CFP 504 Module 5

Roth IRA Distributions

if distributions from a Roth are deemed "qualified," they aretax-free. Distributions that do not meet the definition of a "qualified" distribution may be subject to income tax and the 10% early withdrawal penalty

When Does Establishing a Roth IRA Make Sense?

1. A young person in an entry-level job. 2. Anyone who suspects that the tax rates may change for the worse in the future. 3. Individuals saving for a first home 4. Anyone who wants to shelter income and earnings from taxation after reaching age 70½. 5. Individuals wanting to pass on assets tax-free to their beneficiaries

Roth Recharacterizations

A recharacterization may make sense if the investments have fallen in value since the time of the conversion, if there isn't the cash necessary to pay taxes on the converted amount, or expectations about the future tax rate have changed. The time limit for recharacterizing is the due date, including extensions, of the tax return for the year in which the conversion was done. For example, a Roth conversion done in 2016 would have until mid-October 2017 to recharacterize.

Distributions from a SEP

includible as ordinary income in the year of the distribution. If a withdrawal from a SEP is premature (i.e., it is made before the individual reaches age 59½), the amount withdrawn is subject to a 10% penalty tax in addition to ordinary income tax.

Active Participation in a Defined Contribution Plan

An individual is considered an active participant in an employer-sponsored defined contribution plan if, during the plan year, any of the following are credited to his account: 1. employer contributions, 2. employee contributions, or 3. a forfeiture allocation.

Vesting in a Simple IRA

As with any IRA account, employees are fully and immediately vested in both employee and employer contributions made to their SIMPLE IRAs. This means that they have full control over the management of funds in their IRAs

Nonqualified Roth IRA Distributions

Distributions that do not meet the above requirements are classified as "nonqualified distributions." These distributions are subject to "ordering rules" and possibly tax.

Vesting for SEPs

Employer contributions to a SEP are immediately 100% vested and nonforfeitable

Plan Aggregation and RMD

IRS rules allow a certain amount of aggregation, but only so much. Each IRA's RMD must be calculated separately. The total required minimum distribution can then be taken from any one or several of these IRAs. This same rule applies to 403(b) plans; every other type of plan, however, must individually make an RMD.

Contribution Limit for the Self-Employed

If 25% is contributed on behalf of the common law employees, then the contribution limit for the owner would be 20%.

Economic effect of an IRA contribution credit

In contrast to a tax deduction, which reduces an individual's taxable income, a tax credit results in a dollar-for dollar reduction in the amount of taxes owed by an individual. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit is available to individuals who are 18 or over, other than individuals who are full-time students or claimed as a dependent on another taxpayer's return

Rollovers and Transfers from a SIMPLE IRA

Participants may roll over distributions from one SIMPLE IRA account to another atany time. An individual may also roll over a distribution from a SIMPLE IRA to another individual IRA, SEP, qualified plan, TSA, or Section 457 governmental plan on a tax-free basis after a two-year period has expired from the date the individual first participated in the SIMPLE IRA

What is a qualified distribution from a Roth IRA?

To be considered a "qualified distribution," two requirements must be met: 1. the owner must meet the 5-year holding period requirement, and 2. the distribution must satisfy one of the following four requirements: - must be made on or after the date the owner attains age 59½, - must be made to a beneficiary or after the death of the owner, - must be made to the owner because of the owner's disability, or -must be made for first-time homebuyer expenses of up to $10,000.

Contributions to Traditional IRAs

individuals who are under age 70½ and have earned income can contribute to an IRA. Contributions are limited to the lesser of $5,500 or earned income. individuals who have attained age 50 before the end of the tax year are eligible to contribution an additional $1,000, bringing the annual total contribution to $6,500.

Advantages of SIMPLE IRAs

The employer's contributions are immediately tax deductible by the employer. Employee deferrals reduce an employee's current taxable income. The plan is simple to set up using Form 5305-SIMPLE. Benefits are totally portable for the employee. Individual IRA accounts allow participants to pursue many investment possibilities, with no (or very limited) investment responsibility for the employer. SIMPLEs have fewer restrictions and administrative requirements than qualified retirement plans, which makes them ideal for small employers. And, unlike most other retirement plans, the employer is not required to perform nondiscrimination testing or the more extensive plan reporting. A SIMPLE IRA is not a qualified plan (each individual has an IRA account, and IRAs are not qualified)—this makes a SIMPLE IRA less expensive and easier to manage than a SIMPLE 401(k) plan, which is a qualified plan.

