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Thanks to congressional action and mass media advertising, the IRA ( Individual Retirement Account ) is the most popular pension plan. Major aspects of the IRA which planners must understand include: who may participate, maximum contributions funding, distributions, and termination.
Participants, Anyone who has earned income may contribute to any IRA. The income must be salary, wages, alimony, or net taxable income from a business. If the income is subject to Social Security taxes, it qualifies for IRA contribution purposes. One noteworthy exception is a self-employed person who employs his or her spouse.
For example, if a wife hires her husband and pays him a salary, the amount paid is not subject to Social Security taxes. However, the husband’s wages are taxable and can be used to contribute to an IRA. Income from savings and investments do not qualify.

Maximum contribution and funding. The maximum sum that can be placed in an IRA is 100 percent of qualifiable income up to $2,000 annually. For a married couple with both spouses working, the maximum is $2,000 in each account, for a combined total of $4,000. With a nonworking spouse, the total for couples is $2,250. This can be allocated in any manner between the spouses as long as each account has a minimum of $250. The full amount does not have to be funded, and future contributions may be skipped whenever desired. However, excess contributions are subject to a 6 percent penalty. For 1985, and thereafter, divorced individuals may include their alimony payments for contributing up to $2,000 to an IRA.

The IRA must be funded by the due date of the tax return, which is April 15. The IRS now allows taxpayers to claim the IRA deduction and submit their return before they make the payment, as long as the account is funded by April 15.

Distributions. Individuals may receive a distribution from an IRA once a year. The distributed amount can be placed in another IRA within 60 days without being taxed. The IRA custodian, usually a bank or a trust company, provides an important service in any distribution. The custodian must record all transactions and report any distributions to the IRS. The custodian is also required to withold 10 percent of the distribution unless the taxpayer informs them not to do so. The withholding would be especially inappropriate for those who are completing a tax-free rollover (an exchange of funds from one IRA to another).

Taxpayers may move IRA money from one custodian to another-never receiving the funds-as often as they wish. This is a nontaxable transfer. If clients withdraw their money from an IRA, the amount withdrawn is taxable. A 10 percent nondeductible penalty is levied by the IRS if the distribution is made before the IRA investor reaches age 591/2. There is no penalty if the funds are withdrawn due to disability or death of the taxpayer.
Terminations. IRA accounts may be disbursed when an individual reaches age 591/z without incurring any penalties. The money received is taxed as ordinary income regardless of the investment vehicle used for the IRA. The year after IRA investors become 701/2, they are required to withdraw amounts prescribed in IRS actuarial tables. For example, Roger is 701/z on December 1, 1985; he must begin a systematic withdrawal from his IRA no later than December 31, 1986. (Those who are married may choose the joint-survivor actuarial table.) Ignoring the withdrawal requirement will cost a taxpayer a penalty of 50 percent of the excess amount remaining in the account.

Miscellaneous rules and regulations. There are several additional considerations involving IRAs, such as:

1. Investors may use a variety of investment vehicles to create an IRA, the exceptions are hard assets, tangibles, and art.

2. Some states have not conformed to changes in federal tax laws so that an IRA is not deductible on these state returns.

3. Borrowing from an IRA or using it as collateral is prohibited.

4. Individuals cannot be their own custodians.

Many people are irritated by advertising pushing IRAs and showing a million dollar value in the account in 40 years. These ads emphasize the wrong concept. They overlook the needs of people age 50 and over, who do not have several decades available to accumulate assets. Rather, clients must be aware that, if money is not placed in an IRA, they are going to be paying more taxes. Should clients lack sufficient funds to make an IRA contribution, planners will want to assist them in developing a good cash-flow managment system.
Some individuals believe that an IRA account is not for them because the distributions are taxed as ordinary income when they retire. Certainly, that is one drawback of the program.
Yet, tax deferral and time value must be emphasized. The key is that clients pay less in taxes now, because the IRA lowers taxable income by the amount of the contribution. The money is also compounded much faster when it is not subject to current taxation. Finally, when the IRA funds are distributed, the taxes will be paid with depreciated dollars, because money is worth more today than it will be in the future.
The deferral and tax savings can be seen in the following illustration.

Without Deferral With Deferral
$1,500 per year $2,000 per year
9 percent 12 percent
20 years 20 years
$76,740 Total $144,105 Total
Assumptions:
Tax bracket: 25%.
Yearly contribution: $2,000. Interest/yield rate: 12%.

Without a qualified plan, the taxpayer earns $2,000, but pays $500 in taxes. Therefore, only $1,500 is saved and the interest is taxable. In a 25 percent tax bracket, the taxpayer can keep only 75 percent of the 12 percent interest, or 9 percent. Yield comparisons should be calculated at the same initial gross rate. The yield on the investments shown is the same whether an IRA is involved or not. For example, the same stock will not perform better or worse because it is in a retirement plan.

The total is significantly different under the qualified plan. However, some have argued that if the amount invested in an IRA is taken out in one payment, the total is less because the taxpayer has been thrown into a higher tax bracket. A more rational perspective would be to consider the amounts to be withdrawn over a number of years so the tax bracket would not increase significantly, if at all. The benefits would still be significantly greater with qualified plans.

This entry was posted on Saturday, August 19th, 2006 at 7:27 am and is filed under Economy, Employment, Insurance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.