for employees.
To ensure that you have a solid understanding of the traditional IRA, the following topics will be covered in this lesson:
* When Is It Used?
* Advantages
* Disadvantages
* Tax Implications
* Spousal IRA
* Education IRA
Upon completion of this lesson, you should be able to:
* Explain when a traditional IRA is used,
* Describe its advantages and disadvantages,
* Explain its tax implications,
* Point out distribution and rollover rules,
* Explain who qualifies for an education IRA, and
* Explain the benefits of a spousal IRA.
When are Traditional IRAs Used?
Traditional IRAs are plans for individual savings. The interest earned and the gains received from traditional IRAs are free from income tax during the accumulation stage.
A traditional IRA is used in different situations. These include:
* When there is a need to shelter current compensation or earned income from taxation.
* When it is desirable to defer taxes on investment income.
* When long-term accumulation, especially for retirement purposes, is an important objective.
* When a supplement or alternative to a qualified pension or profit sharing plan is needed.
When is an IRA used? (Select all that apply)
* For long-term accumulation.
* To defer taxes on investment income.
* As an alternative to a nonqualified pension.
* To shelter earned income from taxation.
For long-term accumulation.
To defer taxes on investment income.
To shelter earned income from taxation.
IRAs are used:
* for long-term accumulation,
* to defer taxes on investment income,
* as an alternative to a qualified pension, and
* to shelter earned income from taxation.
What are the Advantages with a traditional IRA?
Eligible individuals may contribute up to the maximum annual contribution amount to a traditional IRA, as shown in the table below, and up to the maximum annual contribution amount for a spouse if a traditional spousal IRA is available. This amount may also be deductible from the individual’s current taxable income.
Note: The Tax Cuts and Jobs Act changed the tax treatment of alimony paid pursuant a divorce decree finalized after December 31, 2018. In such cases, alimony is no longer taxable to the recipient or deductible by the payor. Alimony payments pursuant divorces finalized prior to January 1, 2019 are grandfathered in the previous law and payments continue to be taxable to the recipient and deductible by the payor.
Investment income earned on the assets held in a traditional IRA is not taxed until it is withdrawn from the account. This deferral applies no matter what the nature of the investment income. It may be in the form of interest, dividends, rents, capital gain or any other form of income. Such income is taxed only when it is withdrawn from the account and received as ordinary income.
The maximum annual contribution amount for an IRA is $6,500 (2023).
For individuals who have attained age 50 before the close of the tax year, an additional contribution of $1,000 amount is allowable. The resulting total maximum contribution amount is $7,500 (2023).
The SECURE Act of 2019 eliminated the age limit for making IRA contributions.
Exam Tip:
* A person needs earned income or taxable alimony to contribute to an IRA.
Practitioner Advice:
* The changes to the IRA contribution levels are significant and can play an important role in planning for retirement.
What are the Disadvantages of The traditional IRA?
The traditional IRA deduction is limited to the maximum contribution amount each year.
If a person is single and is not an active participant in an employer-sponsored plan, he or she can contribute and deduct the lesser of 100% of earned income or $6,500 for 2023 (not including the over 50 catch-up provision).
If a married couple filing a joint return does not participate in an employer-sponsored plan, each person can contribute and deduct the lesser of 100% of income or $6,500 (2023).
If one party to the marriage earns less than $6,500, the person might still be able to contribute and deduct depending on the spousal IRA requirements.
The disadvantages of a traditional IRA include:
* Withdrawals are subject to the 10% penalty on premature withdrawals applicable to most tax-favored retirement plans (there are a few exceptions).
* Withdrawals are not eligible for the special-averaging tax computation that applies to certain lump sum distributions from qualified plans.
* Withdrawals from the account are required by April 1 of the year after the year in which the individual reaches age 73 (2023).
What are the Tax Implications of a traditional IRA?
It is important to understand the tax implications of a traditional IRA. You specifically need to understand how contributions, distributions and rollovers affect their taxation.
What are the Contribution Rules for a Traditional IRA?
An individual may make regular contributions to an IRA annually up to the lesser of $6,500 (2023), or 100% of compensation income.
- Taxpayers age 50 and above are allowed an additional $1,000 as a catch-up contribution.
- A spouse without compensation income can contribute to an IRA based on their spouse’s compensation income.
What are the Deduction Limits for a traditional IRA?
The maximum annual deductible IRA contribution for an individual is the lesser of the maximum annual contribution amount or 100% of the individual’s earned income.
* This covers income from employment or self-employment.
* It does not include investment income.
A provision for traditional spousal IRAs permits additional contributions up to an additional maximum annual contribution amount for the spouse in some cases.
Assuming the active participant restrictions do not apply, the maximum allowable deductible contribution in the year 2023 is the lesser of:
$6,500, or
100% of includable compensation plus 100% of includable compensation of a spouse minus the amount of the deduction taken by the spouse for IRA contributions for the year.
* In order to contribute to a traditional spousal IRA, the couple must file a joint return.
If both spouses have earned income, each can have a traditional IRA. The maximum deduction limit for each spouse with earned income is the maximum annual contribution amount/100% limit.
