What Is A Traditional IRA?

Individual Retirement Plans and SEPs

Chapter 51Tools & Techniques of

Estate Planning

Copyright 2011, The National Underwriter Company 1

• A “Traditional IRA” is a tax-deferred savings vehicle

• A limited tax-deductible contribution may be made up to $5,000 (2009-2011)

• Additional catch-up contributions of $1,000 (2006 forward) are permitted for individuals over age 50

What Is A Traditional IRA?



Estate Planning


• An individual or spouse actively participating in a qualified plan or tax-sheltered annuity:– May make an IRA contribution up to the lesser of the $5,000

dollar limit (in 2009-2011, including the total of all IRA contributions combined) or 100% of compensation

– The amount a taxpayer can deduct is determined based on AGI and filing status

• Mandatory distributions are required beginning at age 70½

• Penalties, in addition to income taxes, are imposed for early nonqualified withdrawals

What Is A Traditional IRA?



Estate Planning


AGI ThresholdTax Year Single Joint Separate2010 $56,000 $89,000 $02011 $56,000 $90,000 $0

Note: For non-active participants with an active spouse, the deduction begins to phase out when AGI is > $90,000 (2011)For a taxpayer who exceeds the threshold, the maximum deduction is reduced by the following formula:

Maximum annual contribution x AGI – AGI Threshold $10,000

What Are The AGI Threshold Contribution Phase-Out Limits?



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• Jill participates in a qualified plan and her husband, Jack does not participate in his employer’s plan

• They file a joint return in 2011 showing AGI of $125,000– Jack can make a deductible contribution to his IRA of $5,000

(Couple’s AGI is under $169,000)

• Same facts, but Jill and Jack’s AGI is $200,000– Neither Jack nor Jill can make a deductible contribution,

since their AGI exceeds $179,000

Example Traditional IRA



Estate Planning


• Note: An individual may make a deductible contribution to a spousal IRA for a spouse with less taxable compensation than the individual– In 2011, $5,000 could be contributed to one IRA and another

$5,000 to a spousal IRA

Example Traditional IRA (cont’d)



Estate Planning


• Individuals receiving certain distributions from a qualified plan (pension, profit-sharing, stock bonus or annuity plan) or a tax-deferred annuity are allowed to “roll over” the distribution within 60 days to an IRA without incurring income tax on the distribution

• No rollover is permitted for benefits attributable to nondeductible employee contributions made by the employee to the qualified plan prior to 2002

What Is A Rollover?



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• Taxable distributions from a qualified retirement plan, TSA, or Section 457 governmental plan can be rolled over, without incurring income tax, to an IRA or any of the above listed plans

• A mandatory withholding of 20% applies if the participant receives a distribution instead of electing a direct (trustee-to-trustee) transfer

• A spouse of a deceased IRA holder may roll over a distribution (received after the spouse’s death) to an IRA

What Is A Rollover?



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• Annual contributions may be made up to the lesser of $5,000 (2009-2011) or 100% of compensation– indexed for inflation in $500 increments for years after 2010

• Catch-up contributions of $1,000 (2011) are permitted for individuals over age 50

• Contributions are not deductible, but withdrawals may be entirely income tax free

• Contributions may be made after age 70½

What Is A Roth IRA?



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• If AGI exceeds certain limits, a contribution to a Roth IRA cannot be made for that year– Single phase-out limit $107,000 - $122,000– Married filing joint limit $169,000 - $179,000– Married filing separate limit $0 - $10,000

• Rules on allowable Roth IRA contributions apply regardless of taxpayer’s active participation in a qualified plan

• Distributions are not required to begin until after death• For certain clients a rollover (“conversion”) of a

Traditional IRA to a Roth IRA may be desirable

What Is A Roth IRA?



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• The Coverdell Education Savings Account or Education IRA permits a non-deductible contribution of up to $2,000 (2011) to pay qualified education expenses

• Qualified education expenses now include both elementary and secondary school expenses

• ESA contributions must be designated as such and made in cash, on or before the beneficiary reaches age 18

• Contributions can be made up until April 15 of the following year, by the due date for the filing of the contributor’s income tax return

What Is An ESA?



