FINA 4325 Unit 5: Traditional & Roth IRAs

John and Mary, both age 49, are married and file a joint income tax return for the current year (2021). John is self-employed as an engineering consultant and reports $120,000 of Schedule C net income and pays $16,955 in self-employment tax. Mary is not employed outside the home. What is the maximum deductible IRA contribution John and Mary can make this year?

$12,000 Neither John nor Mary is an active participant in an employer-sponsored retirement plan, qualified retirement plan, SEP plan, SIMPLE, or Section 403(b) plan; therefore, they can contribute and deduct $12,000 ($6,000 each) to traditional IRAs for the current year (2021).

Stewart and Abby, both age 35, plan to contribute a total of $12,000 to their IRAs for this tax year. They both work outside the home, and they file a joint income tax return. Stewart is a teacher at the local high school and participates in a 403(b) plan. Abby's employer does not provide a retirement plan. They expect that their MAGI in 2021 will be $129,000. What amount, if any, can they deduct for their IRA contributions?

$6,000 An individual is not denied a deduction for his IRA contribution simply because of the other spouse's active participation, unless the couple's combined AGI exceeds $208,000 (2021). Based on their AGI, Abby will be able to deduct a contribution of up to $6,000 to an IRA. Since their combined AGI is too high for Stewart to make a deductible IRA contribution, he should consider contributing to a Roth IRA.

Distributions from IRAs must begin by April 1 of the year following the year in which an individual reaches age

72

Which of the following constitutes an exception to the imposition of the 10% premature distribution penalty for distributions made from an IRA owned by an individual who is currently age 40?

A distribution in payment of qualified higher education expenses. IRA distributions are exempt from the early distribution penalty if made in payment of qualified higher education expenses. The other distributions are either exempt only if made from a qualified plan or not exempt, regardless of the source. The exception for a distribution paid as a series of substantially equal payments must extend over the greater of five years or age 59½.

Which of these is considered an active participant for determining the deductibility of traditional IRA contributions this year? I. A participant in a defined benefit pension plan who has just satisfied the eligibility requirements and entered the plan in the past six months II. A participant in a traditional Section 401(k) plan who is currently not making elective deferrals but has $100 of forfeitures reallocated to their account this year III. A highly compensated employee with a $500,000 account balance in a profit-sharing plan for which the plan earnings this year are $35,000 but no employer contributions, employee contributions, or reallocated forfeitures were added this year IV. A self-employed professional with no employees maintaining a simplified employee pension (SEP) with a $10,000 account balance funded by a 20% contribution two years ago plus earnings

I & II

Which of the following groups would NOT benefit from using Roth IRAs?

Low-income wage earners who need current deductions Roth IRAs offer no current deductions. Low-income wage earners needing current deductions are better served by traditional IRAs.

Gordon is the fiduciary for a traditional IRA. He has several different investments available to him to invest the IRA assets. All of the following investments are permitted investments for a traditional IRA except

Stock in Bottle, Inc., which is an S corporation.

Which of these statements is falseregarding the conversion of a traditional IRA to a Roth IRA?

The IRA owner's modified adjusted gross income (MAGI) cannot exceed $100,000 in the year of the conversion. There is no MAGI limit for a taxpayer in the year in which there is a conversion.

Under the IRA minimum distribution rules, if the IRA account owner dies before distribution payments begin, what occurs?

The beneficiary can begin receiving distributions. If no beneficiary is named, the funds revert to the account owner's estate and are distributed according to the will or the state's intestacy laws. The spouse has the option of rolling over the IRA to the beneficiary-spouse's own account, and a nonspouse beneficiary may use a direct trustee-to-trustee transfer of the IRA into an inherited IRA. A nonspouse named beneficiary is not required to distribute the entire IRA balance within five years.

Jane Paschal has contributed $1,000 each year to a Roth IRA, beginning with an initial payment of $500 on December 31, 2016. She wants to know when she can begin making qualified distributions. Which one of the following statements represent what you should tell her?