* However, traditional IRA contribution limits are combined with those for Roth IRAs.
* The maximum annual contribution amount is reduced for each dollar contributed by the same taxpayer to a Roth IRA. For example, if John, age 30, earned $20,000 and wants to contribute to both a traditional IRA and a Roth IRA, he can do it, but the total IRA contributions cannot exceed $6,500.
Exam Tip:
* Alimony received pursuant to a divorce finalized prior to January 1, 2019, is considered compensation for IRA contribution purposes.
Describe the Active-Participant Restrictions on the deductibility of traditional IRA
Current law imposes income limitations on the deductibility of traditional IRA contributions for those persons who are active participants in an employer-sponsored retirement plan.
* This includes all qualified retirement plans, simplified employee pensions (SEPs), Section 403(bs) tax-deferred annuity plans, or SIMPLE IRAs.
If an otherwise eligible person actively participates in the employer plan, the available traditional IRA deduction is reduced below the maximum annual contribution amount if the AGI of the taxpayer is within the phaseout ranges indicated below, with the deduction eliminated entirely if the AGI is above the upper limit of the phaseout range.
IRA ACTIVE PARTICIPANT AGI PHASE-OUT RANGES
The reduction in the maximum annual deductible contribution amount in the phase-out AGI region is proportional to the amount by which the AGI exceeds the lower limit.
* For example, suppose that in 2023 a single taxpayer’s AGI is $76,000, and he is an active participant under age 50. The taxpayer is $3,000 into the phase-out range of $73,000 - $83,000, so his annual traditional IRA deduction is reduced by $3,000/$10,000, or 30%.
* This is a reduction of $1,950 (30% of $6,500), so the maximum IRA deduction is $4,550 ($6,500 less $1,950).
* For MFJ taxpayers, both active participants in an employer-sponsored plan, the deduction phase-out is $116,000 - $136,000 (2023).
An individual is not subject to the active participant restrictions just because his or her spouse is an active participant in an employer-sponsored retirement plan. However, this provision phases out for joint adjusted gross incomes from $218,000 to $228,000 (2023) for the non-active participant spouse. The active participant spouse is subject to the MFJ phase-out threshold of $116,000 and $136,000.
Chris and Pat are MFJ taxpayers. Chris, but not Pat, actively participates in an employer-sponsored qualified plan. Chris and Pat earn $120,000 and 70,000, respectively. Pat may contribute and deduct up to $6,500 to an IRA because their AGI is less than $218,000. Chris may contribute (but not deduct) up to $6,500 to an IRA because their AGI is greater than $136,000. However, if Chris and Pat’s MAGI was greater than $228,000 in 2023, each may contribute, but neither one could claim a deduction.
Single - $73,000 - $83,000
Married filing joint $116,000 - $136,000
Married filing separately $0 - $10,000
Exam Tip:
* Participation in a 457 plan will not affect the deductibility of an IRA contribution. A participant in a Section 457 plan is not considered an active participant for IRA contribution deduction purposes.
Practitioner Advice:
* The definition of an Active Participant is that the taxpayer either received any annual additions within a defined contribution plan during the year or was eligible for any benefits in a defined benefit plan during the year.
* Annual additions consist of employer contributions, employee contributions, or reallocated forfeitures.
Participation in which of the following retirement plans may affect the deductibility of an IRA? Click all the apply.
* SEP
* Qualified retirement plan
* 457 plan
* Section 403(b) tax-deferred annuity plan
* Nonqualified retirement plan
* SMIPLE IRA
SEP
Qualified retirement plan
Section 403(b) tax-deferred annuity plan
SMIPLE IRA
* Not 457 plan or Nonqualified retirement plan
* Current law imposes income limitation on the deductibility of traditional IRA contributions for those persons who are “active participants” in an employer retirement plan that is tax-favored. This includes a qualified retirement plan, simplified employee pension (SEP), Section 403(b) tax-deferred annuity plan or SIMPLE IRA.
Describe Nondeductible Traditional IRAs
An individual or married couple can also make nondeductible traditional IRA contributions, within limits. The limit is the same regardless of income level. It is the excess of the maximum annual contribution amount over the amount deductible. If the individual or couple makes no deductible contributions, they can contribute up to the maximum annual contribution limit in the case of an individual, and up to an additional maximum annual contribution amount in accordance with the spousal IRA rules, on a nondeductible basis.
Nondeductible contributions will be free of tax when they are distributed, but income earned on such contributions will be taxed.
* If nondeductible contributions are made to a traditional IRA, amounts withdrawn will be treated as partly tax free and partly taxable.
It is important that good records be kept of non-deductible contributions as they will be necessary in the future when withdrawals are taken.
* The IRS will assume all money withdrawn from traditional IRA accounts to be fully taxable.
* It is the taxpayer’s job to prove that contributions were made with after tax dollars and therefore not taxed when removed.
Non-deductible IRA account are usually used when no deductible contributions (or Roth-IRA) contributions can be made. Non-deductible IRA’s have the option to convert to Roth-IRA accounts in the future if the taxpayer qualifies for Roth-IRA conversions.
