Unit 16 - Individual Retirement Accounts Flashcards
What form is used to report retirement distributions?
Form one 1099 – R, distributions from pensions, annuities, retirement, or profit, sharing, plans, IRAs, insurance, contracts, etc.
Reports distributions of $10 or more from a retirement plan or an IRA
Will reflect a “code G” in box 7 for any eligible rollover distribution from a qualified retirement plan that is directly rolled over to an IRA
Traditional IRA
Amounts, including contributions and earnings are generally not taxed until they are distributed
Taxpayer can deduct traditional IRA contributions as an adjustment to gross income – above the line
Deduction is phased out at higher income levels when the taxpayer or spouse is also covered by a workplace retirement plan
Roth IRA
Contributions are made with after tax income
Never deductible
Withdrawals from a Roth IRA are generally not taxed
No RMDs until deceased
Roth conversion
Converting from a traditional IRA to a Roth IRA
Involves paying income taxes on the converted amount (contributions plus earnings)
There is no 10% early withdrawal penalty
Converted amounts need to stay in Roth IRA for at least five years to avoid the 10% penalty
IRA contribution limits
The limits for contributions to an IRA in 2023 are the lesser of
- Qualifying taxable compensation.
Or
- $6500 per taxpayer. ($7500 if age 50 or older)
IRA accounts cannot be held jointly and each person must have their own IRA account
But in the case of married spouses that filed jointly – only one spouse must have qualified compensation
Allowing a joint return to have a maximum contribution of $13,000 or $15,000 if both age 50 or older
IRA contribution limits… what amounts are excluded from the limit
- Rollover contributions – rolling over from one IRA account to another.
- Qualified reservist repayments.
- Repayments of qualified disaster distributions (QDDs) and coronavirus related distributions (CRDs).
Repayments of QDD and CRD
Reported on form 8915 – F
Three-year period for repayment
Not related to other types of emergency retirement distributions
Taxpayers could choose to recognize the income relatively over three years – and repay over a three-year period
Repayments are treated as a trustee to trustee transfer
Requirement to be eligible to make contributions to a traditional IRA
Taxpayer must have qualified, taxable, compensation!
Such as wages, salaries, commissions, tips, bonuses, or self-employment income
Includes taxable alimony, combat pay, Medicare waiver payments
Includes certain taxable, stipends, and non-tuition fellowship payments received by graduate students
There is no longer an age limit
IRA contribution deduction limits with an employer plan in addition
If the taxpayer or spouse is covered by an employer plan and their taxable income is too high – the IRA contributions deduction is phased out
If the taxpayer does not participate in a retirement plan at work, a traditional IRA contribution is fully deductible up to their allowable contribution limit
But as long as a taxpayer has qualifying compensation – they may contribute to a traditional IRA they just may not be able to deduct the contribution
IRA contribution “compensation” does not include
Child support or non-taxable alimony
Passive rental income
Dividend and interest income
Pension or annuity income
Deferred compensation
Prize winnings or gambling income
Items that are excluded from income, such as foreign earned income and excludable foreign housing cost
Major differences between a Roth IRA and a traditional IRA
- Contributions to a Roth IRA are not deductible by the taxpayer, and participation in an employer plan has no effect on the taxpayers contribution limits.
- Roth IRA owners are not required to make minimum distributions during their lifetime. Distributions only become required after the owners death.
- Roth IRA contributions can be made at any age.
- Income limits apply, which means high income earners may be prohibited from contributing to a Roth IRA.
Roth IRA income limits
Single, HOH, MFS (did not live with spouse) – $138,000-$153,000
MFJ and QSS - $218,000-$228,000
MFS (lived with spouse) - $0 to $10,000
Taxpayer cannot contribute to a Roth IRA if their income is above the full phase out figures .
Back door Roth IRA
If you don’t qualify to contribute to a Roth a because of income limits…
You use a back door by
- Open a traditional IRA.
- Make a nondeductible IRA contribution.
- Convert the funds to a Roth in the same year.
