University of Miami, Philip E. Heckerling Institute on Estate Planning, 1999
The Maze of IRAs:
Traditional, Roth, SEP, Simple and Education
Does Any of This Make Sense for You?
Marcia Chadwick Holt
Davis, Graham & Stubbs LLP
Attorneys at Law
TABLE OF CONTENTS
I. IRAs: WHAT ARE THEY? 2-1
A. In General 2-1
B. Trust or Custodial Account 2-1
C. Exclusive Benefit 2-1
D. Nonforfeitable 2-2
E. Who can be a Trustee or Custodian? 2-2
II. TRADITIONAL IRAs: aka REGULAR or NONROTH IRAs 2-4
A. Annual Traditional IRAs. 2-4
B. Rollover Traditional IRAs 2-10
III. ROTH IRAs 2-18
A. "Annual" Roth IRAs 2-18
B. Rollover or Conversion of Traditional IRAs to Roth IRAs 2-22
IV. OTHER RULES APPLICABLE TO BOTH TRADITIONAL AND ROTH IRAS 2-34
A. Too Early Withdrawals 2-34
B. Investment Restrictions. 2-37
C. Prohibited Transactions: 2-37
D. Pledge for Loan 2-38
E. No QDROs 2-38
F. No ERISA 2-38
G. Creditors' Rights 2-38
H. No Spousal Rights 2-38
I. Limit on Rollovers 2-38
J. No Limit on Number 2-39
K. Income Averaging 2-39
L. Net Unrealized Appreciation 2-39
M. Withholding Tax 2-39
N. The Trustee-to-Trustee Transfer. Can a Nonspousal Beneficiary Transfer an Account to Another Trustee or
O. Income Tax 2-40
P. Estate Tax 2-40
V. CHART 4: COMPARISON OF TRADITIONAL AND ROTH IRAs 2-41
VI. THE FORMS: DEFAULT PROVISIONS 2-44
A. Lack of Uniformity 2-44
B. Calculating the MRD 2-44
C. No Help 2-44
D. No Election Forms 2-44
E. Customizing IRAs 2-44
F. IRS Forms 2-44
VII. SEP-IRAs and SIMPLE IRAs 2-51
A. What are They? 2-51
C. A Comparison 2-51
VIII. EDUCATION IRAs 2-55
A. What are They? 2-55
C. Beneficiary 2-55
D. Limitations in Contributions 2-55
E. Deductibility 2-55
F. Tax-Free Withdrawals 2-55
G. Annual Exclusion 2-56
H. Earnings 2-56
I. Rollover 2-56
J. Eligibility of Donor 2-57
K. Choice 2-57
L. Investment 2-57
M. Limitations 2-57
N. Termination 2-58
IX. SOME CONCLUSIONS 2-59
The Maze of IRAs:
Traditional, Roth, SEP, SIMPLE and Education
Does Any of This Make Sense for You?
I. IRAs: WHAT ARE THEY?
A. In General.
1. An Individual Account. An individual retirement account ("IRA") is an account established pursuant to the
Internal Revenue Code of 1986 as amended ("IRC") § 408(a) (which is sometimes called a Traditional or Regular
IRA), a Roth IRA pursuant to IRC § 408A, a SEP-IRA pursuant to IRC § 408(k), a SIMPLE IRA pursuant to IRC §
408(p) or an Education IRA pursuant to IRC § 530.
2. An Individual Annuity. An IRA can also include an individual retirement annuity pursuant to IRC §408(h). An
individual retirement annuity is established by purchasing an annuity contract or an endowment contract from a
U.S. life insurance company.
3. This Outline. This outline concentrates on the IRAs which require trust or custodial accounts, that is, the
Traditional, Roth, SEP, SIMPLE and Education IRAs and not the Individual Retirement Annuity. We should note
that an Education IRA is not an individual retirement plan under IRC § 7701(G)(37). Nevertheless, for whatever
reason, Congress labeled the arrangement an IRA and required a trust or custodial account. Education IRAs are
considered separately in VIII of this outline.
B. Trust or Custodial Account. An IRA must be a trust or custodial account which is created or organized in the
United States. IRC §§ 408(a), 408A(a), 408(k), 408(p) and 530.
C. Exclusive Benefit. The IRA must be in writing and must be held for the exclusive benefit of an individual or his or
D. Nonforfeitable. The interest of an individual in his or her IRA must be nonforfeitable.
E. Who can be a Trustee or Custodian?
1. A Bank Trustee. The trustee of an IRA must be a bank, as defined in IRC § 408(n), or other person who can
demonstrate to the IRS the ability to perform fiduciary duties on a continuous basis and to properly administer the
trust or custodial account in accordance with the law. Reg § 1.408-2(b)(2).
a. Bank. A bank includes a bank, trust company or other corporation incorporated and doing business
subject to the supervision and examination of state or federal authorities in charge of the administration of banking
laws and an insured credit union. IRC § 408(n).
b. Custodian. The custodian of an IRA is treated as the trustee for purposes of IRC § 408. IRC § 408(h).
2. Nonbank Trustee.
a. Requirements. A nonbank trustee must meet the requirements of the regulations at § 1.408-2(e) (1)
(1) Application. A nonbank trustee must pay a user's fee and submit an application to the IRS that
demonstrates by clear and convincing evidence that it has the ability to act within the accepted rules of fiduciary
conduct and has the capacity, experience and competence to assure uninterrupted performance of its fiduciary
(2) Notice of Approval. If a nonbank applicant is approved, a written notice of approval will be
issued by the IRS. A copy of the written notice must be given to the person establishing the IRA. Reg § 1.408-2(e)
PRACTICE POINTER: Get a copy of the notice.
b. Not an Individual. The regulations state: "there must be sufficient diversity in the ownership of the
applicant to ensure that the death or change of its owners will not interrupt the conduct of its business. Therefore,
the applicant cannot be an individual." Reg § 1.408-2(e)(2)(i).
c. A Hard Lesson: An Example of the "Individual" Trustee. A financial planner/accountant represented
that he was the trustee of an IRA approved by the IRS. In 1991, he executed a Form 56 (Notice Concerning
Fiduciary Relationship) and a Form 5305-A (Individual Retirement Custodial Account) with 17 different
individuals. The individuals invested a total of $790,000 in the IRAs which invested in bus stop shelters. The IRS
claimed that the financial planner/accountant was not qualified to serve as a trustee of an IRA trust under the Code
or regulations and, therefore, petitioners' qualified plan and IRA proceeds were not rolled over into a qualified IRA.
The Tax Court agreed and "although sympathetic to the petitioners' plight," the Tax Court held that distributions to
the taxpayers were taxable in the year of distribution and subject to 10% additional tax under IRC § 72(t). Schoof v.
Commissioner, 110 TC 1 (Jan. 12, 1998).
MORAL: Ask for a copy of the written IRS notice approving an IRA before investing in an IRA with a nonbank
3. Passive Trustee. A nonbank trustee may act as a passive trustee which merely acquires and holds investments
specified by the trust instrument. A written notice of approval will be issued by the IRS and will specify the
limitations. Reg § 1.408-2(e)(5)(ii).
PRACTICE POINTER: Get a copy of the notice.
4. Automatic Approval. A credit union, industrial loan company or other financial institution designated by the IRS
which accepts trust assets solely for investment in its insured deposits is automatically approved without filing an
application. Reg § 1.408-2(e)(6)(iii).
II. TRADITIONAL IRAs: aka REGULAR or NONROTH IRAs
A. Annual Traditional IRAs.
a. Age. An individual who has not attained age 70½ in the year of contribution can contribute to a
Traditional IRA. IRC §§ 219(d)(1), 408(o)(2)(B).
b. Compensation. An individual must have compensation in the year of the contribution to an IRA except
that an employed spouse can set up an IRA for his or her nonemployed spouse. Compensation includes amounts
shown in the W-2 box 1 for wages, tips and other compensation. It also includes alimony. It does not include
pension, annuities or other forms of deferred compensation. IRC § 219(f)(1).
c. Status. An individual may establish an IRA even if he or she is covered under other retirement plans.
a. Amount Allowed. The lesser of $2,000 or the compensation which is includable in the individual's gross
income for the taxable year may be contributed to an IRA.
b. Form Allowed. Cash.
c. Excess: What to Do?
(1) Tax. Excess contributions are subject to a cumulative 6% excise tax for each taxable year in
which an excess contribution remains in the IRA. IRC § 4973.