Any distribution she takes after January 1, 2021, will meet the five-year requirement. The clock started on January 1, 2016, so five years will have elapsed on January 1, 2021. A Roth IRA owner is required to hold the account for a minimum of five years to qualify for tax-free distributions. In addition, the owner must be at least age 59½, dead, disabled, or withdrawing up to $10,000 of Roth IRA earnings for qualified first-time homebuyer expenses.

Maria has a traditional IRA valued at $500,000. She named her daughter, Faith, as beneficiary of the account. If Maria dies prematurely, which of the following statements is CORRECT? I. Faith inherits the IRA. II. Faith can transfer the inherited funds to an inherited IRA via a direct trustee-to-trustee transfer and name her own beneficiary. III. Because Faith is a non-spouse beneficiary, she is not allowed to roll over the IRA. IV. Faith can roll over the IRA into her own Section 401(k) plan.

I & II Statements I and II are correct. A nonspouse beneficiary (such as an adult child) may use a trustee-to-trustee transfer of the decedent's balance from a qualified plan, Section 403(b) plan, governmental Section 457 plan, or IRA to her own inherited IRA. However, the nonspouse beneficiary must generally begin receiving the distributions from the deceased participant's IRA immediately, whereas a surviving spouse beneficiary may continue to defer payouts until she attains age 72.

Which of the following is subject to the required minimum distribution (RMD) requirements after the account owner/plan participant dies? I. Traditional IRAs II. Roth IRAs III. Qualified plans

I, II, & III All of these retirement accounts are subject to RMD requirements after the account owner/plan participant dies. However, RMD requirements do not apply to Roth IRAs while the owner is alive.

Which of the following persons can make a deductible contribution to an IRA for 2021? I. Jane Single $61,000 Covered by plan? Yes II. Joe Married $100,000 Covered by plan? No III. BettyS ingle $20,000 Covered by plan? Yes IV. Mary Sue Married $40,000 Covered by plan? Yes

I, II, III, & IV

Martha has inherited a traditional IRA that contained no after-tax contributions. She would rather not take the required minimum distributions but instead roll the distributions over into her own IRA to save for her own retirement and avoid paying income tax. Which of the following statements is CORRECT? I. Martha should direct the IRA trustee to make an annual direct transfer to her own traditional IRA of the required minimum distributions so the distributions remain nontaxable. II. To minimize current taxation, Martha should execute a direct transfer of the entire IRA into an inherited IRA.

II Only Only Statement II is correct. Required minimum distributions may not be rolled over. To decrease current taxation, Martha should execute a direct transfer to an inherited IRA. She, will, however, be required to begin required minimum distributions from the inherited IRA.

Which of the following best describes the purpose of establishing a stretch IRA?

To extend the period of tax-deferred earnings beyond the original owner's lifetime. A stretch IRA is used to stretch the period of tax-deferred earnings on the IRA beyond the lifetime of the original owner. The goal is to delay the distribution of assets from the IRA for as long as possible.

Which of these reasons for an early distribution from an IRA is NOT an exception to the 10% penalty?

A distribution made after age 55 and separation from service with an employer A distribution made after age 55 and separation from service with an employer is not a qualified IRA early distribution penalty exception.

Myra, age 35, converted an $80,000 traditional IRA to a Roth IRA last year. Her adjusted basis in the traditional IRA is $20,000. She also made a contribution of $5,000 to the same Roth IRA last year. Myra is in a combined 30% marginal tax rate. If Myra takes a $4,000 distribution from her Roth IRA this year, how much total federal tax, including penalties, is due as a result of the distribution?

$0 Although the distribution is not a qualified distribution, it will not be taxable income because it is treated as a distribution from the Roth IRA regular contributions first. Because the $4,000 distribution is not includible in gross income, nor does it relate to a conversion within the last five years, the distribution is not subject to regular income tax or the 10% early withdrawal penalty.

Assuming the account holder is age 40, which of these withdrawals from a traditional IRA is subject to the 10% early withdrawal penalty?

$10,000 donated directly to a qualified 501(c)(3) charity For tax purposes, the account holder must be at least age 70-1/2 to make a qualified charitable distribution from an IRA. The other answer options are expressly exempt from the 10% early withdrawal penalty, regardless of the account holder's age.