Describe Time Limits
with a Traditional IRA
Eligible persons can establish an IRA account and claim the appropriate tax deduction any time prior to the due date of their tax return, without extensions even if the taxpayer actually receives an extension of the filing date. For most individuals or married couples, the contribution cutoff date is April 15.
* However, since earnings on an IRA account accumulate tax free, taxpayers may want to make contributions as early as possible in the tax year.
* The advantage of making an IRA contribution at the beginning of the year can be seen in the following table, which assumes $5,000 annual contributions and an annualized rate of return of 8%.
Years of Growth Beginning of Year January 1 End of Year January 1 Advantage of Early Contributions
5 $30,766 $28,754 $2,012
10 $73,918 $69,082 $4,836
15 $134,440 $125,645 $7,795
20 $219,326 $204,977 $14,349
25 $338,382 $316,245 $22,137
30 $505,365 $472,304 $33,061
35 $739,567 $691,184 $48,383
40 $1,068,048 $998,176 $69,872
45 $1,528,759 $1,428,747 $100,012
Practitioner Advice:
* A taxpayer can file his or her tax return and claim an IRA deduction even before the actual contribution is made. The taxpayer must contribute the amount reported by the tax filing due date.
What are the Distribution and Rollover Rules for IRAs?
There are certain distribution and rollover rules for IRAs that the premature distribution penalty does not apply to:
* Distributions made on or after attainment of age 59½,
* Distributions made to the IRA participant’s beneficiary or estate on or after the participant’s death,
* Distributions attributable to the participant’s disability,
* Distributions that are part of a series of substantially equal periodic payments made at least annually over the life or life expectancy of the participant, or the participant and a designated beneficiary,
* Distributions for medical expenses that exceed 7.5% of the taxpayer’s AGI. (For example, if a taxpayer had a $100,000 AGI, the penalty would not apply to distributions for medical expenses above $7,500.),
* Distributions to unemployed individuals for health insurance premiums under certain conditions,
* Distributions for higher education costs including tuition, fees, books, supplies and equipment for the taxpayer, spouse, child or grandchild, and
* Distributions to pay acquisition costs of a first home for the participant, spouse, child, grandchild or ancestor of the participant or spouse, up to a $10,000 lifetime maximum.
List Premature Distribution Penalties that do not Apply to IRAs
- Age. Distributions made on or after the attainment of age 59 ½.
- Death. Distributions to participant’s beneficiary or estate on or after the participant’s death.
- Disability. Distributions attributable to the participant’s disability.
- Annual Payments. Part of a series of equal periodic payments over the life expectancy of the participant/beneficiary.
- Medical Care. Within the 7.5% of itemized deduction floor.
- Unemployed Individuals. For health insurance premiums.
- Higher Education. Includes tuition, fees, books, supplies and equipment for the taxpayer, spouse, child, or grandchild.
- Home. Acquisition cost of a first home for the participant, spouse, child, grandchild or ancestor of the participant or spouse, up to $10,000 lifetime maximum.
What is the Penalty for early withdrawals from IRAs?
The government penalizes certain early withdrawals from IRAs.
The premature distribution penalty is 10% of the taxable amount withdrawn from the IRA.
Therefore, IRA contributions should be made from funds that can be left in the account until one of the nonpenalty events listed in the screen above on distributions and rollovers occurs.
When do Distributions from IRAs Begin?
Distributions must begin by no later than April 1 of the year after the year in which age 73 (2023) is reached.
* The SECURE Act of 2019 changed the required beginning date for required minimum distributions to age 73.
* The former rules continue to apply to employees and IRA owners who attained age 70½ prior to January 1, 2020.
* The new provision is effective for distributions required to be made after December 31, 2019, with respect to individuals who attain age 73 after December 31, 2019.
Distributions from qualified pension, profit sharing and employer stock plans and Section 403(b) tax-deferred annuity plans are subject to numerous special rules and distinctive federal income tax treatment.
Advance consideration of all the potential implications of plan distributions is an important part of overall plan design.
Exam Tip:
* If a client waits and takes a minimum distribution on April 1st of the year after the year in which age 73 is reached, the client must take two distributions that year.
Describe Rollovers in IRAs
An IRA can be used to receive a rollover of certain distributions of benefits from employer-sponsored retirement plans. Asset can either be directly transferred from trustee to trustee or they can be distributed out to the participant who has sixty days to deposit them to a new trustee.
For purposes of this course, the following definitions will apply:
Transfer:- A direct movement of assets from one custodian or plan to another custodian or plan, i.e. a trustee to trustee transfer
Rollover: Assets are distributed directly to the participant
(In real life, the difference is often determined by who the distribution check is made out to: the participant or the new custodian or plan)
Trustee to trustee transfers may be effected whenever and as often as the taxpayer likes.
Rollovers may only occur once every twelve months for the assets involved.
Practitioner Advice:
* The federal spousal consent requirements enacted under the Retirement Equity Act of 1984 only apply to qualified plans, not to IRAs.
