Series 6: Retirement Accounts (Individual Retirement Accounts)

The maximum contribution that an individual who earns $1,000 per year can make to an IRA each year is:

$1,000 For the year 2019, the maximum individual contribution to an IRA is the lesser of 100% of income or $6,000. Since this person earns $1,000, the maximum permitted contribution is $1,000.

A 55-year old woman wishes to remove funds from her Individual Retirement Account to remodel her house. The customer is subject to:

both regular income tax liability and 10% penalty tax on the amount withdrawn Premature distributions from an IRA (before age 59 1/2), unless for reason of death, disability, to pay qualified education expenses, or to pay up to $10,000 of first-time home purchase expenses, incur normal income tax plus a 10% penalty tax on the amount withdrawn.

A designated beneficiary that receives proceeds from an inherited IRA:

must deplete the account balance over the beneficiary's life expectancy and must pay tax on the annual amount withdrawn When the owner of an IRA dies, the designated beneficiary must deplete the IRA balance over the beneficiary's (not the deceased owner's) life expectancy. So if the beneficiary is age 50, and has a life expectancy of 25 years, then the IRA must be depleted evenly over 25 years, and tax paid each year on the amount withdrawn (but no penalty tax is due).

In 2019, individuals with earned income who are age 50 or over are permitted to make an extra annual IRA contribution of:

$1,000 For the year 2019, the maximum annual contribution to an IRA for an individual is $6,000. However, individuals age 50 or older can make an extra "catch up" contribution of $1,000, for a total contribution of $7,000. The catch up provision was put into law because for many years, the amount that could be contributed was much lower, so these persons are now permitted the extra contribution to "catch up" in their retirement planning to younger individuals who started making their contributions in later years when the amount was raised.

A husband and wife, both under age 50, wish to open a spousal IRA. The wife works while the husband does not. What is the maximum IRA contribution for the couple?

$6,000 for the wife; $6,000 for the husband For the year 2019, the maximum contribution for a couple where one works is $6,000 to an IRA for the working spouse and another $6,000 to a spousal IRA for the non-working spouse.

Which of the following can an investor contribute to an Individual Retirement Account?

Cash Investors may only contribute cash to an IRA. After depositing the cash, the IRA may purchase money market fund shares, mutual fund shares, stocks and bonds, and other permitted investments.

Which of the following individuals can contribute to an IRA?

A writer whose only income is royalties from book sales An individual must have earned income to contribute to an IRA, so an individual who has income only from investments cannot contribute. Similarly, an individual who receives only Social Security and pension benefits cannot contribute to an IRA.

Which statement is true?

An IRA owner cannot take a loan from his or her IRA at any age An IRA owner cannot take a loan from his or her IRA at any age. An IRA cannot be used to purchase land from the IRA owner. A person can no longer make contributions to an IRA in the year in which the person reaches age 70 ½, not 65. While an IRA can be invested in real estate, it is a prohibited transaction to invest the IRA funds in real estate bought from the IRA owner. The idea is that an individual cannot "sell" an interest in his or her vacation home to him- or herself in an IRA and get a tax deduction for this! An IRA contribution can only be made based on that individual's earned income; it cannot be based on investment (portfolio) income.

An individual, age 35, earning $40,000 makes an annual contribution of $2,000 to a Traditional IRA. Which statement is true?

This person can contribute a maximum of $4,000 to a Roth IRA The maximum annual permitted contribution to a Traditional IRA or a Roth IRA for an individual is $6,000 total in 2019. This can be divided between the 2 types of accounts. In this case, since $2,000 was contributed to the Traditional IRA, another $4,000 can be contributed to a Roth IRA for that tax year.

All of the following are allowed investments in an Individual Retirement Account EXCEPT:

Antiques, Art, and Other Collectibles Collectibles are not allowed as an investment in an IRA account. Securities are allowed; so are gold coins minted by the U.S. Government. (This was first allowed in 1986 and encourages people to buy gold coins from the government. So far, it has not proved terribly popular as an investment.)