Scott and Gayle, who are both age 45, are married and file a joint income tax return for the current year. Scott is a self-employed architect who earns $110,000 of Schedule C income and pays $15,543 in self-employment tax. Gayle is not employed outside the home. What is the maximum deductible IRA contribution Scott and Gayle can make, if any, for 2021?

$12,000 Neither Scott nor Gayle is an active participant in an employer-sponsored retirement plan. Therefore, they can establish a traditional IRA for Scott and a spousal IRA for Gayle and contribute a deductible total of $12,000 ($6,000 each) to traditional IRAs for 2021.

George and Mabel each put $6,000 into their respective IRAs. George's employer does not provide a qualified retirement plan. Mabel participates in a 401(k) plan at work. Their AGI is $201,000 in 2021, and they file jointly. How much of their IRA contributions will be deductible?

$4,200 The IRA rules allow an IRA deduction for individuals who are not active participants but whose spouses are, in some cases. However, that option is phased out if the couple's AGI is between $198,000 and $208,000 in 2021. With a combined AGI of $201,000, George would be able to deduct $208,000 − $201,000 = $7,000; ($7,000 ÷ $10,000) × $6,000 = $4,200.

Guy and Dotty, who are both age 42, are married and file a joint tax return. Their modified adjusted gross income (MAGI) for 2021 is $130,000. Dotty has already made a $6,000 contribution to her traditional IRA and has also made a $2,000 contribution to their son's Coverdell Education Savings Account this year. What is the maximum amount that may be contributed, if any, to a Roth IRA for Guy and Dotty this year given these facts?

$6,000 For 2021, the maximum combined contribution to traditional and Roth IRAs (for an owner younger than age 50) is $6,000 per person annually. Dotty has already contributed the maximum amount for her traditional IRA, but they can make a further contribution of $6,000 to a Roth IRA for Guy. The $2,000 Coverdell contribution is never relevant to any retirement account contribution. Their AGI is below the Roth IRA phaseout range for a married couple ($198,000-$208,000) in 2021.

Sherry, who is currently age 50, made only one contribution during her lifetime to her Roth IRA in the amount of $5,000 in 2014. If she were to receive a total distribution of $6,500 from her Roth IRA in 2021 to take a vacation, how would she be taxed?

Although Sherry waited more than five years, the distribution will not be classified as a qualified distribution, it will be taxable to the extent of earnings, and it will be subject to the 10% early distribution penalty on the taxable amount. A distribution from a Roth IRA is not subject to taxation if it is a qualified distribution or to the extent that it is a return of the owner's contributions or conversions to the Roth IRA. A qualified distribution is one that meets both of the following tests: The distribution was made after a five-year holding period. The distribution was made for one of the following reasons:Owner has attained age 59½Distribution was made to a beneficiary or the estate of the owner on or after the date of the owner's deathDistribution was attributable to the owner's disabilityDistribution was for a first-time homebuyer expense purchase The 10% early withdrawal penalty only applies to a distribution from a Roth IRA that is includable in gross income. The 10% early withdrawal penalty also applies to a nonqualified distribution, even if it is not then includable in gross income, to the extent it is allocable to a conversion contribution made within the five-year period beginning with the first day of the individual's taxable year in which the conversion contribution was made.

All of these are considerations for converting distributions from qualified plans or a traditional IRA to a Roth IRA except

the Roth IRA conversion is more appropriate when the income tax rate is lower at the time of distribution than at the time of conversion. The Roth IRA conversion is more appropriate when the income tax rate is the same or higher at the time of distribution than at the time of conversion.

Which of these statements regarding prohibited transactions by a fiduciary or an individual associated with traditional IRA accounts is CORRECT? I. Generally, if an individual or the individual's beneficiary engages in a prohibited transaction with the individual's IRA account at any time during the year, it will not be treated as an IRA as of the first day of the year. II. If an individual borrows money against an IRA annuity contract, the individual must include in gross income the fair market value of the annuity contract as of the first day of the tax year. III. Selling property to an IRA by a fiduciary or an individual owner of the IRA is not prohibited. IV. A 50% penalty will be assessed against an IRA owner who borrows money against their IRA.

