Unit 11: Individual Retirement Accounts

Kimberly, age 30, a full-time student with no taxable compensation, married Michael, age 30, during 2018. For the year, Michael had taxable compensation of $35,000. He plans to contribute and deduct $5,500 to his traditional IRA. If he and Kimberly file a joint return, how much may each deduct in 2018 for contributions to their individual traditional IRAs and what is the compensation Kimberly uses to figure her contribution limit? 1. IRA Deduction 2. Compensation to figure IRA Contribution Limit A. 1. $5,500 2. $29,500 B. 1. $4,000 2. $35,000 C. 1. $5,500 2. $35,000 D. 1. $2,000 2. $32,250

A. 1. $5,500 2. $29,500 Under Sec. 219(c), if a joint return is filed and a taxpayer makes less than his or her spouse, the taxpayer may still contribute the lesser of 1. The sum of his or her compensation and the taxable compensation of the spouse, reduced by the amount of the spouse's IRA contribution and contributions to a Roth IRA, or 2. $5,500 ($6,500 if over age 50). Kimberly is still eligible to deduct the full $5,500 for her IRA contribution. However, the income is based upon Michael's $35,000 income reduced by his $5,500 IRA contribution.

Frank wants to borrow from his qualified plan for some improvements to his principal residence. Frank's present value of his vested accrued benefit is $80,000. How much can Frank borrow from his plan without receiving treatment as a distribution? A. $40,000 B. $10,000 C. $50,000 D. $80,000

A. $40,000 A loan will not be treated as a distribution to the extent loans to the employee do not exceed the lesser of $50,000 or the greater of half of the present value of the employee's vested accrued benefit under such plan, or $10,000. Frank's vested accrued benefit had a present value of $80,000. Frank's loan is limited to $40,000, the lesser of $50,000, or the greater of $40,000 ($80,000 × 1/2), or $10,000.

After many years as a bachelor, Buddy, age 50, married Penny, age 63. Penny's only income was $10,800 of Social Security. They filed a joint return for year 2018 with a modified adjusted gross income of $150,000. Buddy is covered by a retirement plan at work, where he receives compensation of $121,000. He wishes to contribute to an IRA for himself and for Penny. Which of the following will provide them the greatest allowable tax benefit? A. He may contribute $6,500 to each IRA but only take a deduction for the $6,500 to Penny's IRA. B. He may contribute $6,500 to each IRA but only take a deduction for the $6,500 to his IRA. C. He may contribute $6,500 to each IRA and take a deduction of $6,500 for each IRA. D. He may contribute $6,500 to each IRA but take no deduction for either IRA.

A. He may contribute $6,500 to each IRA but only take a deduction for the $6,500 to Penny's IRA. If covered for any part of the year by an employer retirement plan and no social security payments were received by the individual, the IRA contribution deduction is completely eliminated if the AGI is greater than $121,000 (married filing jointly). However, since Penny received no taxable compensation, the contribution to her IRA is completely deductible. The deduction is $5,500 plus an additional $1,000 for taxpayers age 50 or older. (Publication 590-A.)

Jacob was born on March 1, 1944. He is an unmarried participant in a qualified employer-sponsored plan. He retired in 2017. As of December 31, 2016, his account balance was $300,000. As of December 31, 2017, his account balance was $325,000. His applicable distribution periods are 24.7 and 23.8, respectively. What is Jacob's required minimum distribution (RMD) due on the second payment? A. $12,605 B. $13,145 C. $12,146 D. $13,158

B. $13,145 The required minimum distribution for each year is calculated by dividing the account balance as of the close of business on December 31 of the preceding year by the applicable distribution period or life expectancy. The required beginning date is April 1 of the calendar year following the participant's retirement (since Jacob's retirement date is later than age 70 1/2). Jacob retired in 2017. His second required minimum distribution due is $13,145, calculated as follows: Calculation RMD Amount 300000/24.7 12146 (32500-12146)/23.8 13145

Peter and Jill are married and file a joint return. In 2018, Jill was a media relations manager for a large firm and earned $98,000; Peter owns a graphic design business that showed a net profit of $500 for 2018. In 2018, Jill was covered by an employer's plan and Peter was not. Their annual gross income was $194,000. What is the maximum deductible amount that Peter can contribute to a traditional IRA? A. $0 B. $2,750 C. $500 D. $5,500

B. $2,750 In general, the maximum deduction for a contribution to a traditional IRA is the lesser of taxable compensation for the year or $5,500 ($6,500 for taxpayers age 50 and older). However, if a joint return is filed and one spouse is covered, phaseouts may be applied based on the couple's AGI. In this instance, a partial deduction is permitted. With the couple's AGI of $194,000, Peter is allowed a $2,750 {[($194,000 - $189,000) ÷ 10,000] × $5,500} deductible contribution (Publication 590-A).