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• There is an excise tax for excess contributions• Income tax will be imposed on that portion of

distributions exceeding qualified education expenses• There is a 10% premature distribution penalty• AGI phase-out limits on contributions

– Single contributor $95,000 - $110,000– Married Filing Joint $190,000 - $220,000

What Is An ESA?



Estate Planning


Max annual IRA contribution (under age 50) $5,000

Max annual IRA contribution (age 50+) $6,000

Max annual 401(k), 403(b) or 457 deferral limit (under age 50) $16,500

Max annual 401(k), 403(b) or 457 deferral limit (age 50+) $22,000

Max annual additions limit for defined contribution plan $49,000

Max includible compensation for computing contributions $245,000

Max SIMPLE salary-deferral limit (under age 50) $11,500

Max SIMPLE salary-deferral limit (age 50+) $14,000

Minimum annual compensation for determining a highly compensated employee for 401(k) nondiscrimination tests

$110,000

Summary Of Contribution Limits For Retirement Accounts 2011



Estate Planning


Situation 1:• When a married client or their spouse

– is covered by a qualified plan, and– does not make in excess of the AGI phase-out limits, and– makes income in excess of what is needed to maintain their

current standard of living

• It is preferable to make non-tax deductible contributions to a Roth rather than a Traditional IRA

When Is Use Of A Traditional IRA Appropriate?



Estate Planning


Situation 2:• Where neither the client nor spouse is covered under

a qualified plan, but both work

Situation 3:• Where the client

– Is not covered under a plan– Has earned income– Is married, and– Spouse has no income from employment




Estate Planning


Situation 4:• Client is an employer without a qualified plan and

would like to establish a plan covering only him or herself




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• An individual has received a distribution from a– Qualified plan– TSA, or– Section 457 government plan, and

• Seeks to avoid current taxation on all or a part of the distribution

When Is Use Of A Rollover IRA Appropriate?



Estate Planning


• Where the client would not otherwise qualify for a deduction for contributing to a Traditional IRA

• Where a client anticipates a reduced need to access IRA funds during retirement and wants funds to continue to grow tax-free

• Client anticipates being in a high marginal tax bracket following retirement

When Is Use Of A Roth IRA Appropriate?



Estate Planning


• An individual is permitted to set aside retirement savings in a – Variable premium annuity contract– Fixed rate annuity contract, or– A trusteed or custodial account with a bank, credit union, savings

and loan, brokerage firm, or other financial institution• An individual may split total contributions into more than

one IRA • 3 parties can make contributions to a Traditional IRA

– Employee– Employee’s employer– Employee’s union

What Are The Requirements?



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• Anyone can contribute to an ESA • Annual contributions must be made in cash

– Contributions of other property are only permissible in the case of rollovers

• Plan must be established and contributions made – Within the taxable year for which a deduction is allowed, or– Before the due date for filing the individual’s tax returns for

that taxable year (by April 15th of the following year for most taxpayers)




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• Traditional IRAs must begin to pay a participant’s benefit by April 1st of the year following the year in which the participant turns 70½– RBD – required beginning date

• ESA’s must be distributed within 30 days after the date on which the designated beneficiary attains age 30– Earnings on such distributed balances may be includable in

income and subject to the 10% penalty tax– Any amount remaining in the ESA at the end of the 30-day

period will be deemed to be distributed




Estate Planning


• Alternatives for a Traditional IRA if the owner dies before beginning distributions:– Payments are made over the life expectancy of the

designated beneficiary, or – If there is no designated beneficiary, payments must be paid

out within five years of the IRA owner’s death– If the designated beneficiary is the IRA owner’s spouse, the

spouse may• roll over the balance to the spouse’s own IRA, or• elect to treat the decedent’s IRA as the spouse’s own, or• take distributions over the spouse’s life expectancy beginning

the later of– The end of the calendar year immediately following the calendar

year in which the owner died, or– The end of the calendar year in which the owner would have

attained age 70½




Estate Planning


• Alternatives for a Traditional IRA if the owner dies on or after the required beginning date:– Payments are made over the life expectancy of the designated

beneficiary, or – If there is no designated beneficiary, payments are made over the

remaining life expectancy of the IRA owner immediately before death

– If the sole designated beneficiary is the IRA owner’s spouse, the spouse may

• roll over the balance to the spouse’s own IRA, or• elect to treat the decedent’s IRA as the spouse’s own, or• take distributions over the spouse’s remaining life expectancy

beginning with the calendar year immediately following the calendar year in which the owner died