Withholding of taxes is required in all of the following lump sum distributions from a qualified plan EXCEPT:

the distribution is a direct transfer to an IRA Withholding of 20% of the amount withdrawn is required for an IRA rollover. There is no withholding tax for a direct trustee-to-trustee transfer.

Distributions from an Individual Retirement Account must commence by age:

70 1/2 Distributions from an Individual Retirement Account must commence by April 1st of the year following that person reaching age 70 1/2. Remember that IRA distributions are taxable as ordinary income, and the government wants to get its tax before that person dies!

A working couple, both age 40, with a combined income of $200,000, are not covered by qualified pension plans. Which statement is true about IRA contributions by these persons?

IRA contributions are permitted with the contribution amount being tax deductible Anyone with earned income can contribute to an IRA, whether covered by a pension plan or not. If a couple is not covered by a qualified plan, the contribution is tax deductible and the maximum that can be contributed is $6,000 each ($12,000 total). However, the contribution is not tax deductible for couples, where both are covered by qualified plans, who earn over $123,000 in year 2019 (the deduction phases out between $103,000 - $123,000 of income).

Conversion of a Traditional IRA to a Roth IRA is:

permitted if income tax is paid on the aggregate amount of tax-deductible contributions and tax deferred build-up at the time of conversion An individual might choose to convert an existing Traditional IRA to a Roth IRA because he or she wants tax-free income at retirement or wants the ability to determine when retirement income will be taken (there is no mandatory distribution age of 70 1/2 for a Roth IRA). In order to convert a Traditional IRA to a Roth IRA, any income tax due on tax-deductible amounts contributed to the IRA, and the tax-deferred build-up, must be paid. There is no 10% penalty tax, regardless of the owner's age at the time of conversion.

Which of the following early withdrawals from a Traditional IRA will avoid the 10% penalty tax?

A high income individual withdrew $10,000 to buy her first principal residence The 10% penalty does not apply to premature withdrawals taken due to death, disability, to pay for up to $10,000 of first-time home purchase expenses, to pay for qualified education expenses, and to pay for large medical expenses or for health insurance if the owner is unemployed and is currently receiving unemployment benefits. Thus, the early withdrawal of $10,000 by a first home buyer avoids the 10% penalty tax. Note that regular income tax on the $10,000 withdrawn must still be paid. Also note that the home buyer's income level is not a factor in getting this tax relief.

Which statement is true about Roth IRAs?

Contributions are not tax deductible; qualified distributions after age 59 1/2 are not taxed Roth IRAs, unlike Traditional IRAs, do not permit a tax deduction for the amount contributed. On the other hand, when qualified distributions are taken, unlike a Traditional IRA, the distributions are not taxable (given that the investment has been held for at least 5 years).

John Jones, age 60, recently became disabled and retired from his job. He wishes to withdraw funds from his IRA to supplement his Social Security payments, which are his only source of income. All of his IRA contributions were deductible. Which statement is correct?

John must pay ordinary income tax on the amounts withdrawn The 10% penalty tax is not due on distributions from an IRA once a person reaches age 59 1/2. All of the contributions were made with "pre-tax" dollars (since they were deductible) and the build-up is tax deferred. When distributions commence, 100% of the amount withdrawn is taxable at ordinary income tax rates, since none of these dollars were ever taxed. It makes no difference that John's only other source of income is his Social Security payments. Both the Social Security payments received and the IRA withdrawals are taxable income.

Which statement is true about transfers of Individual Retirement Accounts?

There is no limit on transfers IRA transfers between trustees must be made directly from trustee-to-trustee. There is no limit on the number of transfers that can be made each year. If the transfer is effected by having the check made out to the account holder, this is considered to be an IRA rollover, which must be completed within 60 days and only 1 rollover per year is permitted.

