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Facts About the 72t Early Distribution

Feb 1st, 2012
by jblankenship.
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In case you don’t know what a 72t distribution is, this is shorthand for the Internal Revenue Code Section 72 part t, and the most popular provision of this code section is known as a Series of Substantially Equal  Periodic Payments – SOSEPP for short.

Enough about the code section already.  What is this thing?  A SOSEPP is a method by which you can access your IRA funds prior to age 59½.  In order to take advantage of this rule, you determine the amount of the annual distribution from your IRA (this is done in a prescribed manner, more on this in a bit) and then begin taking the distributions.  Once you start the SOSEPP, you have to keep it going for the longer of five years or until you reach age 59½.

Methods of Distribution

There are three ways that you can determine the amount of the distribution from your IRA, and all are based upon the balance of the IRA account and your age.  The first method is the simplest, known as the Required Minimum Distribution method.

The Required Minimum Distribution method for calculating your Series of Substantially Equal Periodic Payments (under IRC §72(t)(2)(A)(iv)) calculates the specific amount that you must withdraw from your IRA (or other retirement plan) each year, based upon your account balance at the end of the previous year, divided by the life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year. This annual amount will be different each year.

The second method is called the Fixed Amortization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account, from which you then create an amortization schedule over a specified number of years equal to your life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

The third method is similar to the second, but it is called the Fixed Annuitization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account and an annuity factor, which is found in Appendix B of Rev. Ruling 2002-62 using the age you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

Once you’ve calculated your annual payment under one of the two fixed methods, your future payments will be exactly the same until the SOSEPP is no longer in effect. There is a one-time opportunity to change to the Required Minimum Distribution method, described here.

An Important Note

It’s important to know that the amounts you’ve calculated are and will be the exact figures for your payments from the account, no more, no less.  It’s not allowable to simply name your own amount and take that each year – you have to use the prescribed amount from one of the methods.

The way to impact the amount of the payment is to adjust the balance in the IRA.  If you have more than one IRA available, you can rollover funds into one account and therefore increase or decrease your payment.  This has to be done prior to establishing the SOSEPP though – it’s not allowed to deposit money into or remove funds from your IRA while the SOSEPP is in place (well, other than the required payments from the account each year).

Any deviation from the prescribed payments will cause the SOSEPP to be “busted”, which can result in some not-so-nice consequences – which you can read more about here.  For more about the SOSEPP, see the IRA Owner’s Manual.

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Using An IRA Rollover to Eliminate Federal Spousal Rights

Dec 14th, 2011
by jblankenship.
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Qualified Retirement Plans (QRPs), which include 401(k), 403(b) and many other employer-based plans, are governed by federal law under ERISA.  One of the tenets of ERISA is that there are certain rights for the spouse of the employee-participant in the plan.  One of those rights is that the spouse must consent to any distribution from that plan that is in the form of anything other than a Qualified Joint and Survivor Annuity (QJSA).

Depending upon your circumstances, this might not be the way you would like for things to work out.  For example, if you’re planning to get married and you want to ensure that your future spouse doesn’t control distributions from your retirement plan, you could rollover your QRP to an IRA before your marriage – because an IRA isn’t covered by ERISA like the QRP is.  A prenuptial agreement could be used to limit a spouse’s rights to an IRA, but it cannot usurp the ERISA rules.

If you’re already married and you have a reason to consider this option, hopefully it’s not because there are storm-clouds on the horizon for your marriage.  If this is the case, you will likely have some difficulty in enacting this rollover.  The problem, as mentioned before, is that the spousal rights provision requires that your spouse signs off on any distribution other than the QJSA.

If you’re going through a divorce, it’s possible that you’d need to have your ex-spouse sign off on a distribution from your QRP if the QRP isn’t part of the assets to be split.  If the QRP isn’t being split for the divorce, you’ll want to make sure that you have a statement in the decree that ensures that the QRP is positively identified as belonging solely to you. Otherwise, your ex could make a claim against a portion of your QRP later, under ERISA.

Bear in mind that the spousal distribution rights from the QRP also apply to death benefits from the plan, in addition to lifetime benefits.

