Pre-Retirement: If you are five years or less from retirement, this book helps you understand the decisions that you will face in the future. It will give you the road map that you would need to follow with your IRA.
Retiree: If you have already rolled your retirement plan to an IRA, this book can serve as a checkup. Did you make the right moves? Are you working with the right IRA advisor? Do you have your beneficiaries in place? Are there ways that you can improve the investment, safety, and structure of your IRA today and when you are gone?
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Read an Excerpt
11.5 IRA Essentials for Retirement
By Kevin Skipper
AuthorHouseCopyright © 2015 Dr. Kevin Skipper, ChFC
All rights reserved.
What Flavor Should I Choose for my IRA?
The Evolution of IRAs
Everybody is ignorant, only on different subjects.
The only thing new in this world is the history that you don't know.
—Harry S. Truman
Contrary to popular belief, the lack of financial readiness for retirement is not a new phenomenon. In fact, Congress created individual retirement savings accounts (IRAs) in 1975 because it was felt that even with social security and their own savings, many Americans would not have enough retirement income. To address this issue, Congress created IRAs under the Employee Retirement Income Security Act of 1974 (ERISA) to allow Americans to use savings in those accounts to supplement their retirement savings and income and reduce the burden that would be placed of social programs by individuals who had no retirement savings.
The Genesis of IRAs
When IRAs first became available in 1975, they were available only to individuals who were not covered under an employer-provided retirement plan, and they allowed these individuals a tax-favored means of saving for their retirement. Back then, the deductible limit for IRA contributions was 15 percent of compensation or $1,500—whichever was less. IRAs have changed a lot since then, and in many cases, the changes have made them more tax friendly. The following are highlights of some of the changes that have occurred over the years.
IRAs for Spouses
The revenue act of 1976 included a provision that allows individuals to fund IRAs for their spouses who did not have income-producing jobs. Under this provision, a married couple could contribute up to $1,750 in total for both spouses. The amount for a spouse has increased over the years.
IRAs for Everyone
Even with the availability of IRAs for those not covered by an employer plan, social security, and personal savings, Congress felt that Americans did not have enough options for ensuring a financially secured retirement. To help address that concern, the Economic Recovery Tax Act of 1981 (ERTA) was made law, and it included a provision that increased the deduction limit to $2,000 and removed the restrictions on availability, allowing anyone under seventy and one-half years old to fund an IRA even if he or she was already covered under an employer-sponsored retirement plan.
Until 1986, contributions to IRAs were always deductible. However, this was changed under the Tax Reform Act of 1986 (the 1986 Act), which restricted the deduction for contributions by individuals who were covered under an ERISA employer-sponsored retirement plan. In later years, simplified employee pension (SEP) IRAs and savings incentive match plan for employees (SIMPLE) IRAs were added to ERISA plans for purposes of restricting deductibility of IRA contributions. The 1986 Act also allowed individuals who were eligible to deduct IRA contributions to choose to treat those contributions as nondeductible. While earnings on nondeductible contributions accrued on a tax-deferred basis and were therefore taxable when withdrawn, distributions of nondeductible amounts were tax-free so as to prevent double taxation.
The Emergency Unemployment Compensation Act of 1991 and additional amendments to that law were intended to address the extended unemployment, which resulted from then adverse economic status, and it included provisions that allowed individuals to roll over amounts from employer-sponsored retirement plans to their IRAs. These rollovers were permitted only for retirement account owners and their spouse beneficiaries. Nonspouse beneficiaries were not permitted to rollover amounts from ERISA plans.
Increasing Spousal IRA Contributions
The Small Business Job Protection Act of 1996 increased the spousal IRA contribution limit to $2,000, thus allowing married couples to contribute a total of $4,000 for the year, with a limit of $2,000 to one spouse's IRA.
Roth IRA Availability
Roth IRAs became available under the Taxpayer Relief Act of 1997 (TRA-97), and it allowed individuals to make contributions with funds that had already been taxed, which is a similar treatment for nondeductible contributions. However, unlike nondeductible contributions where the earnings grew tax deferred and were taxable upon withdrawal, earnings on Roth IRA contributions are tax-free if distributions meet certain requirements to be considered "qualified distributions."
The contribution limit for Roth IRAs are the same as those that apply to traditional IRAs, and an individual is allowed to split his or her contribution for the year between a traditional IRA and a Roth IRA.
Unlike traditional IRAs, which were not subject to an income cap, only individuals with a modified adjusted gross income (MAGI) below certain amounts are allowed to contribute to Roth IRAs.
In addition to regular contributions to their Roth IRAs, individuals were allowed to convert (move) amounts from their traditional IRAs to their Roth IRAs as long as their MAGI did not exceed $100,000 and their tax-filing status was not "married filing separately."
Generally, Roth conversion amounts are included in income for the year that the conversion occurs. An exception to this rule allowed conversions done in 1998 to be spread over four years in equal amounts and for those done in 2010 to be spread over two years.