(2) Avoidance of Tax. The excise tax can be avoided if (A) the excess is withdrawn before the due
date (including extensions) of the individual's tax return for that year, (B) no deduction is allowed for the
contribution and (C) the distribution includes any net income earned by the contribution (which is taxable in the
year in which the contribution was made). For purposes of determining excess contributions, rollover contributions
are disregarded. IRC §§ 408(d)(4), 408A(c)(6)(B) and 4973(a), (b) and (f).
(3) Traditional First. An individual's excess contributions are applied first to a Traditional IRA and
then to a Roth IRA. Prop Reg § 1.408A-3 Q&A 3.
3. Tax Consequences.
a. Going In? The contribution may or may not be deductible.
(a) Full Deduction. If neither an individual nor his or her spouse is covered for any part of the
year by an employer retirement plan, the individual can take a deduction for total contributions to one or more
Traditional IRAs of up to $2,000, or 100% of compensation, whichever is less. This limit is reduced by any
contributions to a IRC § 501(c)(18) plan which is a plan created before June 25, 1959 pursuant to such IRC section.
(b) Reduced or No Deduction. If either the individual or his or her spouse is covered by an
employer retirement plan, the individual may be entitled to only a partial deduction or no deduction at all,
depending on income and filing status. Even though the taxpayer may not be entitled to a deduction, he or she can
still make a contribution.
(c) Phase-Out Limits. Under the Taxpayer Relief Act of 1997, the deductible Traditional IRA
income phase-out limits are increased as follows:
Taxable Years Modified Adjusted Gross Income ("AGI")
Beginning In: Phase Out Range
1998 $ 50,000-$60,000
1999 $51,000-$ 61,000
2000 $ 52,000-$62,000
2001 $ 53,000-$63,000
2002 $ 54,000-$64,000
2003 $ 60,000-$70,000
2004 $ 65,000-$75,000
Modified Adjusted Gross Income ("AGI")
Phase Out Range
1998 $ 30,000-$40,000
1999 $ 31,000-$41,000
2000 $ 32,000-$42,000
2001 $ 33,000-$43,000
2002 $ 34,000-$44,000
2003 $ 40,000-$50,000
2004 $ 45,000-$55,000
2005 and thereafter $ 50,000-$60,000
Modified AGI is AGI determined without taking into account: any IRA deduction; foreign earned income
exclusion; foreign housing exclusion or deduction; exclusion of Series EE bond interest shown on Form 8815 or
exclusion of amounts for qualified adoption expenses under IRC § 137. IRC § 219(g)(3)(A).
(a) Spousal IRA. In the case of a married couple with unequal compensation who file a joint
return, the limit on the deductible contributions to the Traditional IRA of the spouse with less compensation is the
lesser of $2,000, or the total compensation of both spouses, reduced by any deduction allowed for contributions to
the Traditional IRA of the spouse with more compensation. This limit is reduced by any contributions to an IRC §
(b) Nonemployed Spousal IRA. An employed spouse can set up an IRA for his or her
nonemployed spouse. IRC § 219(c). The maximum deductible contribution to a Traditional IRA for an individual
who is not an active participant but whose spouse is an active participant is phased out at modified AGI between
$150,000 and $160,000.
The following examples taken from the Conference Report illustrate the income phase-out rules:
Example 1: Suppose for a year W is an active participant in an employer-sponsored retirement
plan, and W's husband, H, is not. Further assume that the combined modified AGI of H and W for the year is
$200,000. Neither W nor H is entitled to make deductible contributions to a Traditional IRA for the year.
Example 2: Same as example 1, except that the combined modified AGI of W and H is
$125,000. H can make deductible contributions to an IRA. However, a deductible contribution could not be made
b. Coming Out?
(1) Rules. Distributions from Traditional IRAs (whether to the owner or to a beneficiary of the
owner) are taxable to the distributee except to the extent of any basis in the account. IRC § 72(e). The following
(a) All Traditional IRAs of an individual (including SEPs and SIMPLE accounts) are treated
as a single contract.
(b) All distributions during the individual's tax year are treated as one distribution.
(c) The value of the contract, the income on the contract, and the investment in the contract
are calculated (after adding back distributions made during the year) as of the close of the calendar year in which
the tax year of the distribution begins.
(d) Total withdrawals excludable from income in all tax years cannot exceed the taxpayer's
investment in the contract in all tax years. The individual's investment in the contract is made up of the aggregate
nondeductible contributions to the Traditional IRAs. IRC §§ 408(d)(1), (2).
(e) Traditional IRAs and Roth IRAs are treated separately for purposes of these rules. IRC §
(2) Example: Joe owns two Traditional IRAs. Before 1998, Joe did not make any nondeductible
contributions to either Traditional IRA. During his 1998 tax year, Joe made a deductible contribution of $1,000 to
Traditional IRA 1 and a nondeductible contribution of $500 to Traditional IRA 2. During his 1999 tax year, Joe
withdrew $1,500 from Traditional IRA 1 and made a $2,000 nondeductible contribution to Traditional IRA 2. Joe's
total nondeductible contributions were $2,500 and his total withdrawals were $1,500. Joe's $2,500 in nondeductible
contributions represents his basis in the contract. At the time of the withdrawal of $1,500, the account balance of
Traditional IRA 1 was $10,000, and the value of the account balance of Traditional IRA 2 was $5,000. The portion
of the $1,500 distribution which is excludable from income is a pro rata share of his investment in the contract
determined as follows: $2,500/$15,000 x $1,500, or $250. The balance of the distribution or $1,250 is includible in
Joe's gross income for 1999.
4. Mandatory Withdrawals. The Minimum Distribution Rules under IRC § 401(a)(9).
a. MRDs. The rules for Minimum Required Distributions ("MRDs") under IRC § 401(a)(9) and the
incidental death benefit requirements under § 401(a) apply to Traditional IRAs. IRC § 408(a)(6).
DIFFERENT RULE FOR ROTH IRAs. Roth IRAs are not subject to MRDs during the owner's lifetime. IRC § 408A
(c)(5). See III of this outline.
b. Alternative Rule. The IRS has provided an alternative rule for satisfying MRDs from Traditional IRAs.
An owner must calculate the MRDs separately for each Traditional IRA. However, the owner may combine all such
MRDs and withdraw the total from any one or more of the Traditional IRAs. Notice 88-38, 1988-1 CB 524.
c. Exception. The alternative method may not be used to satisfy the MRDs from Qualified Plans.
5. Timing. Contributions to Traditional IRAs may be made up to and including the due date of the return for the tax
year (April 15th) without considering extensions. IRC § 219(f)(3).
6. Appeal of the Annual Traditional IRA?
a. Current Deduction.
(1) Child. A child who wants (a child whose parents want him/her) to start saving early and wants a
(2) Higher Bracket Now. A taxpayer who prefers a current deduction for a contribution to an IRA or
who is in a higher tax bracket at time of contribution than at time of withdrawal may prefer a Traditional IRA.
b. No Deduction but the Only Game. The taxpayer who is not age 70½ but who can't make contributions
to a Roth IRA (because his or her income exceeds the Roth limitations) may still be attracted to the nondeductible
Annual Traditional IRA since it is the only annual IRA available. Although the contribution is not deductible, the
IRA earnings are tax exempt. However, the earnings are subject to ordinary income tax when withdrawn. Question:
Are investments outside an IRA which are taxable as capital gains and not ordinary income a more attractive
investment? They may be.
PRACTICE POINTER: A taxpayer who elects to treat a Traditional IRA contribution as nondeductible must file
Form 8606 with his or her income tax return for the year of the contribution. IRC §§ 219(f)(7) and 408(o).
B. Rollover Traditional IRAs
a. Age. There is no maximum age requirement.
b. Compensation. Compensation is not required
c. Status. Who can rollover?
(a) One or More. An individual may establish one or more rollover Traditional IRAs into
which he or she rolls his or her Qualified Plan or Traditional IRA benefits.
(b) Over 70½. If an individual over age 70½ establishes a rollover Traditional IRA,
distributions from the rollover Traditional IRA must begin in the tax year in which the distribution was received by
such rollover IRA. Ltr Rul 9311037, Dec. 22, 1992.
(2) Surviving Spouse.
(a) Spousal Rollover. A surviving spouse may rollover a decedent's Qualified Plan or
Traditional IRA benefits to a spousal rollover Traditional IRA.
(b) Over 70½? What if the surviving spouse is over age 70½? No problem. A spouse can
establish a Traditional IRA after his/her own RBD and roll the deceased spouse's Traditional IRA into it. Who are
the spouse's beneficiaries and are they measuring lives? A spouse's beneficiaries were treated as Designated
Beneficiaries since the spouse named them before the spouse's first required distribution date even though that date
was subsequent to the spouse's RBD. Ltr Rul 9311037, Dec. 22, 1992.
