General Notes · Traditional IRA Notes · ROTH IRA Notes · Educational Savings Accounts

General Notes:

Retirement Plans are excellent places to build up assets; however, there are at least two phases to retirement planning - the Accumulation phase and the Distribution phase. The accumulation phase is more often dealt with as a living matter, whereas the distribution one is often addressed as a beneficiary matter involving the transferring of some or all of one’s Retirement Plan assets following one’s death.

Distribution considerations of such plans address how assets will be distributed, either in life or as one retirement plan beneficiary spouse dies and those assets transfer to either a surviving spouse and/or other named heirs ("beneficiaries"). Tax and estate laws deal rather specifically with different types of "heirs" and how distributions to each are treated. For these and other reasons, perhaps the most important planning step one can take on IRA or Retirement Plan assets is keeping beneficiary designations up-to-date. This is especially telling in cases of divorce where spouses often fail to update beneficiary forms to reflect their changed circumstances, or on the death of a beneficiary.

Extreme caution needs to be taken on beneficiary designations, and updating them to reflect that listed beneficiaries are still living and that they reflect most current changes in one’s life.

For examples, once inherited, IRA assets that are distributed to a non-spousal beneficiary loose their tax sheltered status and the distribution becomes taxable.

Also, if an IRA is inherited from an estate that pays federal estate tax, the beneficiary is eligible, under the "Income in Respect of a Decedent" (IRD) rules, to deduct approximately 40% of the IRAs income tax, a deduction commonly overlooked by beneficiaries, accountants, financial advisors and attorneys.

Though this overall subject is far broader and more complex than this venue permits, certain desired beneficiaries may not be old enough or responsible enough to control their spending habits, which might necessitate the use of a Trust to manage and control the distributions of such assets. Trusts, however, create separate accounting and tax issues that one must carefully consider prior to employing them.

Click Here for Special ROTH 2010 Conversion Opportunity & Details

RMD - Required Minimum Distribution Exceptions:  

ROTH IRA Owners are not subject to RMD’s (required minimum distributions); however, once THEY DIE their non-spouse beneficiaries ARE SUBJECT TO RMDs (who do not roll the account over into an IRA or who fail to treat the inherited ROTH IRA as their own).  The ONLY difference in the treatment of RMDs between Traditional IRAs and ROTH IRAs are that the distributions from ROTH IRAs are likely income tax free.

When calculating LIFETIME RMDs, beneficiaries are not to use the IRS "Uniform Lifetime Table". 

Exception to using the IRS "Uniform Lifetime Table" - if a client’s sole IRA BENEFICIARY for the entire year is a spouse who is more than 10 years younger, the IRA Owner can use the actual ages of both spouses based on the "Joint Life Table" (see:  www.irs.gov/pub/irs-pdf/p590.pdf).

RBD - Required Beginning Dates for IRA Distributions:

Typically this date is April 1st following the year the IRA Owner attains age 70 1/2, and thereafter by December 31st annually based upon IRS life expectancy tables.  50% penalties apply for time violations.  

"Still Working Exception" - allows you to delay distributions from employer retirement plans until the year after you retire, but only on those plans of the present employer, not prior employer plans from other previous jobs. N/A on IRA’s but applicable on 401(k)s, 403(b) ("TSA"), etc.

"Grandfather Rule on TSAs (403(b))" prior to 1987 "old money assets" ONLY -  allows you to delay distributions, on those assets only, until you turn Age 75.

UBTI - Unrelated Business Taxable Income in IRA Accounts

IRAs (Traditional, ROTH and even SEP) that receive $1,000 or more of gross UBTI income (generally from certain Limited Partnerships and Limited Liability Companies) in a single tax year must file Form 990-T with the IRS on or before April 15th tax filing deadline, with all applicable taxes paid from Trust assets. Accounts receiving less than $1,000 are not required to file. Accounts that exceed $500 are required to make estimated or pre-payments.

