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Retirement Issues Chapter 3 pp. 63-96

Retirement Issues Chapter 3 pp. 63-96. 2016 National Income Tax Workbook™. p. 63 Retirement Issues . Self-Directed IRAs Retirement Plan Distributions Choosing a Retirement Plan for a Small Business Back-Door Roth IRA Social Security Income.

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Retirement Issues Chapter 3 pp. 63-96

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  1. Retirement IssuesChapter 3 pp. 63-96 2016 National Income Tax Workbook™

  2. p. 63 Retirement Issues • Self-Directed IRAs • Retirement Plan Distributions • Choosing a Retirement Plan for a Small Business • Back-Door Roth IRA • Social Security Income

  3. Issue 1 p. 64Self-Directed IRA • Differences from typical IRA • More options as to type of investment • Account holder chooses investment • Can invest in real estate, closely held business, other investments • Cannot invest in collectible • Can be traditional or Roth

  4. Issue 1 p. 64Purchasing Property • Cannot purchase from owner or disqualified • Must title real estate in name of IRA • Must purchase using IRA funds • Purchase loan must be nonrecourse • Owner or disqualified person cannot be held liable as borrower or guarantor

  5. Issue 1 p. 65Disqualified Persons (DP) • Fiduciaries – one with discretionary authority or control of IRA/assets • Owner, custodian, financial planner, CPA • Family members • Owner’s spouse, ancestors, lineal descendants, spouse of lineal descendant • Entity owned > 50% by fiduciary or family member – directly or indirectly – Ex. 3.1

  6. Issue 1 p. 65Financing Real Property • Funds must come from IRA • Borrowed by IRA – nonrecourse only • IRA property only secures repayment • No disqualified person may secure loan • Example 3.2

  7. Issue 1 pp. 65-66Prohibited Transactions • Tax-deferred status lost & deemed asset distribution taxed at FMV > basis to owner • Prohibited transactions - § 4975 – direct/indirect • Sale, exchange, leasing between plan & DP • Any credit activity between plan & DP • Goods, services, facilities plan to/from DP • DP receipt, use, benefit of IRA asset/income • Act by fiduciary in own interest • $ to DP personally for IRA transaction

  8. Issue 1 p. 66Prohibited Transactions • Any improper use of IRA account by owner, beneficiary or DP • Using IRA as security for a loan • Buying personal use property with IRA funds • IRA payment to owner for work/management • Paying property expenses with personal $ • Guaranteeing debts of the IRA • Observation: Exception for loan to IRA

  9. Issue 1 p. 66Managing IRA Rental Property • IRA owner may: • Manage, hire manager, form LLC to manage • Screen tenants • Collect rent checks (payable to the IRA) • Determine work to be done but IRA must pay • Perform maintenance without pay - cannot add value • Property managemt firm hired cannot be DP

  10. Issue 1 pp. 66-67Managing IRA Rental Property • IRA can form LLC to buy rentals • IRA is 100% owner • LLC uses own $ to purchase • LLC collects rent and pays expenses • Example 3.3 • Self-directed IRA forms LLC, sole member • IRA owner is LLC manager • LLC purchases, pays expenses with LLC $

  11. Issue 1 p. 67Possible Taxable Income for IRA • Unrelated business taxable income (UBTI) • Rent from real property typically not UBTI • Unrelated debt-financed income (UDFI) • Portion of rental income or income on sale • File Form 990-T if UBTI or UDFI > $1,000 • Example 3.4 Rental income: $7,200 • Rental unit $40,000 of $120,000 financed • UDFI = $2,400 (7,200 x 40,000/120,000)

  12. Issue 2 p. 67Retirement Plan Distributions • Regular distributions between ages 59 ½ and 70 ½ • Early distributions before age 59 ½ • Required minimum distributions after age 70 ½ • Distributions from inherited retirement accounts

  13. Issue 2 p. 67Regular Distributions: 59 ½ to 70 ½ • Taxation depends on type of plan • Traditional IRA – taxable in year distributed • Roth IRA – generally not taxable • Pension/annuity – excess over EE cost taxable