(3) Not Executor. An executor of a surviving spouse may not exercise the spouse's right to treat an
IRA as such spouse's own IRA. Ltr Rul 9237038, June 16, 1992.
(4) Not Children or Other Beneficiaries. There is no tax-free rollover for any amount received from
an "inherited IRA" by a beneficiary who is not a surviving spouse. An IRA is treated as inherited if the individual
for whose benefit the IRA is maintained acquired it because of the death of the IRA owner. IRC § 408(d)(3)(C).
a. Amount Allowed. There is no limit on the amount which can be rolled over to an IRA.
b. Form Allowed: Two Different Rules.
(1) From a Qualified Plan. A distribution from a Qualified Plan in the form of money or other
property may be rolled over tax free to a Traditional IRA as long as the transfer occurs within 60 days of receipt of
the property. IRC § 402(c). If the distribution consists of property other than money, the amount transferred must
consist of the property transferred. However, if the property is sold before the rollover, the proceeds (including any
increase in value) are treated the same as property received in the distribution and can be rolled over to a Traditional
IRA. IRC § 402(c)(6).
(2) From an IRA. A distribution from a Traditional IRA in the form of money and other property
may be rolled over tax free to a Traditional IRA as long as the transfer occurs within 60 days of receipt of the
property and the entire amount received (including money and other property) is paid into the Traditional or Roth
IRA. IRC § 408(d)(3).
(3) A Hard Lesson: An Example to Avoid. A self employed accountant withdrew $480,000 from his
Keogh and IRA accounts and used it to purchase certain stock. Within 60 days of the withdrawal, he deposited the
stock in an IRA. The Tax Court held that the taxpayer's reinvestments of his Keogh and IRA distributions did not
constitute rollover contributions and were taxable. Lemishow v. Commissioner, 110 TC No. 11 (Feb 18, 1998).
Moral: Arrange for a direct rollover of the cash or property from an IRA to a self-directed Traditional or Roth
IRA. Then, direct the trustee or custodian to make the appropriate investments.
c. From Where? Amounts can be rolled over to a Traditional IRA from another Traditional IRA, a SEP-
IRA, a SIMPLE IRA (subject to a two year wait), a Qualified Plan, an IRC §§ 403(a) plan or 403(b) plan. IRC §§
401(a)(31), 402(c), 403(a)(4) and (5), 403(b)(8) and 10, and 408(d)(3). There currently is no authority for rolling
over any distribution to a Roth IRA other than a distribution from a Traditional IRA.
d. Exceptions to Permissible Rollovers. Any distribution from a Qualified Plan which is includable in
income (i.e. does not include nondeductible contributions IRC § 402(c)(2)) or from an IRA may be transferred to a
rollover IRA within 60 days of receipt EXCEPT:
(1) Minimum required distributions under IRC § 401(a)(9). IRC § 402(c)(4)(B).
(2) One of a series of substantially equal periodic payments made over a term certain of 10 years or
more; or over life, life expectancy, or joint lives or joint life expectancies. See Temp Reg § 1.402(c)-2T, Q&A 5 for
rules if the amount of payments change. IRC § 402(c)(4)(A).
(3) Refunds of elective deferrals.
(4) Corrective distributions of excess deferrals, contributions and income thereon.
(5) Loans treated as distributions.
(6) Dividends paid on employer securities pursuant to IRC § 404(k).
(7) Cost of life insurance coverage (P.S. 58 Costs).
(8) Hardship distributions from a Qualified Plan.
IRC § 402(c)(4) and (9); IRC § 408(d)(3)(E).
CAVEAT: A distribution of after-tax contributions from a Qualified Plan can not be rolled over to
an IRA. A distribution of nondeductible contributions (i.e. after-tax contributions) from an IRA can be rolled over
to an IRA. Q: Why do the rules have to be so illogical and confusing?
e. Spouse. If a distribution attributable to an employee is paid to the employee's surviving spouse, the
spouse is treated as the employee for purposes of the rollover rules. IRC § 402(c)(9).
f. Excess: What to Do? Same as Annual Traditional IRAs.
9. The Spousal Rollover. There are three methods to transfer Traditional IRA assets without income tax from a
deceased owner to a beneficiary who is the decedent's surviving spouse. Prop Reg § 1.408-8, Q&A-4(b). These
transfer methods are:
a. Elect to Treat as Own.
(1) Change the Owner's Name. The surviving spouse may elect to treat the Traditional IRA as the
spouse's own account and change the name of the owner of the Traditional IRA on the records of the financial
institution from the decedent to the surviving spouse.
(2) vRollover the IRA Assets. The surviving spouse may withdraw the Traditional IRA assets and
transfer them to a new or existing Traditional IRA titled in the name of the surviving spouse. The transfer must be
completed within 60 days of the withdrawal from the IRA in order to be tax-free.
CAVEAT: Only one tax-free withdrawal is allowed from a Traditional IRA in a twelve month
period. IRC § 408(d)(3)(B). Planning is critical. A rollover contribution from a Traditional IRA to a Roth IRA is
disregarded for purposes of this rule. IRC § 408A(e).
(3) Trustee-to-Trustee Transfer. The surviving spouse may direct the trustee or custodian of the
Traditional IRA to transfer the decedent's Traditional IRA assets directly to the trustee or custodian of a new or
existing Traditional IRA titled in the name of the surviving spouse.
GOOD NEWS: There are no limitations to the number of tax-free trustee-to-trustee transfers
b. Deemed Election: Failure to Take. The surviving spouse will be deemed to have elected to treat the
Traditional IRA as his or her own if the MRD is not distributed to the surviving spouse on a timely basis after the
death of the decedent.
c. Deemed Election: Addition. The surviving spouse will be deemed to have elected to treat the
Traditional IRA as his or her own if the surviving spouse makes a contribution to the account.
10. Timing. Does it matter when the surviving spouse transfers a decedent's Traditional IRA to a spousal Traditional
a. One letter ruling approved a surviving spouse taking as a beneficiary in one year and as an owner in the
next year. The decedent died in 1994. The surviving spouse took as a beneficiary in 1995. In 1995, she transferred
the decedent's Traditional IRAs by a trustee-to-trustee transfer to her own Traditional IRA. In 1996, she began
taking her first required distribution from her own Traditional IRA. See Ltr Rul 9534027, June 1, 1995.
b. Other letter rulings have ruled that a surviving spouse's receipt of a distribution as a beneficiary on
which she does not pay the 10% additional income tax imposed by IRC § 72(t)(1) is an irrevocable election NOT to
treat the Traditional IRA as her own. See Ltr Rul 9418034, Feb. 10, 1994, and Ltr Rul 9608042, Dec. 1, 1995.
c. A solution? The surviving spouse could arrange a trustee-to-trustee transfer to transfer the decedent's
Traditional IRA to two Traditional IRAs in the decedent's name. A spouse who has not reached age 59½ could then
take as a beneficiary from one Traditional IRA and avoid the 10% additional income tax and roll the other
Traditional IRA over to his/her own spousal rollover Traditional IRA and postpone distributions until age 59½.
d. Consider also that if a spouse is older than the decedent, a rollover will cause MRDs to occur earlier
that they need to occur, that is--at the spouse's (and not the decedent's) RBD.
11. Tax Consequences.
a. Going In? Rollover contributions are not subject to tax.
b. Coming Out? Distributions from rollover IRAs are taxable as ordinary income except to the extent of
basis because of after-tax contributions.
12. Mandatory Withdrawals. Same as Annual IRAs.
13. Appeal of the Traditional Rollover IRA?
a. The Qualified Plan Distributee: Postpone Tax. A taxpayer or a surviving spouse who wants to postpone
the tax consequences of a distribution from a Qualified Plan may rollover his or her distribution to a Traditional
Rollover IRA. The taxpayer can later decide whether to convert or rollover the IRA to a Roth Rollover IRA.
b. The Surviving Spouse: The Stretch IRA. A surviving spouse may rollover a deceased spouse's account
from a Qualified Plan or IRA to a Traditional Rollover IRA and name a child or children as Designated Beneficiary
(ies). The child's life expectancy (or the oldest child's life expectancy if more than one child is named and separate
shares are not created) will be measuring lives and will "stretch out" the MRDs otherwise payable. For example, a
spouse creates two spousal IRAs, one for a 40 year old child and one for a 30 year old child. See Chart 1. The
spouse does not elect to recalculate his/her life expectancy. The spouse dies in Year 2. Distributions can continue
for 40.9 years and 50.3 years respectively! Remember that after the owner's death the Minimum Distribution
Incidental Benefit Rule no longer applies and each beneficiary's actual age is used to determine the MRD. Prop Reg
§ 1.401(a)(9)-1, Q&A F-3A(b)(1), H-2.