- Traditional IRA, ROTH IRA and ESA - Detailed Matrix -

See Updates & Notes Below This First Upper Page Chart	Traditional IRA	ROTH IRA	"Education IRA" Coverdell Education Savings Accounts ("ESA")
Contribution limits (lesser of chart numbers, or 100% of an individuals compensation)	$5,000* Inflation Adjusted, with Catch Up	$5,000* Inflation Adjusted, with Catch Up	2,000* per Child
Age limit on contributions	70½	None	Under Age 18
Phase Out Ranges for those who can make the maximum deductible (IRA) & non-deductible contributions (ROTH & Education IRA). This section applies a Phase Out of the deductibility that is only applicable when one is also participating in an employer sponsored retirement plan. For others there is no Phase Out, or loss of deductibility.   (Consult Your Tax Advisor)	Contributor’s MAGI (Phase Out dollar amounts apply to those who are also participants in qualified retirement plans) Single Phase Out $53,000 to $63,000 (2009) Joint Phase Out $85-105k ($159k-169k for the spouse not covered via an employer plan) (2009) [IRC Section 219(g)]	Contributor’s MAGI (Phase Out dollar amounts apply regardless of whether or not one also participants in a qualified retirement plan) Single Phase Out  $101k-$116k (2009) Joint Phase Out $159k-$169k (2009) [IRC Section 408A(c)(3)]	Contributor’s MAGI Single Phase Out $95,000 to $110,000 Joint Phase Out $190,000 to $220,000   [IRC Section 530]
Contribution tax-deductible? (Consult Your Tax Advisor)	YES	NO	NO Distributions for qualified expenses are federally tax free (see Notes).
Can convert to ROTH IRA? (see ROTH Notes below)	Yes, but will have tax consequences.	N/A	No
Can convert to Education IRA?	No	No	Can be transferred to another Education IRA at another company for same child. Can also be transferred to another family member.
Can convert to Traditional IRA?	N/A	No	No
Can be transferred to another Traditional IRA at another company.	Yes	N/A	N/A
When is disbursement penalized? (See RBD below)	10% penalty for withdrawals under age 59 ½, unless for qualified expenses. (See section 72(t) exceptions that can avoid pre-age 59 1/2 withdrawal penalties as noted below)	10% penalty for withdrawals under age 59 ½ or on assets held in account less than 5 years, unless for qualified expenses (see notes below).	10% penalty on earnings if  not used for elementary, secondary or college education, or if not used by Age 30 (death or disability exempted).
When is disbursement mandatory?	Before age 70½	NEVER (See General Notes below about RMD & RBD, etc.)	Before age 30 - Within 30 days of age 30 and/or death
Contribution Deadline	By April 15th of following year	By April 15th of following year	By April 15th of following year

*LEGEND:  "MAGI" = Modified Adjusted Gross Income

Generally equal to AGI (Adjusted Gross Income) increased by the addition of earned income from abroad or amounts effectively connected with the individuals conduct of a trade, business, or derived from sources in Guam, American Samoa, or the Northern Mariana Islands (if the individual is a resident of the possession where the source of the income is located), and/or amounts derived from sources in Puerto Rico (if the individual is a Puerto Rican resident).
 

Year	Traditional & ROTH IRA Contribution Limits*	Catch Up for those Age 50+
2009	$5,000	$6,000
2010	$6,000	$7,000
2011+	Indexed to Inflation in $500 Increments	Outcome of Indexed IRA + $1,000

*While you can contribute to both a Traditional IRA & a ROTH IRA in the same year, the total in all Plans can not exceed the Contribution Limits noted in the above chart (in addition to any applicable "Catch-Up" amount for those age 50+). There are no dollar limits on IRA transfers and rollovers.  "FULL" contribution limits for all IRA’s decline and phase out depending on AGI / MAGI if single and/or married filing jointly.