One other thing to keep in mind is that your own state’s law may provide rights to your IRA to your spouse anyhow.  If that is the case, the rollover to the IRA would not have the effect you expected.

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Converting an Inherited 401(k) to Roth

Nov 30th, 2011
by jblankenship.
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One of the provisions that is available to the individual who inherits a 401(k) or other Qualified Retirement Plan (QRP) is the ability to convert the fund to a Roth IRA.

This gives the beneficiary of the original QRP the option of having all of the tax paid up front on the account, and then all growth in the account in the future is tax free, as with all Roth IRA accounts.

What’s a bit different about this kind of conversion is that, since it came from an inherited account, the beneficiary must take distribution of the account over his or her lifetime, according to the single life table.  This means that, in order for this maneuver to be beneficial, the heir should be relatively young, such that there will be time for a lengthy growth period for the account – making the tax-free nature of the Roth account worthwhile.

A downside to this move is that the heir should be in a position to pay the tax on the account from other funds, otherwise the tax pulled from the account will drastically reduce the funds that can grow over time.

If the heir has an IRA of his or her own that could be converted, and there are only enough other funds for paying tax to enable the conversion of one account or the other, the IRA should be converted rather than the QRP.  This is because the IRA has a much better chance for long-term growth than the inherited QRP due to the requirement for distribution of the account (as discussed above).

This is yet another reason that an individual might want to leave funds in a 401(k) plan rather than rolling it over to an IRA – since the heir does not have this Roth conversion option available if the money is in a traditional IRA.  This option is only available for an inherited 401(k) or QRP.

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Arguments in Favor of a Rollover

Nov 16th, 2011
by jblankenship.
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If you have a 401(k), 403(b), a (gasp!) tax-sheltered annuity or other qualified retirement plan from a former employer, you may have considered if it would be beneficial to leave it where it is, or perhaps enact a rollover to an IRA.

While it might be easiest to leave the account where it is, it’s possible that you are sacrificing flexibility and/or paying higher fees in exchange for the easier path.

Quite often, 401(k) plans (and other qualified retirement plans, QRPs) are restricted to managed mutual fund investment options.  Managed funds often carry high expense ratios, often greater than 1% and more.  As you know, if you’ve read much about index funds, it is possible to reduce most of your investing expense ratios to far below .5%, in some cases as low as .1% or less.  Over the course of many years, reducing these expenses can have a profound impact on your investment returns.

For example, if you were to save even 1/2 of a percent in expenses, over 20 years this could compound to a 11.05% improvement in your overall investment returns.  This also assumes that the new funds you’ve chosen will perform at the same rate that the funds you’re leaving behind would have.

It’s not a pure “no brainer” to enact the rollover.  There could be compelling reasons to leave the money where it sits, such as if you believe the funds in your plan are superior to options that you could choose outside the plan (such as restricted-access or closed funds), or maybe you have access to investment advice from the custodian.  In addition, if you left the employer during or after the year when you reached age 55, you might want to leave the money where it is until you’re at least age 59½ – see this article on post-55 withdrawals for more information.  There is also the chance that you could benefit by leaving the funds in the former plan if there is Net Unrealized Appreciation of your former employer’s stock that you intend to have treated by the NUA rules.

In general though, the flexibility to reduce your expenses by choosing any investment available is a pretty compelling argument in favor of the rollover.

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Calculating RMDs for Various IRA Beneficiaries

Aug 17th, 2011
by jblankenship.
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There are a few different ways that Required Minimum Distributions are calculated for beneficiaries of IRAs.  The two primary determining factors are:

  1. Is the beneficiary the spouse of the original owner? and
  2. Did the original owner attain age 70½ prior to death?

There are two more factors that also have an impact on the nature of the calculations, although the impact is different:

  1. Is there more than one beneficiary? and
  2. Is the beneficiary a person or an entity, such as a trust, a charity or the estate of the original owner?
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Spouse

If the beneficiary is the spouse of the original owner of the account, and the original owner died before age 70½, then the rule is that no RMDs are required until the owner would have reached age 70½.  At that time the beneficiary will use the Single Life table to calculate the distribution amount based upon his or her own attained age.  In each subsequent year, the spouse beneficiary will recalculate the RMD using the Single Life table and the currently-attained age.  In this manner, the RMDs will stretch out over the lifetime of the beneficiary spouse.  (We’ll refer to this as Method A.)

