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| Taxation in the United States |
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Contents |
The individual retirement account and related vehicles (see Definitions) were created by amendments to the Internal Revenue Code of 1954 (as amended) made by the Employee Retirement Income Security Act of 1974 (ERISA), which enacted (among other things) Internal Revenue Code sections 219 () and 408 () relating to IRAs.
Subsection (a) of Code section 408 defines the term individual retirement account and subsection (b) defines the term individual retirement annuity. Individual retirement accounts and individual retirement annuities are collectively referred to as individual retirement plans (see Internal Revenue Code section 7701(a)(37)). Individual retirement accounts and individual retirement annuities are also collectively referred to as individual retirement "arrangements" under certain Treasury regulations (e.g., 26 C.F.R. sec. 1.408-4 and sec. 1.408-6) and in Publication 590 (2004) from the Internal Revenue Service.
The term "arrangement" also has more limited meanings. Under subsection (k) of section 408, a simplified employee pension (or SEP) is a particular kind of individual retirement account or individual retirement annuity. A SEP may contain a section 408(k)(6) “arrangement.” Simple retirement accounts with qualified salary reduction “arrangements” are allowed by subsection (p) of section 408.
There are a number of different types of IRAs, which may be either employer-provided or self-provided plans. The types include:
There are two other subtypes of IRA, named Rollover IRA and Conduit IRA, that are obsolete under current tax law (their functions have been subsumed by the Traditional IRA) but this tax law is set to expire unless extended. What was formerly known as an Educational IRA is now called a Coverdell Education Savings Account.
Starting with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many of the restrictions of what type of funds could be rolled into an IRA and what type of plans IRA funds could be rolled into were significantly relaxed. Additional acts have further relaxed similar restrictions. Essentially most retirement plans can be rolled into an IRA after meeting certain criteria, and most retirement plans can accept funds from an IRA. An example of an exception is a non-governmental 457 plan which cannot be rolled into anything but another non-governmental 457 plan.
The tax treatment of the above types of IRAs except for Roth IRAs are substantially similar, particularly for rules regarding distributions. SEP IRAs and SIMPLE IRAs also have additional rules similar to those for qualified plans governing how contributions can and must be made and what employees are qualified to participate.
Once money is inside an IRA, the IRA owner can direct the custodian to use the cash to purchase most types of securities, and some non security financial instruments. Some assets cannot be held in an IRA such as collectibles (e.g. art, baseball cards, and rare coins) and life insurance. Some assets are allowed, subject to certain restrictions by custodians themselves. For example an IRA cannot own real estate if the IRA owner has any involvement with that real estate, for instance as his personal residence or as a property manager (or if a relative fills one of these roles). The IRS specifically states that custodians may impose their own policies above the rules imposed by the IRS.Retirement Plans FAQs regarding IRAs. Internal Revenue Service. Retrieved on 2006-12-21. It should also be noted that custodians cannot provide advice.
Most IRA custodians limit available investments to traditional brokerage accounts such as stocks, bonds, and mutual funds, and do not permit real estate in an IRA unless it is held indirectly via a security such as a real estate investment trust (REIT). However, self-directed IRA custodians/administrators can allow real estate and other non-traditional assets. They typically charge fees based on asset values. There are certain special restrictions on real estate held in an IRA (the IRA owner cannot benefit from the property in any way, i.e. they can not use it). Self directed IRA\'s allowing non security investments are more complicated and to properly set up may require additional expertise and experience that not all CPAs, attorneys, or other advisors would have.
An IRA may borrow money but any such loan must not be personally guaranteed by the owner of the IRA, and also the loan must be secured solely by assets in the IRA (in other words, a non-recourse loan). Also, the owner of the IRA may not pledge the IRA as security against a debt.
Although funds can be distributed from an IRA at any time, there are limited circumstances when money can be distributed, or withdrawn from the account, without penalties. Unless an exception applies, money can typically be withdrawn penalty free as taxable income from an IRA once the account owner reaches age 59 and a half. Also, non-Roth account owners must begin taking distributions of at least the calculated minimum amounts by April 1st of the year after reaching age 70 and a half. If the minimum distribution is not taken the penalty is 50% of the amount that should have been taken. The amount that must be taken is calculated based on a factor taken from the appropriate IRS table and is based on the life expectancy of the account owner and possibly their spouse as beneficiary if applicable. At the death of the account owner distributions must continue and if there is a designated beneficiary, distributions can be based on the life expectancy of the beneficiary.
There are several exceptions to the rule that penalties apply to distributions before age 59½. Each exception has detailed rules that must be followed to be exempt from penalties. The exceptions include:Publication 590 (2005), Individual Retirement Arrangements (IRAs)
There are a number of other important details that govern different situations. For Roth IRA\'s with only contributed funds the basis can be withdrawn before age 59½ without penalty (or tax) on a first in first out basis, and a penalty would apply only on any growth (the taxable amount) that was taken out before 59½ where an exception didn\'t apply. Amounts converted from a traditional to a Roth IRA must stay in the account for a minimum of 5 years to avoid having a penalty on withdrawal of basis unless one of the above exceptions applies.
In the case of Rousey v. Jacoway, the United States Supreme Court ruled unanimously on April 4, 2005 that under section 522(d)(10)(E) of the United States Bankruptcy Code (), a debtor in bankruptcy can exempt his or her IRA from the bankruptcy estate.Rousey Et Ux. v. Jacoway. Supreme Court Of The United States (2005-10). Retrieved on 2006-12-21. The Court indicated that because rights to withdrawals are based on age, IRAs should receive the same protection as other retirement plans. Thirty-four states already had laws effectively allowing an individual to exempt an IRA in bankruptcy, but the Supreme Court decision allows federal protection for IRAs. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 gave further protection to IRAs. Up to $1,000,000 of IRA assets can be exempt from a bankruptcy estate; this now includes both Traditional and Roth IRAs. The 2005 Act also increased the FDIC insurance limit for IRA deposits at banks.
Many states have laws that prohibit judgments from lawsuits to be satisfied by seizure of IRA assets. For example, IRAs are protected up to $500,000 in Nevada from Writs of Execution. However, this type of protection does not usually exist in the case of divorce, failure to pay taxes, deeds of trust, and fraud. Assets in the IRA must be deposited before a lawsuit exists to receive this protection.
It is a prohibited transaction for the IRA owner to borrow money from the IRA. Such a transaction disqualifies the IRA from special tax treatment. An IRA may incur debt or borrow money secured by its assets but the IRA owner may not guarantee or secure the loan personally. Income from debt-financed property in an IRA may generate unrelated business taxable income in the IRA.
The rules regarding IRA rollovers and transfers allow the IRA owner to perform an "indirect rollover" to another IRA. This can be used to temporarily "borrow" money from the IRA, once per year. The money must be placed in another IRA account within 60 days, or the transaction will be deemed an early withdrawal (subject to the appropriate withdrawal taxes and penalties) and may not be replaced.
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