Married Taxpayers – IRA contributions
Filing separately…
If married taxpayers choose to file separately, they must consider only their own qualifying compensation for IRA contribution purposes
Applies to both Roth and traditional IRA
Filing jointly…
Spousal IRA contribution – a married couple filing jointly may contribute to each of their IRA accounts, even if only one taxpayer has qualifying compensation
Traditional IRA Contribution deadline
Contributions can be made to a traditional IRA at any time on or before the due date of the return – not including extensions
A taxpayer can even file their return claiming a traditional IRA contribution before it has actually been made (but doesn’t need to amend the return)
IRA qualifying compensation – self-employment
If a taxpayers only qualifying compensation is self-employment and activity generates a loss – taxpayer is not able to contribute to an IRA
But if there are additional wages – the loss from self-employment would not be subtracted from the wages when figuring total qualifying compensation
Traditional IRA contributions – what is deductible and what is not deductible
If neither the taxpayer or spouse is covered by an employer plan, there is no limitation on the deductibility of the traditional IRA contributions
If a taxpayer or spouse is covered by an employer retirement plan at work – there are income phase out limits making contributions non-deductible .
But could still make the contributions to traditional IRA
When taxpayer makes nondeductible contributions to a traditional IRA
Taxpayer must file form 8606, nondeductible IRAs
Including when taxpayer has Roth conversions
It reflects the taxpayers cumulative non-deductible contributions, which is the taxpayers basis in the IRA
If not, properly reported, all future withdrawals from the IRA may be taxable .
Taxpayer is responsible for keeping track of own IRA’s basis – keep copies of forms 8606 indefinitely
Traditional IRA phase out limits when covered by an employer retirement plan
Single, HOH, MFS (did not live with spouse)
$73,000 or less – full deduction
$73,000-$83,000 partial deduction
$83,000 or more – no deduction
Traditional IRA phase out limits when covered by an employer retirement plan
MFJ , QSS, MFJ (covered spouse)
$116,000 or less – full deduction
$116,001-$135,999 – partial deduction
$136,000 or more – no deduction
Traditional IRA phase out limits when covered by an employer retirement plan
MFS – lived with spouse
$0 to $10,000 – a partial deduction
$10,000 or more – no deduction
Traditional IRA phase out limits when covered by an employer retirement plan
MFJ – non-covered spouse
$218,000 or less – full deduction
$218,000-$228,000 – partial deduction
$228,000 or more – not deduction
Splitting IRA contributions between multiple accounts
Taxpayer can have an unlimited number of accounts, including traditional, IRA and Roth IRA
But the combined contributions for the year are subject to the maximum annual contribution limits
Traditional IRA distributions – when are they taxable and what exceptions?
Generally taxable in the year they are received, subject to the following exceptions
- Rollovers to another retirement plan, other than conversions to a Roth IRA
- Qualified charitable distributions directly to a qualified charity.
- Tax-free withdrawal of contributions – made in the same year.
- Distributions of nondeductible contributions.
Distributions from a Roth IRA – what is taxable?
Distributions from a Roth IRA may be completely tax-free and penalty free if they are qualified distributions
In order to be qualified – must satisfy a five-year waiting period, and taxpayer must be at least 59 1/2 years old
Exceptions for disability or death of the IRA owner
Taxpayer can withdraw regular Roth IRA contributions (their basis, but not the earnings) at any time and at any age with no penalty or tax
Taxpayers over 59 1/2 who have had the Roth account for at least five years can withdraw contributions and earnings with no tax or penalty
IRA early withdrawal penalty – exceptions
These distributions will not be subject to the 10% penalty, but they will be subject to income tax at the taxpayers normal rates for a traditional IRA
Penalty exceptions are reported on form 5329
- To the extent the taxpayer has un reimbursed medical expenses that exceeded 7.5% of AGI.
- To cover the cost of medical insurance while the taxpayer is unemployed.
- The IRA becomes permanently, disabled or dies.
- The distributions are not more than qualified, higher education expenses.
- The distributions are used to buy, build, or rebuild a first home – up to $10,000.
- The distributions are used to pay the IRS due to a levy.
- Made as part of a series of substantially equal periodic payments.
- The distributions are made to a qualified reservist – an individual called up to active duty.
- Qualified disaster distributions, or QDDs
- Qualified birth and adoption distributions – maximum $5000 per child, per parent, made within one year of the date of birth or adoption
- Terminal illness distributions.
IRA early withdrawal penalty
Distributions before age 59 1/2 may be subject to an extra 10% excise tax
For a Roth IRA – must have the account at least five years for no penalty
Required minimum distributions – RMD’s
RMD rules do not apply to Roth IRA’s – because Roth IRA do not require withdrawals until after the death of the owner
Traditional IRA owners have required minimum distributions starting at age 73 each year
The amount of each RMD is based on IRS tables
Failure to take a required RMD can result in an excise penalty equal to 25% of the amount that the taxpayer should have withdrawn, but did not
If the failure is corrected in a timely manner, within two years, the penalty is reduced to 10%
The year the taxpayer turned 73 – they have until April 1 to take the RMD . All following years, the distribution is required by December 31.