CHART 1: NAMING CHILDREN AS BENEFICIARIES OF SPOUSAL ROLLOVER IRAS
I. II. III. IV. V. VI
MDIB or Life
Child's Life Expectancy Expectancy Multiple
after Spouse's Death Spouse Does Not Balance at
Spouse's Child's (Prop Reg §1.401(a)(9)- Recalculate (Table VI Preceding 12/31 MRD on
Year Age Age 1, Q&A F3A(b)(1)) Reg § 1.72-9) (8% interest) 12/31
IRA 1 70 40 40 42.9 26.2 $1,000,000 $38,168
2 71 41 one year 41.9 25.3 $1,041,832 $41,179
3 Deceased 42 less 40.9 40.9 $1,084,000 $26,504
IRA 1 70 30 30 52.3 26.2 $1,000,000 $38,168
2 71 31 one year 51.3 25.3 $1,041,832 $41,179
3 Deceased 32 less 50.3 50.3 $1,084,000 $26,504
There is value in deferring the payments over time since earnings accrue on a tax exempt basis.
c. The Retiree: More Distribution Options. Many retirees are faced with very restrictive distribution options
from Qualified Plans. Qualified Plans are usually written for the convenience of the employer and many do not
offer long-term distributions after the death of an employee. Some Qualified Plans pay only lump sum distributions
or distributions over only a short term. If the beneficiary is not the spouse, the beneficiary will be stuck with the
Qualified Plan's distribution options since a beneficiary who is not a spouse cannot rollover a distribution from a
Qualified Plan. The retiree can avoid the problem simply by rolling over his or her account in the Qualified Plan to
an IRA with distribution options which allow for a long payout to the beneficiary.
d. The Employee Between Jobs: The Conduit IRA. If an employee rolls over his or her distribution from a
Qualified Plan into an IRA and makes no other contributions to such IRA, the IRA can be rolled over into another
Qualified Plan without tax. Ltr Rul 8044030 (Aug 5, 1980). The IRA becomes a conduit for the Qualified Plan
distributions which will later be rolled into a Qualified Plan.
(1) Investments. This could be attractive for an employee who wants to take advantage of investment
opportunities in his new employer's Qualified Plan which are not available in his IRA like investment in closely
held company stock.
(2) Postponed Retirement. It could also be attractive for an employee who wants to postpone MRDs
until his or her actual retirement date. Such a postponement is available for distributions from Qualified Plans but
not for distributions from IRAs. IRC § 401(a)(9)(C)(i).
e. The Control Taxpayer: The Custom IRA. Some taxpayers may want to control distributions from a rollover
IRA. Either the rollover IRA can be "customized" by beneficiary designation (see discussion on forms) or the
rollover IRA can be paid to a trust which includes specific directions to the trustee regarding discretionary
distributions, investments, income and principal definitions, payment of tax and other trust provisions.
III. ROTH IRAs
A. "Annual" Roth IRAs. A Roth IRA must meet the same requirements as a Traditional IRA except as described below.
To be treated as a Roth IRA, the account must be so designated when created. IRC § 408A.
a. Age. Unlike an Annual Traditional IRA, contributions can be made by a taxpayer after age 70½. IRC §
b. AGI Restrictions. An individual with modified AGI within the following income limits:
(1) Up to $95,000 for individuals.
(2) Up to $150,000 for married couples.
(3) Eligibility to contribute phases out for individuals with modified AGI between $95,000-$110,000,
for married couples filing jointly with modified AGI between $150,000 - $160,000 and for married individuals
filing separate returns with modified AGI between $0-$10,000. IRC § 408A(c)(3).
(4) Modified AGI is AGI determined under IRC § 219(g)(3) but does not include income which results
from rollovers or conversions of a Traditional IRA to a Roth IRA. IRC § 408A(c)(3)(C)(i). It also does not take into
account deductions for contributions to an IRA. Prop Reg § 1.408A-3, Q&A 5.
(5) No contribution can be made to a Roth IRA by a single person with modified AGI of at least
$110,000, married individuals filing jointly with modified AGI of at least $160,000 or by a married individual filing
a separate return with modified AGI of at least $10,000.
c. Status. Same as Traditional IRAs.
d. Employer or Association of Employees. An employer or association of employees can establish a Roth
IRA to hold contributions of employees or members. Each employee's or member's account in the trust is treated as
a separate Roth IRA subject to the general Roth IRA rules. IRC § 408(c); Prop Reg 1.408A-2, Q&A 2.
a. Amount Allowed. The lesser of $2,000 or the compensation which is includable in the individual's gross
income for the taxable year may be contributed to a Roth IRA. IRC § 408A(c)(2). The $2,000 limit is coordinated
with the $2,000 limit applicable to a Traditional IRA. Contributions can be made to both a Traditional IRA and a
Roth IRA so long as the total of such contributions do not to exceed $2,000 in total per individual. In determining
excess contributions, the taxpayer is deemed to contribute first to a Traditional and then to a Roth IRA. Prop Reg §
b. Form Allowed. Cash.
c. Excess: What to Do? Same as Traditional IRAs.
3. Tax Consequences.
a. Going In? Contributions to a Roth IRA are not deductible. IRC § 408A(c)(1).
b. Coming Out? An individual can withdraw his or her contributions tax free anytime but can withdraw
earnings tax free only if the distribution is qualified. IRC § 408A(d). If the distribution is not qualified, earnings are
subject to ordinary income tax and penalties for early withdrawal unless an exception applies.
4. Qualified Distributions. There are two requirements for a Qualified Distribution:
a. Five-Taxable-Year Period. The Roth IRA must be held for 5-taxable years before any earnings are
withdrawn ("Five-Taxable-Year Period"). IRC § 408A(d)(2)(B). The 5-taxable years begin with the first-taxable
year for which the individual made a contribution to a Roth IRA. Because of the Five-Taxable-Year Period, no
Qualified Distributions can occur before taxable years beginning in 2003.
b. Purposes of Distribution. A Qualified Distribution is a distribution which is made:
(1) Age 59½. To the owner after he or she reaches age 59½.
(2) Death. To a beneficiary because of the owner's death.
(3) Disability. To the owner after he or she is disabled.
(4) Home Purchase. To the owner for a qualified first-time home purchase of up to $10,000 lifetime.
The distribution must be used within 120 days of the distribution for the "qualified acquisition costs" of acquiring a
"principal residence" for a "first-time homebuyer who is the owner, his or her spouse or a descendant or ancestor of
either." IRC §§ 72(t)(2)(F), 408A(d). See discussion at IV.
5. Other Distributions. All other withdrawals of earnings, i.e., distributions which are not Qualified Distributions, are
subject to income tax on earnings and the 10% penalty tax (unless an exception applies to the 10% penalty under
IRC § 72(t)(2)). See discussion at IV.
GOOD NEWS: Distributions from Roth IRAs are deemed made first from amounts contributed which are not
subject to income tax and then from earnings except in the case of certain rollovers or conversions discussed below.
This could be a planning opportunity.
6. MRDs. There are no MRD's before the death of the owner. IRC § 408A(c)(5). An Owner of a Roth IRA is always
deemed to have died before his or her RBD. The Five-Year Rule governing distributions and its exceptions always
7. Appeal of the Annual Roth IRA?
a. The Child. The child who has wages from a parent or other employer can establish a Roth IRA and the
earnings can accrue on a tax-exempt basis. If the child needs to use his or her earnings for expenses and cannot
afford to fund an IRA, the parent or other donor could fund the child's IRA as a gift to the child and contribute up to
the lesser of $2,000 or the amount which the child earned that year. The younger the child is when he or she starts
the Roth IRA, the longer it has to grow. A child who contributes $2,000 each year from age 8 to 65 will have
$2,692,011 at age 65, assuming an 8% growth and no change in the law.
b. Low Tax Bracket Now. Individuals in a low tax bracket now (e.g. 15%) who are likely to be in a higher tax
bracket at retirement will find Roth IRAs attractive. "Tax-free distributions later" are more attractive than "a
deduction now." Such individuals could include those entering the work force, temporary or part-time workers,
those on temporary leaves or even retirees who don't need their retirement funds now and who anticipate that their
retirement funds will ultimately be paid to beneficiaries in a higher tax bracket.
c. No Qualified Plan. The Roth IRA provides a vehicle for retirement savings. If a retiree is in the same or
higher tax bracket as he or she was at the time of contribution, the Roth IRA performs better than a tax-deductible
Traditional IRA. However, if a retiree is in a significantly lower tax bracket later than at the time of contribution,
the tax-deductible Traditional IRA performs better.
d. In Lieu of Nondeductible Contributions to a Traditional IRA. A taxpayer who exceeds the income
limitations for deductibility or who chooses not to claim a deduction for an IRA contribution may contribute to a
nondeductible Traditional IRA. However, upon withdrawal from a nondeductible IRA, all earnings are taxed. This
is not true for a Roth IRA. Earnings from a Roth IRA will not be taxed as long as the withdrawal is a Qualified
Distribution. Consequently, nondeductible Traditional IRAs may now only appeal to the individual who cannot
qualify for a Roth IRA because of income limitations. It's the only IRA available for these taxpayers.
e. Over age 70½. A taxpayer who wants to continue to contribute to an IRA after age 70½ will like the Roth
B. Rollover or Conversion of Traditional IRAs to Roth IRAs
a. Age. No age limit.
b. Limits. $100,000 or less Modified AGI.