Increased Contribution Limits and Portability
Contribution limits were increased under the Economic Growth Tax Relief Reconciliation Act (EGTRRA) and indexed for inflation. In addition, EGTRRA allowed individuals who are at least age fifty by the end of the year to make additional contributions, referred to as "catch-up" contributions.
EGTRRA also relaxed the portability rules for IRAs, allowing for more opportunities for consolidation of retirement accounts. These will be discussed in later chapters.
Roth Conversion Limit Repealed
The $100,000 MAGI and tax-filing status limit on Roth conversions prevent many from being able to fund Roth IRAs. These limitations were repealed under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA).
Rollovers for Nonspouse Beneficiaries and Rollover of ERISA Plans to Roth
Nonspouse beneficiaries are now allowed to roll over amounts from ERISA plans to their inherited IRAs, as provided under the Pension Protection Act of 2006 (PPA).
PPA also expanded the rollover rules, allowing individuals to roll over amounts from ERISA plans to Roth IRAs.
Reasons for Changes
In most cases, changes were made to provide more opportunities for individuals to fund their retirement nest eggs on a tax-deferred basis and increase the chances of ensuring that they have enough saved to provide for financially sound retirement. However, in some cases, changes were made to provide much-needed revenue to the government. One example of revenue-generating change is the Roth conversion opportunity. The amounts held in traditional IRAs are usually not taxed until withdrawn, but an exception to this rule applies when amounts are moved from the traditional IRA. Congress made the Roth conversion option attractive by providing an opportunity for tax-free earnings in exchange for paying income tax on the amount now instead of waiting until retirement.
IRA Rules, Regulations, and Guidance
IRAs are governed by a strict set of rules and regulations, and in many cases, failure to abide by these rules can result in dire consequences, which include losing the tax-deferred status of your IRA, income taxation—including double-income taxation and excise tax—and penalty. Your IRA is also subject to operation under the terms of any IRA agreement between you and your IRA custodian. Your IRA agreement provides and explains the responsibilities of your IRA custodian as it relates to your IRA, as well as your responsibilities and rights regarding your IRA. Your IRS custodian is also required to provide you with a financial disclosure for your IRA. These documents address such matters as the following:
* the limitations that apply to your contribution amounts, including any age and income limit
* deductibility rules
* default beneficiary provisions in the event that you fail to name a beneficiary or if your named beneficiary predeceases you
* the limitations on your investment options—for instance, your IRA assets cannot be invested in life insurance, any artwork, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages, or any other tangible personal property as defined by the US treasury secretary
* your IRA cannot be commingled with any other property
* your IRA is nonforfeitable
* distribution rules, including the tax treatment of distributions, when the 10 percent early distribution penalty applies, and the required minimum distribution rules
* rollover and transfers rules as they apply to your IRA
* the terms and time period under which you can revoke your IRA, and any fees that may apply to your IRA
Your IRA is not considered "established" until you have received the required disclosures and sign the agreement.
Guidance by the IRS
Generally, the tax laws that govern IRAs are issued by Congress, and the IRS must then take the specifics of these laws and translate them into detailed regulations, rules, and procedures. You can learn more at the IRS.gov web site. You may want to know a brief working definition of these words:
A regulation is issued by the Internal Revenue Service and Treasury Department to provide guidance for new legislation or to address issues that arise with respect to existing Internal Revenue Code sections. Regulations interpret and give directions on complying with the law.
A revenue ruling is an official interpretation by the IRS of the Internal Revenue Code, related statutes, tax treaties and regulations. It is the conclusion of the IRS on how the law is applied to a specific set of facts.
A revenue procedure is an official statement of a procedure that affects the rights or duties of taxpayers or other members of the public under the Internal Revenue Code, related statutes, tax treaties and regulations and that should be a matter of public knowledge. It is also published in the Internal Revenue Bulletin.
Private Letter Ruling
A private letter ruling, or PLR, is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer's specific set of facts. A PLR is issued to establish with certainty the federal tax consequences of a particular transaction before the transaction is consummated or before the taxpayer's return is filed. A PLR is issued in response to a written request submitted by a taxpayer and is binding on the IRS if the taxpayer fully and accurately described the proposed transaction in the request and carries out the transaction as described. A PLR may not be relied on as precedent by other taxpayers or IRS personnel. PLRs are generally made public after all information has been removed that could identify the taxpayer to whom it was issued. (www.irs.gov)
Technical Advice Memorandum
A technical advice memorandum, or TAM, is guidance furnished by the Office of Chief Counsel upon the request of an IRS director or an area director, appeals, in response to technical or procedural questions that develop during a proceeding. A request for a TAM generally stems from an examination of a taxpayer's return, a consideration of a taxpayer's claim for a refund or credit, or any other matter involving a specific taxpayer under the jurisdiction of the territory manager or the area director, appeals.