Benefits of designated Roth Accounts

1. The annual contribution limit is higher. In 2017, $18,000 may be deferred to the plan under the Roth provision, plus an additional $6,000 if the participant is age 50 or older. 2. Contributions under the Roth provision can be made by all participants, regardless of income. Obviously, this is not true for the Roth IRA since it phases out at $196,000 in 2017.

Disadvantages of SEPs

1. Vesting 2. Loans are not permitted 3. Eligibility rules 4. Creditor Protection

Matching Contributions to a Simple IRA

Employers who choose to make matching contributions are required to match the employee's elective contributions dollar-for-dollar up to 3% of the employee's annual compensation. In a SIMPLE IRA an employer may choose to match contributions for all eligible employees at a rate lower than 3% of each employee's compensation in two of five years If the employer chooses to make a matching contribution to a SIMPLE IRA, the normal IRC Section 401(a)(17) $270,000 (2017) limit on compensation does not apply.

The Two-Year, 25% Penalty Tax Rule

A participant who takes a distribution from a SIMPLE IRA before age 59½ is generally subject to the same 10% premature distribution penalty applicable to traditional IRAs. However, there is a special rule for SIMPLE IRAs: A participant who takes a distribution within two years of joining the plan is assessed a 25% penalty tax if the distribution is subject to the early withdrawal penalty. If the distribution qualifies for the exclusions to the 10% early withdrawal penalty discussed earlier, the 25% penalty would not apply

Premature Distributions

Although IRC Section 72(t) specifies that distributions from IRAs taken before age 59½ generally will be subject to the 10% early withdrawal penalty, an exception is made when distributions from an IRA are made for one of the following reasons: 1. death of the IRA owner 2. disability of the IRA owner (must be permanently disabled) 3. medical expenses in excess of 10% of AGI 4. payment of medical insurance premiums after separation from employment as long as a minimum of 12 consecutive weeks of unemployment compensation is received 5. qualified higher education expenses 6. qualified first-time homebuyer up to $10,000 7. qualified reservist distribution made to an individual who is a reservist or National Guardsman called to active duty for a period in excess of 179 days or for an indefinite period 8. a series of substantially equal periodic payments taken under IRS Rule 72(t)

RMDs

An IRA owner may begin penalty-free withdrawals from IRAs upon reaching age 59½, but there is no requirement that withdrawals must be made until the required beginning date (RBD). Withdrawals must begin by April 1 of the year following the year in which the owner turns age 70½—this date is the required beginning date. Of particular note, this required beginning date applies to IRA accumulations whether or not the IRA owner has retired.

Definition of "Active Participant"

An active participant is an employee who during the plan year either received a contribution or accrued a benefit under one of the following plan types: 1. qualified plans, 2.certain government plans NOT including Section 457 plan, 3. tax-sheltered annuity plans (TSAs) (also known as Section 403(b) plans), 4. a simplified employee pension (SEP), or 5. a savings incentive match plan for employees (SIMPLE) IRA.

Nonelective Contributions to a Simple IRA

As an alternative to making matching contributions, an employer may choose to make a nonelective contribution of 2% of compensation for all eligible employees, even those who did not make any salary reduction contributions during that plan year

RMD requirements in a Simple IRA

Individuals over age 70½ with earned income cannot make contributions to a traditional IRA. However, if that individual is a participant in a SIMPLE IRA plan, both salary reduction and employer contributions can be made to the SIMPLE IRA. However, the individual would still be required to begin distributions by April 1 of the year following attainment of age 70½, regardless of employment status

Calculating a Partial Deduction Married taxpayers filing jointly

Married couples can contribute up to $11,000 total per year into two separate IRAs. Separate IRAs are allowed even if one spouse has no earned income; the contribution may be split in any manner as long as no more than $5,500 is deposited in either spouse's IRA

Distribution from multiple Roth IRAs

Multiple Roth IRA accounts are pooled, and the funds are categorized and considered withdrawn in the specified order outlined above.

Annual Additions Limits to Simple 401(k)s

SIMPLE 401(k) plans are subject to the same "annual additions" limits that apply to other defined contribution plans. Additions to a participant's account cannot exceed the lesser of $54,000 or 100% of compensation (maximum for 2017). Additions include all of the following contributions: 1. elective contributions (but not catch-up contributions), 2. matching contributions, and 3. employer nonelective contributions.