(1) A taxpayer can rollover or convert a Traditional IRA to a Roth IRA, so long as the taxpayer's
modified AGI for the taxable year of distribution does not exceed $100,000 and the taxpayer is not a married
individual filing a separate return. IRC § 408A(c)(3)(B) and (d)(3)(C). The $100,000 applies to both single and
(2) Modified AGI for purposes of rollover or conversion to a Roth IRA does not include any amount
included in income due to the rollover or conversion to the Roth IRA. IRC § 408A(c)(3)(C)(i).
(3) The AGI limitations apply for the tax year of the distribution to which the later contribution relates.
IRC § 408A(c)(3). A distribution made in 1998 which is rolled over within 60 days in 1999 will be qualified based
on 1998 AGI.
(4) Effective for tax years beginning after Dec 31, 2004, MRDs from IRAs are excluded from the
definition of AGI for purposes of the $100,000 AGI limitation. IRC § 408A(c)(3)(C).
GOOD NEWS: Recharacterization of Contributions. If a taxpayer discovers he or she exceeds the AGI limitation
after a conversion or rollover of a Traditional IRA to a Roth IRA, the taxpayer may transfer the contribution and
earnings made to the Roth IRA to a Traditional IRA by a trustee-to-trustee transfer providing the transfer is made
before the due date of the tax return for that year including extensions. The transfer is treated as made to the
transferee IRA, not the transferor IRA on the same date and for the same tax year that it was initially made to the
transferor IRA. The transfer must include all the net income earned by that contribution. Taxpayers can elect
whether to recharacterize contributions made to one type of IRA by having the contributions transferred in a
trustee-to-trustee transfer: (1) to a different type of IRA in a different financial institution or, (2) between two IRAs
of a single financial institution. Recharacterization transfers are not deemed rollovers under IRC § 408(d)(3) for
purposes of the one-rollover-per-year rule. IRC § 408A(d)(6)(A). Prop Reg § 1.408A-5.
BAD NEWS: Reconversion Only Once a Year. The IRS has issued a Notice that an individual who converted a
Traditional IRA to a Roth IRA at any time during 1998 and then transfers the converted amount back to a
Traditional IRA may reconvert that amount to a Roth IRA one time only after November 1, 1998. Reconversion
must occur on or after November 1, 1998, and on or before December 31, 1999. Similarly, an individual who
converts a Traditional IRA (that hasn't previously been converted) to a Roth IRA during 1999 and then transfers the
converted amount back to a Traditional IRA may reconvert that amount to a Roth IRA one time only, on or before
December 31, 1999. IRS Notice 98-50 (Oct 21, 1998)
(1) Individual: Same as Traditional IRA except:
(a) A married individual filing a separate return is not eligible for a Rollover or Converted Roth
IRA. However, an individual who has lived apart from his or her spouse for the entire taxable year can treat himself
or herself as not married. Prop Reg § 1.408A-4, Q&A 2(b).
(b) If the individual is at least age 70½, he or she may not convert a Traditional IRA to a Roth
IRA to the extent an MRD for the year has not been distributed. However, if an MRD is contributed to a Roth IRA
it is treated as distributed under IRC § 408(d)(1) and (2) and then contributed as a regular contribution (not as a
conversion) to a Roth IRA. Prop Reg § 1.408A-3, Q&A 6.
(2) Surviving Spouse: Same as Traditional IRA.
(3) Not Personal Representative: Same as Traditional IRA.
(4) Not Children or Other Beneficiaries: Same as Traditional IRA.
a. Three Methods: There are three methods available for conversions: a 60-day rollover, a trustee-to-trustee
transfer and a same institution transfer. Prop Reg § 1.408A -4 Q&A-1(b).
b. Excluded: A 1997 distribution from a Traditional IRA may not be converted to a Roth IRA in 1998.
c. Excess: What to Do? Recharacterize the contribution or reconvert the account.
3. Tax Consequences.
a. Going In?
(1) Income Tax. If a taxpayer rolls over or converts a Traditional IRA to a Roth IRA, the assets of the
Traditional IRA are subject to income taxes. If converted or rolled over, the 10% additional income tax does not
apply except as noted below.
(2) Four Years. If the rollover or conversion occurs before January 1, 1999, the amount required to be
included in gross income may be (but does not need to be) spread ratably over the four tax-year period beginning
with the tax year in which the distribution is made.
Example: In 1998, Mary had AGI of $80,000. She withdrew $100,000 from her Traditional IRA and
within 60 days rolled it over to a Roth IRA. She will have $25,000 of additional gross income in each of 1998,
1999, 2000 and 2001. However, the extra $25,000 of income in 1998 does not increase Mary's AGI of $80,000 for
purposes of the $100,000 AGI limit.
(3) One Year. The taxpayer can elect to have the amount rolled over or converted in 1998 includable in
income in 1998 rather than ratably over four years. IRC § 408A(d)(3)(A)(iii).
b. Coming Out?
(1) Contributions are Tax Free. An individual can withdraw his or her contributions tax free anytime
subject to the rules below. Distributions from a Roth IRA are treated as made from contributions first. All of an
individual's previous Roth IRA distributions are aggregated for this purpose. IRC § 408A(d)(4)(B)(i).
(2) Earnings may be Tax Free. An individual can withdraw earnings tax free only if the distribution is
qualified. IRC § 408A(d). If the distribution is not qualified, earnings are subject to ordinary income tax and
penalties for early withdrawal unless an exception applies. See III above (Roth IRAs) for definition of Qualified
(3) Treated Separately. Roth IRAs and Traditional IRAs are treated separately for purposes of the rules
requiring that all IRAs be treated as one contract, all distributions during any one year be treated as a single
distribution and that the value of the contract be computed as of the close of the calendar year. IRC § 408A(d)(4)
(4) Income Acceleration.
(a) Withdrawal. If a taxpayer elects the four-year rule in 1998 and withdraws amounts before the
entire amount of the rollover or conversion is included in income, the income inclusion is accelerated and the
amount withdrawn plus any amount not yet includable in income (up to the amount of the total conversion or
rollover) is taxable. Acceleration reduces the last income tax payment due not the next payment due. IRC § 408A(d)
(b) Death. If a taxpayer dies before the full amount is includable in income, any remaining
amount must be included in taxpayer's gross income for the taxable year that includes the date of death. However, if
the surviving spouse is the sole beneficiary of all the decedent's Roth IRAs, the spouse can elect to continue income
taxation under the four-year rule. Prop Reg § 1.408A-4, Q&A 11.
(5) Ordering Rules. Amounts withdrawn from a Roth IRA are treated as made in the following order:
(a) From regular contributions.
(b) From conversion contributions on a first-in first-out basis. Distributions allocated to a
qualified rollover or conversion contribution are treated as coming first from the taxable portion of the contribution
(c) From earnings.
IRC § 408A(d)(4)(B). Prop Reg § 1.408A-6 Q&A 8. The 10% penalty applies to income withdrawn unless an
exception applies. IRC § 408A(d)(4)(B).
Note: Distributions which are not qualified distributions may be withdrawn tax-free up to the aggregate amount of
contributions to Roth IRAs. Excess amounts are includible in income.
(6) Penalty Tax. Any amount rolled over or converted from a Traditional IRA to a Roth IRA which is
withdrawn before the Five-Taxable-Year Period is subject to the 10% penalty (unless an exception applies) to the
extent that the amount distributed would have been taxable if it had been distributed from the Traditional IRA and
not rolled over or converted. IRC § 408A(d)(3)(F).
