Individual retirement accounts (IRAs) are, for many people, the cornerstone of their retirement savings plans. Together with 401(k)s and 403(b)s, they are an excellent method of deferring taxes into the future while saving and investing today. The following information is believed to be accurate, but as new tax laws take effect, some of this may change. We suggest that you consult your tax preparer before making any final decisions about what type of IRA is best for you. The following are the principal forms of individual retirement accounts used by most investors:
Traditional IRAGeneral Requirements
- Contributions must be made in cash, unless you are making a qualified rollover contribution.
- Annual contributions for 2005 through 2007 may not exceed the lesser of 100% of your compensation or $4,000, unless you are making a rollover, transfer, or SEP contribution. IRA holders age 50 or older may contribute up to $5,000 per year in 2006 and 2007.
- Annual contributions may be deposited at any time during the taxable year up to the due date for the filing of your federal tax return.
- The Custodian of an IRA must generally be a bank, savings and loan association or credit union.
- No portion of IRA funds may be invested in life insurance contracts.
- Interest in an IRA is nonforfeitable at all times.
- The assets in an IRA may not be commingled with other property except in a common trust fund or common investment fund.
- One may not invest the assets of an IRA in collectibles.
- Distributions from an IRA must begin by April 1st following the year in which one turns 70 1/2.
Contributions may be made to an IRA for any taxable year in which you receive compensation, prior to the year you turn 70 1/2. Compensation includes salaries, wages, tips, commissions, bonuses, alimony, royalties from creative efforts and "earned income" in the case of self-employment. The amount that is deductible depends upon whether or not you are an active participant in a retirement plan maintained by your employer, your adjusted gross income (Modified AGI), your marital status, and your tax filing status.
DistributionsWithdrawals from your IRA may be taken in regular payments, random withdrawals or in a single sum payment. Generally, all distributions from your IRA are included in your gross income in the taxable year in which they are received and are taxed at ordinary income tax rates for federal tax purposes.
If you are under age 59 1/2 and receive a distribution from
your IRA account, an additional penalty of 10% will apply
to the taxable portion of the distribution unless one of the distribution is received for:
- Death.
- Disability.
- A series of substantially equal periodic payments at least annually over your life expectancy or the joint life expectancy of you and your designated beneficiary.
- Medical expenses in excess of 7.5% of your adjusted gross income.
- Health insurance premiums paid by certain unemployed individuals.
- Qualified acquisition costs of a first time homebuyer.
- Qualified higher education expenses.
- A qualifying rollover distribution.
- The timely withdrawal of the principal amount of an excess or nondeductible contribution.
- An IRS levy.
Rollover IRA
A Rollover IRA is any amount you receive from one IRA and roll some or all of it over into another IRA. You are not required to roll over the entire amount received from the first IRA. However, any amount not rolled over will be taxed at ordinary income tax rates for federal income tax purposes, and may incur a penalty if taken before age 59 1/2.
General Requirements- The rollover must be completed within 60 days of the distribution. One may have only one IRA to IRA rollover during a 12-month period.
- The property received in a distribution must be the same property that is rolled over into the second IRA.
- You are required to make an irrevocable election indicating that this transaction will be treated as a rollover contribution.
- You are not required to receive a complete distribution from your IRA in order to make a rollover contribution into another IRA, nor are you required to roll over the entire amount you received from the first IRA.
- If you inherit an IRA due to the death of the participant, you may not roll this IRA into your own IRA unless you are the spouse of the decedent.
- Rollovers from a SEP or an Employer-IRA follow the IRA to IRA rollover rules since contributions under these types of plans are funded directly into your own IRA.
Rollovers from Employer-Sponsored Plan Rollovers to IRAs are permitted if you have received an eligible rollover distribution form for one of the following:
- A qualified plan under Section 401(k);
- A qualified annuity under Section 403(a); or
- A Tax-Sheltered Annuity or Custodial Account under Section 403(b).
Roth IRA
General Requirements
- Contributions must be made in cash, unless you are making a qualified rollover contribution.
- New annual contributions for 2005 through 2007 made to all of your Roth IRAs and traditional IRAs may not exceed the lesser of 100% of your compensation or $4,000. IRA holders age 50 or older may contribute up to $5,000 per year in 2006 and 2007.
- Roth IRA contributions may be deposited at any time during the taxable year up to the due date for the filing of your federal tax return.
- The Custodian of your Roth IRA must be a bank, savings and loan association or credit union.
- No portion of Roth IRA funds may be invested in life insurance contracts.
- Interest in a Roth IRA is nonforfeitable at all times.
- The assets in a Roth IRA may not be commingled with other property except in a common trust fund or common investment fund.
- One may not invest the assets of a Roth IRA in collectibles.
You are permitted to make regular contributions to a Roth
IRA for any taxable year if you received compensation in that
year. Compensation includes salaries, wages, tips, commissions,
bonuses, alimony, royalties from creative efforts and "earned
income" in the case of self-employed. Your actual contribution
limit depends upon your marital status, tax filing status,
and your Modified AGI. The latest AGI range for single people is between
$99,000 and $114,000 and for married couples between $156,000 and $166,000.
Contributions
Regular contributions: All contributions to a Roth
IRA are non-deductible. The maximum amount may be contributed
to a Roth IRA is reduced by any contributions made to all
traditional IRAs for the same tax year. In other words, the
total maximum annual contributions to all IRA's is $4,000, or $5,000 if you are over 50 years old.