Now, if the owner died after attaining age 70½, first of all, in the year of the owner’s death, a regular RMD is required using the Uniform Life table and the decedent’s attained age (if the deceased owner hasn’t already taken it).  For the next and subsequent years, RMDs are based on the lesser of 1) the amount calculated by using the beneficiary spouse’s attained age with the Single Life table; or 2) the amount calculated using the deceased owner’s age with the Single Life table.  If the second factor results in the longer distribution period, then each subsequent year the initial factor is reduced by 1, rather than re-calculating based upon a new factor from the table based on that year’s attained age. (Method B)

In addition to the two above scenarios, a spouse beneficiary has the unique ability to rollover the IRA into an account in his or her own name, and to treat the IRA as such.  Only a spouse beneficiary has this option.  If the original owner had already reached age 70½, RMDs must continue but they are based upon the surviving spouse’s attained age using the Uniform Lifetime table.

Non-spouse (sole beneficiary)

If there is a sole, non-spouse beneficiary and the owner has not reached age 70½, the RMDs must begin in the year following the year of the original owner’s death.  The RMD is calculated based upon the beneficiary’s attained age using the Single Life table for the first year, and the factor from the table is reduced by 1 for every subsequent year. (Method C)

The only difference if the owner was at least age 70½ is that in the year of the original owner’s death the RMD must be made for that year (if the deceased owner hasn’t already taken it).  Thereafter, RMDs for the beneficiary are calculated using Method C.

Non-spouse (multiple beneficiaries)

If there is more than one beneficiary of the account, there is one activity that could take place which will change the outcome of the distribution calculations.  If the account is divided into separate accounts for each beneficiary by the end of the calendar year following the year of the death of the original owner, then each non-spouse beneficiary will be able to treat the distributions just the same as was explained above for sole non-spouse beneficiaries (Method C).  The same is true if one of the beneficiaries is a spouse – this beneficiary can use the rules for a spouse beneficiary (outlined above, Method A or Method B).

If the account is not divided into separate accounts as described above, RMDs are calculated based upon the oldest beneficiary’s attained age as if the oldest beneficiary is a sole beneficiary.  Then each subsequent distribution is divided up based upon the nature of the beneficiary designations to each beneficiary. (Method D)

See-through Trust

If the beneficiary of the account is a see-through trust designed to create a single source of funds for multiple beneficiaries, then Method D is used. On the other hand, if the see-through trust has separate sub-trusts for each beneficiary, then each beneficiary’s RMD is calculated using Method C.

Non-Qualified Trust

If the beneficiary of the account is not qualified as a see-through trust, typically because one or more of the beneficiaries is not a person, if the original owner had not reached age 70½ then the entire account must be distributed within five years of the death of the original owner. (Method E)

If the original owner was at least age 70½, then the regular RMD must be made for that year (if the deceased owner hasn’t already taken it).  Then for subsequent years, RMDs are calculated using Method C.

It should be noted that a non-qualified trust could become qualified as a see-through trust if the non-individual (entity-type) beneficiary’s portion is cashed out of the account.  If this is possible, then the trust is treated as a See-Through trust and RMDs are calculated as describe in that paragraph above.

Charity

If the beneficiary is a charity, distributions are handled exactly the same as the non-qualified trust, using Method E or Method C, depending on the age of the original owner.  The difference is that these are the only options available to the charity.

Estate

The estate as the beneficiary uses the same methodology as a charity.

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UBTI in an IRA

Aug 3rd, 2011
by jblankenship.
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I’ve mentioned before about various types of transactions that are not allowed in your IRA, but we’ve not actually covered the topic of Unrelated Business Taxable Income (UBTI) in your IRA.  UBTI isn’t prohibited within an IRA, but it does pose problems and adds a great deal of complexity to your account.