* This means that all pension plans must automatically provide survivorship benefits for a spouse, unless the spouse opts out in writing.
* However, spousal consent may be required when a qualified plan distribution is rolled over to an IRA, but distributions thereafter can be made without spousal consent.
* A spouse’s property rights in an IRA account are a matter of state law, and may differ depending on whether the state is a common law or community property state.
What happens When an IRA Owner Dies?
When an IRA owner dies, a complex pattern of tax rules applies. Planners need to understand the tax treatment of this common situation to prevent unnecessary tax penalties for their clients.
These rules are designed to prevent IRA distributions from being stretched out unduly to increase tax deferral.
The Secure Act of 2019 made significant changes to the rules pertaining to required distributions for beneficiaries who inherit an IRA or a defined contribution qualified plan account. Under previous law, a beneficiary could stretch the required minimum distributions over their remaining life expected. The first beneficiary could name their own beneficiary who could also stretch the required distribution of any remaining account balance over their respective remaining life expectancy. This “stretching” could conceivably go on for generations and minimize the taxes paid.
The Secure Act of 2019 essentially did away with the “stretch IRA” strategy.
* Unless the beneficiary is an “eligible designated beneficiary,” the entire inherited account balance must be distributed within 10 years after the date of death.
* This applies regardless of whether the employee or owner dies before or after RMDs have begun.
The new law excepts from the 10-year rule distributions to** “eligible beneficiaries,” which include**:
* Surviving spouses
* Chronically ill or disabled beneficiaries
* Minor children, up to the age of majority (not grandchildren)
* Individuals not more than 10 years younger than the IRA owner (such as a sibling)
This special rule allows distributions to “eligible beneficiaries” to be made over the life or life expectancy of the eligible beneficiary beginning in the year following the year of death.
* In the case of a child who has not reached the age of majority, calculation of the RMD under the exception is only allowed through the year the child reaches the age of majority.
* The 10-year rule applies after a child reaches the age of majority or after the death of an eligible beneficiary.
* Prior law applies to distributions to surviving spouses.
* Distributions may be delayed until the end of the year that the employee or owner would have turned 72.
* If the spouse dies before distributions were required to begin to the spouse, the surviving spouse is treated as the employee or owner in determining the required distributions to beneficiaries of the surviving spouse.
These provisions are generally effective for RMDs with respect to employees or owners with a date of death after December 31, 2019.
Describe a Spousal IRA
If a person is married, files a joint return, and has little or no earned income, an IRA can be set up for that person subject to the regular contribution and deductibility rules based on the spouse’s earned income.
* In a spousal IRA, if one spouse is not covered by an employer-sponsored retirement plan, and files a joint return, that spouse may be able to deduct all of his or her contributions to a traditional IRA even if his or her spouse is covered by a plan.
* To qualify, the couple’s AGI needs to be under the current $218,000 - $228,000 (2023) threshold.
For example, Minnie (age 35) and Bill (age 40), a married couple, earn $75,000 annually. Neither is an active participant in any qualified plan, SEP, Section 403(b) plan, or SIMPLE IRA. For 2023, Minnie and Bill can each contribute and deduct up to $6,500 to their own IRA plan (a total of $13,000 combined).
Another example: Mabel earns $75,000 annually. Her husband, Al, has no earned income, although he has investment income in excess of $100,000 annually. Neither spouse has attained age 50 and neither is an active participant in an employer-sponsored retirement plan. Mabel can contribute and deduct up to $6,500 to an IRA for her and Al may contribute and deduct up to $6,500 to an IRA based on Mabel’s income, for a total of $13,000, provided they file a joint return.
Describe the Coverdell ESA
The Education IRA was renamed the Coverdell Education Savings Account in 2001.
* A Coverdell ESA is a trust or custodial account that is created for the express purpose of funding the qualified education expenses of the designated beneficiary.
* The designated beneficiary of a Coverdell ESA must be a life-in-being at the time it is established.
* Contributions that cannot exceed the annual cumulative limit of $2,000 must be made in cash, and are not tax-deductible.
In addition, contributions must be made on or before the date on which the beneficiary attains the age of 18.
The contribution limit is phased out for single contributors with AGI between $95,000 and $110,000 (2023).
This means that no contribution is available for a single taxpayer with AGI above $110,000.
The phase-out for joint filers is between $190,000 and $220,000 (2023).
Distributions from an education IRA that are made for the payment of qualified higher education expenses are penalty-free and tax-free.
* Qualified higher-education expenses are defined as tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible higher-education institution. An eligible higher education institution is any college, university, vocational school, or other postsecondary educational institution described in Section 481 of the Higher Education Act of 1965.
Distributions can also be used for elementary and secondary public, private or religious school expenses.
Generally, contributions to an Coverdell ESA must be made on or before the beneficiary attains what age?
* 14
* 16
* 18
* 21
18
- Contributions must be made on or before the date on which the beneficiary attains the age of 18.
