Understanding IRA and SIMPLE Plans

Transcription

1 This Document Will Help You Prepare To Take The Online Examination A Center for Continuing Education 1465 Northside Drive, Suite 213 Atlanta, Georgia (404) (800) Fax: (404)

2 UNDERSTANDING IRA AND SIMPLE PLANS 2

3 Published by Erland Education Services (formerly Erland Financial Education Services). No part of these courses may be reproduced, transmitted in any form or by any means, electronic or mechanical, for any purpose, without the express permission of Erland Education Services. Although great effort has been made to ensure this publication contains accurate, timely information, it is provided with the understanding that the author is not engaged in rendering legal, accounting, tax, or other professional service. If professional advice is required, the services of a competent legal advisor should be sought. (formerly Erland Financial Education Services)

4 Table of Contents UNDERSTANDING IRA AND SIMPLE PLANS... 2 INTRODUCTION CHAPTER ONE: INTRODUCTION TO INDIVIDUAL RETIREMENT ACCOUNTS REGULAR INDIVIDUAL RETIREMENT ACCOUNTS THE ROTH IRA THE SIMPLE IRA SEP PLANS THE COVERDELL ESA THE MEDICAL IRA SUMMARY CHAPTER TWO: ELEMENTS OF RETIREMENT SAVINGS RETIREMENT SAVINGS Income Level Inflation EFFECT OF INFLATION ON PURCHASING POWER Savings Rate Life Expectancy Social Security Benefits Social Security s Future Social Security and Taxation CALCULATING NEEDED RETIREMENT INCOME SAMPLE RETIREMENT INCOME CALCULATION SUMMARY CHAPTER THREE: ADVANTAGES OF THE REGULAR IRA AVAILABILITY TAX-DEFERRAL TAX DEDUCTIBILITY FLEXIBILITY EASY TO COMBINE OR TRANSFER PROBATE AVOIDANCE SUMMARY CHAPTER FOUR: ELIGIBILITY AND CONTRIBUTION RULES OF THE REGULAR IRA ELIGIBILITY CONTRIBUTIONS Catch-Up Contributions On-Going Contributions IRA INVESTMENTS TYPES OF REGULAR IRAS Individual Retirement Accounts Individual Retirement Annuities SPOUSAL REGULAR IRAS DEDUCTIBILITY OF IRA CONTRIBUTIONS Active Participant Phase Out of Deductibility Active Participant Spouse Non-Deductible Contributions EXCESS CONTRIBUTIONS TO REGULAR IRAS Interest Earned on an Excess Contribution

5 IRA FEES SUMMARY APPENDIX TO CHAPTER FOUR - WORKSHEETS FOR SOCIAL SECURITY RECIPIENTS WHO CONTRIBUTE TO AN IRA CHAPTER FIVE: DISTRIBUTION RULES OF REGULAR IRAS DISTRIBUTIONS FROM REGULAR IRAS WITH NON-DEDUCTIBLE CONTRIBUTIONS Cost Basis Taxation of Earnings PREMATURE DISTRIBUTIONS Exceptions REQUIRED MINIMUM DISTRIBUTIONS Required Beginning Date Required Minimum Amount Distribution Methods Distributions Annuity Method Designated Beneficiary Calculating Required Minimum Distributions Distributions Greater Than the Minimum Distribution Amount Excess Accumulations PLEDGING A REGULAR IRA AS COLLATERAL DISTRIBUTIONS DUE TO THE DEATH OF THE REGULAR IRA HOLDER Death After Distributions Have Begun Death Before Distributions Have Begun Designated Beneficiary Named No Designated Beneficiary Determination of A Designated Beneficiary ESTATE TAXES AND THE IRA Estate Taxes and Naming A Spouse As Beneficiary Estate Tax and Distribution Methods Exceptions FORM 1099-R DEEMED IRAS SUMMARY CODE SECTION 72(T) 10-PERCENT ADDITIONAL TAX ON EARLY DISTRIBUTIONS FROM QUALIFIED RETIREMENT PLANS46 CHAPTER SIX: ROLLOVER AND TRANSFER RULES OF THE REGULAR IRA ROLLOVERS AND TRANSFERS FROM AN IRA TO AN IRA Trustee-to-Trustee Transfers IRA to IRA Rollovers Sixty-Day Rule One-Year Rule PARTIAL TRANSFERS AND ROLLOVERS ROLLOVERS AND DIRECT ROLLOVERS FROM QUALIFIED PLANS TO A REGULAR IRA Amount of Qualified Plan Rollovers and Direct Rollovers Direct Rollovers ROLLOVERS AND DIRECT ROLLOVERS FROM A QUALIFIED PLAN TO A QUALIFIED PLAN Conduit IRAs ROLLING PROPERTY OTHER THAN CASH INTO AN IRA ROLLOVERS AFTER REQUIRED DISTRIBUTIONS HAVE BEGUN TRANSFERS DUE TO DIVORCE Qualified Domestic Relations Order Rollover Rules For a Distribution Received Due to A Divorce SUMMARY SECTION CHAPTER SEVEN: ADVANTAGES OF THE ROTH IRA