Beth was born on October 1, 1947. She is an unmarried participant in a qualified defined contribution plan. As of December 31, 2017, her account balance was $24,660. As of December 31, 2018, her account balance was $27,400. Her applicable distribution period is 27.4 years. What is her required minimum distribution due by the required beginning date? A.$2,000 B. $900 C. $0 D. $1,000

B. $900 The required minimum distribution for each year is calculated by dividing the IRA account balance as of the close of business on December 31 of the preceding year by the applicable distribution period or life expectancy. The required beginning date is April 1 of the calendar year following the participant attaining age 70 1/2. Beth attained age 70 1/2 during 2018. Her required minimum distribution due by the beginning date is $900 [$24,660 (previous year-end balance) ÷ 27.4 years (applicable distribution period)].

Generally, an employee must begin receiving distributions from his or her traditional IRA no later than which of the following dates? A. April 1 of the year in which the employee reaches age 70 1/2. B. April 1 of the year following the year in which the employee reaches age 70 1/2. C. Six months after his or her 70th birthday. D. December 31 of the year in which the employee reaches age 70 1/2.

B. April 1 of the year following the year in which the employee reaches age 70 1/2. Retirement payments must begin no later than April 1 following the later of the calendar year in which the individual reaches age 70 1/2 or the year of retirement.

Martin, age 35, made an excess contribution to his traditional IRA in 2018 of $1,000, which he withdrew by April 15, 2019. Also in 2018, he withdrew the $50 income that was earned on the $1,000. Which of the following statements is true? I. Martin must include the $50 in his gross income in 2018. II. Martin would have to pay the 6% excise tax on the $1,050. III. Martin would have to pay the 10% additional tax on the $50 as an early distribution. IV. Martin would have to pay the 10% additional tax on the $1,000 because he made a withdrawal. A. I only. B. I and III only. C. III and IV only. D. I, II, and III only.

B. I and III only Premature distributions are amounts withdrawn from an IRA or annuity before a taxpayer reaches age 59 1/2. The additional tax on premature distributions is equal to 10% of the amount of premature distribution that must be included in gross income. Therefore, both I and III are true statements, making this the best choice of the listed options.

Winston turned 70 1/2 on June 1, 2018. What date must he receive his minimum distribution by? A. June 30, 2018. B. None of the answers are correct. C. December 31, 2018. D. April 15, 2019.

B. None of the answers are correct. A taxpayer who has a traditional IRA must begin receiving distributions by April 1 of the year following the year the taxpayer reaches age 70 1/2. Winston turned 70 1/2 in 2018, so he must begin receiving distributions on April 1, 2019.

Which of the following is NOT an account requirement for a CESA? A. The trustee must be a bank or other qualified individual. B. Upon the death of the beneficiary, any balance in the fund must not be distributed to the beneficiary's estate. C. All contributions must be in cash. D. Contributions must be made before the trust beneficiary reaches age 18.

B. Upon the death of the beneficiary, any balance in the fund must not be distributed to the beneficiary's estate. A CESA is a tax-exempt trust. Seven requirements must be met for a CESA: 1. No contribution may be accepted by the CESA after the beneficiary attains age 18. 2. Except in the case of rollover contributions, annual contributions may not exceed $2,000. 3. Contributions must be in cash. 4. The trustee must be a bank or other qualified person. 5. No portion of the trust's assets may be invested in life insurance contracts. 6. Trust assets must not be commingled with other property, except in a common trust or investment fund. 7. Upon death of the beneficiary, any balance in the fund must be distributed to the beneficiary's estate within 30 days of death.

Which of the following would be an allowable investment for a traditional IRA? A. Stamps that have been issued by the United States Postal Service. B. An oil painting certified by an art expert as being an authentic original by a Dutch master artist. C. One-ounce silver coins minted by the U.S. Treasury Department. D. All of the answers are correct.