Unrelated Business Taxable Income

So, what is UBTI anyway?  The concept of UBTI pre-dates IRAs – it was originally developed in relation to charitable organizations, trusts, and other tax-exempt entities.  The IRS developed this concept to ensure that tax-exempt organizations didn’t have a competitive advantage over taxable organizations, such as for-profit corporations.  The way that income is determined to be “unrelated” is by checking these two tests:

  • Is the income from a trade or business that is regularly carried on?
  • Is the trade or business unrelated to the tax-exempt entity’s exercise of the entity’s tax-exempt purpose?

If these two tests are met, then the income may be UBTI.  Here’s an example that may help you to better understand the concept of UBTI (taken from IRS Publication 598:

An exempt vocational school operates a handicraft shop that sells articles made by students in their regular courses of instruction. The students are paid a percentage of the sales price. In addition, the shop sells products made by local residents who make articles at home according to the shop’s specifications. The shop manager periodically inspects the articles during their manufacture to ensure that they meet desired standards of style and quality. Although many local participants are former students of the school, any qualified person may participate in the program. The sale of articles made by students does not constitute an unrelated trade or business, but the sale of products made by local residents is an unrelated trade or business and is subject to unrelated business income tax.

The concept of UBTI covers many more situations, and you can find out much more about other types of activities that can generate UBTI by going to IRS Publication 598.

IRAs

Since IRAs are, until distribution, exempt from tax, UBTI applies to certain types of income received within an IRA account as well (all of this applies to Roth IRAs as well as traditional IRAs).  The IRS Code defines any active trade or business to unrelated to the IRA’s tax-exempt purpose.

There are exceptions as well (of course there are!).  The exceptions for tax-exempt organizations are numerous and complicated.  The following is a partial list exceptions specifically for IRAs:

  • dividends
  • interest (includes “points”)
  • royalties
  • rent from real property (real estate)
  • sales proceeds from real property, as long as the property is not held as inventory or held in the normal course of a business (e.g., flipping)

This is nowhere near an exhaustive list – see Publication 598 for more details.

Examples of ways that an IRA investment could generate UBTI include: full ownership of a pass-through business, such as a limited partnership or S-Corporation; use of IRA funds to loan to a business – and the terms of the loan include participation in the profits of the business (as opposed to simple loan payments); and use of IRA funds to flip properties (via a partnership or LLC, for example), since the property is considered inventory and not investments.

Another way that UBTI is generated is through debt-financed income (also known as UDFI).  UDFI occurs in a case like this:  An IRA purchases a piece of real estate to be held for rental property.  In the purchase of the property, the IRA put 50% down in cash and financed the remaining 50% through the seller.  Even though rental income is considered to be exempt (see the list above), since debt was used to acquire the property, half of the rental income (reducing as the debt is paid off) would be considered UDFI, and therefore subject to taxation.  The good news is that the proportional part of the expenses associated with the debt-financed income would offset the income.

Okay, so my IRA has UBTI.  Now what?

If your IRA generates UBTI, it doesn’t disqualify the IRA (like prohibited transactions would).  No, what UBTI does is requires your IRA to file an income tax return.  This is unusual since an IRA is supposed to be tax-exempt, but since the UBTI is generated, income tax will be owed on the income if it reaches certain levels.

If the IRA generates gross income of $1,000 or more during the tax year, the IRA must file Form 990-T by April 15 of the following year, just like individual tax returns.  The issues that arise with this include:

  • The IRA must have a federal tax id (EIN).
  • The custodian is considered responsible for filing Form 990-T, but most self-directed IRA custodians transfer this responsibility to the account owner.
  • The IRA custodian may not have all of the information required to file the return, as much of the information in these privately-held investments is given directly to the account owner.
  • The account owner ultimately has the final responsibility to file the Form 990-T, and lack of understanding of the rules can cause major issues for the account owner.
  • The account owner also will be required to file quarterly estimated tax payments as long as the investment is in place.  Every three months, a tax payment must be made to the IRS if the total tax for the year is expected to be greater than $500.

Form 990-T is a four-page form, and filling it out can be a fairly complex undertaking – one that you’re not likely to enjoy filling out (as I’m sure you do most tax forms).

Lastly, UBTI is one of those cases where income within an IRA is actually destined to be double-taxed.  Even though you pay tax on the UBTI as it is earned within the IRA (at trust rates, not individual rates, which are more compressed), when you take the money out of the IRA you’ll be taxed again.  Paying tax on UBTI doesn’t create non-taxable basis in the IRA, in other words.

