Unit 16 - Individual Retirement Accounts

Question 1

What form is used to report retirement distributions?

Answer 1

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

Question 2

Traditional IRA

Answer 2

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

Question 3

Roth IRA

Answer 3

Contributions are made with after tax income

Never deductible

Withdrawals from a Roth IRA are generally not taxed

No RMDs until deceased

Question 4

Roth conversion

Answer 4

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

Question 5

IRA contribution limits

Answer 5

The limits for contributions to an IRA in 2023 are the lesser of

1. Qualifying taxable compensation.

Or

2. $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

Question 6

IRA contribution limits… what amounts are excluded from the limit

Answer 6

1. Rollover contributions – rolling over from one IRA account to another.
2. Qualified reservist repayments.
3. Repayments of qualified disaster distributions (QDDs) and coronavirus related distributions (CRDs).

Question 7

Repayments of QDD and CRD

Answer 7

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

Question 8

Requirement to be eligible to make contributions to a traditional IRA

Answer 8

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

Question 9

IRA contribution deduction limits with an employer plan in addition

Answer 9

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

Question 10

IRA contribution “compensation” does not include

Answer 10

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

Question 11

Major differences between a Roth IRA and a traditional IRA

Answer 11

1. 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.
2. Roth IRA owners are not required to make minimum distributions during their lifetime. Distributions only become required after the owners death.
3. Roth IRA contributions can be made at any age.
4. Income limits apply, which means high income earners may be prohibited from contributing to a Roth IRA.

Question 12

Roth IRA income limits

Answer 12

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 .

Question 13

Back door Roth IRA

Answer 13

If you don’t qualify to contribute to a Roth a because of income limits…

You use a back door by

1. Open a traditional IRA.
2. Make a nondeductible IRA contribution.
3. Convert the funds to a Roth in the same year.

Question 14

Married Taxpayers – IRA contributions

Answer 14

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

Question 15

Traditional IRA Contribution deadline

Answer 15

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)

Question 16

IRA qualifying compensation – self-employment

Answer 16

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

Question 17

Traditional IRA contributions – what is deductible and what is not deductible

Answer 17

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

Question 18

When taxpayer makes nondeductible contributions to a traditional IRA

Answer 18

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

Question 19

Traditional IRA phase out limits when covered by an employer retirement plan

Single, HOH, MFS (did not live with spouse)

Answer 19

$73,000 or less – full deduction

$73,000-$83,000 partial deduction

$83,000 or more – no deduction

Question 20

Traditional IRA phase out limits when covered by an employer retirement plan

MFJ , QSS, MFJ (covered spouse)

Answer 20

$116,000 or less – full deduction

$116,001-$135,999 – partial deduction

$136,000 or more – no deduction

Question 21

Traditional IRA phase out limits when covered by an employer retirement plan

MFS – lived with spouse

Answer 21

$0 to $10,000 – a partial deduction

$10,000 or more – no deduction

Question 22

Traditional IRA phase out limits when covered by an employer retirement plan

MFJ – non-covered spouse

Answer 22

$218,000 or less – full deduction

$218,000-$228,000 – partial deduction

$228,000 or more – not deduction

Question 23

Splitting IRA contributions between multiple accounts

Answer 23

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

Question 24

Traditional IRA distributions – when are they taxable and what exceptions?

Answer 24

Generally taxable in the year they are received, subject to the following exceptions

1. Rollovers to another retirement plan, other than conversions to a Roth IRA
2. Qualified charitable distributions directly to a qualified charity.
3. Tax-free withdrawal of contributions – made in the same year.
4. Distributions of nondeductible contributions.

Question 25

Distributions from a Roth IRA – what is taxable?

Answer 25

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

Question 26

IRA early withdrawal penalty – exceptions

Answer 26

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

1. To the extent the taxpayer has un reimbursed medical expenses that exceeded 7.5% of AGI.
2. To cover the cost of medical insurance while the taxpayer is unemployed.
3. The IRA becomes permanently, disabled or dies.
4. The distributions are not more than qualified, higher education expenses.
5. The distributions are used to buy, build, or rebuild a first home – up to $10,000.
6. The distributions are used to pay the IRS due to a levy.
7. Made as part of a series of substantially equal periodic payments.
8. The distributions are made to a qualified reservist – an individual called up to active duty.
9. Qualified disaster distributions, or QDDs
10. Qualified birth and adoption distributions – maximum $5000 per child, per parent, made within one year of the date of birth or adoption
11. Terminal illness distributions.