6 TAX-FREE WITHDRAWALS TAX ADVANTAGE WITH A SHORT INVESTMENT HORIZON AVAILABILITY FLEXIBLE CONTRIBUTION FREQUENCY FLEXIBLE INVESTMENT OPTIONS CONTRIBUTIONS CAN CONTINUE NO MANDATED DISTRIBUTIONS PROBATE AVOIDANCE SUMMARY CHAPTER EIGHT: ELIGIBILITY AND CONTRIBUTION RULES OF THE ROTH IRA ELIGIBILITY CONTRIBUTIONS Roth IRA Investments Frequency of Contributions Contributions after Age 70 ½ Spousal Roth IRAs Excess Contributions SUMMARY CHAPTER NINE: DISTRIBUTION RULES OF THE ROTH IRA QUALIFIED DISTRIBUTIONS TAXATION OF NON-QUALIFIED DISTRIBUTIONS FROM A ROTH IRA REQUIRED BEGINNING DATE PLEDGING A ROTH IRA AS COLLATERAL ROTH IRA DISTRIBUTIONS AT DEATH ROTH IRA DISTRIBUTIONS DUE TO DIVORCE ROLLOVER RULES OF THE ROTH IRA ROLLOVERS FROM A ROTH IRA TO A ROTH IRA ROLLOVERS FROM A TRADITIONAL IRA TO A ROTH IRA QUALIFIED PLAN AFTER-TAX ROTH-IRA CONTRIBUTIONS Maximum Designated Roth Contribution Amounts Qualified Distributions from Designated Roth Accounts Rollovers from Designated Roth Accounts SUMMARY SEC. 408A. ROTH IRAS SEC. 402A. OPTIONAL TREATMENT OF ELECTIVE DEFERRALS AS ROTH CONTRIBUTIONS CHAPTER TEN: COMPARISON OF THE ROTH AND REGULAR IRAS FEATURES COMPARISON TAXATION COMPARISON % Tax Bracket Today and At Retirement % Tax Bracket Today and 15% At Retirement Distributes Half Her IRA at Age 50, Remainder at Age WHEN WILL A REGULAR IRA BE USED? Regular IRAs and Qualified Plan Distributions CHAPTER ELEVEN: THE COVERDELL ESA ACCUMULATING ASSETS FOR A COLLEGE EDUCATION Cost of A College Education ADVANTAGES OF THE COVERDELL ESA Tax-Free Withdrawals Availability Ability to Make Rollovers CONTRIBUTION AND ELIGIBILITY RULES OF THE COVERDELL ESA Eligibility

7 Contributions Qualified State Tuition Programs Coverdell ESA Investments Excess Contributions to Coverdell ESAs DISTRIBUTIONS FROM COVERDELL ESAS HOPE and Lifetime Learning Credits Additional Tax on Distributions Naming a New Beneficiary Distributions Due to Death Spousal Beneficiary Non-Spousal Beneficiary Distributions Due to Divorce ROLLOVERS FROM AN COVERDELL ESA TO AN COVERDELL ESA TERMINATION OF COVERDELL ESAS SUMMARY SEC EDUCATION INDIVIDUAL RETIREMENT ACCOUNTS CHAPTER TWELVE: FEATURES AND BENEFITS OF IRA PRODUCTS AND PLANS CERTIFICATES OF DEPOSIT Risk Maturities Calculation of RMD for Regular IRAs Fees MUTUAL FUNDS Diversification Types of Mutual Fund Securities Objectives Loads Fund Families Opening Requirements Calculation of RMD for Regular IRAs Fees Risk INDIVIDUAL STOCKS AND BONDS Self-Directed IRAs Fees Calculation of RMD for Regular IRAs FIXED ANNUITIES Interest Rate Risk and Conservation of Principal Surrender Charges Calculation of RMD for Regular IRAs Features EQUITY-INDEX ANNUITIES Risk and Return Guarantees Opportunity For Growth Guaranteed Minimum Return Calculation of RMD for Regular IRAs VARIABLE ANNUITIES Sub-Accounts Calculation of RMD for Regular IRAs Surrender Charges and Fees Stepped up Death Benefit Other Features SUMMARY

8 CHAPTER THIRTEEN: SEP PLANS SEP AND SAR-SEP ADVANTAGES Tax Deferral Ease of Establishment Flexibility Easy to Transfer and Combine Relative Low Cost Tax Deductibility ELIGIBILITY Excluded Employees CONTRIBUTIONS Excess Contributions SAR-SEP PLANS ELIGIBILITY CONTRIBUTIONS Elective Deferrals Excess Deferrals Highly Compensated Employee Elective Contributions Employer Contributions PLAN INVESTMENTS DISTRIBUTIONS Premature Distributions Distributions From A Sep With Non-Deductible Ira Contributions ROLLOVERS AND TRANSFERS POTENTIAL DISADVANTAGES OF SEP AND SAR-SEP PLANS Lack of Vesting and Loan Options CHAPTER FOURTEEN: SIMPLE PLANS SIMPLE PLAN ADVANTAGES Ease of Establishment Easy To Transfer and Combine Relative Low Cost Tax Deductibility ELIGIBILITY Excluded Employees CONTRIBUTIONS INVESTMENT OPTIONS DISTRIBUTIONS ROLLOVERS AND TRANSFERS POTENTIAL DISADVANTAGES OF SIMPLE PLANS SEC INDIVIDUAL RETIREMENT ACCOUNTS CHAPTER FIFTEEN: HOW IRAS COMPARE TO OTHER RETIREMENT SAVINGS PLANS REGULAR AND ROTH IRAS COMPARED TO SEP AND SIMPLE IRAS EXHIBIT COMPARISON OF REGULAR AND ROTH IRAS TO SIMPLE PLANS SELF- EMPLOYED PLANS (KEOGH PLANS) Contributions Eligibility Vesting Investment Options Tax Deductibility Distributions Advantages Disadvantages