RMD penalty tax – where is it reported?
Form 5329 – additional taxes on qualified plans
Reports the excise tax applies for failure to take a required minimum distribution
What is an IRA rollover?
A transfer from one retirement plan to another retirement plan
Most rollovers are non-taxable events
A taxpayer can make only one indirect rollover from an IRA to another IRA in any 12 month Period.
However, trustee to trustee transfers between IRAs are not limited,
and rollovers from a traditional IRA to a Roth IRA are not limited
Direct rollover
Funds from the taxpayers current retirement account are transferred directly to a new retirement account
Also called a “trustee to trustee” transfer
Not limited to one rollover per year and there is no 20% mandatory withholding
Indirect rollover
It is up to the employee to redeposit the funds into the new IRA or another qualifying retirement account within the mandatory 60 day. Period to avoid penalty.
Limited to one rollover per year
The employer generally withhold 20% of the amount that is pending transfer in order to pay the taxes due.
The withholding is mandatory – taxpayer would need to add funds from other sources equal to the amount of tax withheld . Then the money is returned as a tax credit (tax paid) for the year when the rollover process is completed.
Rollover rules for distributed property (stocks, or bonds distributed from an IRA)
Taxpayer sells the distributed property and rules over all proceeds - no gain or losses recognized. The sale proceeds, including any increase are treated as part of the distribution and not included in taxable gross income
Not permitted for taxpayer to keep property and replace the received funds with their own
Inherited IRAs – designated beneficiaries
Eligible designated beneficiaries (EDBs)
And
Other beneficiaries
Eligible designated beneficiary includes
A surviving spouse
A disabled or chronically ill individual
A minor child of the IRA owner, but not a grandchild
An individual who is not more than 10 years younger than the account owner
Inherited IRAs – spousal beneficiary
A surviving spouse can elect to treat the IRA as their own by
- Changing the ownership designation.
Or
- Rolling over the IRA balance to their own IRA account.
Surviving spouse can also choose to take distributions over their own life expectancy if desired
Inherited IRA – other eligible designated beneficiaries (non-spouses)
Allowed to stretch the inherited IRA – taking distributions and stretching the tax liability over the lifetime
Except for minor children
They must still take remaining distributions within 10 years of reaching the age of majority (18)
minor child must distribute all the assets in an inherited IRA on or before turning 28 years of age
Inherited IRAs – RMD penalty
If a beneficiary does not distribute the balance of the account by the end of the 10th year following the year of the death
A default 25% exercise tax will apply to any amount left in the account that is not distributed
Inherited IRAs – other beneficiary
Account balance must be fully distributed by the 10 year period after the death of the IRA owner
Also applies to entities - trust, estates, charities, and other organizations
Inherited IRAs – early withdrawal penalties
The 10% early withdrawal penalty is waived for a beneficiary of an IRA when the original IRA owner has died
Regardless of how old the beneficiary are is
Roth IRA conversions – inherited IRA
Unless it is inherited directly from a spouse…
And inherited traditional IRA is not eligible to be converted to a Roth IRA
Excise tax on over contributions to IRAs
Access contribution is subject to a 6% excise tax
Taxpayer can correct an excess contribution if certain rules are followed
- The excess contribution and all related earnings must be withdrawn from the IRA before the due date, including extensions of the tax return for that year.
- if done, the 6% penalty will apply only to the amounts earned on the excess contribution
- Taxpayer must also report the earnings on the access contributions as taxable income for the year
If over, contributions are not withdrawn – taxpayer must pay a 6% excise tax
And the tax applies every year the contribution remains in the account
Taxpayer is allowed to apply an excess contribution to a later year if the contributions for that later year (never earlier ) are less than the maximum allowable for that year
IRA re-characterizations
Undo or reverse a rollover, conversion, or contribution
A Roth IRA conversion cannot be reversed
Characterization is allowed for fixing certain mistakes
Including invalid contribution or an invalid rollover
When a taxpayer accidentally makes an over contribution to an IRA, they can also choose to either re-characterize the contribution or withdraw it to avoid the penalty
Self-directed IRA
A type of account that offers a taxpayer the ability to use his retirement funds to make almost any type of investment without requiring a financial institution or another custodian
IRA prohibited transactions
A prohibited transaction is the improper use of an IRA by the owner, a beneficiary, or a disqualified person
Prohibited transactions related to an IRA include
- Using an IRA as security or collateral for a loan.