A 50-year old individual leaves a corporate employer and receives a $50,000 lump sum distribution from the pension plan. He rolls over $30,000 of the funds within 60 days into an IRA and deposits the rest to his checking account. The individual:

pays tax on the $20,000 not rolled over Any pension plan distributions not rolled over into an IRA are subject to tax. The individual rolled over $30,000 - this remains tax deferred. The $20,000 not rolled over is taxable. Also note that the distribution of $20,000 will be subject to penalty tax because this individual is not yet age 59 1/2.

A working couple, both age 30, with a combined income of $150,000, are both covered by qualified pension plans. Which statement is true about IRA contributions by these persons?

IRA contributions are permitted; however the contribution amount is not deductible Anyone with earned income can contribute to an IRA, whether covered by a pension plan or not. If a couple is not covered by a qualified plan, the contribution is tax deductible and the maximum that can be contributed is $6,000 each ($12,000 total). However, the contribution is not tax deductible for couples, where both are covered by qualified plans, who earn over $123,000 in year 2019 (the deduction phases out between $103,000 - $123,000 of income).

Mr. Jones, age 42, earns $70,000 per year at his job, but his employer does not have a retirement plan. Which of the following statements is TRUE about an IRA for this customer?

If his spouse has no earned income, Mr. Jones could contribute and deduct up to $12,000 Choice (B) is an incorrect statement because the annual deductible contribution for Mr. and Mrs. Jones is $6,000 each ($12,000 total) as long as one of them has earned income. Since Mr. Jones has enough income for the maximum deduction of $12,000, Mrs. Jones does not need any income in order to make the maximum IRA contribution. IRAs cannot be invested in whole life insurance policies and cannot be borrowed against.

Which statement is TRUE for both Traditional IRAs and Roth IRAs?

Earnings accumulate without annual taxation If an individual is not covered by another qualified retirement plan, contributions to a Traditional IRA are tax-deductible while contributions to a Roth IRA are not deductible under any circumstances. Earnings in either account accumulate without annual taxation. Distributions after age 59 1/2 from Traditional IRAs are taxable; distributions from Roth IRAs after age 59 1/2 are tax-free. Unlike Traditional IRAs that require distributions to start on April 1st of the year after reaching age 70 1/2, there is no mandatory distribution age for Roth IRAs. This is true because distributions are tax-free, so not requiring distributions does not cost the Treasury any tax revenue.

A working couple, both age 40, has a combined income of $150,000. Neither are covered by an employer sponsored pension plan. Which statement is true about IRA contributions by these persons?

IRA contributions are permitted with the contribution amount being tax deductible Anyone with earned income can contribute to an IRA, whether covered by a pension plan or not. If a couple is not covered by a qualified plan, the contribution is tax deductible and the maximum that can be contributed is $6,000 each ($12,000 total). However, the contribution is not tax deductible for couples, where both are covered by qualified plans, who earn over $123,000 in year 2019 (the deduction phases out between $103,000 - $123,000 of income).

All of the following are true statements about Roth IRAs EXCEPT:

owners may not be active participants in an employer-sponsored retirement plan There is no age limit on contributions to a Roth IRA, as is the case with a Traditional IRA (where contributions must stop at age 70 1/2). This is true because contributions are not deductible; they are made with after-tax dollars, so allowing contributions at an older age does not cost the Treasury any tax revenue. As long as assets are in the Roth IRA for at least 5 years, distributions after age 59 1/2 are not taxable. Also note that there is no mandatory distribution age of 70 1/2 - again because qualified distributions are tax-free, so not requiring distributions does not cost the Treasury any tax revenue. Note that high-earning individuals cannot contribute to a Roth IRA - they can only contribute to a Traditional IRA. Finally, anyone with earned income is able to contribute to an IRA, whether or not they are covered by another qualified retirement plan.

A customer is employed by a company with a pension plan, to which the company contributed $70,000. The employee has made voluntary contributions to the plan of $10,000. The account is now worth $100,000. The customer leaves the company at age 60 and will need access to the funds for retirement income. How much should the customer roll over into an IRA?