With so many other eligible investment options, why not stick with the simple, non-UBTI investments for your IRA?  If you must invest in one of these investments that could trigger UBTI if it were in an IRA, just go ahead and invest your taxable monies in the endeavor – you’ll save yourself a lot of grief.

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Adjusting Your Withholding and Estimated Tax Payments

May 9th, 2011
by jblankenship.
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Now is a good time to look at the amount of tax that you have withheld from your pay, pension or Social Security, as well as any estimated payments that you make throughout the year.  The amount of any payment that you had to make on April 15 should be fresh in your mind – and if it was a sizeable amount you should review the situation and quite possibly adjust your withholding or estimated payments.

It’s also possible that you’ve been having more tax withheld than necessary. If you received a rather large refund, you’re essentially giving the government a tax-free loan of your money for a good part of a year.  Many folks like to receive a big refund, it’s sort of a “bonus” each year, but you could help yourself out paycheck-by-paycheck if you adjusted withholding.

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For example, if you commonly receive a $2,500 refund, you could adjust your withholding so that you get an extra $100 per month in your take-home pay, and still have a $1,300 refund after filing your taxes.

So How Do You Do It?

First of all, you need to estimate how much your total pay is going to be for the year.  You can start with your pay stub for the current month – then project out for the remainder of the year how much your total pay will be at the end of the year.  The same would be true for pensions and Social Security payments.  Be sure to use the “taxable gross” figures for your calculations, not the take-home amount or gross pay amount.

Having calculated the total payments you’ll receive for the year, make the same sort of calculation to project the amount of income tax you’ll have withheld for the year.  Do the same thing for your state income tax withholding (if you’re lucky enough to live in one of the states that imposes an income tax).

Don’t forget to include any planned IRA distributions (including Roth Conversions) as income, along with any tax you plan to withhold from these distributions.  Also calculate any capital gains or losses you may be planning during the year, as well as your dividends you’ll receive.

Next, go to the IRS website and locate form 1040-ES for the current year.  This form will help you to complete the calculations.  Follow the instructions on the form, using your prior year’s tax return to help you with things like your itemized deductions.  In the instructions for form 1040-ES, you’ll also find the tax rates to apply to your projected taxable income for the year.

You’ll need to make sure that your total withholding and estimated payments tally up to at least 90% of the projected tax you’ll owe, or 100% (110% if your AGI is $150,000 or more) of your prior year’s tax amount (whichever is less).  If your withholding is less than the prior year’s tax and more than $1,000 less than the 90% figure for this year’s tax, you could be subject to a penalty for underpayment.  Generally this is only applied if you have had a significant underpayment in the previous year (the first year is a “gimme”).

You’ll also want to locate the estimated tax payment calculations for your state tax withholding and run through the numbers there as well.

Okay, I did that. Now what?

If you’re underpaying your tax significantly, now it’s time to figure out how to reconcile the situation.  (If you’re overpaying tax and you want to increase your take-home pay or net payments from pensions or Social Security, you can use similar measures.)  The tactics you use depend upon the type of pay that you receive:

W2 Pay (regular employee pay): If you are receiving a paycheck from an employer, you can make adjustments to the amount of pay that is being withheld by using the form W4 – available from your Human Resources department.  Follow the instructions for the form, making adjustments for your pay as it continues through the remainder of the year so that you have a total withholding that is appropriate for your projected taxable income.  A simple way to do this is to request a specific amount to be withheld in addition to your regular withholding.

Pensions: Much the same as with W2 pay, you make adjustments to your withholding for pension payments using form W4P, which will be available from your pension administrator.  Use the same methods of calculation mentioned above with W2 pay.

Social Security: Same as pensions and W2 pay.  You will be using form W4V, available from the Social Security Administration.

IRA or 401(k) Distributions: When you take a distribution from an IRA or 401(k) account, one part of your distribution includes the ability to withhold taxes from the distribution.  You can increase the total tax you’ve had withheld for the year by having some of your distribution withheld in taxes.