(a) Under Age 59½. If the taxpayer is under age 59½, he or she must keep track of which dollars
were rolled over or converted and when. The penalty is imposed if a distribution of a rolled over or converted
amount occurs within the Five-Taxable-Year Period beginning with the taxable year in which the contribution was
made. If such a distribution occurs, IRC § 72(t) imposes the 10% penalty as if the distribution were includible in
gross income. IRC § 408A(d)(3)(F). Note: the rule measuring the Five-Taxable-Year Period beginning with the first
year for which the taxpayer made a Roth contribution does not apply.
Example: Jane rolls over $50,000 to a Roth IRA in year 1 from a Traditional IRA. Jane has a basis of $30,000
in the conversion amount and so must include $20,000 in gross income She withdraws $15,000 to buy a car
in year 2. Under the ordering rules, the withdrawal is attributable to amounts includible in income due to the
conversion. Since the $15,000 is withdrawn within the Five-Taxable-Year Period beginning with the year in
which the IRA was converted into a Roth IRA, the $15,000 withdrawal is subject to a 10% early withdrawal
tax of $1,500. Jane would have been better off withdrawing from a Traditional IRA since the amount
withdrawn would have been a pro-rata portion of nondeductible contributions which are not taxable and
earnings which are taxable.
(b) Age 59½ or Older. If the taxpayer is age 59½ or older, the taxpayer can withdraw all
rollovers as qualified distributions beginning five years after the first rollover. Since the taxpayer is 59½ or older,
there is no 10% penalty tax. IRC § 408A(d)(2).
Example: Bob rolls over $20,000 to a Roth IRA in year 1. He rolls over $60,000 in year 5. He withdraws
$70,000 in year 6 when he is 59½ . The withdrawal is a tax-free qualified distribution since the holding
period is satisfied and he is over age 59½.
(7) Surviving Spouse. Any amounts includable in income because of a conversion or rollover are
includable in income in the decedent's final return. The surviving spouse as beneficiary of the Roth IRA could
continue the deferral. IRC § 408A(d)(3)(E)(ii).
(8) Series of Substantially Equal Period Payments. A taxpayer's conversion of funds from a Traditional
IRA from which the taxpayer was receiving a series of substantially equal periodic payments will not be treated as a
modification of that series and would not trigger recapture of the 10% penalty tax on previous distributions from a
Traditional IRA as long as the series of substantially equal periodic payments is continued under the Roth IRA.
Prop Reg § 1.408A-4 Q&A 12.
c. An Example of a Conversion:
A widow with a large IRA and "sufficient" other assets wants to rollover $150,000 of her IRA into a Roth
IRA and name her three children as beneficiaries
A Personal Fund of $36,584 available to pay any tax on the rollover
3% inflation rate
8% growth rate
Widow's date of birth 10/11/34
Widow's assumed date of death 2017 (age 83)
Oldest child's date of birth 11/29/59
Oldest child's assumed date of death 2042 (age 83)
Income tax marginal rate at date of rollover: 28%
Net-After Tax Assets means IRA value less any income tax on withdrawal plus Personal Fund
CHART 2: VALUE OF IRA
Roth IRA: Tax Paid from Roth IRA: Tax Paid from
Traditional Roth IRA
Roth IRA Outside Roth IRA
IRA Beginning Annual Roth IRA Annual Roth IRA Annual
Year Value Distribution Beginning Value Distributions Beginning Value Distributions
1998 $150,000 $0 $150,000* $0 $150,000* $0
2005 (widow 70 1/2) $257,075 $10,161 $197,473 $0 $257,073 $0
2008 $285,600 $12,581 $248,760 $0 $323,838 $0
2017 $351,214 $22,955 $497,272 $0 $699,141 $0
$579,398 $598,189 $699,141
*Amount converted in 1998. Assume 28% tax bracket and income tax paid (inside or outside) is spread over four years.
**Net After-Tax Assets, that is, the assets remaining after income tax is paid.
(2) A Comparison: Assume all funds withdrawn in 2017 when the widow dies
The Traditional IRA: The widow has taken MRDs during her lifetime. She has withdrawn $207,587 taxable
at 28%. She dies with an IRA of $351,214 which is IRD to her beneficiaries. Her personal fund assuming a
5.7% after-tax growth is worth $326,524 and the Net After-Tax Assets are $579,398.
Roth IRA: Tax Paid from Roth IRA. The widow takes no distributions during her lifetime. She dies with an
IRA of $497,272 which is not subject to income tax. Her personal fund assuming a 5.7% after-tax growth is
worth $100,917 and the Net After-Tax Assets are $598,189 or 3.24% more than the Traditional IRA.
Roth IRA: Tax Paid Outside Roth IRA. The widow takes no distributions during her lifetime. She dies with
an IRA of $699,141 which is not subject to income tax. Her personal fund is worth "0" and the Net After-Tax
Assets are $699,141 or 20.66% more than the Traditional IRA.
(3) Conclusion: If the widow's goal is to leave the largest amount to her children after income tax, the
Roth IRA beats the Traditional IRA.
PLANNING POINTER: A Roth IRA is an excellent vehicle for passing on wealth to the next generation free of
d. An Example of Withdrawal:
CHART 3: THE IMPACT OF CHANGING INCOME TAX BRACKETS
Chart 3 illustrates how the Annual Traditional IRA (deductible) beats an Annual Roth IRA (nondeductible) if the taxpayer's tax rate drops
in retirement. The chart assumes that the taxpayer contributes $2,000 a year for five, 10, 15 and 20 years; that the account earns a
compound annual return of 8%; and that the taxpayer then withdraws the proceeds without penalty. For the Traditional IRA, the figures
assume that the taxpayer was in the 28% bracket when the contributions were made. The figures also show how much the taxpayer
receives after tax if the tax rate drops, holds steady or rises.
YEARS IN IRA
5 10 15 20
ANNUAL ROTH IRA
Total available for tax-free withdrawal:
$12,672** $31,292** $58,648** $98,845**
ANNUAL TRADITIONAL IRA
Total available, after tax, if rate was 28% when contributed and then during retirement, the rate:
Drops to 15% $13,849*** $35,162*** $663,242*** $105,182***
Stays at 28% $12,466 $30,249 $55,763 $92,401
Rises to 31% $12,122 $30,391 $54,036 $89,451
Rises to 36% $11,581 $27,910 $51,157 $84,533
Rises to 39.6% $11,191* $26,795* $49,084* $80,992*
Note: Contributions are made at the beginning of the year, withdrawals at year end. Annual Traditional IRA balances assume that annual
tax savings were reinvested in taxable accounts and combined with IRA balance upon withdrawal.
Source: Deloitte & Touche
(1) Moral: You need a crystal ball. Question: Will you be in a lower tax bracket during retirement?
(2) A Conclusion: An Annual Traditional IRA which is deductible beats a Roth IRA if the tax bracket
is lower on withdrawal. The Roth IRA wins if the tax bracket on withdrawal stays the same or is higher.
e. Another Idea: A Life Time Gift of a Roth IRA Trust
(1) The Suggestion. At least one commentator has suggested that a taxpayer could make a gift of his or
her interest in an irrevocable Roth IRA trust during lifetime by retaining no interest in, or powers over, the
irrevocable IRA trust including the right to withdraw funds during life. The beneficiary designation would provide
that no distributions could be made to anyone during the taxpayer's life. According to this suggestion, the IRA
would not be includable in the taxpayer's estate and all increases in value after the creation of the irrevocable IRA
trust would escape estate taxation. See "Innovative Estate Planning Strategies Using Roth IRAs" by Mervin M.
Wilf, Estate Planning, March/April 1998.
(2) Not a Good Idea? The Proposed Regulations issued September 3, 1998 provide that a transfer of a
Roth IRA by gift constitutes an assignment and that the assets are deemed to be distributed to the owner and are
treated as no longer held in the IRA. Furthermore, if any gift made prior to October 1, 1998 is reversed prior to
January 1, 1999, it would be treated as if it had never been made for estate, gift and generation-skipping tax
purposes. Prop Reg § 1.408A-6, Q&A 19. Q: Is the suggestion in (1) above a transfer covered under this new
4. Appeal of Roth Rollover IRAs?
a. Who Should Consider Rollover or Conversion of a Traditional IRA to a Roth IRA? Who has a Crystal
(1) Same or Higher Tax Bracket. The taxpayer will be in as high a tax bracket when he or she takes
distributions from a Roth IRA as he or she is in now.
(2) Little Income Taxes Due. The Traditional IRA has been open for a relatively short period of time or
it consists of nondeductible contributions. Little income taxes will be due because of the rollover or conversion.