Rollovers: You may not roll over an employer-sponsored
plan to a Roth IRA. However, you may roll over from an employer-sponsored
plan to a traditional IRA and then "convert" the
traditional IRA to a Roth IRA in a Conversion explained below.
Conversions: You are permitted to convert from a
traditional IRA to a Roth IRA if your Modified AGI for the
year during which the distribution is made is between $99,000 and
$114,000 and you are not a married person filing a separate
tax return.
You are also permitted to re-characterize ("unwind")
a conversion made to a Roth IRA if the amount plus earnings
is transferred back to a traditional IRA before the tax filing
deadline.
Distributions: Qualified distributions are tax free
and may be taken in regular payments, random withdrawals or
in a single sum payment.
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SIMPLE IRA
A SIMPLE IRA is a small business pension plan called the Savings
Incentive Match Plan for Employees. The Plan is specifically
designed for companies with 100 or fewer employees who received
at least $5,000 in compensation from the company in the preceding
year. An employer may not establish a SIMPLE IRA plan if they
have maintained/contributed to another qualified plan during
the calendar year.
Tax Deferral Feature
Assuming an employee elects to have you, the employer, contribute
a potion of his or her pay, the tax liability to the employee
is reduced by the amount of the contribution. The maximum
dollar amount that an employee can defer each year into a
SIMPLE IRA is currently $7,000.
Which Employees Are Eligible
Employees who have worked in any 2 preceding years, have earned
at least $5,000 in such years and are expected to receive
at least $5,000 in the current year are eligible to participate
in the SIMPLE Retirement Plan for the current plan year. However,
you may adopt less restrictive eligibility requirements. You
may exclude from your plan employees who are covered under
a collective bargaining agreement where retirement benefits
were the subject of good faith bargaining, and nonresident
alien employees with no U.S. source of income.
Employer Contributions
SIMPLE Plans allow you, the employer, to either match each
employee's elective deferrals on a dollar-for-dollar basis
up to 3% of their compensation or to make a regular employer
contribution (referred to as "nonelective") of 2%
of compensation for each eligible employee. The maximum compensation
that can be considered for each participant in determining
this 2% nonelective contribution is $160,000, subject to the
cost of living adjustment.
The employer may elect a lesser percentage (not less than
1%) for any year if:
- The employer notifies all eligible employees within a reasonable time before the Election Period; and
- Employer matching contributions are not less than 3% for more than 2 of the years in the 5-year period ending with the current plan year.
Money that you contribute to an employee's IRA through a SIMPLE plan is always 100% vested.
What Must the Employees Do to Begin Deferring
- You must notify each eligible employee 60 days prior to the effective date of the plan whether you will be matching employee deferrals or making the 2% nonelective contribution.
- Each employee must establish a SIMPLE IRA so that you, the employer, can deliver all contributions directly to the IRA Custodian.
- Each employee will then complete a "Deferral Election Form" which will indicate how much per pay period the employee wants to defer.
Anytime between January 1 and October 1. The employer must, however, provide at least a 60-day enrollment period prior to January 1 in which all eligible employees are given the right to enter into, or modify, their salary reduction agreement.
Contribution Deadlines
Elective Deferrals must be made to the employee's SIMPLE IRA no later than 30 days following the last day of the month after being withheld from the employee's wages.
Employer matching or nonelective contributions must be made to the employees' accounts no later than the employer's tax filing deadline, including extensions.
Deductibility of Employer Contributions
Contributions to a SIMPLE Plan are deductible by the employer for the taxable year within which the Plan Year ends.
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SEP IRA
A Simplified Employee Pension (SEP) is a retirement plan that allows an employer to make contributions toward his or her own (if self-employed) and employees' retirement plans without becoming involved in more complex arrangements. The contributions are made to a SEP-IRA of each participant.
Contributions
Contributions are limited to 15% of compensation or a maximum of $30,000 per year. There is no mandatory annual contribution. Flexible contribution amounts are allowed.
Who benefits most from a SEP?
A SEP account is of the greatest benefit to a self-employed individual or business owner with few or no employees. If you have full-time employees, you must make the same contribution percentage for them as for yourself if the employee:
- Is over 21 years old;
- Has worked for you three of the preceding five years; and
- Has earned at least $450 in compensation (the indexed amount for 2002). All eligible employees are 100% vested with all contributions from the start of their participation.
Education IRA (now known as the Coverdall Education Savings Account)
An Education IRA is a trust or custodial account that is created in the United States exclusively for the purpose of paying the qualified higher education expenses of the designated beneficiary of the account. To be treated as an Education IRA for tax purposes, the account must be properly designated when it is created. It can be established for any child under 18. Contributions to the Education IRA will not be accepted after the designated beneficiary reaches his/her 18th birthday.
A taxpayer may start making contributions of up to $2,000 per year in aggregate contributions for any child on January 1 or at any time thereafter. Contributions may be placed in a single Education IRA or in multiple Education IRAs. All contributions must be made in cash. Taxpayers do not have to be related to the designated beneficiary in order to make contributions. A child may contribute to his/her own account.
The eligibility of any individual or couple to contribute to an Education IRA is subject to limits on that individual or couple's modified adjusted gross income for that taxable year.