Tax Deduction for Employer Contributions

Subject to the maximum contribution limitation for each employee, the maximum amount an employer can deduct from current taxes for contributions to a SEP is 25% of total eligible employees' compensation

Trustee-to-trustee transfer for Converting IRA to Roth

The IRA owner can direct the traditional IRA trustee to transfer part, or all, of the traditional IRA to the trustee of a Roth IRA.

Deadlines for Simple IRAs

Under the Internal Revenue Code, employers must forward employee salary reduction contributions to the financial institution selected by each eligible employee for his or her SIMPLE IRA as soon as they can reasonably be segregated from the employer's general assets, but in no event later than the 30th day of the month following the month in which they were withheld from the employee's paycheck

Traditional versus Roth IRAs

Traditional IRAs may be tax-deductible or nondeductible. In a tax-deductible IRA, contributions are deductible from current income and earnings are taxdeferred until they are distributed and taxed as ordinary income. In a nondeductible IRA, contributions are made on an after-tax basis and earnings accrue tax-deferred. Upon distribution, all earnings are fully taxable as ordinary income; however, distributions of after-tax contributions are nontaxable. In contrast, contributions to a Roth IRA are always nondeductible (after-tax) and earnings accrue tax-deferred; however, distributions that are considered "qualified" are tax-free

What is an IRA

a trust or custodial account set up for the exclusive benefit of its owner and/or his or her named beneficiaries. IRAs were introduced as a means of supplementing retirement income after Congress realized that personal savings, payments from employer-sponsored plans, and Social Security benefits were insufficient to meet the financial needs of many Americans at retirement. not qualified plans and are not covered by the Employee Retirement Income Security Act (ERISA). However, they are subject to a number of restrictions designed to preserve the assets for retirement by impeding unencumbered access to an IRA's assets

Contributions to a Simple IRA

allows employees to make elective salary reduction contributions and requires employers to make either matching or nonelective contributions

SIMPLE 401(k) and Regular 401(k) Compared

any comparison between these two plans is essentially moot for large and even medium-sized companies—if they employ over 100 people who earned $5,000 or more during the preceding calendar year, they cannot consider a SIMPLE 401(k). Companies with 100 or fewer employees who earned $5,000 or more during the preceding calendar year, however, have a choice.

Simple IRA Employee Eligibility

any employee who is reasonably expected to receive at least $5,000 in compensation during the year, and who received at least $5,000 in any two preceding years, must be considered an eligible employee

Employee Contributions to a Simple IRA

can elect to contribute up to $12,500 (2017) of their compensation per year. This contribution must be expressed as a percentage of compensation, or as a specific dollar amount. All contributions are deposited into a SIMPLE IRA established for each eligible employee with a financial institution selected by the employee. In addition, participants who have attained at least age 50 during the calendar year qualify for an additional "catch-up" contribution of $3,000

taxation of distributions from Nondeductible IRAs

contributions are made on an after-tax basis. Therefore, nondeductible IRAs have a cost basis and when the account owner begins taking distributions, ordinary income tax is owed only on the account earnings. The cost basis is not subject to taxation upon distribution.

Active Participation in a Defined Benefit Plan

if you are eligible to participate you are considered active. This is the case even if you decline participation, do not make a contribution, or do not accrue a benefit for the year.

What is Earned Income?

salaries, fees, bonuses, and commissions an individual receives as a result of services performed (W-2 income, Schedule C net income, or K-1 income from a partnership if the partner is a material participant); and/or taxable alimony.

Saver's Credit

the law permits eligible taxpayers to take a credit for contributions to a nondeductible IRA, deductible IRA, Roth IRA, 401(k) plan, SIMPLE 401(k) plan, Section 403(b) plan, SEP, Section 457 governmental plan, or voluntary after-tax employee contributions to a tax-sheltered annuity or qualified retirement plan.