C. One-ounce silver coins minted by the U.S. Treasury Department. Generally, an IRA is prohibited from investing in collectibles. However, an IRA may hold platinum coins as well as gold, silver, or platinum bullion. Thus, 1-ounce silver coins minted by the U.S. Treasury Department are considered an allowable investment for a traditional IRA.

All of the following types of income are considered earned compensation in determining whether an individual retirement account can be set up and contributions made EXCEPT A. Partnership income of an active partner providing services to the partnership. B. Self-employment income. C. Rental income from a property in which the taxpayer has active participation. D. Alimony.

C. Rental income from a property in which the taxpayer has active participation. Section 219(f) defines compensation as earned income. Rental income is not generally considered earned income; rather, it is treated as a passive form of income.

In which situation must a taxpayer pay the additional 10% tax on a premature distribution from his or her IRA? A. Taxpayer, age 30, withdrew his entire balance in an IRA and invested it in another IRA at another bank 45 days after the withdrawal from the first bank. B. Taxpayer, age 45, became totally disabled. C. Taxpayer, age 40, used the distribution to pay emergency medical bills for his wife. The medical bills equal 5% of the couple's AGI. D. Taxpayer, age 50, died, and the IRA was distributed to his beneficiaries.

C. Taxpayer, age 40, used the distribution to pay emergency medical bills for his wife. The medical bills equal 5% of the couple's AGI. Distributions from an IRA to a participant before (s)he reaches age 59 1/2 are subject to a 10% penalty tax. Taxpayers are exempted from this penalty tax if the distribution is attributable to the taxpayer becoming disabled or is made on or after the taxpayer's death. Certain other exceptions apply, but payment of medical expenses is not one of them, unless the medical expenses exceed the Sec. 213 nondeductible floor. Since the medical expenses are only 5% of the couple's AGI, they are below the 7.5%-of-AGI nondeductible floor, and the 10% penalty applies to the entire distribution.

Rena is a single, 72-year-old chemical engineer. She works part-time for a pharmaceutical company and earned $22,000 in 2018. Her modified adjusted gross income is $36,000. She participates in her employer's pension plan and profit sharing plan. In 2018, she contributed $5,500 to a traditional IRA. How much of her contribution can Rena deduct in 2018? A. $5,500 B. $1,600 C. $1,400 D. $0

D. $0 The normal contribution permitted to a traditional IRA is the lesser of $5,500 ($6,500 if aged 50 or older) or taxable compensation. Generally, the deduction is limited to the contribution or a general limit dependent upon possible employee retirement coverage. However, no contribution (or deduction) is permitted to a traditional IRA account after an individual attains the age of 70 1/2. Therefore, the deduction is $0 (Publication 590-A). In general, if the excess contributions for a year are not withdrawn by the date on which the return for the year is due (including extensions), the taxpayer is subject to a 6% tax. The 6% tax each year on excess amounts that remain in the taxpayer's traditional IRA must be paid at the end of the tax year. The tax cannot be more than 6% of the value of the IRA as of the end of the tax year.

John failed to take required minimum distributions from his traditional IRA. The excess accumulation is subject to a penalty of A. 6% B. 15% C. 10% D. 50%

D. 50% Generally, under Sec. 4974, a taxpayer must begin receiving distributions by April 1 of the year following the year in which (s)he reaches age 70 1/2. If distributions are less than the required minimum distribution for the year, a 50% excise tax will be imposed on the amount not distributed. The tax may be excused if the excess accumulation is due to reasonable error and the taxpayer is taking steps to remedy the insufficient distribution.

Sunnie is single and does not actively participate in her employer's pension plan. She received taxable compensation of $3,500 in Year 1 and $4,500 in Year 2. Her modified adjusted gross income was $26,000 in both years. For Year 1, she contributed $5,500 to her IRA but deducted only $3,500 on her income tax return. For Year 2, she contributed $2,500 but deducted $4,500 on her income tax return. Based on this information, which of the following statements is true? A. Sunnie will be assessed a 10% tax for early withdrawals when she withdraws the excess contribution. B. Sunnie must pay an excise tax on the excess contribution for Year 1 and also for Year 2 since she did not withdraw the excess. C. Sunnie should claim an IRA deduction of only $1,500 for Year 2. D. Sunnie must pay an excise tax for Year 1 on the $2,000 excess contribution made in Year 1, but since she properly treated the Year 1 excess contribution as part of her Year 2 deduction, she does not owe the excise tax for Year 2.

