IRAs Common Mistakes and Risks

1. IRAsCommon Mistakes and Risks Judith A. Dorian

2. Agenda • Historical Background • Documentation • Types of IRAs • Contributions, Risks, Risk Control • Investments, Risks, Risk Control • Investment Restrictions • Distributions • Questions

3. Historical Background • Established in ERISA Legislation 1974 • Recognition that pension coverage voluntary for employers • Some employees without coverage • Encourage personal savings • Defined contribution model • Investment risk borne by IRA owner

4. IRA Documentation • Prototype Document Typical • Drawn and approved by each institution • Trustee/Custodian Differentiation

5. Types of IRAs • Traditional/Conventional • Deductible Contributions • Taxable Distributions • Premature withdrawal subject to 10% penalty • Required minimum distributions at age 70 1/2

6. Types of IRAs • Roth • After tax contributions • Tax free distributions • No penalty for early withdrawal • No forced distributions

7. Types of IRAs • SEP Simplified Employer Plan • Established and funded by small employer for employees

8. IRA Contributions • Traditional IRA • Owner must be younger than 70 1/2 • For 2006, lesser of: • $4,000 ($5,000 over 50) OR • Owners taxable comp for year • Deductibility subject to limits • Must File Form 8606 for non-deductible contributions

9. IRA Contributions • Roth • No age restrictions • Same limits as Traditional IRA • Contributions are never deductible • Qualified Distributions are tax free

10. Contribution Risks • Contributions must be in cash - except rollover property Non cash contributions are excess contributions Contributions by others are excess contributions • Trustee/Custodian generally cannot accept excess contributions • Penalty 6% per year until withdrawn • IRA owner responsible for penalty

11. Contribution Risk Control • Ensure that documentation is drawn to place responsibility for monitoring contribution amount on IRA owner instead of financial institution

12. IRA Investments • Prohibited Transaction • Any improper use of an IRA account by the IRA owner, beneficiary or any disqualified person • Disqualified Persons • IRA Owner • IRA Fiduciary • Member of IRA owner’s family • Spouse, ancestor, lineal descendant, spouse of linear descendant

13. Prohibited Transactions • Borrowing from the IRA • Selling property to the IRA • Receiving unreasonable compensation for managing the IRA • Using the IRA as security for a loan • Buying property for personal use - present or future- with IRA funds

14. Prohibited Transaction Penalties • Account loses IRA status as of 1st day of year in which PT occurs • Funds treated as distributed at fair market value on 1st day of year • If amount exceed basis, taxable gain may be includable in income • Distribution may be subject to 10% early distribution tax • Additional penalties for financial institution

15. Prohibited TransactionRisk Control • Staff training • Design documentation to prohibit all loans from IRAs • Pre-empt “dear friend” possibility

16. Prohibited TransactionRisk Control • Beware of any transactions requiring assets not purchased on a regulated exchange • Personally owned stock • Vacation home • Real estate/limited partnerships - may be permissible, but can cause problems

17. Prohibited TransactionsRisk Control • When permitting or accepting assets about which there may be any question, place the burden of decision making on the IRA owner • Require the IRA owner to sign a statement that describes the regs and the assets and states that the IRA owner certifies that the asset is permissible

18. Investment in Collectibles • Amounts invested in collectibles are deemed distributed in the year in which invested at fair market value at the time of acquisition • Failure to pay tax when due triggers monthly percentage penalty up to a 25% maximum • Also possible 10% early withdrawal tax if under 59 1/2

19. Investment in Collectibles • Collectibles Defined • Art works • Rugs • Antiques • Metals • Gems • Stamps • Coins • Alcoholic beverages • Certain other tangible personal property

20. Investment in Collectibles • Exception: • 1, 1/2 1/4 or 1/10 ounce US gold coins or 1 ounce silver coins minted by the US Treasury Department and certain platinum coins and certain gold, silver, palladium and platinum bullion

21. Collectibles - Risk Control • Staff training • Same certification from IRA owner suggested for possible prohibited transaction

22. Unrelated Business Taxable Income • Definition • Income from a trade or business regularly carried on by the IRA not substantially related to the exercise by the IRA of its tax exempt purpose • UBTI is subject to tax • Filing 990-T usually responsibility of financial institution

23. UBTI - Risk Control • Do not allow the IRA to hold assets which might produce UBTI • Ensure that documentation requires IRA owner to file 990-T

24. Distributions • Traditional/Conventional IRA • Can be withdrawn at any time subject to 10% penalty if before 59 1/2. • Must begin withdrawals at age 70 1/2 • Taxable as ordinary income in the year in which withdrawn • Nondeductible contributions cause partly taxable distributions

25. Distributions • Roth Qualified Distributions not taxable • Distribution made after the 5-year period beginning with the 1st taxable year for which Roth contribution made • Payment or distribution is: • Made after 59 1/2 • Due to disability • To beneficiary after death of IRA owner • Meets requirements for First Home Exceptions

26. Exceptions to Distribution Rules • There are exceptions for both Traditional and Roth IRA distribution rules. • Listed in IRS Publication 590 • Some examples: • Medical insurance • IRS levy • First home buying

27. Distribution Risk Control • Maintain some methodology of determining when IRA owners attain age 70 1/2 • 50% excise tax on amounts not distributed as required (excess accumulations) • Be mindful of beneficiary IRAs

28. Questions?