9 EXHIBIT 15.3 COMPARISON OF REGULAR AND ROTH IRAS TO KEOGH (SELF EMPLOYED) PLANS K PLANS Contributions Investment Options Vesting Distributions Advantages Disadvantages EXHIBIT 15.4 COMPARISON OF A REGULAR AND ROTH IRA TO 401K PLANS EXHIBIT 15.5 COMPARISON OF A REGULAR AND ROTH IRA TO QUALIFIED RETIREMENT VEHICLES NON-QUALIFIED ANNUITIES Premature Distributions Distributions Taxation at Withdrawal Exchanges Advantages EXHIBIT 15.7 COMPARISON OF A REGULAR IRA TO A NON-QUALIFIED ANNUITY Disadvantages SUMMARY CHAPTER FOURTEEN: HEALTH IRAS ELIGIBILITY AND CONTRIBUTION RULES OF MSAS Eligibility High Deductible Health Plans Other Health Insurance Contributions Maximum Contributions Deductibility of Contributions Spousal Rules MSA Investments Excess Contributions Employer Plans DISTRIBUTION RULES OF MSA ACCOUNTS Additional Tax on Distributions Medical Expense Deduction Distributions Due to Death Spousal Beneficiary Non-Spousal Beneficiary Distributions Due to Divorce ROLLOVER RULES OF THE MSA Tax Filing HEALTH SAVINGS ACCOUNTS Eligibility Rules of HSAs High Deductible Health Plan Establishing An HSA HSA Contributions Last Month Rule Catch-Up Contributions Spousal Rules Deductibility of HSA Plan Contributions Timing of Contributions Excess Contributions Distributions from HSAs Distributions after Death Rollovers to HSAs FSA Plans and HSAs

10 SUMMARY CODE SECTION 220. MEDICAL SAVINGS ACCOUNTS CODE SEC HEALTH SAVINGS ACCOUNTS GLOSSARY SOURCES

11 INTRODUCTION The IRA now has several forms - the traditional or regular IRA, the SIMPLE and SEP IRAs, the Roth IRA, the Coverdell ESA, the Health Savings Account (which evolved from a plan first called a Medical IRA ) and a special category of IRA called a Deemed IRA. All of these IRA types are retirement savings vehicles except the Coverdell ESA, which is an education savings vehicle. All provide tax advantages to encourage Americans to save. This course begins by introducing the types of IRAs. Then, the retirement savings IRAs will be discussed. The element of retirement savings begins this section, followed by a detailed look at traditional IRAs. The Roth IRA is then examined, with a thorough look at its eligibility, contribution, distribution and rollover rules. The Coverdell ESA and the Health Savings Account plans are also covered in detail. The IRA options Congress has created provide the financial professional with the privilege of offering a valuable service to his or her customers: introducing them to tax-advantaged savings vehicles. This course will give a strong foundation to the financial professional willing to assist his or her customers in utilizing these programs. 11

12 CHAPTER ONE: INTRODUCTION TO INDIVIDUAL RETIREMENT ACCOUNTS Regular IRAs SIMPLE IRAs SEP IRAs Roth IRAs Coverdell ESAs Medical Savings Accounts The need to accumulate savings is a very real one for most Americans. Congress has created several types of savings vehicles to help individuals meet this need: the Individual Retirement Account, the Roth IRA, the SIMPLE Plan and it s predecessors, the SEP Plans, and the Coverdell ESA. The Roth and Coverdell ESA types became available beginning in 1998 and were created by The Taxpayer Relief Act of The first type, which will often be referred to in this manual as the traditional or regular IRA, has been available in some form since The SIMPLE Plan became available in The Medical savings accounts became available in 1997, and its current form, the Health Savings Account, became available in REGULAR INDIVIDUAL RETIREMENT ACCOUNTS The regular IRA allows annual contributions to be made by individuals to individually held accounts or plans. The earnings in these plans are not taxed annually; rather, earnings are taxed when they are withdrawn. Earnings in an IRA are therefore tax-deferred. The impact of tax-deferral on earnings can be significant. The impact on return increases the more money is contributed to the tax-deferred plan and the longer the money remains tax-deferred. A contribution to traditional IRAs may be tax-deductible in the year the contribution is made as well. These legislated tax advantages are meant to encourage individuals to save for retirement. Withdrawals from regular IRAs must be made beginning no later than April 15 of the year following the year in which the IRA holder reaches age 70 ½. An additional 10% tax applies to most withdrawals of earnings prior to age 59 ½. THE ROTH IRA The key differences between a Roth IRA and a traditional IRA is that contributions to a Roth IRA are never tax-deductible and withdrawals are generally free from income taxation. Contributions may also continue to be made after age 70 ½ to a Roth IRA if the individual is still working. Distributions do not have to be made beginning after age 70 ½, as they do in a traditional IRA. The Roth IRA is a streamlined version of the traditional IRA, without many of the cumbersome rules associated with the traditional IRA. THE SIMPLE IRA The SIMPLE IRA plan is a retirement plan which allows both employer and employee contributions. It is designed for small businesses; it may not be established by employers with more than 100 employees earning more than $5000 in compensation. 12