Section 1 - Traditional IRA Summary
An individual retirement account allows a person to save money for use after retirement. At the same time, it allows the savings to grow tax-free. Funds in an IRA can be invested in stocks and bonds. But, there are serious limitations on investments. These limitations include investing in life insurance and collectibles.
In this lesson, we have covered the following:
* Traditional IRA is used to protect earned income and investment income from taxation and when an alternative or a supplement to a qualified pension is needed.
* Advantages of traditional IRA include potential tax deductibility and deferral of taxes.
* Disadvantages include limitations on or no tax deduction for persons or spouses who have a tax-favored employer retirement plan. Moreover, traditional IRA withdrawals are subject to a 10% penalty on premature withdrawals, and these withdrawals are not eligible for averaging tax computation.
- Tax Implications of a traditional IRA are as follows. A nonactive participant spouse filing a joint return may receive a full IRA deduction if joint income is less than $198,000. The nonparticipant spouse may receive a partial deduction if joint income is between $198,000 and $208,000.
- Spousal IRA the same tax implications apply if one spouse is not covered by an employer retirement plan, provided they file a joint return. The non-covered spouse may be able to deduct all of his or her contributions to a traditional IRA in this situation as long as the couple’s AGI is less than $198,000. A partial contribution may be possible if AGI is between $198,000 and $208,000.
- Coverdell ESA is a trust or custodial account that is created to fund the qualified education expenses of the designated beneficiary. Distributions for qualified higher educational expenses from an education IRA are penalty free and tax-free. Qualified higher education expenses include tuition, fees, books, supplies and equipment required for enrollment or attendance at an eligible higher education institution, and now also for elementary and secondary public, private or religious school expenses.
Which of the following are advantages of traditional IRAs? (Select all that apply)
* Eligible individuals can contribute up to the maximum annual contribution amount to a traditional IRA
* This amount may be deducted from their current taxable income
* Investment income earned on the assets held in a traditional IRA is not taxed until it is withdrawn from the account
* Traditional IRAs do not have the early withdrawal penalty
Eligible individuals can contribute up to the maximum annual contribution amount to a traditional IRA
This amount may be deducted from their current taxable income
Investment income earned on the assets held in a traditional IRA is not taxed until it is withdrawn from the account
* Eligible individuals can contribute up to the maximum annual contribution amount to a traditional IRA, and the amount may be deducted from their current taxable income. Income earned from the assets in a traditional IRA is not taxed until it is withdrawn (subject to the 10% early withdrawal penalty).
Dan, age 56, wants to contribute the maximum allowable amount to his IRA account for 2021. His MAGI is $167,000 and he actively participates in his 401(k) plan. What amount can he contribute?
* $0
* $1,000
* $6,000
* $7,000
$7,000
* He can contribute $7,000, the $6,000 regular contribution and an additional $1,000 as a “catch-up” contribution as he age 50 or older. He may not be able to deduct his contribution but he can make it.
Assume that Mr. And Mrs. Stevens are both participants in qualified retirement plans and that their combined modified adjusted gross income (MAGI) for 2021 is $180,000. Which of the following statements is true?
* They may not contribute funds to an IRA
* They may make a contribution to an IRA, but the contribution is limited
* They may make a contribution to an IRA, but it will not be deductible
* They may make a contribution to an IRA, but only to the extent allowed under Code Section 415
They may make a contribution to an IRA, but it will not be deductible
* For married filing jointly taxpayer who are both participants in an employer-sponsored retirement plan, the deduction for traditional IRA contributions is fully phased out at MAGI of $125,000 (2021). However, they can make nondeductible contributions to the traditional IRA within limits.
Benefit payments from a traditional IRA must begin by:
* April 15th following the calendar year in which the participant turns 70½
* April 1st following the calendar year in which the participant turns 72
* Between the ages of 72 and 75, depending on the IRA contract provisions
* When the participant separates from service
April 1st following the calendar year in which the participant turns 72
- Distributions must begin by April 1 of the year after the year in which age 72 is attained.
- If the first RMD is deferred until April 1 of the year following the year in which age 72 is attained, the participant will be required to make two RMDs that year; one distribution by April 1 and the second by December 31.
A person who has only investment income can contribute to an IRA.
* False
* True
False
* A person needs to have earned income to be able to contribute to an IRA.
Section 2 - Roth IRA
A Roth IRA is a form of IRA under which contributions may be made up to a specified limit on a nondeductible basis, but withdrawals are tax free within certain limitations.
Roth IRAs, like traditional IRAs, are primarily plans of individual savings. They are an alternative form of an individual retirement plan. While they are not employee benefits, benefit planners should understand their features because they fit into an employee’s plan of retirement savings and therefore need to be coordinated with other employer retirement plans.
To ensure that you have a solid understanding of the Roth IRA, the following topics will be covered in this lesson:
* When Is It Used?
* Advantages
* Disadvantages
* Tax Implications
Upon completion of this lesson, you should be able to:
* Explain when a Roth IRA is used,
* Point out advantages and disadvantages of a Roth IRA,
* Point out the differences between a traditional IRA and Roth IRA,
* Describe the tax implications of a Roth IRA,
* Define the distribution rules of a Roth IRA, and
* Describe the rollover rules guiding Roth IRA plans.