$90,000 At the time of an IRA rollover, it is preferable to remove any after-tax dollars and not roll them into an IRA. The after-tax contribution of $10,000 can be taken out without tax, and the remaining $90,000 of pre-tax dollars should be rolled-over and retain their tax deferred status. If the customer rolled-over the $10,000 of after-tax contributions, then this is the customer's cost basis in the IRA. Any withdrawals are subject to the "Pro-Rata" Rule. If all $100,000 were rolled-over, inclusive of $10,000 of cost basis, then $10,000/$100,000 = 10% of any withdrawal would be treated as cost basis and the remaining 90% would be taxable. If the customer removed $10,000 from the account after rolling the $100,000 over, then 90% of $10,000 = $9,000 would be taxable and the remaining $1,000 would be a non-taxable return of capital. Thus, it is better to remove the $10,000 after-tax contribution without any tax due before making the rollover.

Distributions from qualified retirement plans that are not transferred directly into an IRA or other qualified plan are subject to:

20% withholding tax Distributions from qualified retirement plans, unless they are rolled over into an IRA, are taxable. To insure that the tax will be paid, the tax code requires that 20% of the distribution amount be withheld as a credit against taxes due. The 20% withholding tax is taken out if the individual takes a check from "old" pension plan No withholding tax is imposed if a trustee to trustee transfer is made - with the assets being transferred directly into another IRA or qualified retirement plan.

To avoid penalties, funds cannot be withdrawn from IRAs before age:

59 1/2 Before age 59 1/2, distributions from an IRA are subject to regular income tax plus a 10% penalty tax. Afterwards, withdrawals are subject to regular tax, but not to the 10% penalty tax.

For an Individual Retirement Account contribution to be deductible from that year's tax return, the contribution must be made by no later than:

April 15th of following year IRA contributions must be made by April 15th of the following year - no extensions are permitted. Note that this is different than the requirement for qualified retirement plans, where the contribution must be made no later than the date the tax return is filed, even if the return is filed under an extension.

Which statements are true about Roth IRAs?

Contributions can continue after age 70 1/2 and distributions are not required to start after age 70 1/2 Unlike Traditional IRAs, Roth IRA contributions can continue after age 70 1/2, as long as that person has earned income. And unlike Traditional IRAs, there are no required minimum distributions after age 70 1/2 for Roth IRAs. This is true because distributions are tax-free, so not requiring distributions does not cost the Treasury any tax revenue.

Which statements are true about Roth IRAs? I Distributions from an account that is less than 5 years old are taxable II Distributions from an account that is less than 5 years old are tax-free III Distributions from an account in existence for 5 years or more are taxable IV Distributions from an account in existence for 5 years or more are tax-free

I and IV Contributions to Roth IRAs are not deductible, so they are made with after-tax dollars. The account must be in existence for 5 years before withdrawals start, otherwise the withdrawals will be taxable. If the account has been set up for at least 5 years, then at age 59 1/2 or later, distributions can commence without any tax due.

Which of the following statements concerning tax-free rollovers and transfers from qualified plans to IRAs are correct? I The rollover to an IRA must be completed within 60 days of the distribution from the "old" qualified plan II A taxpayer must create a new IRA to accept a rollover from a qualified plan and cannot use an existing IRA III A rollover must occur before age 70½ and after age 59½ IV A taxpayer can rollover an IRA account only once per year

I and IV IRA rollovers often occur when an individual leaves employment from a company where he or she participated in a qualified retirement plan. The individual may not be able to stay in that plan, and will receive a check for the vested benefit amount from the plan upon termination. He or she can take the check and roll it over, without limit, to an IRA and maintain tax-deferred status. Rollovers must be completed within 60 days of the distribution, making Choice I correct. The rollover can be made into a new IRA account or into an existing IRA account, making Choice II incorrect. Choice III is incorrect because rollovers can be made anytime, even prior to age 59½ and after age 70½. Only 1 rollover per year is permitted, making Choice IV correct. The "idea" behind only 1 rollover permitted per year is that most qualified pension plans require at least 1 year of service before participation starts.