13 It s distribution rules are similar to those of regular IRAs, although the tax on withdrawals during the first two years of participation is higher than those of regular IRAs. SEP PLANS SEP plans are also IRA plans for small businesses. No new Salary Reduction SEP plans (SARSEPs) may be established after December 31, 1996 (Congress replaced them with SIMPLE plans.) However, SARSEP plans which are already in place may continue to be contributed to. Because of this provision, this manual will include information on SARSEP plans. Regular SEP plans may still be established. SEP plans include a few more eligibility restrictions than do SIMPLE plans. THE COVERDELL ESA The Coverdell ESA, previously known as the Education IRA, is not really an individual retirement account, but rather is an education savings vehicle. It was called an IRA because it shares many of the rules of the traditional and Roth IRAs. An individual may place up to $2000 per beneficiary annually in an Coverdell ESA, generally until the beneficiary reaches age 18. Under specified conditions, withdrawals from Coverdell ESAs are income tax free. These conditions include that the withdrawal is made to pay for a beneficiary s qualified education expenses, and that they are made prior to the beneficiary s age thirty. THE MEDICAL IRA The Medical IRA, or medical savings account is used in conjunction with a high-deductible health insurance plan. A high-deductible health insurance plan is purchased, and contributions are made to a medical savings account to pay for those expenses the health plan does not cover. The contributions are either deductible to the medical savings account holder or are not included in gross income if made by another person or entity for the account holder. The contributions in medical savings accounts grow tax-deferred, and if used for certain medical expenses, are withdrawn tax-free. The current version of medical savings accounts are called Health Savings Accounts. SUMMARY IRAs are vehicles which provide a federal income tax incentive to save. Traditionally, this tax incentive was limited to retirement savings. Recent legislation has expanded tax advantages to include education and medical savings as well. 13

14 CHAPTER TWO: ELEMENTS OF RETIREMENT SAVINGS Most people will live beyond their working years, and will need income from savings for this retirement period. But, relatively few are putting enough money aside for retirement. This chapter discusses why it is important to save for retirement and what factors should be considered to determine the amount of retirement funds to accumulate. RETIREMENT SAVINGS To determine the retirement savings need for any individual, several elements are involved: current income level, expected expenses during retirement years, inflation, current savings and life expectancy. Taxation issues impact each of these elements. Income Level Financial experts generally agree that a comfortable retirement requires income equal to seventy to eighty percent of pre-retirement income. Many people estimate their retirement income needs as being much lower than this amount. The tendency is to overestimate the reduction in expenses attributable to earning a living, such as commuting expenses and clothing, and underestimate both those expenses related to a retirement lifestyle, such as travel, and those expenses unfortunately related to aging, such as medical expenses. By using a rule of thumb seventy or eighty percent of today s expense levels, most people will have a reasonable estimation of retirement needs without having to guess about the future. Inflation The inflation rate has varied over the years, with a 7.2% average during the seventies, an approximately 3.5% average from 1985 through 2000, and a 2.2% rate in In 2009, the inflation rate was -.4% in 2010 was 1.6%. For the year 2014, the annual inflation rate was 0.8%, the lowest increase since For many years, the U.S. inflation rate averaged 3%. The impact of inflation cannot be forgotten in the determination of retirement income amount. Inflation decreases the purchasing power of today s dollars for future purchases. For example, if a three percent inflation rate occurs over the next twelve months, and we assume every product and service will be affected equally by this inflation rate, then a loaf of bread that costs one dollar today will cost $1.03 in twelve months, and an apartment that rents for $900 per month today will rent for $927 in twelve months. If the annual three percent inflation rate occurs over a period of ten years, then by the end of the tenth year, the loaf of bread will cost $1.35 and the apartment rent will be $1214 per month. 14

15 EFFECT OF INFLATION ON PURCHASING POWER END OF YEAR BREAD RENTAL EXPENSE Current $1.00 $900 1 $1.03 $927 2 $1.06 $956 3 $1.09 $985 4 $1.13 $ $1.16 $ $1.20 $ $1.23 $ $1.27 $ $1.31 $ $1.35 $1214 Exhibit 2.1 Assumes 3% inflation rate. The impact of inflation can be reduced through an increase in after tax-income. For example, if inflation were at three percent and an individual s after-tax income grew by five percent, the effect of inflation on this individual s situation would be to reduce his income increase by three percent in terms of purchasing power. His five percent income increase will purchase an approximate additional two percent in goods and services, after taking into account inflation In the same way inflation impacts purchasing power for bread and an apartment, inflation impacts the amount of retirement income to be saved. More of today s dollars must be saved to purchase future goods and services because inflation erodes the value of the dollar over time. For the individual on a fixed income, or planning toward a fixed income, inflation is more significant than for the income earner, since the individual on a fixed income may not have significant income increases to offset inflation. Savings Rate The rate of personal savings in the United States in January 2015 was 5.5%. This rate had dropped to almost zero in the months following the economic plunge we saw in Financial experts recommend saving at least 10% each month, even more as one nears retirement. But, the average American is saving much less than this. Assume a forty year old is planning to retire at age 65 and saves 5.5% of his $60,000 annual income. This $3300 ($275 a month) receives an average return of 5% for 25 years. He will have saved about $163,750 at age 65. If the inflation rate is 3% over this time, this savings will have a spending value of only about $77,000. If the inflation rate is only 1.5% over this 25 year span, this savings will have a spending value of about $111,000. Unfortunately, a total of $77,000 to $111,000 will not meet the retirement savings needs of many people. Life Expectancy How long is retirement income needed? According to the U.S. Government, women reaching age 65 could expect to live 20.3 more years on average, and men could expect to live an additional 17.7 years. (U.S. Department of Health and Human Services, Health, 2013, 15