D. Sunnie must pay an excise tax for Year 1 on the $2,000 excess contribution made in Year 1, but since she properly treated the Year 1 excess contribution as part of her Year 2 deduction, she does not owe the excise tax for Year 2. Section 408 limits contributions to an IRA to the lesser of $5,500 ($6,500 if aged 50 or older) or the amount of compensation includible in the taxpayer's gross income. Sunnie's Year 1 contributions should have been limited to $3,500. She therefore had $2,000 of excess contributions in Year 1 ($5,500 - $3,500). Under Sec. 4973, a nondeductible 6% excise tax is imposed on excess contributions to an IRA. Under Sec. 219(b), the deduction for contributions to an IRA is limited to the lesser of $5,500 or the amount of compensation that must be included in gross income. Sunnie's $3,500 deduction in Year 1 was correct. In Year 2, Sunnie contributed only $2,500 but deducted $4,500. Under Sec. 219(f)(6), Sunnie may treat the $2,000 unused contributions from Year 1 as having been made in Year 2. Therefore, her allowable deduction for IRA contributions in Year 2 is $4,500.

The use of IRA funds in prohibited transactions can result in additional taxes and penalties. Which of the following is NOT a prohibited transaction in a traditional IRA? A. Borrowing money from the IRA. B. Using an IRA as security for a loan. C. Inheriting your spouse's IRA. D. Selling property to an IRA.

C. Inheriting your spouse's IRA. A taxpayer may not engage in the following transactions with a traditional IRA: sell property to it, use it as security for a loan, or buy property for the taxpayer's personal use. The taxpayer is allowed to inherit an IRA from a spouse.

Joe has a traditional IRA with a basis of $8,800. In 2018, this was his only IRA. On December 31, 2018, he converted $44,000 of the $88,000 total value of the IRA to a Roth IRA. He files as head of household and his AGI, without the conversion, is $62,000. What amount of income will be included on Joe's 2018 return as the result of this conversion? A. $35,200 B. $44,000 C. $39,600 D. $8,800

C. $39,600 Under Sec. 408A(d)(3)(A)(ii), amounts in a regular IRA can be rolled over or converted into a Roth IRA. Generally, amounts transferred or converted from a regular IRA into a Roth IRA must be included in gross income. An individual must include in gross income distributions from a traditional IRA that would have been included had they not been converted into a Roth IRA. Additionally, an individual does not include in income any amount that is a return of basis. Thus, Joe does not include $4,400 of his basis in the traditional IRA in his 2018 income. The amount includible in income is thus $44,000 - $4,400 = $39,600. (Publication 590.)

Owners of traditional individual retirement accounts (IRAs) are required to begin receiving distributions no later than which of the following? A. By April 1 of the year in which the owner reaches age 70 1/2. B. By April 1 of the year following the year in which the owner reaches age 59 1/2. C. By January 1 of the year in which the owner reaches age 70 1/2. D. By April 1 of the year following the year in which the owner reaches age 70 1/2.

D. By April 1 of the year following the year in which the owner reaches age 70 1/2. Distributions to the owner of a traditional IRA must commence no later than April 1 following the calendar year in which the owner reaches age 70 1/2.

Gary and Mabel have been married for many years and file jointly. Gary was born February 21, 1946. Mabel was born April 10, 1950. They each received Social Security benefit payments throughout 2018. Gary earned $7,200 as a part-time security guard in 2018; he was not covered by any type of retirement plan. Mabel has been retired for many years. Gary and Mabel expect their 2018 adjusted gross income to exceed $101,000. What is the amount of Gary and Mabel's largest allowable spousal IRA deduction for 2018 (assume the proper amount claimed as a deduction was paid timely)? A. $11,000 B. $0 C. $6,500 D. $5,500

C. $6,500 An individual may not make contributions to an IRA for the year (s)he reaches age 70 1/2 or any later year. However, if the individual has received compensation, a spouse who has not reached age 70 1/2 may still deduct up to $5,500 of contributions, plus $1,000 if age 50 or older.