Question 27

IRA early withdrawal penalty

Answer 27

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

Question 28

Required minimum distributions – RMD’s

Answer 28

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.

Question 29

RMD penalty tax – where is it reported?

Answer 29

Form 5329 – additional taxes on qualified plans

Reports the excise tax applies for failure to take a required minimum distribution

Question 30

What is an IRA rollover?

Answer 30

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

Question 31

Direct rollover

Answer 31

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

Question 32

Indirect rollover

Answer 32

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.

Question 33

Rollover rules for distributed property (stocks, or bonds distributed from an IRA)

Answer 33

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

Question 34

Inherited IRAs – designated beneficiaries

Answer 34

Eligible designated beneficiaries (EDBs)

And

Other beneficiaries

Question 35

Eligible designated beneficiary includes

Answer 35

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

Question 36

Inherited IRAs – spousal beneficiary

Answer 36

A surviving spouse can elect to treat the IRA as their own by

1. Changing the ownership designation.

Or

2. 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

Question 37

Inherited IRA – other eligible designated beneficiaries (non-spouses)

Answer 37

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

Question 38

Inherited IRAs – RMD penalty

Answer 38

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

Question 39

Inherited IRAs – other beneficiary

Answer 39

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

Question 40

Inherited IRAs – early withdrawal penalties

Answer 40

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

Question 41

Roth IRA conversions – inherited IRA

Answer 41

Unless it is inherited directly from a spouse…

And inherited traditional IRA is not eligible to be converted to a Roth IRA

Question 42

Excise tax on over contributions to IRAs

Answer 42

Access contribution is subject to a 6% excise tax

Taxpayer can correct an excess contribution if certain rules are followed

1. 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

Question 43

IRA re-characterizations

Answer 43

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

Question 44

Self-directed IRA

Answer 44

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

Question 45

IRA prohibited transactions

Answer 45

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

1. Using an IRA as security or collateral for a loan.
2. Buying property for personal use with IRA funds.
3. Borrowing money from the IRA.
4. Selling, leasing, or exchanging property to the IRA account.
5. Excepting unreasonable compensation for managing IRA assets.
6. Granting fiduciaries to obtain, use, or borrow against account assets for their own gain.
7. 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.

Question 46

Penalty for IRA prohibited transactions

Answer 46

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

Question 47

Prohibited IRA investments

Answer 47

1. Collectibles such as artwork, jewelry, antiques, porcelain, fine wines, baseball cards, uncut, gemstones, and comic books.
2. Most precious metals or coins, although there is a narrow exception for investments in gold and silver coins, minted by the US treasury department.
3. S Corporation stock.
4. Life insurance contracts.
5. Real estate held for personal use.

Question 48

Penalty for prohibited IRA investments

Answer 48

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

Question 49

SEP – IRA plans

Answer 49

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

Question 50

SIMPLE plans

Answer 50

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

1. SIMPLE IRA. - similar to traditional IRAs.
2. SIMPLE 401(K) PLAN - similar to the qualified 401(k) plans

Question 51

Qualified retirement plans

Answer 51

There are two basic kinds of qualified retirement plans

1. Defined contribution plans.
2. 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)

Question 52

Government requirement for employer retirement plans

Answer 52

The federal government does not require an employer to establish a retirement plan

But it provides minimum federal standards for qualified plans

Question 53

Defined contribution plans

Answer 53

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

Question 54

Defined contribution plans – distributions

Answer 54

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

Question 55

Defined contribution plans – RMD’s

Answer 55

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

Question 56

Defined benefit plans

Answer 56

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

Question 57

Loans and distributions from qualified plans

Answer 57

Distributions of elective deferrals cannot be made until one of the following occurs.

1. The taxpayer dies, becomes disabled, or has a severance from employment.
2. The plan terminates, and no success or defined contribution. Plan is established or maintained by the employer.
3. The taxpayer reaches age 59 1/2, or the taxpayer incur significant financial hardship.

Question 58

Hardship distributions

Answer 58

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