16 Table 17.) Government projections indicate that life expectancy will continue to increase. When working with a client, these figures may be used as a starting point to determine how long the client may need retirement income. Some clients will want to use a longer life expectancy horizon because there is a history of long life in their family, or because they would like to be conservative in their retirement income need planning. Using a longer life expectancy when determining retirement savings needs means that an individual will strive to save more for retirement than if a shorter life expectancy were used. Social Security Benefits Despite the now well-known problems with the Social Security system, many people believe Social Security will meet retirement income needs. However, Social Security provides far less retirement income than the recommended seventy percent of current income benchmark. It is currently designed to replace about 24% of pre-retirement pay. The average retired worker receiving Social Security benefits in 2015 receives $1328 per month, or $15,936 annually. Social Security cannot be relied upon to provide sufficient income during retirement. Social Security s Future For the younger client, the question of whether social security benefits will even be available is not unthinkable. By some estimates, if no changes to the system are made, the Social Security trust funds will run out of money by If so, it will have to rely on current tax revenue only, which the Trustees of the Social Security Administration state will pay only about ¾ of required benefits through Congress continues to discuss methods of saving Social Security or dramatically revamping its rules so that some sort of benefits may be provided to retirees in years to come. However, those planning for retirement should take into consideration that the future of the Social Security system is in question. Social Security and Taxation Whether Social Security benefits are here to stay at its current levels is arguable. However, taxation of Social Security benefits is currently a fact. Social Security benefits are taxable under the following circumstances: If a single taxpayer s modified adjusted gross income ( modified agi ) added to one-half of social security benefits received during a tax year is greater than $25,000 and up to $34,000 (Threshold I), then up to fifty percent of social security benefits received during the tax year may be included in gross income and are therefore taxable. If modified agi plus one-half of social security benefits received exceed $34,000 (Threshold II), up to 85% of social security benefits may be included in gross income. A married taxpayer filing jointly is subject to a Threshold I of greater than $32,000 and up to $44,000 and a Threshold II of greater than $44,000. Modified agi is equal to adjusted gross income (disregarding any foreign income and savings bonds exclusions) plus any nontaxable interest income received or accrued during the tax year. 16

17 In addition to Social Security benefit taxation, Social Security FICA taxes must be paid as well. Currently, the FICA rate is 15.4%, but it is projected by some experts to be 20-27% by the year 2020, and % by The bottom line regarding Social Security and retirement planning is that Social Security will not provide sufficient retirement income for most individuals and the related FICA and benefit taxation further reduce its overall contribution to retirement savings. CALCULATING NEEDED RETIREMENT INCOME Bringing the elements of projected retirement income level, inflation, savings life expectancy and tax rate together, the amount of needed retirement savings can be derived. Today, a variety of software programs are available which will assist in computing desired retirement income and monthly or annual savings needed. The more sophisticated software packages will estimate projected social security income, pension plan income, and growth of individual investment accounts, taking into account the tax consequences of each. Retirement worksheets are also available from various investment providers to assist in determining retirement savings and income needs. Whether a worksheet or software package is used, most calculations include all or some of the following elements: 17

18 SAMPLE RETIREMENT INCOME CALCULATION Step One Step Two Step Three Determine the desired retirement income Current income (annual or monthly) multiplied by 70 or 80 percent equals Desired Retirement Income Determine expected retirement income from other sources (Social Security, pension plans) Expected pension plan benefits plus Expected Social Security benefits equals Expected Retirement Income Determine additional retirement income needed. Desired Retirement Income minus Expected Retirement Income equals Additional Retirement Income Needed. Step Four Adjust (increase) income needed due to inflation. Step Five Step Six Step Seven Step Eight Multiply inflation adjusted income needed by life expectancy to determine Total Retirement Savings Needed. Determine future value of current savings based on an assumed rate and adjusted for inflation. Determine additional retirement savings needed. Inflation adjusted retirement savings minus Inflated adjusted future value of current savings equals Retirement Savings Needed. Determine monthly or annual income to contribute until retirement to accumulate retirement savings needed. 18

19 The table below shows the result of starting a retirement savings program at different ages for a worker earning $80,000 annually, having a savings rate of 5.5%, which is $376 monthly or $4512 annually, and earning a return of 5%. The assumed inflation rate for the period is 2%. Exhibit 2.3 Age Savings Begins Retirement Age Retirement Savings at 65 Inflation Adjusted Savings at $559,700 $253, $307,800 $170, $153,200 $103, $58,300 $47,800 This simple table points out some important information:! The amount of savings required for retirement is well above the average 5.5% Americans are currently saving on an annual basis.! The earlier savings start the better; starting to save ten years later approximately doubles the savings amount needed for the same retirement income.! Monthly savings may seem much easier to plan toward than a large annual commitment. SUMMARY Most Americans dramatically underestimate the amount of retirement income they will require to live comfortably. Social Security benefits will not by themselves provide adequate retirement income. Inflation must be taken into consideration when determining retirement needs. Savings for retirement need to begin as early as possible for maximum growth potential. 19

20 CHAPTER THREE: ADVANTAGES OF THE REGULAR IRA This chapter begins a detailed discussion of the regular or traditional IRA. This IRA has several significant advantages as a retirement vehicle. AVAILABILITY Many workers are not offered a way by their employers to save for retirement, e.g., through a qualified retirement plan. However, anyone earning compensation and under the age of seventy and one-half may contribute to a traditional IRA. TAX-DEFERRAL Many retirement vehicles, including IRAs, have the advantage of being tax-deferred: pre-tax accumulations are not taxable as current income until withdrawn. Tax-deferral can have a significant impact on savings growth. Taxable investments generate a statement Income must be reported and tax paid on the income annually. The effect of this taxation is to reduce the effective rate of return on the investment. For example, a product earning taxable rate of 8% purchased by an investor in a 25% tax bracket is equivalent to an after-tax rate of only 6%. This after-tax yield is derived by applying the following formula: taxable rate x (1-tax bracket) Exhibit Tax Brackets Tax Bracket Married, Filing Jointly Single 10% $0 $18,450 $0 - $9,225 15% Over $18,450 - $74,900 Over $9,225 - $37,450 25% Over $74,900 - $151,200 Over $37,450 - $90,750 28% Over $151,200 - $230,450 Over $90,750 - $189,300 33% Over $230,450 - $411,500 Over $189,300 - $411,500 35% Over $411,500 - $464,850 Over $411,500 - $413, % Over $464,850 Over $413,200 20

