IT'S ALL ABOUT MONEY
By William A. Clemmer and Gary S. Lesser, Esq.
It's tax time for most of us. April 15 (or 16 if you file in Massachusetts) is T-day--or when individuals must file taxes or extensions. Corporations have different rules and different filing dates (but that's for another time). Last month we reviewed some of the common misconceptions about IRAs. Along with not getting things wrong, there are a number of issues that we must get right in order for our clients to receive the benefits of an Individual Retirement Arrangement.
This list is not meant to be exhaustive and may raise additional questions. Two sources that provide extensive detail on all aspects of Individual Retirement Arrangements are Publication 590, Individual Retirement Arrangements, which is available at www.irs.gov and Quick Reference To IRAs--2001, Donald R. Levy and
Gary S. Lesser, a Panel
Publication, which is available
from www.panelpublishers.com.
1. All IRA contributions (including non-deductible IRAs and Roth IRAs) must be made on or before the due date of an individual's income tax return for that year not including extensions. For most taxpayers the due date is April 15, following the calendar year for which the contribution is being made.
- No extensions are allowed.
- Contribution must be made in cash (cash, check, money order and by credit card).
- Rollovers, transfers and conversions of a traditional IRA into another traditional IRA may be made in cash or the same property (in kind).
2. A contribution to an IRA may be the smaller of:
--compensation that must be included in income for the year, or
--A couple can contribute $2,000 each for 2001, even if only one has earned income.
--Contributions to a traditional IRA reduce the limit for contributions to a Roth IRA. Thus, any excess must be removed from the Roth IRA.
--Catch-up contributions are possible for an individual who has attained the age of 50 by the end of the taxable year.
--Note: For 2002, the IRA limits increase to $3,000 ($3,500 if age 50 or older).
3. Contributions to nondeductible IRAs must be entered on form 8606.
4. A full deduction may be taken for a contribution to an IRA in the following situations:
--If neither spouse was an active participant in an employer-sponsored plan, or
--If income was no more than the modified adjusted gross income (MAGI) of $53,000 (married and filing jointly or a qualifying widow or widower) or $33,000 (single or head of household).
--If only one spouse was an active participant and joint income was under $150,000.
Note: Higher retirement plans contribution caps are vexing some states. Starting in 2002, the regular contribution limit for IRAs increased by $1,000 and the 401(k) limit increased by $500. Filers age 50 or older can contribute an additional $500 into an IRA and $1,000 into a 401(k) in addition to the increased contribution ceilings.
Sixteen states must still amend their laws to approve the additional contributions (AK, AZ, CA, GA, HI, IA, ID, IN, KY, MA, ME, NC, NJ, SC, WV, WI). If they do not, people will owe state income tax to the extent that deductible contributions exceed the 2001 caps. Many states are reluctant to conform to the federal tax law because of budget shortfalls caused by the economic slowdown.
5. Management and trustee fees incurred on an IRA can be paid with either IRA or separate non-IRA funds.
--If paid from separate funds, the cost of the fees can be added to miscellaneous itemized deductions, the total of which is deductible to the extent it exceeds 2% of the adjusted gross income.
--Even if fees cannot be deducted, it is best to pay them from non-IRA funds. This allows the IRA to receive tax-favored investment returns on the maximum amount of money.
--Brokerage commissions on IRA investments cannot be paid from non-IRA funds to obtain a deduction for them. Commissions are part of the cost of the investment held in the IRA.
--If commissions on IRA transactions are paid from non-IRA funds, the payment will be considered an extra contribution to the IRA and may be subject to an excess contribution penalty.
6. IRA distributions are taxed to the recipient. This is true even in a community property state where the spouse (by state law) has a 50% interest in the other spouse's IRA. A withdrawal by a spouse is taxed entirely to that spouse.
7. Required distributions from IRAs and Keoghs cannot be combined. The IRS has stated privately that minimum distributions must be taken separately from IRAs and Keoghs. On the other hand, distributions from multiple IRAs may be combined and withdrawals taken from whichever IRA the person chooses.
8. The IRS has issued a new mortality table for pension plans that will replace the 1983 table now being used. [94 GAR, projected to 2002]
--The revised table must be used for distributions made after 12/30/02. Also, plans must be amended to adopt the new numbers. Note that participants will likely receive higher lump-sum distributions. Early retirement benefit ceilings will be slightly higher as well.
9. Mistakes to avoid when considering withdrawals and management of retirement funds:
a. Not using the Minimum Distribution rules. When a taxpayer reaches 70 1/2, federal tax law requires a minimum annual distribution from traditional IRAs and most retirement accounts.
--Current tax is due on the taxable portion of the distribution.
--Failure to take the distribution results in a 50% penalty on the amount that should have been withdrawn.
--Old law: An irrevocable decision had to be made regarding mandatory withdrawals.
--New law: A formula can be used that allows the minimum withdrawal each year. Divide the total amount in IRAs, SEP-IRA and 401(k) plans each year by the joint life expectancy of the owner and a beneficiary assumed to be 10 years younger (whether or not there is a beneficiary and that beneficiary is older or younger). If the spouse is the sole beneficiary and is more than 10 years younger, then use the actual joint life expectancy.
--IRA life expectancy and minimum distribution tables can be found in the sources listed above.
--Beneficiaries may be changed at any time.
--After death, beneficiaries have the additional option of transferring their inheritance to other parties or charities.
b. Withdrawing too much too soon from an IRA: Just because the law permits withdrawals without penalty starting at age 59 1/2 doesn't mean that one should.
--Keep tax deferred accounts growing by using taxable accounts first.
--Withdraw only as much as needed from an IRA, remembering that there is a minimum distribution requirement from any retirement plan after age 70 1/2.
--Use Roth IRA funds last, since Roth IRAs do not have a minimum distribution requirement.
c. Not starting or converting to a Roth IRA, if eligible. A Roth IRA is more flexible than a traditional IRA because it is not subject to income tax, even after death, and beneficiaries can let it accumulate subject to their own required distribution rules.
d. Investing too conservatively. It is better to determine the amount of risk a client can take and then adjust the equity-debt allocation accordingly. An investment plan is preferable to a "sit and hold" plan regardless of allocation.
10. Forms: Using the Web site www.irs.gov is much faster than calling (800) 829-3676 and waiting for forms to arrive by regular mail. A fax service is available via (703) 368-9694. *
The authors
William A. Clemmer and Gary S. Lesser, JD, head up Financial Services Agency Consulting (FSAC), a division of The Rough Notes Company. Clemmer has more than 25 years of financial services industry experience on Wall Street. Lesser writes and lectures widely on retirement planning and taxation issues. He is a member of the board of advisors for the Journal of Taxation of Employee Benefits.