Chapter 16 Part 1

Question 1

(IRA) is a type of

Answer 1

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.

Question 2

usually not appropriate for IRAs

Answer 2

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bonds, the interest that would be tax-exempt from bonds held outside of a retirement account would become taxable when withdrawn from an IRA.

Question 3

Anyone who will not turn

Answer 3

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.

Question 4

You may not include income from

Answer 4

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.

Question 5

Contribution Limits

Answer 5

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.

Question 6

A spousal account is an

Answer 6

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.

Question 7

A single person who is not covered by an employer-sponsored retirement plan may always

Answer 7

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.

Question 8

roth ira Eligibility

Answer 8

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.

Question 9

roth Contribution Limits

Answer 9

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.

Question 10

Conversions

Answer 10

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.

Question 11

When an owner of an IRA withdraws money from his account before reaching the age of 59.5, it is considered an

Answer 11

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.

Question 12

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

Answer 12

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.

Question 13

Since investors fund Roth IRAs with after-tax dollars, they may withdraw

Answer 13

contributions at any time without paying taxes.

Question 14

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

Answer 14

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.

Question 15

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

Answer 15

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.

Question 16

A rollover is a

Answer 16

tax-free withdrawal of cash or other assets from an eligible retirement plan. All or part of the withdrawal is contributed (rolled over) to another eligible retirement plan. The transaction is reportable on a federal tax return.

Question 17

However, to avoid a tax penalty, the rollover must be completed within

Answer 17

60 days. The taxable amount of the distribution that is not rolled over within 60 days must be included in income in the year of the distribution. Rollovers are allowed only once during a rolling 12-month period.

Question 18

Initially, Roth IRAs were allowed to accept only rollover contributions distributed from another Roth IrA. Since the passing of the Pension Protection Act (PPA) of2006, Roth IrAs are able to receive

Answer 18

company retirement plan assets from 457(b) governmental plans, 403(b) plans, and 401(k) plans. All other roth IRA rules regarding taxation and holding periods apply.

Question 19

The shifting of funds from one IRA trustee/ custodian directly to another trustee/ custodian is called a

Answer 19

transfer. Transfers are not considered rollovers because no distribution is paid to the owner. An investor may transfer funds directly from one IRA custodian to another without incurring a tax liability and there is no limit to the number of transfers allowed each year.

Question 20

In 1974 the Employee Retirement Income Security Act was passed, which

Answer 20

set standards for private sector employee benefit plans. As a federal law, ERISA supersedes state laws relating to employee benefit plans, with a few exceptions. If an employer establishes a pension plan under ERISA, certain standards must be met. These standards encompass: Participants—Who must be covered in the plan? Vesting-How long must the employee work in order to be entitled to the contributions made by the employer? Funding-What amount must be on reserve annually to pay for future pension obligations?
ERISA also set standards covering the responsibilities of individuals who service these plans, those who act as fiduciaries, and reporting and disclosure requirements.