  14. Issue 2 p. 68Traditional IRA Distributions • Nontaxable distribution if: • Rollover • Qualified charitable distribution • Tax-free withdrawal of excess contributions • Return of nondeductible contributions • One-time qualified HSA funding distribution • Generally taxable in year distributed • Partially taxed if have basis in IRA

  15. Issue 2 pp. 68-69Traditional IRA Distributions • Partially taxable distribution – Form 8606 • Must know amount of all nondeductible contributions and value of IRA accounts • Basis/current value determines taxable $ • Example 3.5 $5,000 distribution • Prior year 8606 - $19,000 basis • FMV $25,000 at end of 2016 • Taxable: $1,835 Figure 3.1

  16. Issue 2 p. 69Roth IRA Distributions • Qualified distributions tax-free • Made > 5 years after first contribution and • On or after turning 59 ½ • At or after death (to beneficiary/estate) • On account of disability or • For first-time home purchase • Nonqualified taxable to extent of earnings • Plus possible 10% penalty

  17. Issue 2 p. 69Nonqualified Roth IRA Distributions • 10% penalty does not apply if: • Taxpayer is 59 ½ • Taxpayer totally & permanently disabled • Taxpayer is beneficiary of deceased owner • Used to buy, build, rebuild first home • Series of substantially equal payments • For unreimbursed medical > 10% AGI • For medical insurance during unemployment

  18. Issue 2 pp. 69-70Nonqualified Roth IRA Distributions • 10% penalty does not apply if: 8. Not > than qualified higher-education exp. 9. Due to an IRA levy of the qualified plan • Is a qualified reservist distribution • Order of distribution (Form 8606, Part III) • Regular contributions • Conversion and rollover contributions • Earnings

  19. Issue 2 p. 70Defined Benefit Plan Distributions • Simplified method determines tax-free $ • Cost/total # of anticipated payments • If payable for life use IRS tables • Single life – Table 1, Pub 575 • Multiple lives – Table 2, Pub 575 • If contract use # payments in contract

  20. Issue 2 p. 70Early Distributions • 10% applies to taxable portion from any retirement plan • SIMPLE IRA – 25% penalty if within 2 years of funding and owner under 59 ½ • Roth IRA – 10% applies if under 59 ½ and Roth not open for at least 5 years • Example 3.6

  21. Issue 2 p. 70Early Distributions • Example 3.6 – Age 52, $10,000 withdrawn • Traditional IRA: Income tax + 10% penalty • Roth IRA & only contributions: no penalty if Roth held for 5 years (no income tax) • Roth IRA and age 60 and < 5 years: earnings subject to income tax, no 10% penalty • SIMPLE IRA: 10% if in plan > 2 years, 25% if in plan ≤ 2 years

  22. Issue 2 p. 71Exceptions to 10% Penalty § 72(t) • Unreimbursed medical expenses • > 10% of AGI (> 7.5% if ≥ age 65 -12/31/16) • Regardless of whether itemizing on return • Medical insurance when unemployed • Unemployment comp 12 consecutive weeks • Distributions in year of or year following, and • Distributions ≤ premiums paid for family Distribute no later than 60 days after reemployed

  23. Issue 2 p. 71Exceptions to 10% Penalty § 72(t) • Disabled • Per Dr., cannot do any gainful activity due to mental/physical conditions • Expected to result in death or be of long, continued and indefinite duration • Beneficiary receives distribution • No exception if spouse who is not 59 ½ unless another exception met

  24. Issue 2 p. 71Exceptions to 10% Penalty § 72(t) • Substantially Equal Payments • Over life expectancy • At least one distribution per year • IRS approved method (Rev. Rul. 2002-62) • Required minimum distribution • Fixed amortization • Fixed annuitization

  25. Issue 2 p. 71Exceptions to 10% Penalty § 72(t) • Higher Education Expenses • For owner, spouse, children, grandchildren • Used for qualified expenses: tuition, fees, books, supplies, equipment • Expenses for special needs • Room & board if at least half-time • Not if paid with tax-free assistance • At a qualified institution

  26. Issue 2 p. 72Exceptions to 10% Penalty § 72(t) • First-time home buyer • Up to $10,000 in distributions • To buy, build or rebuild main home • Home of owner, spouse, child, grandchild, parent, grandparent • First-time = not a homeowner for the 2-year period ending on date of acquisition • Distribution as a result of IRS levy

