IRA ACCOUNTS

(THE BASICS)

 TRADITIONAL TAX DEDUCTIBLE IRA: 

The traditional tax deductible IRA account IS still available. 

1. The maximum contribution for 2005 is $4,000 per year to a tax deductible IRA account in which the earnings grow tax-deferred.  The maximum contribution is scheduled to increase to $5,000 in 2008.  IRA participants over age 49 are allowed to make additional annual contributions of up to $500 per year through 2005,  and $1,000 in 2006.  These are known as “catch-up” contributions.  So, the maximum contribution for those taxpayers over 49, both men and women, is scheduled to be $4,500 in 2005, and $5,000 in 2006.
2. A taxpayer MUST have “Earned Income” in an amount at least equal to their IRA contribution amount.  “Earned Income,” means salary or wages from an employer, net income from a business or farm, or taxable alimony.  Interest, dividends, retirement income, capital gains, and rental income DO NOT qualify as earned income.
3. No traditional IRA contributions can be made after reaching age 70½.
4. The owner of an IRA account MUST begin taking withdrawals at age 70½.  The minimum withdrawal amount is prescribed by law and is based upon IRS published life expectancy tables. 
5. Taxpayers covered under an employer-sponsored retirement plan such as a 401(k), 403(b), SEP, SIMPLE, etc., may be able to make a fully tax deductible IRA contributions if their adjusted gross income (“AGI”) is less than the IRS imposed level, currently $50,000.  A partial deduction can be taken with AGIs between $50,000 and $60,000.  If married, the AGI limit for a fully deductible contribution to an IRA is $70,000, and a partial deduction can be taken for AGIs between $70,000 and $80,000.  Each of these AGI levels is scheduled to increase in future years.  Married filing separately taxpayers can receive a partial IRA deduction if their AGI is between $0 to $10,000. 
6. For married couples, if only one spouse is a participant in an employer-sponsored plan, the non-covered spouse can make a tax-deductible contribution to an IRA if the couple’s AGI does not exceed $150,000.  A partial contribution can be made with AGI from $150,000 to $160,000. 
7. A tax deductible contribution to an IRA of up to the maximum annual allowed amount can also be made for a non-working spouse, as long as the taxpayers report “earned income” equal to the amount of the combined taxpayer and spouse contributions and the working taxpayer is not covered under an employer-sponsored retirement plan. 

8. IRA contributions must be made by the April 15^th tax-filing deadline, even if the taxpayer files for an extension of time to file the federal return.
9. If an IRA contribution is made in excess of the allowable amount, that amount MUST be withdrawn before the date the tax return is filed, including extensions, otherwise the IRS imposes a tax penalty for the excess contribution of 15%.  This 15% tax penalty is imposed on the excess contribution each year until the excess is withdrawn.
10. Withdrawals made before reaching age 59½ are subject to a federal income tax early withdrawal penalty equal to 10% of the taxable distribution amount.  There are limited number exceptions where the 10% early withdrawal penalty generally does apply including situations where the:

a.   Distribution is part of a scheduled series of substantially equal periodic payments made over the life expectancy of the IRA owner and the beneficiary.  This is a very complex area and the distribution amount cannot be changed for five years, otherwise the 10% tax penalty is imposed retroactively on ALL of the distributions.

b.   Distribution made due to disability of participant.

c.  Distribution proceeds are used for qualified higher education expenses for  participant, or for participant’s spouse, children, or grandchildren.

d. Distribution proceeds used for qualified first-time home purchase (no home ownership in prior 2 years) acquisition costs.  There are very specific guidelines that must be met to qualify.

e. Distributions received due to death of account owner.

f. A limited number of other situations, distributions under a qualified domestic relations order (QDRO); distributions for tax levies by the IRS; distributions to pay heath insurance of certain unemployed individuals (very restrictive); and distributions to pay certain tax deductible medical expenses.

NON-DEDUCTIBLE TRADITIONAL IRA:

A taxpayer can still contribute up to the maximum annual contribution per year to a non-deductible IRA if their AGI prevents them from contributing to a tax-deductible IRA or the Roth IRA.  The contribution is made with after-tax dollars and the earnings grow tax-deferred.  No contribution can be made after reaching age 70½.   Owners MUST begin taking withdrawals by age 70½.  A portion of the amounts distributed is tax-exempt based upon the ratio of total contributions made to the total funds in the account at the beginning of the tax year, so the after tax portion of each distribution is non-taxable..