Which of the following statements concerning rollovers and direct transfers from qualified plans to IRAs are correct? I A trustee must withhold 20% of the distribution in a direct transfer from a qualified plan II Withholding is not required in a direct transfer from a qualified plan III A trustee must withhold 20% of the amount of a rollover from a qualified retirement plan to an IRA IV Withholding is not required in a rollover from a qualified plan to an IRA

II and III only IRA transfers occur directly between trustees. Typically, the funds are wired from one trustee to another, but the transfer can also be made by check payable to the new plan trustee. There is no 20% withholding tax when such a direct trustee-to-trustee transfer occurs. There can be an unlimited number of transfers per year. Do not confuse an account transfer with an IRA rollover. If the trustee pays the funds to the account owner in the form of a check, the owner can rollover the proceeds into an IRA within 60 days and maintain tax deferred status on the distribution. If the IRA owner does not redeposit the proceeds, the distribution amount is taxable (and also subject to 10% penalty tax if the owner is under age 59 1/2). To insure that the tax will be paid, the tax code requires that 20% of the distribution amount be withheld as a credit against taxes due. Only 1 rollover is permitted per year.

An unmarried person, earning $100,000 a year, is not covered by a pension plan and has been contributing to an IRA account annually. If this individual joins a corporation at the same salary, and is included in that company's pension plan, which statement is true?

Annual contributions to the IRA can continue but will not be tax deductible Anyone who has earned income can contribute to an IRA, whether covered by a pension plan or not. However, the contribution is not tax deductible for individual employees covered by a pension plan who earn over $74,000 in year 2019 (the deduction phases out between $64,000 - $74,000 of income).

A self employed individual has an adjusted gross income of $100,000 per year. This person has another qualified plan and contributes $6,000 to an Individual Retirement Account. Which statement is true?

The contribution is not tax deductible If a person is not covered by another retirement plan, contributions to an IRA are tax deductible, without any income limitation. If the person is covered by another plan, then as that person's income rises, the tax deduction for the IRA contribution phases out (this occurs between $64,000 and $74,000 of income in year 2019 for an individual). Because this individual's gross income is $100,000 per year and he contributes to another plan, his contribution to an IRA is not tax deductible.

An individual would choose to convert a Traditional IRA to a Roth IRA in order to: I reduce current tax liability II obtain tax-free income at retirement III be able to choose when to take retirement income distributions IV be able to take distributions prior to age 59 1/2 without being subject to the 10% penalty tax

II and IV An individual might choose to convert an existing Traditional IRA to a Roth IRA because he or she wants tax-free income at retirement or wants the ability to determine when retirement income will be taken (there is no mandatory distribution age of 70 1/2 for a Roth IRA). In order to convert a Traditional IRA to a Roth IRA, any income tax due on tax-deductible amounts contributed to the IRA, and the tax-deferred build-up, must be paid. Thus, there can be a large tax bill due in order to make the conversion. However, there is no 10% penalty tax, regardless of the owner's age at the time of conversion. Note that if premature distributions (prior to age 59 1/2) are taken from either a Traditional IRA or a Roth IRA, ordinary income tax is due plus a 10% penalty tax (this is a much worse tax rule for Roth IRAs, since there was no deduction for the contribution).

Emma, age 64 and recently widowed, has made deductible contributions to an IRA. Emma wants to withdraw money from her IRA to help her daughter in a financial emergency. Which of the following taxes may apply if she makes this withdrawal?

Income tax A withdrawal from an IRA account after age 59½ is not a premature distribution. It is subject to regular income tax, but not to the 10% penalty tax. The 6% penalty tax only applies to excess contributions, not to withdrawals. The 50% penalty tax applies to required minimum distributions not being taken once one reaches age 70 1/2.