21 Assume a thirty year old contributes $5,500 a year to a regular IRA until age 65, and the IRA earns 5% annually. The IRA owner is in a 25% tax bracket. Below is a comparison of the growth in the IRA to the growth in a taxable investment. Year Tax- Deferred After Tax Accumulations Accumulations 5 $31,190 $30, $121,790 $110, $269,360 $225, $509,750 $392,840 Exhibit 3.1. TAX DEDUCTIBILITY Despite recent tax law changes, up to 87% of working Americans may take a partial or total income tax deduction for regular IRA contributions. Deducting contributions reduces the amount of income tax due for the tax year the contribution was made. For example, assume a single individual has taxable income of $38,000 and is in a 25% federal tax bracket. If he or she contributes $5500 to an IRA this year, his or her tax liability will be reduced by $1250 ($5500 contribution multiplied by 25% marginal tax bracket). FLEXIBILITY Contributions to a traditional IRA are flexible. Once the IRA is opened, annual contributions do not have to continue, but may be made as the owner decides. Investment options are flexible as well. Regular IRA moneys may be placed in bank certificates of deposit, fixed and variable annuities, mutual funds, individual securities - just about anything other than life insurance and certain collectibles. EASY TO COMBINE OR TRANSFER Regular IRA funds may be moved via trustee-to-trustee rules at any time, or once every twelve months via an IRA rollover and retain tax-deferral. Qualified pension plan distributions may also be rolled directly into a regular IRA and retain tax-deferral. Many clients approaching retirement want to combine IRA and pension plan distributions so that they may enjoy the ease of receiving one statement and one income check. Ease of transfer is also important as investment needs change. A younger IRA contributor may place IRA moneys in an aggressive stock fund early on with the plan to move the funds to more conservative instruments as retirement approaches. PROBATE AVOIDANCE An IRA may be structured to avoid probate. If a beneficiary is named for the IRA, death distributions will be made directly to that beneficiary without going through the publicity, delay and expense of probate. 21

22 SUMMARY Traditional IRAs have many advantages, making them an attractive, flexible retirement savings vehicle for many working Americans. 22

23 CHAPTER FOUR: ELIGIBILITY AND CONTRIBUTION RULES OF THE REGULAR IRA ELIGIBILITY Any individual may contribute to a regular IRA who: a) has not reached age seventy and one-half during the tax year for which the contribution is made, and b) has compensation. Compensation includes wages, salaries, tips, commissions, fees, bonuses, and taxable alimony and separate maintenance payments. Compensation does not include deferred compensation received or social security or railroad retirement income. Disability income is also not included in compensation for the purpose of calculating IRA contribution eligibility. Other items not included in compensation are rental income, interest income, dividend income, pension or annuity income, and foreign earned income. CONTRIBUTIONS In years 2002 through 2004, an individual could generally contribute up to $3000 or one hundred percent of compensation earned in a tax year, whichever is smaller, to a regular IRA. This amount was increased to $4,000 in years 2005 through 2007 and to $5,000 in 2008 through This contribution amount is $5,500 for 2013 through For example, if 45-year old Mr. Johnson earned $25,000 in compensation for the year, he could contribute up to $5500 to an IRA in If 18-year old Ms. Daniels earned $2700 in compensation in 2015 her maximum regular IRA contribution would be $2700, or one hundred percent of her compensation. Catch-Up Contributions Beginning in 2002, older individuals are able to make additional catch-up contributions to their regular IRAs. Individuals who have reached age 50 before the end of the tax year wereable to contribute an additional $500 annually to their regular IRAs in years 2002 through 2005, and an additional $1,000 annually in the year 2006 and thereafter. For example, if 51-year old Mrs. Takashi earned $40,000 in 2015, she could contribute up to $6500 to her traditional IRA ($5500 regular contribution, plus $1000 catch-up contribution). On-Going Contributions Once a regular IRA is established, there is no requirement that future contributions be made. Contributions may be made each tax year, monthly during the tax year, every other year, or never again. Additional Individual Retirement Accounts may be opened and maintained as well. There is no requirement that only one regular IRA may exist per IRA owner. 23

24 Contributions to a regular IRA must be in cash. Once established as an IRA, the IRA moneys may be used to purchase any of a variety of investments, such as mutual funds, certificates of deposit, individual stocks or bonds, real estate, annuities, or any other investment other than life insurance and most collectibles. IRA INVESTMENTS Collectibles. In 1982, legislation included in the Tax Equity Fiscal Responsibility Act, or TEFRA, mandated that collectibles could not be purchased through an IRA. Collectibles include items such as art, rugs, antiques, gems, stamps and coins. The Tax Reform Act of 1986, TRA 86, modified this legislation to state that certain US gold and silver coins could be purchased in a traditional IRA. The Taxpayer Relief Act of 1997 added platinum coins and gold, silver, platinum and palladium bullion which meets certain specifications to the list of acceptable collectibles. None of these coins or types of bullion are now prohibited from use as an IRA investment. Life Insurance. Life insurance cannot be purchased through a traditional IRA. prohibition does not include tax-deferred annuities, however, whether fixed or variable. This TYPES OF REGULAR IRAS Two types of regular IRA plans are currently allowed under IRS regulations: the Individual Retirement Account and an Individual Retirement Annuity. Individual Retirement Accounts An Individual Retirement Account must be an account opened through a written trust or a custodial account. The IRS allows banks, federally insured credit unions, other financial institutions and other corporations to act as trustee or custodian for IRA agreements, assuming the institutions meet IRS requirements. These requirements include continuity of life, established location, fiduciary experience, fitness to handle retirement funds, ability to administer fiduciary powers and adequate net worth. The Individual Retirement Account administered by these entities must meet the following requirements: a) The trustee or custodian cannot accept contributions, other than rollover contributions, over the maximum IRA contribution ($5500 for 2015) for a tax year. b) Contributions, other than rollover contributions, must be in cash. c) The IRA holder must have a nonforfeitable right to the amount in the account at all times. d) The account cannot invest in life insurance nor most collectibles. e) Distributions must generally be made by April 1 of the year following the year in which the IRA holder reaches age seventy and one-half. f) The assets in the account cannot be commingled with other property, except in a common trust fund or common investment fund. 24