If one is also a participant in an employer sponsored retirement plan (i.e. like a 401(k) or Profit Sharing Plan) then one has to observe what are known as the 415 Limits on total aggregated contributions into all employer plans (not IRAs or ROTH IRAs). For  2009 the maximum contributions from all sources cannot exceed $46,000, plus $5,000 in catch up from one’s own salary for those over Age 50 (effectively an increase to your allowed salary deferral amount), for a maximum of: $51,000.

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Traditional IRA Notes

 

I.  Section 72(t) Exceptions to Avoid Pre-Age 59 1/2 Withdrawal Penalties
 

II. Traditional IRA - Distribution Planning Strategies

 

I.  Section 72(t) Exceptions to Avoid Pre-Age 59 1/2 Withdrawal Penalties From Traditional IRA’s:

 

There are several 72(t) exceptions available to avoid pre-age 59 1/2 withdrawal penalties from the Traditional IRA, the most common being "SEPP" - or Substantially Equal Periodic Payments. 

 

Applicable SEPP Rules Include:

*  SEPPs must continue until the later of  5 years, or age 59 1/2.

*  Taking out more or less than the SEPP amount produces penalties and interest

    on all prior withdrawals.

*  Requires the consistent use of one of the following three ways of calculating the

    SEPP amount:

·  Life Expectancy Method - results in lowest withdrawal amount, and is annually recalculated at reduced life expectancy due to aging.

 

·  Amortization Method - results in increased withdrawal amounts than under the Life Expectancy Method, and bases its calculations on a set initial value that typically can not be changed.

 

·  Annuitization Method - results in increased withdrawal amounts than under the Life Expectancy Method, and bases its calculations on a set initial value that typically can not be changed.

The latter two Methods, while resulting in greater withdrawal amounts (increased income), also put one in danger of more rapidly depleting the IRA asset.  Great care must be taken when electing these latter two Methods.  

 

Some advisers suggest recoveries from the outcomes of these last two Methods through personalized "Private Letter Rulings", that are costly to obtain from the IRS (rulings that may allow for reducing withdrawal amounts due to reduced asset values following significant market declines), or "hybrid Methods" [valuing the IRA on the same day of each year, and using the same type of monthly interest rate each year - typically the Applicable Federal Rate ("AFR")], but neither of these indicated solutions are simple or guaranteed.  

 

One must determine, for the period in question (i.e. the latter of 5 years or age 59 1/2), what is most important; namely, one’s needed income amount, not only during this period, but regarding any remaining IRA assets that are or will be needed to support one’s ongoing retirement income requirements.

 

 

II.  Traditional IRA Distribution Planning Strategies:
 

 

It is one thing to set up, fund, and build a Traditional IRA retirement plan account, but it is equally important to structure/design the plan in such a way as to substantially avoid and/or reduce Estate & Income Taxes. Properly structured the IRA can:  

*  Maintain it’s tax deferred status over the lives of the owner, spouse, children and

   even grandchildren.

*  Avoid a forced lump sum distribution & lump sum income taxes.

*  Reduce or eliminate estate taxes.

*  Control asset distributions, even after the owner’s death.

Properly structuring beneficiary designations, use of Trust beneficiaries, use of disclaimers, etc., all contribute to effectively "stretching out" a Traditional IRA.  In the process, all parties benefit with the ultimate beneficiaries (typically grandchildren), reaping typically 10x-20x what the primary beneficiaries would have received by simply getting capable advice & distribution planning guidance.

 

At death, IRAs are included in the IRA owner’s estate and they create an income tax liability for the beneficiaries when they take the assets.  IRAs are considered "Income with Respect to a Decedent (IRD)" according to IRC Section 691(c).  Therefore, beneficiaries are entitled to take an income tax proportional deduction for any estate taxes they paid on the IRA. In order to calculate this tax deduction you first have to calculate the estate taxes due on the entire estate of the IRA owner and then you subtract the item of IRD and re-calculate the estate tax again.  A solution for IRA beneficiaries is for estate owners to establish irrevocable life insurance trusts funded with life insurance to pay the estate taxes and preserve more of the overall estate assets for the intended heirs, as well as IRA beneficiaries subject to IRD taxes, and for such estate owners to spend down more of their assets that are subject to IRD, while living, rather then consuming non-IRD assets. 
 