Which of the following statements concerning the required distributions from an IRA are correct? I Distributions are required in the year after a person turns age 59 ½ II Distributions are required in the year after a person turns age 70 ½ III The penalty for failure to take minimum distributions is 50% of the shortfall IV The penalty for failure to take minimum distributions is 50% of the amount distributed

II and III only If a person fails to start taking mandatory IRA distributions (which are based on that person's life expectancy and must commence during the year after reaching age 70 1/2), the shortfall is subject to a 50% excise tax penalty. This large penalty encourages people to take their distributions. Remember, distributions are taxable (except for any portion of the account funded with after-tax dollars) and the government wants to collect that tax! The 10% penalty applies to premature distributions. The 6% penalty is for excess contributions.

Which statement concerning contributions to an IRA is TRUE?

An individual who is age 50 can contribute more than a person who is age 35 An individual under age 50 can contribute 100% of gross income, up to $6,000 to an IRA in 2019. Individuals that are age 50 or older can contribute an extra $1,000 as a "catch up" contribution. The catch up provision was put into law because for many years, the amount that could be contributed was much lower, so these persons are now permitted the extra contribution to "catch up" in their retirement planning to younger individuals who started making their contributions in later years when the amount was raised. Any individual with earned income can contribute to an IRA - it makes no difference whether they are covered by another qualified retirement plan. If that individual is covered by another qualified retirement plan and that person's income is too high, the contribution can be made, but it will not be deductible. If that individual is not covered by another qualified plan, the contribution can be made and will be deductible, regardless of that person's income level.

A customer is employed at a company with a pension plan, to which the company contributed $25,000. The employee has made voluntary contributions to the plan of $5,000. The account is now worth $50,000. The customer leaves the company at age 60 and will need immediate cash to bridge the gap between the date that he retires and the date he receives his first social security check. How much should the customer roll over into an IRA?

$45,000 At the time of an IRA rollover, it is preferable to remove any after-tax dollars and not roll them into an IRA. The after-tax contribution of $5,000 can be taken out without tax, and the remaining $45,000 of pre-tax dollars should be rolled-over and retain their tax deferred status. If the customer rolled-over the $5,000 of after-tax contributions, then this is the customer's cost basis in the IRA. Any withdrawals are subject to the "Pro-Rata" Rule. If all $50,000 were rolled-over, inclusive of $5,000 of cost basis, then $5,000/$50,000 = 10% of any withdrawal would be treated as cost basis and the remaining 90% would be taxable. If the customer removed $5,000 from the account after rolling the $50,000 over, then 90% of $5,000 = $4,500 would be taxable and the remaining $500 would be a non-taxable return of capital. Thus, it is better to remove the $5,000 after-tax contribution without any tax due before making the rollover.

Alvin made non-deductible contributions to an IRA in the amount of $30,000. At age 60 when the account is valued at $50,000, Alvin wants to liquidate the account and use the proceeds to buy a retirement home. Which statement is true?

$20,000 of the liquidation amount is taxable at ordinary income tax rates Alvin will pay income tax only on part of the distribution because his IRA contains non-deductible contributions. The $30,000 of contributions were made with "after-tax" dollars because they were non-deductible. The earnings in the account ($20,000) build tax-deferred (these are "pre-tax" dollars). When distributions are taken, the portion attributable to the tax-deferred build up ($20,000) is taxable; and the portion attributable to the non-deductible contributions ($30,000) is returned with no tax due. Alvin will not owe the 10% penalty tax because he is taking distributions after age 59 1/2.

What is the penalty imposed for excess contributions to an IRA or Keogh?

6% of the excess contribution Excess contributions to an Individual Retirement Account or Keogh Plan are subject to a 6% penalty tax. Do not confuse this penalty with that imposed on premature distributions from these plans. Premature distributions (prior to age 59 1/2) are subject to a 10% penalty tax.