  27. Issue 2 p. 72Exceptions to 10% Penalty § 72(t) • Qualified reservist • Ordered/called to active duty for > 179 days or for indefinite period after 9/11/2001 • Qualified plan – e.g. 401(k) (N/A: medical ins., 1st-time home., higher ed) • Separation age ≥ 55 (50 if public safety EE) • To alternate payee under QDRO • Dividends from ESOP

  28. Issue 2 p. 72Calculating the 10% Penalty § 72(t) • Form 5329, Part I • Example 3.8 Traditional IRA • 40 year-old returning to school • Withdrew $8,400 = education expenses • Scholarship paid $2,400 of expenses • Income tax on $8,400 • 10% penalty on $2,400

  29. Issue 2 pp. 72-73Required Minimum Distributions (RMD) • Start: April 1 of year following year 70 ½ • Defined contribution plans – profit sharing, 401(k), Roth 401(k), 403(b), 457(b) • IRA – traditional, SEP, SARSEP, SIMPLE • No RMD for Roth IRA while owner alive • 403(b) – RMD for pre 87 contributions: age 75 year or April 1 of year following retirement • Working (& not ≥ 5% owner) w/defined benefit – later of year 70 ½ or year of retirement

  30. Issue 2 pp. 73-74Required Minimum Distributions (RMD) • If in following year, two taxed distributions • RMD = Account balance at prior December 31 divided by applicable distribution period or life expectancy (Pub 590-B) • Table II - Joint life and survivor (sole beneficiary is spouse > 10 yrs younger) • Table III – Uniform Lifetime Table (Fig. 3.2) (spouse not sole beneficiary or is ≤ 10 yrs younger) • Example 3.9

  31. Issue 2 p. 74Required Minimum Distributions (RMD) • Multiple Plans • Defined contribution • compute for each & withdraw from each • 403(b) • Total RMDs & take from any account(s) • IRA • Total RMDs & take from any account(s)

  32. Issue 2 p. 75Failure to Take RMD • 50% excise tax on undistributed amount • Part IX, Form 5329 • Can be waived if • Failure due to reasonable error AND • Taxpayer takes reasonable steps to remedy • Example 3.10 Failure $9,623 RMD • Figure 3.3 – Form 5329 • Attach letter of explanation

  33. Issue 2 p. 76Distributions from Inherited Accounts • Dies > age 70 ½ RMD for year must be made • Reported on final return if made before death • Reported by beneficiary if made after death • Subsequent distributions determined by who is beneficiary and whether decedent reached age for RMD

  34. Issue 2 p. 76Individual Nonspouse Beneficiaries • Death on or after beginning date • Use Single Life Table (Table I, App B, 590-B) • Choice of life expectancy to use • Beneficiary’s using age @ birthday following yr of death or • Owner’s life expectancy in year of death • Each year reduce life expectancy by 1

  35. Issue 2 p. 76Individual Nonspouse Beneficiaries • Death before beginning date • RMD based on beneficiary’s life expectancy or • 5 year rule – entire balance by Dec 31 of fifth year following owner’s death • Roth IRA owner dies - apply rules of Traditional with death before RMD start

  36. Issue 2 pp. 76-77Individual Nonspouse Beneficiaries • Example 3.11 Death before Beg’g Date • Phoebe died in 2016 at age 69, no RMD • Beneficiary – Louella, niece, age 25 in 2017 • Value at end of 2016: $100,000 • Withdraw entire balance by 12/31/2021 or • Annual RMD – 58.2 expectancy in 2017 • 2017: $1,718 (100,000/58.2) • 2018: $1,740 (99,500/57.2)

  37. Issue 2 p. 77Individual Nonspouse Beneficiaries • Example 3.12 Death after Beg’g Date • Phoebe died in 2016, age 72, before distrib. • Beneficiary – Louella, niece, age 25 in 2017 • Value at end of 2016: $100,000 • 2016: RMD using Phoebe’s age: $3,906 • 2017: • Table I - her or Phoebe’s life expectancy • Cannot use the 5 year rule

  38. Issue 2 p. 77Spousal Beneficiaries • Year of death: RMD based on decedent’s life expectancy • Elect to treat as own IRA: RMDs begin when spouse 70 ½ • Do not elect to treat as own IRA: RMD based on decedent’s or spouse’s age • If died before beg’g date, 5 year option • If died before 70 ½, can wait until that date

