IRA

12.1 IRAs Defined

General Concept:

• An IRA is a personal savings plan with tax advantages for retirement.

• Two Main Advantages: 1) Potential deductibility of contributions, 2) Tax-deferred growth of earnings.

Eligibility & Compensation:

• Any individual with taxable compensation can contribute to an IRA.

• Compensation Includes: Wages, salaries, commissions, self-employment income, taxable alimony (pre-2019 decrees).

• Compensation Excludes: Earnings from property (rental income, interest, dividends), pension income, and deferred compensation.

Key Rules:

• Spousal IRA: Allowed if a joint return is filed, enabling a contribution for a non-working spouse.

• Fully Vested: IRA assets must be fully vested at all times.

• Prohibited Investments: Cannot invest in collectibles (except for specific gold, silver, platinum bullion/coins). Cannot purchase life insurance.

12.2 Contributions

Contribution Limits (2024):

• Traditional & Roth IRA: $7,000 ($8,000 if age 50 or older).

• SIMPLE IRA: $16,000 ($19,500 if age 50 or older).

• SEP IRA: Lesser of 25% of compensation or $69,000.

Deadline: Contributions must be made by the tax return due date (April 15th, not including extensions).

Deductibility of Traditional IRA Contributions:

• If NOT covered by an employer plan: Full deduction is always allowed.

• If COVERED by an employer plan: Deduction is phased out based on Modified AGI (MAGI).

  • Single: Phase out between $77,000 - $87,000

  • Married Filing Jointly: Phase out between $123,000 - $143,000

  • Married Filing Separately: Phase out between $0 - $10,000

• Spouse is Covered, You Are Not (MFS): Special phase-out range applies.

Nondeductible Contributions & Basis:

• If a contribution is not deductible, it creates a cost basis in the IRA.

• Form 8606 must be filed to designate and track nondeductible contributions (basis).

• Upon distribution, basis is recovered tax-free.

Rollovers:

• Direct Rollover: Trustee-to-trustee transfer. No tax withholding or penalty risk.

• 60-Day Indirect Rollover: Taxpayer receives funds and must redeposit into a qualified plan within 60 days to avoid taxes and penalties.

• Inherited IRA (Non-Spouse): Cannot be rolled over or treated as your own. Must be distributed within 10 years. No contributions are allowed.

• Inherited IRA (Spouse): Can be rolled over into the spouse's own IRA.

Other Important Topics:

• Recharacterization: Changing a contribution from one type of IRA to another. Must be done by the tax return due date.

• Qualified Charitable Distribution (QCD):

  • Allows a tax-free distribution (up to $105,000 in 2024) directly from an IRA to a qualified charity.

  • Requirements: Taxpayer must be age 70½ or older.

  • Counts toward the Required Minimum Distribution (RMD).

• Saver’s Credit: A tax credit for low-to-moderate income taxpayers for retirement plan contributions.

  • Eligibility: Age 18+, not a full-time student, not claimed as a dependent.

  • Credit is a percentage (50%, 20%, 10%) of contributions up to $2,000, based on AGI.

12.3 Penalties

Excess Contributions:

• Contribution exceeding the lesser of compensation or the annual limit.

• Penalty: 6% excise tax each year the excess remains in the IRA.

• To Avoid: Withdraw the excess + earnings by the tax return due date (earnings are subject to income tax and a 10% penalty).

Premature Distributions (Early Withdrawals):

• Distribution from an IRA before age 59½.

• Penalty: 10% additional tax on the amount included in gross income.

• Key Exceptions to the 10% Penalty:

  • Death or Disability of the owner.

  • Substantially Equal Periodic Payments (72(t) payments).

  • First-time homebuyer expenses ($10,000 lifetime limit).

  • Qualified higher education expenses.

  • Medical expenses > 7.5% of AGI.

  • Health insurance premiums while unemployed.

  • Birth or adoption expenses (up to $5,000).

  • IRS levy.

  • Qualified reservist distribution.

• SIMPLE IRA Special Rule: Distributions within first 2 years of participation are subject to a 25% penalty.

Excess Accumulations (Failure to Take RMD):

• Required Beginning Date (RBD): April 1 of the year following the year you turn 73.

• Penalty for insufficient distribution: 25% excise tax on the shortfall (reduced to 10% if corrected timely).

Plan Loans:

• Treated as a distribution unless they meet specific criteria:

  • Loan limit is the lesser of $50,000 or 50% of vested balance.

  • Must be repaid within 5 years (except for principal residence loans).

  • Level payments required at least quarterly.

12.4 Roth IRAs

Contributions:

• Always Nondeductible.

• Same contribution limits as Traditional IRA ($7,000 / $8,000).

• Income Limits for Eligibility (Phase-Out Ranges):

  • Single/HoH: $146,000 - $161,000

  • Married Filing Jointly: $230,000 - $240,000

  • MFS: $0 - $10,000

• No Age Limit: Contributions can be made at any age.

Qualified Distributions (Tax-Free and Penalty-Free):

• Must satisfy BOTH of these requirements:

  1. 5-Year Holding Period: Begins with the first tax year for which any Roth IRA contribution was made.

  2. And meet one of these conditions:

     • Age 59½ or older

     • Death

     • Disability

     • First-time homebuyer ($10,000 lifetime limit)

• Ordering Rules: Distributions are considered to come from contributions first, then earnings. Contributions are always tax and penalty-free.

Non-Qualified Distributions:

• Earnings portion is subject to income tax and a 10% penalty (unless another exception applies).

Rollovers & Conversions:

• Can convert a Traditional IRA to a Roth IRA.

  • The converted amount (except for any basis) is taxable income in the year of conversion.

  • No 10% penalty on the conversion amount itself.

• Recharacterization of a Roth conversion back to a Traditional IRA is no longer allowed.

Required Distributions:

• No RMDs during the owner's lifetime. RMDs are required only for beneficiaries after the owner's death.

12.5 Section 529 Qualified Tuition Programs

General Concept:

• A tax-advantaged savings plan for qualified higher education expenses.

• Contributions: Not deductible for federal income tax.

• Earnings: Grow tax-free. Distributions are tax-free if used for qualified expenses.

Qualified Expenses Include:

• Tuition, fees, books, supplies, equipment.

• Room and board (for at least half-time enrollment).

• Computer technology and internet access.

• K-12 Tuition: Up to $10,000 per year per beneficiary.

• Apprenticeship Programs: Up to $10,000 lifetime.

• Student Loan Repayment: Up to $10,000 lifetime (for beneficiary and siblings).

Gift Tax Rules:

• 5-Year Election: A donor can contribute $90,000 ($18,000 annual exclusion x 5) in one year without gift tax, by electing to spread the gift over 5 years.

• Form 709 must be filed.

• If the donor dies within the 5-year period, a pro-rata portion of the gift is added back to their estate.