(3) No Plans to Withdraw. The taxpayer will not need to withdraw from the Roth IRA when he or she
retires. The taxpayer prefers to allow the Roth IRA to increase tax free after his or her retirement and plans to pass
it to his or her children. After the taxpayer's death, the account can continue to build tax free subject only to the
(4) Favorable Status. The taxpayer has separate funds from which to pay the income taxes due because
of the rollover or conversion. The taxpayer has charitable deduction carryforward or other credits which can be used
to offset the tax due.
(5) Lots of Time. The taxpayer is young and has many years until retirement.
(6) Correct a Mistake. The taxpayer is beyond his or her Required Beginning Date ("RBD") and has
failed to name a Designated Beneficiary and has no possibility of naming one for the Traditional IRA. The
taxpayer's Traditional IRA must be paid over only the owner's life expectancy either recalculated or not
recalculated. If the owner converts to a Roth IRA, the Five-Year Rule and its exceptions will apply on the death of
the owner regardless of the age of the taxpayer at death. This could be an estate planning opportunity. For example,
without a rollover, an owner who has passed his RBD and who failed to name a Designated Beneficiary and whose
life expectancy was being recalculated is stuck. His entire Traditional IRA must be distributed to his beneficiary by
December 31st of the year following his death. However, if that same owner rolled over his Traditional IRA to a
Roth IRA, he could name a new Designated Beneficiary and at the owner's death, the IRA could be distributed to
his beneficiary over his or her life expectancy.
(7) A New Designated Beneficiary. Estate planners often advise a surviving spouse to rollover a
decedent's account balance to an IRA and then designate a new beneficiary for purposes of the MRDs. What
happens if there is no surviving spouse, that is, the spouse dies before the IRA owner but after the IRA owner's
RBD? Is the owner stuck with his or her life expectancy elections? No. The owner could rollover his or her
Traditional IRA to a Roth IRA and name a new Designated Beneficiary. Upon the owner's death, MRDs could be
made over the life expectancy of the new Designated Beneficiary. Of course, the owner must recognize income tax
on the amount rolled over to the Roth IRA. This technique could be used in the event any beneficiary (not just the
surviving spouse) died prior to the IRA owner but after the IRA owner's RBD.
(8) A Full Exemption Equivalent. If a taxpayer has a short life expectancy and has only a Traditional
IRA available to fund an exemption equivalent trust, a death-bed rollover or conversion to a Roth IRA could be
attractive. The exemption equivalent trust could be funded with the Roth IRA. Distributions from the Roth IRA
would not be IRD as long as they were qualified distributions and, consequently, would be more valuable to the
beneficiaries than taxable distributions. The federal and state income tax payable because of the rollover or
conversion would be deductible for estate tax purposes and beneficiaries would not be subject to IRD rules because
of the Roth IRA.
(9) IRA to Children or Grandchildren. The taxpayer wants to provide a gift or retirement vehicle for
children or grandchildren at the taxpayer's death. The taxpayer does not intend to make any withdrawals during
lifetime and intends to allow the IRA to grow and pass (without income taxes but with estate taxes) at the taxpayer's
b. Who Gets Hurt by a Rollover or Conversion of a Traditional IRA to a Roth IRA?
(1) Withdraw Funds. A taxpayer who needs to withdraw funds for college tuition or other reasons
which are not Qualified Distributions gains no benefit from paying income taxes early to convert or rollover the
Traditional IRA. If the taxes hadn't been paid to the IRS, the funds could still be earning tax-free for the taxpayer.
(2) Close to Retirement. A taxpayer who expects to withdraw funds from the IRA soon may realize
little benefit from paying the taxes early to convert or rollover the Traditional IRA. If the taxes hadn't been paid, the
funds could still be earning tax-free and the retiree may need those funds.
(3) Lower Tax Bracket. If the taxpayer expects to be in a lower tax bracket when the funds are
withdrawn from the IRA than when they were contributed, the taxpayer gains no benefit from paying the taxes early
to convert or rollover a Traditional IRA to a Roth IRA.
(4) Social Security. A taxpayer on Social Security may find his or her payments taxable because
income from a rollover or conversion is AGI for purposes of determining whether Social Security benefits are
taxable. Additional income in the year of rollover or conversion could cause a retiree's Social Security benefits to be
taxed. On the other hand, after the rollover or conversion, withdrawals from Roth IRAs are not taxable and, hence,
would not affect the taxability of Social Security payments. Also, after the rollover or conversion, MRDs aren't
required from a Roth IRA. The AGI will be less and Social Security may escape taxation.
c. Some Problems.
(1) No Exception at Death. Apparently, there is no exception to the Five-Taxable-Year Period rule for
death. But, holding periods can be tacked. In addition, if the surviving spouse treats the decedent's Roth IRA as his
or her own, the Five-Taxable-Year Period ends on the earlier of the decedent's or the spouse's Five-Taxable-Year
Period. Prop Reg § 1.408A-6, Q&A 7.
(2) If an MRD is required in the year of rollover or conversion to a Roth IRA, the MRD is includable in
AGI at least until the year 2004. IRC § 408A(c)(3)(C)(i)..IV. OTHER RULES APPLICABLE TO BOTH
TRADITIONAL AND ROTH IRAS
A. Too Early Withdrawals: The 10% Additional Income Tax on Premature Distributions.
1. The Tax. IRC § 72(t) imposes a 10% additional income tax on the taxable amount of distributions from a Qualified
Plan, IRA or other qualified retirement plan under IRC § 4974(c) unless the distribution is described immediately
2. Exceptions to the 10% Additional Income Tax. A distribution:
a. 59½. To a participant on or after he or she attains age 59½.
b. Death. To a beneficiary of a deceased participant.
c. Disability. To a disabled participant.
d. Periodic Payments. Which is part of a series of substantially equal periodic payments and which, in the
case of a distribution from a Qualified Plan, begin after the participant separates from service. If the periodic
payments are subsequently modified before 5 years or before the employee attains age 59½, a penalty will apply.
e. Dividends. Which represent dividends paid with respect to certain employer securities.
f. Age 55. To a participant after separation from service after he or she attains age 55. (Does NOT apply to
g. Medical Expenses. To a participant for medical expenses deductible under IRC § 213. For distributions
after Dec. 31, 1996, this exception applies to IRAs as long as the distribution is used to pay medical expenses in
excess of 7.5% of adjusted gross income or to pay health insurance premiums after separation from service under
certain conditions. IRC § 72(t)(2)(B), 3(A) and § 72(5)(2)(D).
h. QDRO. To an alternate payee pursuant to a qualified domestic relation order. (Does NOT apply to IRAs).
i. Education. From an IRA, if the distribution is used to pay the qualified higher education expenses
(including those related to graduate-level courses) of the taxpayer, the taxpayer's spouse, or any child or grandchild
of the individual or the individual's spouse.
(1) Qualified expenses include tuition, fees, books, supplies, and equipment required for enrollment or
attendance, as well as room and board, at a post-secondary education institution.
(2) The provision is effective for distributions after 1997, for expenses paid and education commencing
after that date. (IRC § 72(t)(2)(E)).
j. Roth IRA. From a Roth IRA, if the account is held for 5 years and withdrawals are made after age 59½, or
on account of death, disability or a qualified first-time home purchase pursuant to (xi) below. IRC §§ 72(t)(2)(F),
k. Home. From an IRA, for a qualified first-time home purchase (up to $10,000 lifetime). IRC § 72(t)(2)(F).
(1) A distribution which is used within 120 days of the payout for qualified acquisition costs of a
qualified first-time homebuyer's principal residence.
(2) The homebuyer (or spouse, if married) cannot have had a present ownership interest in a principal
residence within the 2-year period ending on the new home's acquisition date. A first-time homebuyer can be the
taxpayer, his or her spouse, or a descendant or ancestor of either.
(3) There is a $10,000 lifetime limit on distributions that may be treated as qualified first-time
(4) The rules for qualified first-time homebuyer distributions are effective for payments and
distributions in tax years beginning after 1997.
CHART 5: Summary of Income Tax Consequences
Qualified Plans Traditional IRAs Roth IRAs
Held Less Than 5 Years Held More Than 5 Years
10% 10% 10% 10%
Principal* Earnings Principal Earnings Principal Earnings Principal Earnings
Penalty Penalty Penalty Penalty
from service yes yes no yes yes yes no yes yes no yes yes
in year attain
2. Age 59
yes yes no yes yes no no yes no no no no
1/2 or later
3. Death yes yes no yes yes no no yes no no no no
4. Disability yes yes no yes yes no no yes no no no no
age 59 1/2,
because of 1, yes yes yes yes yes yes no yes yes no yes yes
3 or 4 above,
or through e
a. Series of
equal yes yes no yes yes no no yes no no yes no
under IRC § yes yes no yes yes no no yes no no yes no
yes yes no N/A N/A N/A N/A N/A N/A N/A N/A N/A
yes yes yes yes yes no no yes no no yes no
under IRC §
yes yes yes yes yes no no yes no no no no
under IRC §
*Except to the extent of basis.
