Chapter 16 Part 1 Flashcards
(IRA) is a type of
traditional individual retirement arrangement that is established as a custodial account or a trust. The custodian or trustee must be a bank, savings and loan association, federal credit union, or any other entity approved by the IRS. The account is created for the benefit of an individual or his beneficiaries and must meet specific requirements. Though the institution acts as a custodian for the account, the account owner is responsible for deciding how to invest the funds. These funds may be placed in a wide variety of investment vehicles, including stocks, bonds, mutual funds, annuities, limited partnerships, certain collectibles, or U.S. gold and silver coins. However, money contributed to an IRA may not be used to purchase life insurance.
usually not appropriate for IRAs
Although not prohibited, most tax-free or tax-defeffed investments, such as municipal bonds or variable annuities, are usually not appropriate for IRAs. This is because the investor is already receiving the benefits of tax-deferred earnings. In the case of municipal bonds, the interest that would be tax-exempt from bonds held outside of a retirement account would become taxable when withdrawn from an IRA.
Anyone who will not turn
70.5 by the end of the tax year and who has received certain taxable compensation can contribute to an IRA. In general, compensation is what an individual earns from working. The type of eligible compensation allowed to be used as a basis for an individual’s IRA contribution would include income earned from wages, salaries, commissions, and professional fees. Even though alimony is not considered earned income, taxable alimony is considered compensation and can be included when determining income for purposes of making an IRA contribution.
You may not include income from
interest, dividends, or capital gains from investments or retirement plans or accounts as a basis for your IRA contribution. The IRS does not define these types of income as compensation.
Contribution Limits
Under certain circumstances, traditional IRA contributions are tax-deductible. The maximum amount that an individual may contribute annually to an IrA is $5,500 or 100% of earned income, whichever is less. Contributions in excess of this amount are subject to a 6% tax penalty. The contribution for any given year must be made by the deadline for filing income tax returns for that year, usually April 15. For example, someone could make her IRA contribution for the Year 2013 any time between January I, 2013, and April 15, 2014. Currently, individuals age 50 and older may contribute an additional $1,000 catch-up amount per year.
A spousal account is an
IrA that is owned by an unemployed spouse. A married couple with only one employed spouse may contribute to two separate IRAs if the working spouse has an earned income of at least $11,000 in the current tax year. The contributions of the working spouse are invested in a traditional IRA. The contributions made on behalf of the unemployed spouse are invested
in a spousal IRA. Contributions in excess of the designated limit arc not allowed in either account.
A single person who is not covered by an employer-sponsored retirement plan may always
deduct an IRA contribution of up to the annual maximum allowed. the same is true of a married person who does not participate in such a plan, and whose spouse does not participate in one either. However, if either person is covered by an employer-sponsored plan, their ability to deduct an IRA contribution depends on their taxable income and filing status. The deduction for IrA contributions is gradually phased out once the taxpayer reaches a specified income level and is eventually eliminated entirely.
roth ira Eligibility
Anyone, regardless of age, is eligible to open a Roth IRA, provided the person’s income does not exceed specific levels. A single person with modified adjusted gross income (AGI) of $114,000 or less may contribute the full amount of $5,500 to a Roth IRA. A single taxpayer’s ability to contribute is gradually phased out if that person’s adjusted gross income is between $114,000 and $129,000. For married couples who file a joint tax return, the limit is an adjusted gross income of $181,000, with the deduction being phased out for couples whose income is
between $181,000 and $191,000. Participation in an employer- sponsored retirement plan is not relevant for determining eligibility for a Roth IRA.
roth Contribution Limits
The contribution limits for Roth IrAs mirror those of traditional IRAs-currently the lesser of$5,500 or 100% of earned income. A married person may also contribute $5,500 a year to a spouse’s Roth IRA even if the spouse is not employed. The total contributions made to any one individual retirement account (traditional or Roth) may not exceed $5,500 per year. In addition, individuals age 50 and older may contribute an extra $1,000 catch-up amount per year.
Conversions
As of 2011, when converting a traditional IRA to a Roth IRA, adjusted gross income is not a factor. The disadvantage of conversion is that the investors will be required to pay ordinary income taxes on the amount converted that is above the cost basis. Whether an investor should convert an existing IRA to a Roth IRA depends on the investor’s individual situation. Here are some of the factors to be considered.
When an owner of an IRA withdraws money from his account before reaching the age of 59.5, it is considered an
early withdrawal. The ainount withdrawn will be added to his income for that year. In addition, he will be subject to a 10% tax penalty on the taxable amount withdrawn.
The IRA owner is not subject to a tax penalty for early withdrawals if the reason for the withdrawal is one of the following exceptions
The account owner becomes disabled; The account owner dies; the money is used to pay certain medical expenses; The money is used for expenses related to the purchase of a home for the first time (limited to $10,000); The money is used to pay qualified higher education expenses (including tuition, fees, books, and room and board) for the account holder or a member of his immediate family; The withdrawals are set up as a series of “substantially equal periodic payments” taken over the owner’s life expectancy.
Since investors fund Roth IRAs with after-tax dollars, they may withdraw
contributions at any time without paying taxes.
However, accumulated earnings in the account may be withdrawn tax-free, provided the distribution is made five years after the first taxable year in which a contribution was
made, and one of the following conditions exists
The account owner is age 59.5 or older; The account owner dies or becomes disabled; The money is used for the purchase of a first home (maximum $10,000 withdrawal); the money is used to cover certain medical expenses or medical insurance premiums; The money is used to pay for qualified higher education expenses. If these conditions are not met, then the account owner will be subject to ordinary income taxes plus a 10% tax penalty on the earnings portion of the distributions.
A key feature of an IrA is that income earned by the money invested accumulates on a tax-deferred basis until it is withdrawn. To avoid a tax penalty, an investor is required to begin taking
minimum distributions from her IRA. The IRS will levy a 50% penalty if the investor does not start withdrawals by April I following the year in which she reaches the age of 70.5. The penalty is based on the amount the investor should have withdrawn, but did not. Unlike a traditional IrA, investors who are age 70.5 are not required to take minimum distributions
from a roth IRA and are permitted to continue to make contributions past age 70.5 if they have earned income.
