Individual Retirement Account Frequently Asked Questions

General IRA Questions

The tax reform Act of 1986 changed the IRA deductibility rules for persons participating in employer sponsored retirement plans. It did not, as many people think, eliminate all IRA deductions. A single taxpayer that is not an active participant in a company sponsored plan can take the full deduction, regardless of their compensation level.

Who can contribute to an IRA?

Anyone under 70-1/2 with earned income can still invest in an IRA

The annual contribution allowed is:

not to exceed 100% of earned income. All dividends, interest and capital gains will accumulate tax deferred.

What is the Catch-up IRA Contribution?

Under the EGTRRA, individuals who have reached age 50 and who meet the law's Adjusted Gross Income limits for regular contributions for the year may make additional "catch up" IRA or Roth IRA contributions to make up for possible missed retirement savings opportunities earlier in life. The otherwise maximum IRA Contribution annual limit for a person who has reached age 50 by the end of the tax year (before application of the Adjusted Gross Income phaseout limits) was increased by $500 for 2004 through 2005 and $1,000 for 2006 and beyond.

What are Deemed IRAs under Employer Plans?

Under the EGTRRA, effective for plan years beginning after 2002, if an eligible retirement plan (such as a 401(k) plan or 403(b) plan) allows employees to make voluntary contributions to a separate account that is established within the plan and meets the requirements of either a traditional IRA or Roth IRA, then the account will be deemed a traditional IRA OR ROTH IRA. The contributions would be governed by the tax law rules for the type of IRA chosen.

Traditional IRA

Who is eligible for a traditional IRA?

Generally, anyone with earned income who has not reached age 70 ½ during the year of the contribution is eligible to contribute to a traditional IRA. The ability to deduct the contribution is based on whether you are an active participant in a qualified retirement plan and your adjusted gross income (AGI).

Who can make a deductible contribution to a traditional IRA?

A single taxpayer, or if married couple filing jointly, and one spouse is considered an active participant in a qualified retirement plan and the other spouse is not, the spouse that is not an active participant in an employer sponsored retirement plan may make a fully deductible IRA contribution provided their combined adjusted gross income is $200,000 or less. However for the couple with only person participating in an employer sponsored plan, the deduction for the nonparticipant spouse is phased out as joint AGI rises from $150,000 to $160,000. If the single taxpayer is an active participant in an employer plan, but has an adjusted gross income (AGI) in 2006 of less than $50,000, an IRA is fully deductible and a reduced portion is deductible up to an AGI of $60,000, at which point is completely non deductible. The same holds true for a married couple filing jointly with an AGI of less than $85,000 and the deduction is completely phased out at an AGI of $75,000. Or stated another way, the phase out starts for a single person earning $50,000 and is completely nondeductible at AGI $60,000 who is covered by a company plan, or the couple earning between $75,000 and $85,000 while both of them participate in an employer sponsored plan, an IRA is partially deductible. If the single person earns more than $60,000, and the couple earning more than $85,000 while both are participating in a company plan there is no IRA deduction allowed.

However, even if a deduction is not allowed, $4,000 can be contributed to a non-deductible IRA and the earnings will still be tax deferred. Any time after attaining the proper age, under most circumstances 59 1/2, withdrawals of the nondeductible contribution amounts are not a taxable event.

How much can be contributed to a traditional IRA?

100% of earned income up to $4,000 can be contributed to your IRAs each year. This is the annual combined limit for contributions to both traditional IRAs and Roth IRAs. Further, individuals 50 and over can make additional catch-up contributions of $1,000.

Can a retiree who has no earned income, but receives Social Security benefits, fund a traditional IRA?

No. Social Security is not considered earned income.

What is a spousal IRA contribution?

A spousal IRA contribution is a way in which a working spouse can fund an IRA for a non-working spouse. The couple must be married and file a joint return. 100% of earned income up to $8,000 can be contributed to the couple's IRAs each year, but no more than $4,000 can go into either spouse's IRA.

When must distributions from an IRA begin?

Distributions from a traditional IRA must begin by April 1 of the year following the year in which you reach age 70 1/2. For full information on Required Distributions see The New IRA Distribution Regulations (click here) 2002 and the Distribution Frequently Asked Questions.

How do I determine the minimum distribution that must be taken from my traditional IRA?

Generally, the required minimum distribution amount is determined by dividing the previous December 31 account balance by your life expectancy or that of you and your designated beneficiary (within IRS rules). This is called the "Uniform Distribution" table. For the Single Life Expectancy Table for Inherited IRAs click here or for the IRA Owner or Plan Participant table click here or for the Joint and Last Survivor Table click here

What happens if I do not take my required minimum distribution?

There is a federal tax penalty equal to 50% of the amount that was required to be withdrawn but was not. For example, if your required minimum distribution was $1,000 but you withdrew only $800, you would owe a penalty of $100 (50% of $200).

If I directly transfer my IRA to the same type of IRA at another institution, is that considered a distribution? No, a direct transfer is not considered a distribution and there are no tax consequences, although the institution's withdrawal charges may apply.

Does the 10% early distribution penalty still apply if someone is disabled?

No, provided you meet the definition of disabled under the Internal Revenue Code.

Are there any circumstances when a taxable distribution taken from my IRA before age 59 ½ will avoid the 10% penalty?