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ROTH IRA Notes

 

I.    ROTH IRA Distributions & Rollovers from Traditional IRA’s

II.   ROTH IRA Conversions

I.  ROTH IRA Distributions:   

The 2 forms of withdrawals from ROTH IRA’s include either distributions of earnings or of principal. Earnings on contributions of principle grow federally tax-free provided certain DISTRIBUTION REQUIREMENTS are met (see IRS Publication 590 for full details).

ROTH IRA - DISTRIBUTION REQUIREMENTS:

Withdrawal of Contributions - since principal contributions are made on an after-tax basis, withdrawals of such contributions are generally federally tax-free.

Withdrawal of Earnings (on Contributions) - may be federally tax-free and penalty free IF the owner has had the ROTH IRA for at least 5 years AND one of the following applies:

     1) the owner is age 59 1/2 or older
     2) the owner is disabled or deceased
     3) the proceeds are used for a first time home purchase ($10,000 lifetime limit)

Withdrawal Exceptions (not subject to the IRS 10% premature withdrawal penalty): withdrawals that do not exceed the contribution amount; the owner is age 59 1/2 or older; the owner becomes disabled or dies; the proceeds are used for a first time home purchase ($10,000 lifetime limit); certain medical expenses; distributions of certain substantially equal periodic payment plans (SEPP); payment of health insurance premiums by certain unemployed persons; rollovers; qualified education expenses; divorce and IRS levy.

Non-Spousal ROTH IRA Beneficiaries must begin distributions under either the 5 year rule, or can opt out of this rule in favor of life expectancy.  If you are the beneficiary of more than one ROTH IRA, from different decedents, you cannot take the required distributions from just any account, but must take them from an account that was inherited from the same person.  NOTE:  you cannot aggregate ROTH and Traditional IRA’s for computing RMD’s (required minimum distributions).

Rollovers to a ROTH IRA from a Traditional IRA (both pre-1998 and after):  these are allowed but are fully taxable; however, they do not invoke the 10% pre-mature distribution penalty.

II.  ROTH IRA Conversions ~ Estimated Tax Penalties & Other Thoughts:

Some risk attaches to the long-range tax-saving move of converting your regular Traditional IRA to a ROTH IRA. In a Traditional IRA, funds grow tax-free but are taxable when withdrawn. ROTH IRA funds get tax-free growth and are tax-free when withdrawn, but with a tax cost up front: ROTH IRA contributions are never tax-deductible (as Traditional IRA contributions are) and conversions of Traditional IRAs to ROTH IRAs are always taxable. Conversions, at a tax cost today, are done so that today’s funds when withdrawn, and all future appreciation when withdrawn, will be tax-free.

IRS is finding that some taxpayers making the conversion have failed to take the resulting conversion income into account in their estimated tax calculations. This has led to unexpected tax penalties.

Example:

 

Jane has a salary of $70,000 a year. Her tax on this, after allowable deductions, is covered by wage withholding. But last year she converted her $150,000 Traditional IRA to a ROTH IRA. She knew this would increase her income tax bill, which she intended to pay out of savings. But she may be surprised to learn she’s subject to a tax penalty for underpayment of estimated tax, a tax she may not have known about or considered inapplicable to wage earners.

IRS has encountered many in Jane’s situation, who come to IRS asking that their penalties be abated (waived). IRS says it has no legal authority to abate the penalty.

TIP: You can undo the conversion to ROTH IRA, restoring the funds to a Traditional IRA. That would undo the income tax liability on the conversion, and with it the estimated tax liability thereon. For a conversion in 2000, you have until the due date of the 2000 return, including extensions. 

TIP: Tax law allows several options for calculating estimated tax. One method reduces the payment due—and hence the underpayment penalty—where income balloons in the last 4 months of the year, the period when many choose to make their ROTH IRA conversions.