Calculating a Partial Deduction for Single Taxpayers

the maximum IRA deduction is reduced ratably as AGI exceeds the lower limit of the phaseout range used for single taxpayers ($62,000-$72,000). The maximum partial deductibility is computed by the following formula: Allowable IRA contribution limit × {(UL - AGI) ÷ phaseout range} = Deductible amount For single individuals, the upper limit (UL) of the phaseout range is $72,000. The phaseout range is $10,000

Downside of a Regular 401k to a Simple IRA

the regular 401(k) has a downside for any small employer—it costs more to set up and administer. Professional help is required to get it up and running. In addition, as you will see in Module 7, 401(k) plans are subject to ADP, ACP, and top-heavy testing

Disadvantages of SIMPLE IRAs

Maximum annual elective deferrals are less than those in a 401(k) plan ($12,500 compared with $18,000). An employer who adopts a SIMPLE IRA cannot also maintain a qualified plan (except in very limited situations). Employees are immediately fully vested in employer contributions. Therefore, forfeitures are not available to reduce (i.e., subsidize) employer contributions. Of course, immediate vesting is advantageous for the employee-participants. The extent to which assets in a SIMPLE IRA are protected from creditors may not be as great as under a qualified retirement plan because they are not ERISA qualified plans. As a general rule, federal law (ERISA) protects qualified plan assets (including SIMPLE 401(k) assets) from the claims of creditors. IRA accumulations are generally protected up to $1 million.

SEP Eligibility Requirements

1. Age 21 or over 2.Earned 600 during the current year 3.performed services for the employer in at least three of the five years The employer may set less restrictive eligibility requirements, but may not set requirements that are more restrictive. For example, the employer may choose to cover all otherwise eligible employees who are over 20 (rather than 21) years of age. However, the employer is not permitted to raise the eligibility age to 25.

Advantages of SEPs

1. Easy to establish 2. Easy Admin 3. No direct investment responsibility 4. Post year funding 5. Flexible contributions 6. Equal Contributions

Disadvantages of Roth 401(k)s

1. If an individual starts contributing to a Roth 401(k), then this new 401(k) will have its own five-year clock that is separate from other Roth accounts, including Roth IRAs. 2. Roth 401(k) accounts, just like the regular 401(k) account, have required minimum distributions upon attaining age 70½, or retirement

Simple IRA Employer Eligibility

A SIMPLE IRA may only be established by companies that employ 100 or fewer employees who receive at least $5,000 of compensation from the employer during the prior calendar year. The employer may have more than 100 employees, but we only count those with $5,000 or more in compensation Corporations (C or S), partnerships (including LLCs and LLPs treated as partnerships for federal income tax purposes), sole proprietorships, and taxexempt entities (including governmental units) may establish SIMPLE plans, so long as the other requirements are met

taxation of distributions from Fully Deductible IRAs

At distribution, a fully deductible IRA has a cost basis of $0 because: 1. contributions were made with pretax money, and 2. investment earnings have accrued tax-deferred. Therefore, the full amount of any distribution will be taxable as ordinary income.

Tax Consequences for Simple IRAs

Employees may exclude their salary reductions from personal taxable income, and distributions from a SIMPLE account are generally taxed like distributions from an IRA. Accordingly, distributions are includible in a participant's income as ordinary income when withdrawn from the account.

Active Participant

If a taxpayer is classified as an active participant for any part of the plan year his ability to deduct an IRA contribution will then depend on his adjusted gross income (AGI) as compared to the phaseout ranges published annually by the IRS. There are three possible scenarios, which are outlined below: 1. Taxpayer's AGI is less than the lower limit of the phaseout range: a FULL deduction is allowed. 2. Taxpayer's AGI is greater than the upper limit of the phaseout range: NO deduction is allowed. 3. Taxpayer's AGI is between the upper and lower limit of the phaseout range: PARTIAL deduction is allowed.

Not an Active Participant

If a taxpayer is not classified as an active participant for any part of the plan year then he may deduct his full IRA contribution for that year, regardless of his AGI.

Same trustee transfer for Converting IRA to Roth

If the traditional IRA trustee also offers Roth IRAs, the owner can direct the trustee to transfer part, or all, of the traditional IRA to a Roth IRA. This could also be accomplished by simply reclassifying the traditional IRA as a Roth IRA, rather than opening a new account or having a new contract issued.