Yes, there are certain situations where a distribution prior to age 59 ½ is not subject to the penalty. These situations include distributions due to death, disability or under a series of substantially equal periodic payments over your life. Also, the penalty does not apply if the distribution is taken to pay for qualified higher education expenses, qualified first-time home purchases (up to $10,000) or certain health and medical expenses.

What if I contribute more to my IRA than the tax law allows?

If not corrected by the deadline for filing your income taxes for the year in which the contribution was made, there is an excess contribution tax equal to 6% which is assessed each year on the excess amount that remains in the traditional IRA.

ROTH IRA

While contributions to a Roth IRA are not tax deductible as they may be for a traditional IRA, earnings in a Roth IRA are potentially tax free. You can qualify for tax-free withdrawals of earnings once you reach age 59 1/2 and have had a Roth IRA for five years or more. In addition, tax-free withdrawals from a Roth IRA are available regardless of age after five years for first-time home purchase expenses (subject to a $10,000 lifetime cap) or on account of disability or death. Your eligibility to contribute to a Roth IRA phases out as your modified adjusted gross income rises from $95,000 to $110,000 (filing singly). For joint filers, phaseout occurs as income rises from $150,000 to $160,000.

The maximum that you can contribute to a Roth IRA each year is the lesser of $4,000 or 100% of your earned income. (These restrictions do not apply to conversions from a traditional IRA to a Roth IRA.) Any contributions made to traditional IRA's that you maintain for your own benefit reduce the contribution limit to a Roth IRA by the same amount. The annual combined contribution limit is $8,000 for joint filers.

What is the deadline for making a regular contribution to a Roth IRA?

You have until the deadline for filing your tax return (excluding extensions) to make a contribution to a Roth IRA Thus, most taxpayers have until April 15 of the following calendar year.

Can I withdraw money from a Roth IRA before age 59 ½ without paying taxes?

It depends upon whether the withdrawal is from contributions or earnings. No taxes will be due on withdrawals that represent your contributions (there is an exception for certain withdrawals of converted amounts made before 59 ½). In general, a withdrawal of earnings will be subject to tax and, if under age 59 ½, possibly a 10% federal tax penalty unless:

1. 1. the Roth IRA has been in existence at least five taxable years and
2. 2. the withdrawal is made on or after 59 ½, on account of death, disability or for a qualified first-time home purchase (up to $10,000).

Withdrawals of taxable converted amounts within five taxable years of such conversion will (unless you meet an exception) be subject to a 10% premature penalty tax if you are under 59 1/2. Also, withdrawals during the first three years of converted amounts receiving four-year income inclusion treatment will be included in income in the year of withdrawal. (This is in addition to the amounts to be included under the four-year income spread election.) The total aggregate amount to be included in income will not exceed the total taxable amount of the conversion.

Your beneficiary will receive Roth IRA earnings free from federal income tax provided the Roth IRA has been in existence for at least five taxable years. Roth IRAs included in your estate may be subject to federal estate tax. If you converted a traditional IRA to a Roth IRA and die before including all of the taxable amount in income under the four-year income inclusion rule, the remaining taxable amount must be included in year of the decedent's death, unless the beneficiary is the decedent's surviving spouse.

Can I contribute to both a traditional IRA and Roth IRA in the same year?

Yes, provided you meet the compensation requirements and you do not exceed the modified adjusted gross income limits for Roth IRAs. Please note that the total contributions to both may not exceed $4,000 or 100% of your earned income.

A traditional IRA requires mandatory distributions upon reaching age 70 1/2. If I own a Roth IRA and a traditional IRA, must I include the balance in the Roth in determining the amount I must withdraw from my traditional IRA?

No. One benefit of owning a Roth IRA is that you are not required to start taking a distribution upon reaching age 70 1/2. Furthermore, you do not have to include the Roth IRA balance when aggregating your traditional IRAs for purposes of calculating the required minimum distribution while you are alive.

What are the requirements for converting a traditional IRA to a Roth IRA?

In order to convert from a traditional IRA to a Roth IRA, your modified adjusted gross income (MAGI) must be $100,000 or less in the year of the conversion and if you are married, you must be filing a joint return.

Could the conversion of a traditional IRA to a Roth IRA have an effect on the taxability of Social Security?

Yes. The taxable amount of a conversion from a traditional IRA to a Roth IRA is includable as income in the year of the conversion and therefore could effect the taxability of an individual's Social Security benefits.

Can a spousal Roth IRA be opened if he or she does not have earned income?

Spousal contributions can be made to a Roth IRA

To be eligible, the other spouse must have earned income, the couple must file a joint tax return and they must meet the MAGI limits. The maximum combined contribution for both spouses is the lesser of $8,000 or 100% of the couple's earned income. Also,individuals 50 and over can make additional catch-up contributions of $1,000

In the situation described above, can the maximum contribution be made to one Roth IRA?

No. As with traditional IRAs, no more than $4,000 may be contributed to one Roth IRA. . .

EDUCATION IRA - Coverdell Education Savings Account

The Education IRA was introduced to help pay for a child's college tuition. This relatively new type of IRA allows contributions up to $2000 a year on a nondeductible basis toward a child's future education expenses until the child turns age 18. You can withdraw tax free any money, including account earnings, to pay qualifying higher education expenses of the child. Education IRA's are subject to the same phaseout ranges as Roth IRA's.

For 2002 this plan has been renamed Coverdell Educational Savings Accounts.Click here for more