I & II

Which of the following statements most accurately describes the tax treatment of contributions to and distributions from a Roth IRA? I. Contributions are made with pretax dollars. II. A withdrawal from the account will not be subject to tax if the account has been established for at least three years and the funds (up to $10,000) are being used for a first-time home purchase. III. Distributions are not taxable if they are attributable to disability and the account has been established for at least five years. IV. If the account has been open for at least five years and the account owner is age 59½, distributions are penalty free and income tax free.

III & IV Contributions to a Roth IRA are made with after-tax dollars. Distributions from a Roth IRA are income tax and penalty free if the owner has maintained the account for at least five years and the distribution is attributed to one of the following: Death Disability First-time home purchase ($10,000 lifetime maximum) Attainment of age 59½

In considering whether to convert a traditional IRA to the Roth IRA form, which of the following is a valid consideration?

If the source of payment for taxes due upon conversion comes from an outside source, it generally is advantageous to convert. The Roth IRA yields greater after-tax benefits than a traditional deductible IRA if the front-end tax due upon conversion is paid from funds outside the Roth IRA and an equivalent amount of funds is, thereby, available for investment.

Which of these statements is false about Roth 401(k) accounts?

Just as with any Roth IRA account, there are no required minimum distributions (RMDs) that must be made from a Roth 401(k) account. Roth 401(k) accounts, just as with traditional 401(k) accounts, have RMD rules that apply, meaning that distributions must start in the year the participant reaches age 72 (unless they are still working). This can be avoided by rolling the Roth 401(k) over into a Roth IRA since there are no RMDs with Roth IRAs. There is a new clock that is started for a Roth 401(k) account, even if the participant already has a Roth IRA account. However, if a participant transfers the Roth 401(k) into a Roth IRA, then the Roth IRA clock will be the one that applies, not the Roth 401(k) clock.

Which of the following statements regarding the tax effects of converting a traditional IRA to a Roth IRA is CORRECT?

The converted amount is treated as a taxable distribution from the IRA to the extent the distribution does not represent a return of basis. When a traditional IRA is converted to a Roth IRA, the converted amount is treated as a taxable distribution to the extent the distribution does not represent a return of basis and is included in the owner's gross income. A penalty does not apply for amounts converted from a traditional IRA to a Roth IRA, regardless of the owner's age. However, the amount that was taxable at the conversion will be subject to the 10% early distribution penalty if it is withdrawn within five years of the conversion and the withdrawal does not qualify for an exception to the 10% early withdrawal penalty. This rule protects against people converting to a Roth and then taking a distribution as a way of escaping the 10% early withdrawal penalty.

Which of these is CORRECT about a Roth IRA?

Withdrawals of earnings up to $10,000 from a Roth IRA for the purchase of a first home can be penalty free if the five-year holding period has been met. Withdrawals of earnings from a Roth IRA are not penalized under these circumstances if the five-year holding period has been met.

Marian, age 62, converts $30,000 from a traditional IRA to a Roth IRA in 2014. In 2019, she converts another traditional IRA with a fair market value of $35,000 to a Roth IRA. She makes no other IRA contributions. In 2021, Marian takes a $40,000 distribution from her Roth IRA. This distribution is treated as $30,000 from the 2014 conversion contribution and $10,000 from the 2019 conversion contribution, both of which were includable in her gross income when converted. As a result, for 2021,

the $10,000 withdrawal from the 2019 conversion is not subject to the 10% penalty tax. The conversion amounts were already included in Marian's gross income when converted. Therefore, they will not be subject to income taxes again when withdrawn. The distribution allocable to the $10,000 conversion contribution made in 2019 (less than five taxable years ago) starts out as being subject to the early distribution penalty because it was withdrawn less than five years after the conversion. However, it is not subject to the 10% penalty tax under Section 72(t) in this case because Marian is over age 59½, which is one of the exceptions to the 10% penalty. The withdrawal of the conversion amount from the first conversion is not subject to the 10% early withdrawal penalty because the conversion is more than five years old. Thus, if the owner would have been younger than age 59½, the withdrawal of that money would not have been subject to the early withdrawal penalty.