When doing a Roth Conversion, you need to keep in mind that any amount that you don’t convert by either having it withheld for taxes or just taking as a regular distribution will not only be taxed but also can be subjected to the early withdrawal 10% penalty if you’re under age 59½.

1099 Pay (such as an independent contractor): In this case you can make estimated payments using the vouchers included with form 1040-ES.  You’ll want to make these payments in a timely fashion – April 15, June 15, September 15 and January 15 – for the amount of net income you’ve received up to the end of the prior month.  Don’t forget to run the calculations for your self-employment income and include that in your estimated payments.

You can make estimated payments no matter what sort of income you receive throughout the year, in addition to the W4 form adjustments mentioned above.  Failure to make these payments in a timely manner can also result in interest and penalties for underpayment.

Timeliness

Bear in mind, only the quarterly estimated payments are necessary to be made within specific timeframes.  For example, if you found that your tax withholding was going to be too little for the year, you could even wait until December and make up the difference using any of the W4 options or IRA distribution withholding mentioned above (this is not recommended).  Withholding in all the methods besides the quarterly estimated payment method is considered to have been made evenly through the entire year.

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What Amount of Savings Should You Have at 40?

Apr 25th, 2011
by Kelly Austin.
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International Money Pile in Cash and Coins

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By the time you turn 40, your attention is likely to gain more focus on the amount of savings that you have. If you haven’t already gained control of your spending and saving habits, now is the time to do so. 40 is also an age when you’re probably beginning to think about future retirement or sending the kids off to college. What amount of savings should you have put back by then, and how will you ever be able to accomplish your goal? The truth is, there are no restrictions to the amount of money that you can save if you put your creativity and knowledge to good use.

What Are You Saving For?

Building a hefty savings account is only made more difficult if you do not have a clear idea of exactly what it is that you are saving for. Saving money just to save it can be effective, but it is still important to set a clear goal for yourself. If you know what you are saving for, deciding between a $5 latte and that trip to Italy is made a lot easier. Do you want to be able to travel after the kids leave for college? Do you want to retire early? What about college tuition for your children? All of these are important questions to ask yourself when building a savings account.

Start Saving Early for the Best Payoff

Did you know that if you start saving just $50 per week at the age of 30, you will have more than $40 thousand dollars by the time you are 40 years old? Starting early on savings can have a huge payoff in the end. Ultimately, the longer you are able to save for your goal, the less you have to save each week or month.

Earn Savings by Freelancing Your Skills and Talents

Freelancing your skills on the side can be an excellent source of revenue for your savings. Offering guitar or beading lessons, tutoring and even landscaping on the weekends are all ways that you could earn money towards your savings goal. Trying to save can be difficult if you’re on a tight budget, but there are always new ways to make money.

Maintaining a clear focus on your goals and getting creative with your ideas (rather than letting your savings account overwhelm you) is by far among the best foundations for building a strong savings at 40, or at any age.

This article was written by Kelly Austin from HigherSalary.com. Visit her site for information about the average accountant salary and pay information for other popular careers.

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The Early Bird Gets the Worm: Start Planning Your Retirement with Your Spouse

Apr 22nd, 2011
by Jamie.
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Early Bird

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Planning your retirement can be a daunting task. If you are pretty new to the work force, your life at old age may not seem like a pressing issue. You have at least twenty years until you want to quit your job for good. Why worry now? However, unless you would like to work well into your 70′s, planning your retirement as early as possible should be a top priority. The comfortable living and traveling we associate with retirement isn’t guaranteed for everyone. If you and your spouse don’t discuss options from now, you may be struggling when old age hits. Don’t forget to consider the medical bills, college tuition, and extra expenses you will accumulate at a later age.  Make a spread sheet of your retirement funds in addition to your spouse’s. Figure out how much money you would be able to withdraw on a yearly basis.

So if you want to get the worm, or in this case, that exotic vacation to Bali with your wife/husband, be an early bird and get your funding options in order! Some different types of plans to consider are listed and described below.

Types of IRAs and Employer Sponsored Plans

An IRA is an individual retirement account, which provides savings and tax benefits to account holders before and after retirement. In addition to holding the account, tax payers often set up an annuity, which is a contract you sign with a life insurance company. The company will pay either a lump sum payment during the time of retirement, or regular payments to their client. Other plans are employer-sponsored, which are based on employee salaries and employer options.