BIF Bites Podcast: work through Roth IRA practice question (1:57–11:07)
Mike and Jerry work through a Roth IRA practice question (1:57 – 11:07).
https://soundcloud.com/bif-bites/study-plans-quiz-scores-roths
When are Roth IRAs Used?
Roth IRAs are applicable in certain situations and are used when:
* It is desirable to defer taxes on investment income,
* Long-term accumulation, especially for retirement purposes, is an important objective, and
* A supplement or alternative to a qualified pension or profit-sharing plan is needed.
The Roth IRA is used as an alternative to a traditional IRA when the particular tax benefits available under the Roth IRA are better suited to the individual’s planning needs than the tax benefits from a traditional IRA.
- The Roth IRA may provide slightly more money at retirement depending on future tax brackets.
- However, individual circumstances may dictate otherwise. The figure depicted below shows a comparison of various features of Roth and traditional IRAs.
Comparison of Traditional and Roth IRA:
Using the table above, answer the following questions:
* Can a Roth IRA roll over to a traditional IRA?
* Are withdrawals tax-free in a traditional IRA?
* When do the required minimum distributions start in a Roth IRA?
* Does a Roth IRA have a tax-free buildup during the accumulation period?
- Can a Roth IRA roll over to a traditional IRA? NO
- Are withdrawals tax-free in a traditional IRA? NO
- When do the required minimum distributions start in a Roth IRA? NO RMD
- Does a Roth IRA have a tax-free buildup during the accumulation period? YES
What are the Advantages of Roth IRAs?
Eligible individuals may contribute up to $6,500 in 2023 to a Roth IRA. Participants aged 50+ may contribute an additional $1,000.
Contributions, called basis, can be redeemed from the Roth-IRA at any time without tax liability or penalty.
All growth and income (gains) generated inside a Roth-IRA are tax-sheltered. Earnings from the account can be distributed tax-free if two requirements are satisfied: 1)The account has existed for at least five years 2) One of the following circumstances is associated with the distribution:
* upon the death of the owner
* the owner is disabled
* the distribution is for a first-time home purchase ($ 10,000-lifetime limit), or
* the owner is age 59 1/2 or older
If the two requirements are both satisfied the initial investment, as well as all investment income, capital gains, or other gains, would be entirely tax-free at the time of withdrawal.
There are several differences between traditional IRAs and Roth IRAs. Unlike traditional IRAs, Roth IRA contribution eligibility is not restricted by active participation in an employer’s retirement plan.
There is no age limit for Roth IRA contributions.
* Roth IRAs are not subject to minimum distribution rules until the death of the Roth IRA owner.
* For traditional IRAs, required minimum distribution (RMD) rules apply upon attainment of age 73.
* Moreover, minimum distributions from traditional IRAs are generally taxable.
Assuming the 5-year holding period has been met, when are withdrawals from a Roth IRA tax-free in their entirety? Click all that apply.
* After age of 55
* Upon death or disability
* After a three-year wait
* First-time home-buying expense
Upon death or disability
First-time home-buying expense
Withdrawals are tax-free in their entirely in a Roth IRA: After a five-year wait, and either:
* Upon death or disability
* First time home-buying expense
* After the age of 59 ½
What are the Disadvantages of Roth IRAs?
The Roth IRA contribution is limited each year for each individual.
* The limit is reduced for single annual Modified Adjusted Gross Income (MAGI) above $138,000 (2023) and eliminated entirely for a single filer with MAGI of $153,000 (2023) or more.
* The corresponding limits for joint-return filers are $218,000 and $228,000 (2023).
Premature Roth IRA withdrawals in excess of contributions are taxed in full and are also subject to a 10% penalty on early withdrawal similar to that applicable to traditional IRAs.
Practitioner Advice:
* Unlike a traditional IRA, distribution from a Roth IRA are first considered return of principal and thus nontaxable, even before age 59½.
What are the tax implications of Roth IRA plans?
The tax implications of Roth IRA plans are explained by taking into consideration the following:
* Contribution rules that set the annual dollar limit on contributions and the phaseout that is applicable for taxpayers with higher adjusted gross incomes. These rules also set the time limits for establishing a Roth IRA account, the nonrefundable credit that is available to certain lower-income taxpayers and the employer’s alternative of sponsoring Roth IRAs for employees.
* Distribution rules that specify if Roth IRA distributions are tax-free or taxable. These rules also define the minimum distribution requirements, rollovers and conversions from Roth IRA plans.
What is the maximum Contribution to a Roth IRA?
The maximum Roth IRA contribution for an individual is the lesser of $6,500 or 100% of the individual’s earned income, less contributions to traditional IRAs (not including rollovers to such IRAs).
For example, in 2023, if an individual under age 50 contributes $3,500 to a traditional IRA, then no more than an additional $3,000 can be contributed to a Roth IRA. Earned income means income from employment or self-employment. Investment income is not counted.