25 Individual Retirement Annuities An Individual Retirement Annuity is an annuity contract issued through a life insurance company. The annuity must meet the following requirements: a) The IRA holder must be named as owner and only the IRA holder or beneficiary or beneficiaries may receive payments or benefits from the annuity. b) The annuity cannot be transferable. c) Contracts issued after November 6, 1978, cannot require a fixed premium payment. d) Contributions, other than rollover contributions, cannot exceed the maximum IRA contribution for a tax year ($5500 for 2015). e) Distributions must generally begin by April 1 of the year following the year in which the IRA holder reaches age seventy and one-half. SPOUSAL REGULAR IRAS A deductible contribution may be made by an individual under special IRA rules even if the individual has not earned compensation during the tax year. The requirements of this rule are: a) the amount of compensation, if any, includible in the individual s gross income is less than the amount of compensation includible in the gross income of the individual s spouse, and b) the individual files a joint return for the taxable year. As long as these requirements are met, the maximum contribution that may be made for this individual is the lesser of: the maximum annual contribution amount ($5500 in 2015, plus any catch-up contribution, for example), or the sum of the compensation includible in the individual s gross income for the tax year, plus the compensation includible in the gross income of the individual s spouse for the tax year reduced by the amount allowed as a deduction to the spouse for a contribution to the spouse s own IRA for that tax year. For example, in 2015, Mr. Smith, age 66, has retired and has no compensation. His wife, Mrs. Smith, age 62, is working and earned $37,000 in includible compensation. A maximum of $6500 can be contributed to each of the Smith s IRAs ($5500 IRA contribution maximum plus $1000 catch-up contribution for individuals 50 and over). Or, for example, in 2015, Mr. Jones, age 48, earned $10,000. His wife, Mrs. Jones, age 49, earned no compensation. If Mr. Jones contributes $5500 to his IRA, A maximum of $4500 may be contributed to Mrs. Jones IRA - total includable compensation for the couple is $10,000, less $5500 contribution to Mr. Jones IRA, leaves $4500 which may be contributed to Mrs. Jones IRA. Although this IRA funding structure is commonly called a Spousal IRA, each IRA is individually owned. 25

26 DEDUCTIBILITY OF IRA CONTRIBUTIONS TRA 86 changed the rules regarding the deductibility of IRA contributions. Prior to this legislation, anyone eligible to contribute to an IRA could deduct the full amount of the contribution for income tax purposes. After this legislation took effect however, in order to determine whether an IRA contribution is deductible in full or in part, one must look at several factors. These factors include: 1. Whether or not the IRA owner or his or her spouse is covered by an employer retirement plan (is an active participant in a qualified plan). 2. The IRA owner s income level. 3. The IRA owner s filing status. Active Participant If an individual is an active participant in a qualified employer retirement plan, the allowable deductible amount of his or her regular IRA contributions is limited, based on adjusted gross income and filing status. The definition of an active participant varies depending upon what type of qualified plan is in effect. One of the easiest methods of determining active participant status is to check the employer generated W-2, Statement of Earnings. Employers are required to report whether the employee is covered by the qualified plan by marking the pension plan box on the W-2. If the pension plan box is checked, any contribution made by the employee to an IRA is subject to the deductibility limits. Phase Out of Deductibility If neither an individual or spouse is covered by an employer plan, then the full eligible regular IRA contributions made may be deducted for income tax purposes, regardless of income level. Active Participant Spouse If one spouse is an active participant and the other is not, deductibility for the non-active participant is phased out only if the couple s combined adjusted gross income is between $183,000 and $193,000. If both are active participants, then deductibility for both when filing jointly is phased out between $98,000 and $118,000. Non-Deductible Contributions Although a regular IRA holder s IRA contributions may be subject to limited deductibility, non-deductible contributions may be made. The maximum IRA contribution limits of the smaller of $5500 (2015) or 100% of compensation, apply to all contributions to an IRA, whether deductible or non-deductible. Non-deductible contributions grow tax-deferred. The earnings attributable to nondeductible contributions are not subject to income taxation until withdrawn. If nondeductible contributions are made to an IRA, the taxpayer must report them on his or her tax return when filed. 26