Traditional IRA: This type of account is tax-deferred. To be eligible to hold this account, you must have sufficient income to regularly contribute to the account. Your transactions not subject to tax until withdrawal, and this includes all interest, capital gains, and dividends in the account. Once you do withdraw the funds, they will be subject to federal income tax. You may also be penalized if you take the funds out before age 59½. The main advantage of this account is your contributions are tax deductible.

Roth IRA: This type of retirement account can contain your investments in securities, stocks, bonds, and mutual funds. The account can also consist of an annuity contract, which you sign with a life insurance company. The main advantage of this type of account is its flexibility. You can take out your contributions at any time. The disadvantage of this type of account is it is not tax deductible.

Defined Benefit Plan: This is an employer sponsored plan, which enables employees to be paid regular payments for a set number of years or months post retirement. The amount of money employees receive is usually based on a formula, based on salary history and years of employment. Over time, this is a more favorable plan, but employers are increasingly choosing to offer defined contribution plans.

Defined Contribution Plan:  This employer-sponsored plan is becoming increasingly popular, although it does involve risk for employees. Employers or employees put a certain amount of money as contribution every month for this plan. The money is invested in mutual funds or company stocks. Thus the amount of money available at the employee’s time of retirement depends on the success of the company stocks. Some types of defined contribution plans are listed below.

  • 401 K: This is the most popular employer sponsored plan, in which employers match employee contributions to this plan. However, you are not eligible to withdraw the funds until retirement.
  • Profit Sharing: This is a really great plan, if employers offer it to their employees. The employer makes all the contributions to the employees’ retirement     plan, but this is based on the profit made by the company that year.

By-line:

This guest contribution was submitted by Jamie Davis, who specializes in writing about masters degree. Questions and comments can be sent to: davis.jamie17@gmail.com.

 

 

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More Clarification on Rollovers and Transfers

Apr 20th, 2011
by jblankenship.
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I’m compelled to provide an additional update to the posts I’ve provided in the past in the article Running Afoul of One Rollover Per Year Rule and its follow-up More on the One-Rollover-Per-Year Rule.  This is primarily to provide clarity to a portion of this rule that I personally was unclear on when the articles were originally written.

The rule is that you are restricted to one IRA rollover in a 12-month period.  So let’s define a few things for the purpose of this discussion:

Rollover – this is when you move money from one IRA to another, first taking possession of the funds prior to depositing the funds into the new (or the same old) account.  You have 60 days to complete this process.  At the end of the tax year you’ll receive a 1099R from the original custodian, with a distribution code of 1 or 7 (this form is important to the rule).

Transfer – Also known as a trustee-to-trustee transfer or a direct rollover, in this case you do not take possession of the funds, they are transferred directly from one IRA to another.  Another possible way this could occur if you receive a check from the old custodian made out to the new custodian.  Typically this sort of movement of funds does not generate a 1099R at the end of the year, as you’ve not actually made a distribution – no taxable event has occurred.

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12 months – this really means a full year, 365 days in a normal year, 366 days in a leap year.

The Rule

Now that we have our definitions, here is the rule:

You are restricted to only one Rollover for each IRA account, either receiving or distributing during a full 12 months from the date of distribution.

Transfers are not influenced by this rule. You are allowed to make as many transfers between IRAs as you like, uninhibited by the rule.

An example is in order:  You have an IRA at Mutual Fund Company A, and you take a rollover distribution, and you deposit the money into your IRA account at Brokerage B.  You are restricted in that you cannot make any other rollovers into or out of these two IRAs.

If you have other IRAs, the rule does not apply to those – only IRAs that have been subject to rollover (as defined above) into or out of them within the previous 12 months.

Roth IRA Conversions and Recharacterizations do not apply to this rule either – these are different sorts of distributions, and can be taxable events, but are not subject to this rule’s restriction.

Lastly, the rule does not apply to rollovers into or out of Qualified Retirement Plans (QRPs) such as a 401(k).  You are free to do as many rollovers into or out of an IRA to/from QRPs with no time restrictions.

Hopefully this has helped to fully clarify the rule.

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