A notice is a public pronouncement that may contain guidance that involves substantive interpretations of the Internal Revenue Code or other provisions of the law. For example, notices can be used to relate what regulations will say in situations where the regulations may not be published in the immediate future. (www.irs.gov)
An announcement is a public pronouncement that has only immediate or short-term value. For example, announcements can be used to summarize the law or regulations without making any substantive interpretation; to state what regulations will say when they are certain to be published in the immediate future; or to notify taxpayers of the existence of an approaching deadline. (www. irs.gov)
The IRS also provides guidance in their forms and accompanying instructions. For example, their Form 1099-R and instructions tells IRA custodians and plan trustees how and when to report distributions from IRAs and other retirement accounts, and it provides instructions to tax preparers on how to report the amounts on taxpayers' tax returns.
Tying It All Together
It can be challenging to understand all the rules and "flavors" that apply to your IRAs, how new rules affect how your IRA should be managed, and the steps that should be taken to ensure that you minimize taxes, avoid penalties, and maintain the tax-deferred status of your IRA. As such, it may be necessary to engage the services of a professional who specializes in this area. At a minimum, you may need a financial advisor who can get the right people involved with your IRA planning. This includes a tax professional who understands how IRAs work and an estate planner or attorney to help you implement the appropriate solutions for you and your beneficiaries.CHAPTER 2
Which Retirement Plan Do I Choose for My Business?
When you come to a fork in the road, take it.
You've got to be very careful if you don't know where you're going, because you might not get there.
Gone are the days when Americans could rely on pensions and social security to finance their retirement years. In the past, most companies provided benefits under defined-benefit pension plans, which promised a guaranteed lifetime retirement income to retirees, the amount of which was based on several factors, including the number of years that they worked for the employer and their salaries over the years during which they worked for the employer. Unfortunately, a large number of employers have (and continue to) stop offering defined-benefit pension plans, as they felt they were too costly to fund and maintain, and they have chosen to either not offer a retirement plan at all or offer the less costly defined-contribution plans or IRA-based plans, such as SEP IRAs and SIMPLE IRAs. American companies with pensions have declined from over 125,000 in 1980 to less than less than 25,000 today.
Further, social security, which seemed like a safe and guaranteed source of additional retirement income, seems to be on shaky ground, with the trustee predicting that the fund will be depleted by 2034.
This underscores the need for effective money management, as well as ensuring that every available means is utilized for funding your retirement nest egg. Funding your own retirement savings accounts is one of the most effective means of doing so, as they provide tax benefits that are not available to other savings. In addition, you can make contributions to retirement plans offered by your employer if those plans allow you to make salary-deferral contributions.
The question then becomes, where should you put your savings, and how should they be managed?
The following are some general ideas that can help you to choose the retirement accounts to which you make your contributions.
Options for IRA Savings
You have two options from which to choose when funding your IRA, and you must take certain factors into consideration to ensure that you choose the option that is most suitable for you. Generally, your options are to fund a traditional IRA or a Roth IRA. In either case, you can contribute the lesser of 100 percent of your taxable compensation received for the year, or $5,500 ($6,500 if you are at least age fifty by the end of the year). If you prefer and if you are eligible to contribute to a Roth IRA, you can split your contributions between both accounts.
The traditional IRA and the Roth IRA share many similar features; however, there are some differences, and these differences are what often determine which of the two is more suitable.
Excerpted from 11.5 IRA Essentials for Retirement by Kevin Skipper. Copyright © 2015 Dr. Kevin Skipper, ChFC. Excerpted by permission of AuthorHouse.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents
Introduction: Dr. Kevin Skipper's Story, xi,
Chapter 1: What Flavor Should I Choose for my IRA? The Evolution of IRAs, 1,
Chapter 2: Which Retirement Plan Do I Choose for My Business?, 9,
Chapter 3: Which Plan Do I Choose When I Don't Know Which Plan to Choose?, 27,
Chapter 4: Common Mistakes with Retirement Accounts, 47,
Chapter 5: IRA Rollover Rules: When to Roll Over or Not, 57,
Chapter 6: Choosing an Advisor with Expertise in IRAs, 73,
Chapter 7: Answers to Your IRA Questions, 91,
Chapter 8: Investment Philosophy and Your IRA, 99,
Chapter 9: The Second Half of the IRA Game, 111,
Chapter 10: Beneficiary Distributions and Estate Planning, 117,
Chapter 11: Lessons from the Worst IRA Mistakes and Strategies for How to Avoid Them, 139,
Chapter 12: The Most Important Questions for a Retiree to Ask and Answer, 157,
Chapter 13: Answers to IRA Questions, 171,
Chapter 14: You Might Be an IRA Redneck If, 183,
Appendixes: Essential Tables and Resources for Your IRA, 193,