Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Types of IRAs
Retirement accounts for individual savers:
– Traditional IRA
– Roth IRA
Employer-sponsored IRA accounts:
– SEP IRA
– SAR-SEP IRA
– SIMPLE IRA
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
What is it?
IRA means
Individual Retirement Account
Individual Retirement Annuity
A type of retirement savings arrangement that allows
contributions (up to certain limits) and investment
earnings to grow tax-deferred.
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
What is it? (cont)
Traditional IRAs are primarily individual
retirement plans.
However, employers can
–
sponsor traditional IRAs as a limited alternative to an
employer-sponsored qualified retirement plan
–
sponsor a “deemed IRA” as part of a qualified plan
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
When is it indicated?
1. to shelter current compensation or earned income from
taxation
2. to defer taxes on investment income
3. for long-term accumulation, especially for retirement
4. as a supplement or an alternative to a qualified plan
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Advantages
• eligible individuals (and their spouses) may contribute
up to the maximum annual contribution amount and,
within limits, take a tax deduction for the
contribution(s)
• tax deferred investment income
–
but withdrawals taxed as ordinary income
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Disadvantages
• deductions are limited and can be
unavailable to active participants in a taxfavored employer retirement plan
• early withdrawals subject to 10% penalty
• generally, cannot establish IRA after age
70½; withdrawals must begin April 1 of year
after year reach age 70½
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
1. No required minimum contribution
can contribute in one year, skip another year
but failure to contribute reduces tax-favored accumulation
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
(cont)
2. Deduction Limits
maximum annual deductible IRA contribution for
an individual is the LESSER of
- the maximum annual contribution amount
or
- the individual’s earned income
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Maximum Annual Contribution Amount (2009)
Type
Dollar Limit
Regular
$5,000
Catchup (attained age 50)
$1,000
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
(cont)
3. Earned Income
must be produced from personal services such as wages,
salaries, commissions, and bonuses
excludes unearned income such as dividends, interest, or rent
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
(cont)
4. Spousal IRAs
in some cases, an additional contribution can be made for a
spouse
earned income of one spouse can be used as income of other
spouse, so, for example, contributions can be made for spouse
who does not work or who has little income
must file a joint return to use earned income of other spouse
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
(cont)
5. Married couples with two incomes
should each establish separate IRA
even if couple live in community property state
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
(cont)
6. Active Participant Restriction
if an otherwise eligible person actively participates in an
employer plan, the available traditional IRA deduction is
reduced
amount of reduction depends on adjusted gross income (AGI)
level
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
AGI Phaseout Ranges for Deduction
of Active Participant (2009)
Single Return
$55,000-$65,000
Joint Return (active
$89,000-$109,000
participant spouse)
Joint Return (non active
$166,000-$176,000
participant spouse)
Separate Return
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$0-$10,000
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
(cont)
6. Active Participant Restriction (cont)
•
if taxpayer is below the AGI cutoff level, at least
$200 can be contributed to IRA and deducted
•
If neither spouse is active participant, then no AGI
phaseout
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules (cont)
7. Nondeductible IRA
–
nondeductible contributions can be made to traditional IRA
–
limit is excess of maximum annual contribution amount
over the amount deductible
–
nondeductible contributions withdrawn tax free, investment
earnings taxed
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Contribution Rules
(cont)
8. Time Limits
can establish IRA and claim tax deduction any time
prior to due date of tax return without extensions
9. Saver’s Credit
limited nonrefundable tax credit available to some low income
taxpayers who contribute to IRA
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Investments
1. IRA contributions are not locked into any
particular investment
can have more than one IRA and invest with different
sponsors
can transfer (within limitations) from one IRA to
another
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Investments (cont)
2. In general, can invest in any type of assets
but cannot invest in
–
–
–
collectibles (other than certain government coins)
life insurance contracts
a participant’s own note (since loans are not permitted)
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Loans
1. Cannot borrow from own IRA
2. Can use rollover provision to, in effect, make 60day interest free loan
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Distribution and Rollover
Rules
1. Free to take out money at any time or leave it in
indefinitely, but
penalty on early distributions before age 59½, unless
exception applies
penalty if required minimum distributions are not made
starting at age 70½
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Distribution and Rollover
Rules (cont)
2. Participant’s spouse does not need to consent to an IRA
distribution under federal law
spousal consent may be required when a qualified plan is
rolled over to an IRA
property rights in an IRA are a matter of state law, varies
by state
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Tax Implications: Distribution and Rollover
Rules (cont)
3. Generally, all amounts distributed from
traditional IRA are ordinary income
if nondeductible contributions have been made
to traditional IRA, a portion of a distribution can
be received tax-free
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Distribution and Rollover Rules (cont)
4. 10% early withdrawal penalty
EXCEPT distributions made
–
–
–
after age 59½
after death
as part of a series of substantially equal periodic
payments over the life or the life expectancy of the
participant, or the participant and a beneficiary
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Distribution and Rollover Rules (cont)
4. 10% early withdrawal penalty (cont)
EXCEPT distributions made (cont)
–
–
–
–
for medical care (in excess of the 7.5% of itemized
deductions floor for such expenses)
to unemployed for health insurance premiums
to pay higher education costs for self, spouse, child, or
grandchild
to pay acquisition cost of first home for self or specific
relatives up to $10,000 lifetime maximum
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Distribution and Rollover Rules (cont)
5. Minimum distribution requirement
distribution must begin by April 1 of the year after the year in
which age 70½ is reached
6. Can use IRA for direct rollover of certain
distributions from employer sponsored
retirement plans within 60 days after receipt
7. Complex tax rules apply at death of IRA owner
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
True or False?
1. Employers cannot sponsor an individual IRA.
2. Only interest and dividends are allowed within an
IRA. Other investment income such as rent, cannot
be sheltered in an IRA.
3. To contribute to a traditional spousal IRA, the couple
must file a joint return.
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
True or False? (cont)
4. Ira D. Posit, age 59, withdrew money from
his IRA to pay for a niece’s college
expenses. Ira must pay income tax but no
penalty tax on the amount withdrawn.
5. To avoid tax, a distribution of benefits from
an employer-sponsored retirement plan
must be directly transferred or rolled over to
the “rollover” IRA within 30 days.
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Traditional IRA
Chapter 5
Employee Benefit & Retirement Planning
Discussion Question
How can an employer sponsor IRAs for employees?
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