  39. Issue 2 p. 77Distributions to Estates or Trusts • Died on or after beginning date, RMDs based on account owners life expectancy • Died before beginning date, 5 year rule • With see-through trust, RMDs based on life expectance of oldest trust beneficiary

  40. Issue 3 p. 78Retirement Plans – Traditional § 401(k) • No restrictions on size, but have 1 EE • High level of salary deferrals,100% vested • Can offer other types as well • Contributions • EE salary deferrals and/or ER contributions • 2016: EE $18,000 limit, ≥ age 50 + $6,000 • 2016: Total $53,000 if < 50, $59,000 if ≥ 50 • Example 3.13

  41. Issue 3 p. 78Traditional § 401(k) • Employee Benefits • Greatest contribution potential • Employee can borrow from plan • May allow hardship distribution (taxable, 10%) • Employer Considerations • Need assistance to set up • Must annually file Form 5500 • Age 21 + 1,000 hours prior year must allow

  42. Issue 3 pp. 78-79Traditional § 401(k) • Employer Considerations • Annually test for discrimination • Deduction for contributions cannot exceed 25% of aggregate comp of all participants + all salary reduction contributions • Administrative costs grow with EE ability to borrow or take hardship distributions

  43. Issue 3 p. 79Optional 401(k) Choices • Automatic enrollment 401(k) plan • EEs must elect out – increases participation • Safe harbor 401(k) plan • Nondiscrimination testing not required • Employer contribution • Matching or a 3% contribution for all • 100% vested • Works well with highly compensated

  44. Issue 3 p. 79Optional 401(k) Choices • Profit-sharing plan • ER contributions only and not required yearly • Can establish vesting schedule • SIMPLE 401(k) • Must have ≤ 100 employees • No other type of plan can be offered • EEs elect to contribute, ER 3% match/2% nonelective • EEs fully vested in all contributions • 2016 EE limit $12,500 + $3,000 if age ≥ 50

  45. Issue 3 p. 79Solo 401(k) Choices • Sole proprietors or companies with only owner and spouse as EEs • Offers largest contribution • Less expensive to set up and maintain • Form 5500 not required until account value reaches $250,000

  46. Issue 3 p. 79SEPs • Any size business - Form 5305-SEP • Prototype or individually designed plan • Contributions made only by employer • Not required every year • Up to 25% of comp, $265,000 comp max, Contribution max of $53,000 • Immediately vests • Example 3.14

  47. Issue 3 p. 80SEPs • Employee Benefit: no loans, can withdraw $ • Employer Considerations • Admin $ low, fund up to filing date, no F5500 • Must offer to all ≥ age 21, employed 3 of last 5 years and with comp ≥ $600 in 2016 • Offer no other plan (except another SEP) • Flexibility in annual contributions • Employer solely responsible for contributions

  48. Issue 3 p. 80SIMPLE IRA Plans • ≤ 100 employees, easy, inexpensive • Prototype or individually designed plan • Form 5304 SIMPLE – EE designates where • Form 5305 SIMPLE – ER designates where • Contributions by EE & ER (immediate vest) • EE: 2016 max $12,500, ≥ 50 + $3,000 • ER: 2% comp up to $265,000 or ≤ 3% match • Can reduce to 1% (in 2 of 5 years)

  49. Issue 3 p. 81SIMPLE IRA Plans • Example 3.15 2016 SIMPLE IRA • Nelson earns $65,000, EE $5,000 to plan • ER @ 3% - $1,950 (could be even 1%) • Nelson earns $300,000, EE $5,000 to plan • ER @ 3% = $9,000 but limited to $5,000 • If Nelson contributed -0-, ER 3% = -0- • ER @ 2% nonelective amount = $5,300 (max 2% x $265,000 of compensation)

  50. Issue 3 p. 81SIMPLE IRA Plans • Employee Benefits • Cannot borrow from account • Withdrawals any time – subject to taxation, early 10%, or 25% if within first two years • Employer Benefits • Easy, inexpensive, no Form 5500 • Must establish by Oct 1 of the tax year • No required discrimination testing

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