THE ROTH IRA:

Like a traditional non-deductible IRA, the Roth IRA allows taxpayers to make contributions up to the maximum annual limit, as shown above, with after-tax dollars.  The difference is that the earnings in a Roth IRA grow tax-free and can be withdrawn tax-free as long as the following two conditions are met.  First, the Roth IRA must be opened for at least five tax years, AND, secondly, one of the following additional conditions must also be met:  the account holder is at least age 59½, OR the funds are used for first-time house purchase acquisition costs up to a lifetime maximum of $10,000, OR the account holder becomes disabled or dies.  A full contribution to a Roth IRA may be made if: A) Single and AGI is $95,000 or less, and a partial contribution may be made if AGI is between $95,000 and $110,000, or B) Married and AGI is $150,000 or less, and a partial contribution may be made if AGI is between $150,000 and $160,000.  The phase out range for married filing separately is AGI of $0 to $10,000. Roth contributions can be made at any age as long as the taxpayer has “earned income” equal to the contribution amount and income does not exceed AGI limits.  Distributions from a Roth IRA are NOT required to, even after age 70½. 

CONVERTING A TRADITIONAL IRA TO A ROTH IRA (A “ROLLOVER”):

Income taxes MUST be paid on the entire amount withdrawn from a deductible IRA and on the earnings portion of the amount withdrawn from a non-deductible IRA, and a conversion to a Roth IRA is considered a withdrawal and is therefore subject to income taxes.  A taxpayer under age 59½ is allowed to convert all or part of either their current traditional deductible and/or non-deductible IRA to a Roth IRA and avoid the 10% early withdrawal penalty.  IMPORTANT! A taxpayer CAN NOT convert ANY amount to a Roth IRA if their AGI, including a spouse’s income if filing joint, exceeds $100,000, exclusive of the income recognized from the IRA withdrawal.  Taxpayers are subject a 10% penalty if they withdraw converted amounts within five years.  REMINDER!  You should talk with your tax advisor BEFORE making a conversion, since there are many pitfalls to avoid and economic considerations.

BENEFICIARIES

IRA owners may now change their beneficiaries as often as they want prior to their death, and this will not affect the amount of minimum annual distributions, unless the owner is moving into or out of a beneficiary relationship with a spouse who is more than 10 years younger (see distribution rules below).

DISTRIBUTION RULES

The formula to calculate the required minimum distribution from IRAs, excluding Roth IRAs, has been changed and simplified.  The IRA owner locates their current age on the IRS life expectancy table to determine the number of years over which IRA benefits are expected to be paid.  Then divide that number from the table into all of the owner’s IRA account balances at the end of the previous year to arrive at the amount that must be distributed during the current year.  The only exception is where an IRA owner’s spouse is the beneficiary on the IRA account and the spouse is more than 10 years younger than the IRA owner.  In that case, the owner is allowed to use the old joint and last survivor table to stretch out and reduce the required minimum annual payment amount.

Although the computation of the required distribution in based upon all IRA accounts, the IRA owner is not required to take an equal percentage out of each IRA account if the owner has multiple accounts.  The owner can designate withdrawals equal to the required amount from either one or multiple accounts as long as the owner notifies the trustees of the other accounts that the required distribution is being made from other accounts.

ESTATE TAX ISSUES

The total value of ALL IRA accounts owned, deductible IRAs, non-deductible IRAs, and Roth IRAs, is included as an asset in the owner’s estate and valued as of the date of the owner’s death.  The IRA values are added to all of the other estate assets in arriving at the total estate value.  In many cases, the IRA value creates an estate tax liability even when the IRA account is the only significant asset in an estate.  IRA accounts in an estate are payable to the beneficiaries, so the beneficiaries are then liable for an estate tax resulting from the IRA accounts.  The beneficiaries IRA accounts generally can elect to rollover the IRA into an IRA account in their name as beneficiary and not trigger any immediate income tax. 

ALL distributions from inherited traditional IRAs are fully taxable as ordinary income to the beneficiaries.  Often, there is an estate tax imposed on IRA account balances as well as an income tax imposed on the distributions to the beneficiaries, so the combined tax rate can be extremely high.  The only benefit is that inherited IRAs are not subject to the 10% early withdrawal penalty.