TIP: Speaking of undoing conversions, some undo where the funds’ value drops after conversion, as for example in the 2000 stock market decline. Undoing the conversion won’t get their money back, but will save them from tax on wealth they no longer have. 

TIP: Some with an eye on President Bush’s 2001 approved tax cut may want to undo a conversion last year at last year’s rates, and convert anew this year or later, at promised lower rates.

ROTH IRA conversions are risky and involve big bucks. Making and undoing conversions, and estimated tax calculations, should be done with a professional advisor. SEE SPECIAL 2010 ROTH IRA CONVERSION OPPORTUNITY.

 

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Educational Savings Accounts Notes

Coverdell Education Savings Account ("ESA") - A College Savings Plan

A Coverdell Education Savings Account ("ESA"), formerly and still more widely known as an "Education IRA", is a trust or custodial account created exclusively for the purpose of paying the "qualified education expenses" of a specified living beneficiary; hence, a College Savings Plan.  These Plans began accepting contributions as of January 1, 1998, and from then through 2001 only allowed for a maximum contribution of up to $500.  As of 2002 that contribution is increased as shown in the above chart. Education IRA’s can also accept contributions by corporations, tax-exempt organizations, and other entities.

 

Covered, "eligible expenses", were expanded in 2002 to include costs for grades K1-K12, public, private, religious, and college, and include such "qualified higher education, elementary & secondary education expenses" as:  tuition, fees, books, supplies, equipment required for enrollment or attendance, computer and software used during attendance (non game, hobby or sports), tutoring, extended day programs (as required or provided by the institution), computer equipment, special needs services, room & board if at least a half-time student (at the schools posted room rate, otherwise limited to $2,500 for students living off campus, and not at home), uniforms & extended day program costs, and also contributions made to a qualified state tuition program.

 

 

Taxation Issues Regarding - Contributions, Earnings & Distributions:

* Contributions are not tax deductible and are instead treated as "completed present interest gifts" for gift tax purposes.  Contributions may be made up until April 15th of the following year, not including any extensions.  Contributions may be made to both Education IRA & Section 529 College Savings Plans without triggering a 6% excise tax as prior to 2002.

 

*  Earnings on contributions are not taxed until distribution.

 

* Taxation on distributions for "Eligible Education Expenses" - contributed principal or generated earnings are not taxable.

 

* Taxation on distributions for "Ineligible Education Expenses" - contributed principal or generated earnings are taxable.  Such distributions are taxed under IRC Section 72 annuity rules in the following manner:

Contribution Portion Distributions - subject to income tax.

Earnings Portion Distributions - subject to income tax PLUS a 10% penalty tax.

Termination of an Education IRA after 30 days of a beneficiary turning age 30 will result in taxation on the earnings portion of any assets not used or distributed for their intended education purpose, PLUS a 10% penalty tax.  The penalty will not apply on distributions made on account of either death or disability, or individuals with "special needs" as so defined.

 

*  The Hope Scholarship Credit and Lifetime Learning Credit:  As of 2002 there is no longer a restriction on using this Credit during the same year you make a withdrawal from an "Education IRA", as long as they are used for separate expenses. 

 

Account Beneficiary Flexibility:

 

The question often arises "may the designated beneficiary of the account be changed from one child to another, or to some other party without triggering a tax?"  The answer is YES!

 

The restrictions on this are that it may be done but only with or for "Account Beneficiaries" that are defined as - "qualified family members"; namely, spouse, child, stepchild, daughter-in-law, son-in-law, mother, stepmother, mother-in-law, father, stepfather, father-in-law, sister, half sister, stepsister, sister-in-law, brother, half brother, stepbrother, brother-in-law, aunt, uncle, niece, nephew, first-cousin, or the spouse of any of the foregoing.

 

Disclaimer: The material discussed herein is meant for general illustration or informational purposes only and is not to be construed as financial advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary; therefore, the information contained herein should be relied upon only when coordinated with individual professional advice. We are not licensed for and therefore do not provide tax or legal advice.