27 EXCESS CONTRIBUTIONS TO REGULAR IRAS An excess contribution is a contribution to a regular IRA greater than the maximum contribution amount, e.g. greater than the smaller of $5500 or 100% of compensation in years 2013 through Excess contributions are subject to a 6% tax if not withdrawn before the date the IRA owner s tax return is due. The tax is assessed each year the excess contribution and attributable earnings remain in the IRA. If the excess contribution, along with any earnings attributable to the excess contribution, are withdrawn within the mandated time frame, the excess contribution tax does not apply. Interest Earned on an Excess Contribution The interest earned on the excess contribution, whether withdrawn from the IRA or not, must be included in gross income for the tax year in which it was earned. The withdrawal of interest may be subject to the tax on premature distributions if the IRA holder is under age 59 ½, as discussed under Premature Distributions later in this manual. For example, 45 year-old Ms. Masterson contributed $6000 to her IRA in 2015 ($500 too much). She noticed the error prior to filing her taxes in April She contacted her IRA trustee to notify the trustee of the error. The trustee withdrew the $500 and accumulated interest of $5. No tax on the excess contribution was due since it was withdrawn prior to April 15, 2016, her tax due date. If instead she had contacted her IRA trustee in May of 2016, a tax of $30 would have been assessed on the excess contribution and a tax of $.30 would have been due on $5 of interest. IRA FEES IRA Trustees may charge a fee to the IRA holder for the duties performed as trustee, e.g. tax reporting, issuing annual account statements, making distributions, etc. If this fee is separately billed and paid to the trustee rather than being taken from the IRA contribution, this fee is not considered part of the IRA contribution. The trustee fee in this case may be considered an itemized deduction for income tax purposes. For example, an IRA holder contributed $5500 to an IRA. Each year a trustee administration fee of $25 is billed to the IRA holder, who writes a check and pays the trustee. The $25 annual fee is not considered part of the IRA contribution. The IRA holder may list the $25 as an itemized deduction for income tax purposes. Exhibit 4.1 Effect of Modified AGI on Deduction if a Taxpayer is Covered by a Retirement Plan at Work AND taxpayer modified adjusted IF taxpayer filing status is... gross income (modified AGI) is... THEN taxpayer can take... $61,000 or less A full deduction Single or Head of Household More than $61,000 but less than $71,000 A partial deduction $71,000 or more No deduction Married filing jointly or qualifying widow(er) $98,000 or less A full deduction More than $98,000 but less than A partial deduction 27

28 Married filing separately $118,000 $118,000 or more No deduction Less than $10,000 A partial deduction $10,000 or more No deduction Effect of Modified AGI on Deduction if a Taxpayer is NOT Covered by a Retirement Plan at Work AND taxpayer modified adjusted IF taxpayer filing status is... gross income (modified AGI) is... THEN taxpayer can take... Single, Head of Household or A full deduction Any amount qualifying widow(er) Married filing jointly or A full deduction separately with a spouse who IS NOT covered by a retirement plan Any amount at work $183,000 or less A full deduction Married filing jointly with a More than $183,000 but less than A partial deduction spouse who IS covered by a $193,000 retirement plan at work $193,000 or more No deduction Married filing separately with a Less than $10,000 A partial deduction spouse who IS covered by a $10,000 or more No deduction retirement plan at work (From IRS Publication 590-A) SUMMARY An individual may contribute to a traditional IRA $5500 in years 2013 through 2015, or one hundred percent of compensation earned within a tax year, whichever amount is greater, to a regular or traditional IRA. Individuals who reach age 50 during the tax year or who are older may make an additional $1,000 catch up contribution. Two types of regular IRA plans are available: an Individual Retirement Account and an Individual Retirement Annuity. A spouse earning compensation may fund an IRA for his or her non-earner spouse. The maximum contribution available for spousal IRAs is the same as the maximum annual contribution level applicable for the year. Neither spouse s IRA can receive more than this maximum annual contribution. Deductibility of IRA contributions is based upon whether the IRA holder or spouse is an active participant, his or her filing status and adjusted gross income. Non-deductible contributions may be made to a regular IRA, subject to maximum IRA contribution limits. 28

29 APPENDIX TO CHAPTER FOUR - WORKSHEETS FOR SOCIAL SECURITY RECIPIENTS WHO CONTRIBUTE TO AN IRA (From IRS Publication 590-A, 2015 Returns) If you receive social security benefits, have taxable compensation, contribute to your IRA and are covered (or considered covered) by an employer retirement plan, complete the following worksheets. Use Worksheet 1 to figure your modified adjusted gross income. This amount is needed in the computation of your IRA deduction, if any, which is figured using Worksheet 2. The IRA deduction figured using Worksheet 2 is entered on your tax return. Worksheet 1 Computation of Modified AGI (For use only by taxpayers who receive social security benefits) Filing Status Check only one box: A. Married filing a joint return. B. Single, Head of Household, Qualifying Widow(er) or Married filing separately and lived apart from your spouse during the entire year C. Married filing separately and lived with your spouse at any time during the year. 1) Adjusted gross income (AGI) from Form 1040 (not taking into account any social security benefits from Form SSA-1099, RRB-1099, any deduction for contributions to a traditional IRA, any student loan interest deduction, or any exclusion of interest from savings bonds to be reported on Form 8815) 2) Enter the amount in Box 5 of all Forms SSA-1099 and Forms RRB ) Enter one half of line 2 4) Enter the amount of any foreign earned income exclusion, foreign housing exclusion, U.S. possessions income exclusion, exclusion of income from Puerto Rico you claimed as a bona fide resident of Puerto Rico, or exclusion of employer-paid adoption expenses 5) Enter the amount of any tax-exempt interest reported on line 8b of Form 1040 or 1040A 6) Add lines 1,3,4 and 5 7) Enter the amount listed below for your filing status $32,000 if you checked box A above. $25,000 if you checked box B above. $-0- if you checked box C above. 8) Subtract line 7 from line 6. If zero or less, enter 0 on this line 9) If line 8 is zero, STOP HERE. None of your social security benefits are taxable. If line 8 is more than 0, enter the amount listed below for your filing status. $12,000 if you checked box A above. 29