- Buying property for personal use with IRA funds.
- Borrowing money from the IRA.
- Selling, leasing, or exchanging property to the IRA account.
- Excepting unreasonable compensation for managing IRA assets.
- Granting fiduciaries to obtain, use, or borrow against account assets for their own gain.
- Transferring plan, assets, lending money, or providing goods and services to disqualified persons – usually a close family member, or a business that a close family member owns and controls.
Penalty for IRA prohibited transactions
The entire IRA account will no longer be treated as an IRA from the date of the withdrawal
Any access above the account basis is reported as taxable income
Subject to the additional 10% penalty if funds are withdrawn before the age requirement
Prohibited IRA investments
- Collectibles such as artwork, jewelry, antiques, porcelain, fine wines, baseball cards, uncut, gemstones, and comic books.
- Most precious metals or coins, although there is a narrow exception for investments in gold and silver coins, minted by the US treasury department.
- S Corporation stock.
- Life insurance contracts.
- Real estate held for personal use.
Penalty for prohibited IRA investments
The IRA will be immediately deemed disqualifying
The entire amount of the IRA is deemed distributed and early withdrawal penalties apply .
Applies to the entire amount of the IRA not just the amount of the prohibited investment
SEP – IRA plans
Simplified employee pension plans
Only the employer makes contributions, employees are not allowed to contribute
If an individual is self-employed and earns income from their business, they can establish and fund a SEP plan
SIMPLE plans
Savings incentive match plan for employees plans
Businesses with 100 or fewer employees
Employees can choose to make salary reduction contributions
The employer is allowed to contribute matching contributions or non-elective contributions
Structured in one of two ways
- SIMPLE IRA. - similar to traditional IRAs.
- SIMPLE 401(K) PLAN - similar to the qualified 401(k) plans
Qualified retirement plans
There are two basic kinds of qualified retirement plans
- Defined contribution plans.
- Defined benefit plans.
And employer is allowed to have more than one type of qualified plan, but contributions cannot exceed annual limits
All qualified plans are subject to federal regulation under the employee, retirement income security act (ERISA)
Government requirement for employer retirement plans
The federal government does not require an employer to establish a retirement plan
But it provides minimum federal standards for qualified plans
Defined contribution plans
The participant, the employer, or both may contribute to the individual participant accounts
Examples of defined contribution plans include profit, sharing, plans, 401(k) plans, 403(b) plans, and 457 plans
Salary reduction/elective deferral contributions are employee contributions based on a percentage of the employees compensation - pretax basis
Depending on the individual plan, the employer may provide matching contributions for employees who make elective deferrals
Defined contribution plans – distributions
Made either on a periodic basis, such as a annuity payments or as a lump sum
Generally, not permitted prior to when the participant retires or otherwise terminates, employment, dies, becomes disabled, or reaches age 59 1/2
Earlier distributions are subject to an additional 10% penalty tax
Defined contribution plans – RMD’s
Required minimum distributions from defined contribution plans must begin by April one of the year, following the calendar year when the taxpayer retires
or the year in which the taxpayer reaches age 73, whichever comes later
Defined benefit plans
Often called a traditional pension plan
Promises a specified benefit amount or annuity for each participant after retirement
Benefits are based on formulas that consider the participants years of service and earnings history
Provided by the federal government and most state and local governments
Protected by federal insurance
Contributions to a defined benefit plan are not optional - based on actuarial calculations, the estimate the amounts necessary to pay benefits in the future
Loans and distributions from qualified plans
Distributions of elective deferrals cannot be made until one of the following occurs.
- The taxpayer dies, becomes disabled, or has a severance from employment.
- The plan terminates, and no success or defined contribution. Plan is established or maintained by the employer.
- The taxpayer reaches age 59 1/2, or the taxpayer incur significant financial hardship.
Hardship distributions
401(k) plan may allow participants to receive hardship distributions
Limited to the amount of the employees contribution – not to include any income earned
Amount withdrawn can be subject to income tax as well as early withdrawal penalty
Not eligible for repayment