Estate Planning


• Roth IRAs generally follow the same rules as Traditional IRAs for owners dying before the required beginning date– Roth IRAs do not have a lifetime required beginning date

• ESAs must be distributed within 30 days of the death of the beneficiary– If the ESA is distributed to the designated beneficiary’s surviving

spouse or a family member, it will be treated as if the spouse or family member is the designated beneficiary as long as they are under the age of 30

– Any balance remaining in the ESA at the end of the 30-day period following the designated beneficiary’s death will be deemed distributed




Estate Planning


• Banks and insurance companies provide prototype plans

• IRS provides prototype trusteed and custodial plans

• Once an IRA is established, contributions need to be made

How Is It Done?



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Examples of tax savings:– Individual in a 15% tax bracket would save $750 per year

with a $5,000 annual deductible contribution

– A partner in a partnership who did not wish to include other employees in a plan could save $1,250 per year in taxes by making a $5,000 annual deductible IRA contribution, assuming a 25% tax bracket

How Is It Done?



Estate Planning


• Money contributed to a Traditional IRA is currently deductible from gross income up to the specified limits

• Earnings accumulate on a tax-deferred basis

• Generally, individual needs to be 59½ to receive distributions without a 10% premature distribution penalty (unless an exception to the penalty applies)

Tax Implications



Estate Planning


• Exceptions to the 10% penalty include:

– Withdrawals due to death or disability

– Withdrawals in the form of a series of substantially equal periodic payments

– Distributions up to $10,000 for a “qualified first-time homebuyer distribution”

– Withdrawals used to pay qualified higher education expenses

Tax Implications



Estate Planning


• Distributions from a Traditional IRA are taxed to the client at ordinary income tax rates

• A “qualified distribution” from a Roth IRA is not taxable if distribution is made:

– after the five year waiting period

– in the event of death or disability

– for first-time homebuyer expenses

– at or after age 59½

Tax Implications



Estate Planning


• Non-qualified distributions from a Roth are includable in income only to the extent that the withdrawal (plus earlier withdrawals) exceeds the total of contributions made to the Roth IRA

• There is no required beginning distribution date at age 70½ for a Roth IRA

– However, traditional IRA minimum distribution rules apply to the beneficiary of a Roth following the death of the IRA owner

Tax Implications



Estate Planning


• Division of an interest in an IRA should be less difficult than division of a qualified plan, since all benefits in an IRA are vested and nonforfeitable

• ERISA provides that the transfer of the spouse’s entire interest in an IRA to a former spouse under a divorce decree is not a taxable distribution

Caution: Transfers of partial interests may cause the “premature distribution” tax and ordinary income tax to be imposed

Issues In Community Property States



Estate Planning


Active Participant defined

Individual is an active participant if covered by a(n):

– qualified pension, profit sharing or stock bonus plan,

– qualified annuity plan

– SEP

– government sponsored plan, or

– employee only contributory plan exempt from tax under IRC Section 501(c)(18)



Estate Planning


Simplified Employee Pensions

• IRA-based plan established by an employer that receives contributions by employer based on predetermined formula

• Contribution limit is lesser of 25% of compensation or $49,000 (in 2011)

• Compensation limit is $245,000 (2011)• Elective deferrals to preexisting plans (SARSEPs) still

allowed



Estate Planning


Simplified Employee Pensions

• Employer must contribute for every employee 21 or older who earned $550 or more (2011) in 3 of the last 5 years

• May not discriminate in favor of HCEs• Limited integration is permitted• 100% vesting for all employees required• Plan must be in writing, must spell out how

contributions will be allocated• SEP participants are active participants for IRA

deduction purposes



Estate Planning


SIMPLE IRAs

• Available to employers with 100 or fewer employees earning $5,000 or less

• May not sponsor another plan• Salary deferrals up to $11,500 permitted in 2011• Catch-up contributions permitted up to $2,500 in

2011



Estate Planning


SIMPLE IRAs

Contribution formula requirement: must be one of following:

– Match contribution: dollar for dollar up to 3% of compensation, or

– Nonelective contribution: 2% of compensation for all eligible employees earning at least $5,000

Documents

What Is A Traditional IRA?