"Ira Withdrawal While on Unemployment"
INDIVIDUAL RETIREMENT ACCOUNTS (IRA) M.P.Kelsey and L.R. Borton Department of Agricultural Economics Michigan State University Employees and self-employed businessmen are encouraged to establish their own retirement plan. While everyone will not be interested, the options are very attractive for those wishing to postpone taxes on a portion of their income until retirement and to build a nest egg. This pension program is separate from the Keogh plan (H.R. 10) or a Simplified Employee Plan (SEP) or the SIMPLE plan. To Qualify: 1. The individual must be receiving earned income. 2. Can be either an employee or self-employed. 3. Husbands and wives may both qualify, even if only one has earned income. 4. Employees do not have to be covered for the owner operator to participate in an IRA. Contributions: 1. Up to 100% of earned income to a maximum of $3,000 each year ($4,000 in 2005). (Doubled if a spousal IRA is involved.) A catch-up provision allows anyone who is at least 50 years old sometime in 2002 an extra $500 contribution. 2. If an employer does not contribute the maximum amount to the plan, the employee can make up the difference. 3. The contributions are not taxed until retirement when the retiree will usually drop into a lower tax bracket. (However, the Roth IRA contributions are taxed currently, but withdrawals are not taxed.) 4. The earnings from the funds are also tax-free until retirement. If in the 27.0% tax bracket, savings would be $810 in federal taxes the first year on a $3,000 contribution. Interest continues to compound tax free until the funds are withdrawn. 5. Contributions can be made up to the due date of the tax return. (April 15, 2003 for 2002 tax returns.) Payments of Benefits: 1. Benefits cannot be withdrawn without penalty except under special circumstances until age 59 1/2. 2. Distribution must begin no later than April 1 of the year following the calendar year in which the owner attains age 70 1/2. 3. Penalty-free withdrawals can be made for death or disability. 4. A penalty of an additional 10% tax is imposed for early withdrawals. Example: If taxable income is $20,000 and a taxpayer decides to withdraw $2,000 from his account, he would pay the regular tax rate on the $2,000, plus an additional $200 (10% withdrawal penalty). 5. Beginning in 1997, early withdrawals could be made without penalty for medical expenses that exceed 7.5% of adjusted gross income. Medical insurance premiums also qualify for a taxpayer who has received at least 12 weeks of unemployment compensation. Beginning in 1998, penalty fee withdrawals could be made for qualified higher education expenses or up to $10,000 for a first-time home buyer. 2002 Limits: Individuals participating in an employer retirement plan which includes an H.R. 10 or Keogh plan will have their nontaxable contribution reduced, if their adjusted gross income exceeds $54,000 for a married taxpayer filing a joint return ($34,000 single). The nontaxable contribution is zero when AGI reaches $64,000 ($44,000 single). These phase-out ranges increase erratically to $80,000 to $100,000 for joint returns by 2007 and $50,000 to $60,000 for single returns by 2005. 14 October 2002 If the taxpayer has AGI within the phase-out range, the maximum deductible contribution that can be made is reduced 20 cents for each dollar the AGI exceeds the lowest phase-out range figure. For example, a $58,000 AGI for a couple married filing joint, would reduce the maximum contribution $1,200 to $1,800 for each. [($58,000 - $54,000)/ ($64,000 - $54,000)]*$3,000 = ($4,000/$10,000) x $3,000 = 0.4 * $3,000 = $1,200 We now have three IRAs. 1. The regular IRA with a $3,000 maximum contribution and deduction from earned income. The contribution and earnings are tax deferred and fully taxable when withdrawn. If the income earner is eligible for an employee sponsored retirement plan, there is a phase out of the deduction if AGI in 2002 is between $54,000 and $64,000 for joint files and $34,000 and $44,000 for a single return. A spouse who is not a participant in an employee’s retirement plan may contribute to a deductible IRA with a phase out, if their AGI is between $150,000 and $160,000. 2. A nondeductible IRA with a $3,000 maximum contribution, but only earnings are tax deferred until withdrawn. No phase-out rules apply. 3. The Roth IRA with a $3,000 nondeductible maximum contribution, and distributions are not included in income when withdrawn. Qualified distributions are: a. made after the five-taxable year period beginning with the first taxable year for which a contribution was made to the Roth IRA, and b. which are: (1) made on or after the date on which the individual attains age 59 1/2; (2) made to a beneficiary on or after the date of death; (3) attributable to disability; or (4) for a qualified special purpose distribution which is initially for first-time home-buyer expenses. The maximum contribution to a Roth IRA is phased out for singles with AGI between $95,000 and $110,000 and for joint filers with AGI between $150,000 and $160,000. Current IRA holders with an AGI of less than $100,000 may convert a current IRA into a Roth IRA. For a conversion after December 31, 1998, all income is included in the conversion year. The 10% early withdrawal tax does not apply. Contributions to all of an individual’s IRAs are limited in 2002 year to $3,000. A catch-up provision allows anyone who is at least 50 years old sometime in 2002 an extra $500 contribution. A couple who are both 50 or older may contribute up to $7,000 to their IRAs. Saver’s Credit To encourage lower income taxpayers, up to $1,000 of credit per individual is available if at least 18 years old, not a full-time student, and not claimed as a dependent on another return. Maximum income limitations and percentages are: Credit Rate MFJ AGI HoH AGI Single/MFS AGI 50% Up to $30,000 Up to $22,500 Up to $15,000 20% $30,001-$32,500 $22,501-$24,375 $15,001-$16,250 10% $32,501-$50,000 $24,376-$37,500 $16,251-$25,000 15 October 2002