Earned income is computed the same way for both traditional and Roth IRAs. For example, taxable alimony payments are included for both types of IRAs.
Assume that in 2023, Kate, age 35, contributes $2,000 to a traditional IRA. Kate’s AGI is $50,000. How much can she contribute to a Roth IRA for 2023 if the payment is made before April 15, 2024?
* $6,500
* $0
* $4,000
* $4,500
$4,500
* The maximum Roth-IRA contribution for an individual is the lesser of the dollar limit for 2023 ($6,500) or 100% of the individual’s earned income.
* Since Kate has contributed $2,000 to a traditional deductible IRA, she can only contribute an additional $4,500($6,500-$2,000=$4,500) to a Roth IRA for 2023.
For who and How much is the “catch-up contribution”?
For individuals who have attained age 50 before the close of the tax year, an additional dollar amount is allowable. This is known as a “catch-up contribution”.
In 2023, the age 50 catch up election is $1,000. For individuals age 50 or older, the largest contribution to a traditional and/or Roth-IRA is $7,500 a year including any catch-up contribution.
Exam Tip:
* If the MAGI for a given client allows for a contribution to a Roth IRA and an above-the-line deduction for a Traditional IRA, the total combined annual contribution cannot exceed the limits of $6,500 (2023), and an over-50 catch-up of $1,000, or the total taxable compensation (if less than the contribution limits).
What is the AGI Phaseout for Roth IRAs?
The contribution limit described in the previous screen is phased out for taxpayers with higher adjusted gross incomes.
The phase-out MAGI limits for 2023 are:
* Single Filers $138,000-$153,000
* Married joint return filers $218,000-$228,000
* Married separate filers $0-$10,000
The adjusted gross income used for these limits is modified AGI, which excludes taxable income from a conversion of a traditional to a Roth IRA.
The reduction in the dollar limit in the phase-out AGI region is proportional to the amount by which the AGI exceeds the lower limit. For example, suppose that a single taxpayer’s 2023 MAGI is $145,500.
* The taxpayer is halfway into the $15,000 phase-out threshold, so their annual contribution limit for 2023 is reduced by half of the maximum amount (½ of $6,500, or $3,250).
What are the contribution Time Limits for a Roth IRA?
As with a traditional IRA, eligible persons may establish a Roth IRA account any time prior to the due date of their tax return, without extensions, even if taxpayers actually receive an extension of the filing date.
For most individuals or married couples, the contribution cutoff date is April 15th.
However, since earnings on a Roth IRA account accumulate tax-free, taxpayers may want to make contributions as early as possible in the tax year.
There is no maximum age limit to make Roth IRA contributions, as long as the taxpayer has compensation income at least equal to the Roth contribution, up to the annual limit.
What is the contribution deadline for a Roth IRA?
* December 31st
* April 15th
* April 1st
* January 1st
April 15th
- For most individuals or married couples, the contribution cutoff date is April 15th. However, since earnings on a Roth IRA account accumulate tax-free, taxpayers may want to make contributions as early as possible in the tax year.
Describe Employer-sponsored Roth IRAs
Employers can sponsor Roth IRAs for employees as a limited alternative to an employer-sponsored qualified retirement plan. Employers who have a qualified plan can also sponsor a deemed IRA as part of the qualified plan, to provide an additional form of retirement savings for employees.
An IRA can be made available to any employee or a discriminatory group of employees. Contributions to the IRA can be made either as additional compensation from the employer or as a salary reduction elected by the employee.
* If the employer contributes extra compensation, it is taxable to the employee, but the employee may be eligible for the IRA deduction.
* The maximum annual contribution limit for an employer-sponsored IRA is the same as for traditional individual IRAs.
With a Roth IRA, the employee will elect a voluntary employee contribution that will not reduce the employee’s salary.
Describe Qualified Roth Contribution Programs
Employers may amend their Section 401(k) or Section 403(b) plan to provide that participants’ elective deferrals may be contributed to a Qualified Roth Contribution Program, which would be a separate account under the Section 401(k) or Section 403(b) plan.
Contributions are made with after tax dollars and gains may be tax-free if withdrawn after retirement or certain other circumstances.
What are the Distribution Rules for multiple Roths?
Account holders with more than one Roth IRA must treat the Roth IRAs as a single account when calculating the tax consequences of distributions from any of them.
Describe tax-free Distributions from a Roth IRA
Tax-free
Distributions of contributions from a Roth IRA are always tax-free.
Distributions of tax-sheltered gain, called a qualified distribution, may be tax-free if the Roth-IRA is over five years old and meets one of the following purposes for distribution:
* The distribution must be made after the five-year period beginning with the first taxable year in which the individual made a Roth IRA contribution, and the distribution must be either:
* Made on or after the individual attains age 59½,
* Made to a beneficiary or the individual’s estate after the individual’s death,
* Attributable to the individual’s being disabled, or
* Made for a first-time home purchase.
* The five-year holding period is defined as beginning with the first taxable year for which the account holder has a Roth IRA contribution of any kind.
Subsequent rollovers into a Roth IRA will not require a new five-year holding period.