Advantages of a Regular 401k over a Simple 401k

Potential larger contributions - The upper limit on contributions, from employee elective deferrals, catch-up contributions, and company matches can be higher. Also, discretionary profit sharing contributions can be made to a 401(k) but not to a SIMPLE 401(k). Flexibility of contributions - Companies with fluctuating levels of cash flow or profits may be drawn to the regular 401(k) because it allows them to make their own contributions discretionary or tied to profits

Ordering Rules

Roth IRA funds are considered withdrawn in a specific order. In addition, funds in multiple Roths are aggregated, or treated as if in one pooled account. "Ordering" the distribution involves attributing each dollar to its source: either contributions, conversion, or earnings. The funds are considered withdrawn, or "distributed," in the following "first-in, first-out" order: 1. annual contributions 2. conversion contributions (first-in, first-out basis) 3. earnings (on contributions and conversions)

Taxation of Nonqualified Roth IRA Distributions

Roth contributions are deemed to be withdrawn first. contributions can be withdrawn at any time without any tax implications Conversion contributions come next. Since these amounts were taxed at the time of conversion they will not be taxed again all earnings (on both contributions and conversions) avoid taxation if they are part of a qualified distribution.

Contributions to a SEP

SEPs are entirely employer funded. Employer contributions are entirely discretionary from year to year; there is no mandatory funding requirement or even a "substantial and recurring" As a general rule, the employer's annual contribution to a SEP on behalf of each employee is limited to the lesser of 25% of the employee's compensation, or $54,000 (in 2017, indexed).

Rollover Method for Converting IRA to Roth

The IRA owner can receive a distribution from a traditional IRA and roll it over to a Roth IRA within 60 days of the distribution.

Deductibility of IRA Contributions

The ability to deduct contributions made to a traditional IRA depends on two factors: 1. the individual's status as an "active participant" in a qualified or other retirement plan and 2. the individual's adjusted gross income (AGI).

Recapture of an IRA contribution credit

The amount of any contribution eligible for the credit is reduced by taxable distributions received by the taxpayer and his or her spouse from any retirement savings arrangement described below during the taxable year for which the credit is claimed, the two taxable years prior to the year the credit is claimed, and during the period after the end of the taxable year and prior to the due date for filing the taxpayer's return for the year.

Roth IRA Contributions

no deduction is available for contributions to Roth IRAs—all contributions are made with after-tax dollars. However, Roth IRAs offer a unique opportunity for tax-free distributions—for the owner and the beneficiary.

Roth Conversions

Unique to the Roth IRA is the ability to accept tax-deferred asset funds from a traditional IRA or employer-sponsored retirement plan, such as a 401(k), 403(b), or governmental 457(b). Such a conversion can be done without regard to income eligibility limits. When converting pretax dollars to a Roth IRA, the converted amount is taxable as ordinary income in the year of conversion but future growth will be tax-free.

Calculating a Partial Deduction

partial deduction is allowed if the active participant taxpayer's AGI is between the limits of the applicable phaseout range. The phaseout range that applies to a particular taxpayer is determined by his filing status.

Eligibility to make Roth IRA Contributions

subject only to the earned income requirement and the annual income limitations. Neither active status nor age is relevant for determining Roth eligibility. Unlike traditional IRAs, Roth IRAs do not require an individual to determine the "deductibility" of a contribution- remember, all contributions are after-tax. For Roth IRAs you are determining "eligibility," and this is based solely on income. In 2017, individuals filing as single taxpayers with modified adjusted gross income up to $133,000 and married joint filers with modified adjusted gross income up to $196,000 are eligible to contribute to a Roth IRA Unlike traditional IRAs, individuals can continue to contribute to a Roth IRA after age 70½, as long as they have earned income. In addition, Roth IRA owners are not subject to mandatory required minimum distribution rules

The SIMPLE 401(k) Plan

the SIMPLE 401(k) plan is a qualified plan that provide small employers with a plan that had the attractive features of the traditional 401(k) plan used by large firms, but without the administrative complexities. For example, a SIMPLE 401(k) is not subject to the ADP and ACP tests, or to top-heavy testing.

Five-year clock for Roth IRA contributions

the five-year holding period begins in the year of the first Roth IRA contribution and this same holding period will apply to all future contributions, whether made to the same or different Roth IRAs

Calculating a Partial Deduction Married taxpayers filing separate returns

the maximum IRA deduction is reduced ratably according to the following formula. Multiply the allowable IRA contribution limit for that year times the ratio of the individual's adjusted gross income divided by $10,000. In effect, the IRA deduction limit is $0 for married individuals with AGI of $10,000 or more who are active participants and file separately.