The first-time homebuyer exception is somewhat misleadingly titled. It is available for purchasing a principal residence of the individual, spouse, child, grandchild or ancestor of the individual or spouse.
* It can be used at any time if the individual and spouse did not own a principal residence within the preceding two years.
* The exception can be used more than once.
* However, there is a $10,000 lifetime limitation on the use of the first-time homebuyer exception for Roth IRAs.
Mini Bite: Qualified Distributions from Roth IRAs
Mini Bite: Qualified Distributions from Roth IRAs
https://www.youtube.com/watch?v=W49sPDQFTRc
In this 5-minute video, Mike discusses the requirements for taking a “qualified” (income tax and penalty free) distribution from a Roth IRA. Two key requirements must be satisfied for a distribution to be qualified. Mike explains the nuances of those two requirements as well a few important CFP® Exam points.
The Boston Institute of Finance’s Mini Bite video series aims to tackle key financial planning topics that are both important in practice and testable on CFP® Board’s certification exam.
Qualified distributions are completely tax free.
* There are 2 levels of requirements for a qualified distribution
* First level - 5 year holding period
* Second level - death, disability, home ($10k max), age 59.5yo
* Don’t have to be 59.5yo if met other requirement
Five year holding period example:
* Made contribution 4-1-2020
* But Actual holding period began January 1, 2019
* Actual holding period ends January 1, 2024
* (even though that’s actually only 3 years and 9 months)
Describe taxable Distributions from a Roth IRA
If a Roth IRA distribution is not tax-free under the rules described in the above screens, the distribution is subject to federal income tax, except that the total of the original nondeductible contributions is distributed first.
* Only after all contributions have been distributed will the earnings be deemed to have been withdrawn.
* In addition, there is a 10% penalty imposed on the taxable amount of any distribution, unless the distribution meets one of the exceptions to the 10% penalty for traditional IRAs.
Mini Bite: Non-Qualified Distributions from Roth IRAs
Mini Bite: Non-Qualified Distributions from Roth IRAs
https://www.youtube.com/watch?v=7a2zIVluBuM
In this 5-minute video Mike discusses the tax treatment of Roth IRA distributions that do not meet the qualified requirements. Many assume that non-qualified distributions will always result in heavy penalties and a big tax bill, but that’s not always the case. Mike clearly explains the distribution ordering rules in this video and the results may surprise you.
The Boston Institute of Finance’s Mini Bite video series aims to tackle key financial planning topics that are both important in practice and testable on CFP® Board’s certification exam.
Distributions are non-qualified - if they did not meet the 5 years or 4 qualifying circumstances.
Distribution ordering / Layers:
* First layer that gets distributed are the regular Roth contributions. No income tax. No penalty bc it’s a return of the contribution.
* Second layer - distributing Roth conversion contributions (traditional IRA converted to Roth IRA). No income tax bc they paid tax on the conversion. But if before 5 years, there could be a 10% penalty.
* Third layer - Account earnings. There will be regular income tax at the marginal bracket level and 10% penalty.
Example.
Regular Roth contributions: $24,000
Roth conversion contributions: $50,000
Account Earnings: $26,000
Total Account: $100,000
If client needs $40k.
* first $24k, no tax, no penalty
* next $16k, no tax, maybe 10% penalty depending on 5 year holding window ($1600)
If client wants to liquidate $100k.
* first $24k, no tax, no penalty
* next $50k, no tax, maybe 10% penalty depending on 5 year holding window ($5000)
* next $26k, Income tax, 10% Penalty ($2600)
What are the RMDs for Roth IRAs?
There are no minimum distribution requirements at age 73 as there are for traditional IRAs, and the Roth IRA owner can, therefore, accumulate the fund, if appropriate, until death.
What happens with a Roth IRA at the Death of Owner?
The SECURE Act changes discussed previously for inherited traditional IRAs also apply to RMDs from an inherited Roth IRA.
* Under the legislation, distributions to individuals other than the surviving spouse of the employee (or IRA owner), disabled or chronically ill
individuals, individuals who are not more than 10 years younger than the employee (or IRA owner), or child of the employee (or IRA owner) who has not reached the age of majority are generally required to be distributed by the end of the tenth calendar year following the year of the employee or IRA owner’s death.
If the beneficiary is the owner’s spouse, the surviving spouse can elect to treat the Roth IRA as his or her own, which means the beneficiary-spouse is not required to take distributions while living.
- Distributions to beneficiaries after the owner’s death are tax-free to the recipients, assuming the original 5 year holding period has been satisfied, but they lose their character as Roth IRAs when distributed.
- Further investment returns on the amounts distributed are taxable.
What is the tax treatment of a distribution to a beneficiary of a seven-year-old Roth-IRA following the owner’s death?
* Tax-free
* Taxed as ordinary income
* Taxed at capital gains rate
Tax-free
- Distributions to beneficiaries after the owner’s death are tax-free to the recipients, but they lose their character as Roth IRAs when distributed. Had the Roth-IRA been established for less than five years, any gain would be taxable at the owner’s death.