B. Investment Restrictions.
1. No Life Insurance. No part of an IRA may be invested in life insurance contracts.
2. No Commingling. The assets of the IRA must not be commingled with other property except in a common trust
fund or common investment fund.
3. No Collectibles. The assets of the IRA may not be invested in collectibles except for certain U.S. minted gold and
silver coins. Any investment in collectibles which is not covered by the exception is considered a taxable
distribution to the Owner.
C. Prohibited Transactions:
1. What are they? An Owner or beneficiary must not participate in a transaction with his or her IRA that is prohibited
by IRC § 4975 or the IRA will be disqualified. IRC § 408(e)(1). If an IRA is disqualified, the assets of the IRA will
be treated as if they were distributed as of January 1 of the year in which the IRA was disqualified. IRC § 408(e)(2).
It is a prohibited transaction for the owner or beneficiary to enter into a transaction with the IRA that constitutes a
direct or indirect:
a. Sale or exchange, or leasing, of any property;
b. Lending of money or other extension of credit;
c. Furnishing of goods, services, or facilities;
d. Transfer of any assets of the IRA to or for the use of an Owner, beneficiary, family member or other
e. Dealing with the income or assets of the IRA by an Owner, beneficiary, family member or other
disqualified person for his/her own account; or
f. Receipt of consideration for his/her own account by an Owner, beneficiary, family member or other
disqualified person in connection with a transaction involving the income or assets of the IRA.
2. Some Examples. It is a prohibited transaction if:
a. An Owner or beneficiary invests his or her IRA in companies that he or she owns;
b. An Owner or beneficiary lends his or her IRA funds to himself or herself or to a family member;
c. An Owner or beneficiary buys a family vacation home with assets of his or her IRA; or
d. An Owner or beneficiary swaps personal assets for IRA assets.
D. Pledge for Loan. If an Owner uses an IRA as security for a loan, the portion so pledged is treated as distributed to the
Owner. IRC 408(e)(4).
E. No QDROs. Qualified Domestic Relations Orders ("QDROs") do not apply to IRAs. However, IRAs may be
transferred tax-free to a spouse incident to a divorce. IRC § 408(d)(6).
F. No ERISA. IRAs are not subject to the Employee Retirement Income Security Act (ERISA) unless the IRA is part of
an employer sponsored plan.
G. Creditors' Rights.
1. State Law. State law will usually apply to determine creditors' rights to reach the IRA assets. Although IRAs are
required to be nonforfeitable under IRC § 408, some state laws allow creditors to attach an IRA of a debtor. Some
state laws exempt IRAs qualified under IRC § 408. Roth IRAs are created under IRC § 408A. Query: Are they
covered under the exemption?
2. Federal Preemption. ERISA preempts state law. Creditors cannot reach a debtor's interest in a Qualified Plan
subject to ERISA. Patterson v. Shumate, 112 S. Ct. 2242 (1992). There is no general federal preemption as to IRAs.
3. Spendthrift Clauses. Many IRAs include a spendthrift clause. Query: In the case of a spendthrift clause, which law
applies? The governing law of the IRA or the law of the Owner's domicile?
H. No Spousal Rights. A spouse has no right to an annuity from an IRA nor to be named beneficiary of an IRA under
federal law. Anyone can be named beneficiary. On the other hand, under a Qualified Plan, a spouse must be the
beneficiary of a part or all of a qualified Plan (depending on the kind of Qualified Plan) unless he or she has otherwise
consented in writing and that consent has either been notarized or has been witnessed by a representative of the Qualified
I. Limit on Rollovers. An Owner can withdraw funds from a single IRA and rollover the funds tax-free only once in a
one year period. IRC § 408(d)(3)(B). There is no limit on the number of trustee-to-trustee transfers.
J. No Limit on Number. There is no limit on the number of separate IRAs an Owner may establish.
K. Income Averaging. The special 5-year and 10-year income averaging and capital gains taxation available to certain
distributions from a Qualified Plan are not available for distributions from IRAs. IRC § 402(d)(4)(A).
L. Net Unrealized Appreciation. Employer stock purchased with after-tax employee contributions and employer stock
purchased with employer contributions and distributed as a lump sum distribution from a Qualified Plan is not taxed on its
net unrealized appreciation until the stock is sold. IRC § 402(e)(4). It is taxed upon distribution from an IRA.
M. Withholding Tax. The 20% withholding tax on distributions does not apply to distributions from IRAs. IRC § 3405
(c)(1) and (2).
N. The Trustee-to-Trustee Transfer. Can a Nonspousal Beneficiary Transfer an Account to Another Trustee or
Custodian? Yes. Simply open an account for a decedent!
1. A nonspousal beneficiary of an inherited IRA may transfer the decedent's IRA without tax and without losing the
tax-deferred status of the IRA as long as the transfer is a direct transfer between trustees or custodians. Such a
transfer is considered neither a distribution nor a rollover. The transferred IRA must remain in the name of the
deceased original owner even though the beneficiary receives the payments. Ltr Rul 9504045, Nov. 4, 1994; Ltr Rul
9433032, May 28, 1994; Ltr Rul 9305025, Nov. 12, 1992; Ltr Rul 9250040, Sept. 16, 1992.
2. After a trustee-to-trustee transfer of an inherited IRA, the beneficiary was entitled to distributions over the life of
the Designated Beneficiary as an exception to the Five-Year Rule. Ltr Ruls 9623037, 9623038, 9623039, 9623040,
Mar. 11, 1996; Ltr Rul 9504045, Nov. 2, 1994.
3. A surviving spouse died at age 74 naming her three sons as beneficiaries of her Rollover IRA. At the time of her
death, she was receiving MRDs over her and the oldest son's lifetimes. The IRS approved dividing the IRA into
three equal subaccounts, one for each son, all titled in the spouse's name. Each son could transfer his subaccount
from one trustee or custodian to another. The IRS ruled that the mere segregation of beneficiaries' interests in an
IRA into separate subaccounts does not affect the qualification of the IRA. Furthermore, although a nonspouse
beneficiary cannot roll over an inherited IRA, the beneficiary is not barred from moving the subaccount from one
trustee or custodian to another. Ltr Ruls 9810031, 9810032 and 9810033, Dec. 10, 1997.
4. CAVEAT: Finding a trustee or custodian willing to open an account in the name of a decedent may be difficult.
O. Income Tax. An IRA is exempt from income tax other than taxes imposed under the unrelated business income
tax (UBIT) rules.
P. Estate Tax. An IRA is subject to estate tax. Q: Should the probate estate or the IRA beneficiaries pay? Direction
V. CHART 4: COMPARISON OF TRADITIONAL AND ROTH IRAs
Traditional IRA Roth IRA
Annual Rollover Annual Rollover
Age at Which Year in which taxpayer None None None
Contributions Must reaches 70 1/2
Compensation Required Not required Required Not required
Deadline to Create Date tax return due not Within 60 days Date tax return due not Within 60 days of
including extensions of receipt of including extensions receipt of property
(usually April 15) property (usually April 15)
Status Wage Earning Individual Individual Wage earning individual Individual
Non-employed spouse Surviving Non-employed spouse Married couples
who files a joint return spouse who files a joint return filing separately
are not eligible
Amount of Lesser of $2,000 or Eligible rollover Lesser of $2,000 or Eligible rollover
Contributions annual compensation amount annual compensation amount
Non-employed spouse Non-employed spouse
may also contribute up to may also contribute upt o
$2,000 per year $2,000 per year
Form of Cash Same property Cash Same property as
Contributions as received received
Maximum $2,000 per year Not deductible Not deductible Not deductible
Traditional IRA Roth IRA
AGI Requirements • None, although • To contribute to annual Roth IRA, taxpayer must have AGI
deductibility is below $95,000 (single) and $150,000 (joint). Reduced
determined based on contributions allowed when AGI is $95,000 - $110,000 (single),
AGI $150,000 - $160,000 (joint) or $10,000 married filing separately
• To convert or rollover a Traditional IRA to a Roth IRA, a
taxpayer's (single or joint) AGI must not exceed $100,000
• Married taxpayer filing separately cannot rollover or convert to a
MRDs • Yes. If owner dies • No, during owner's lifetime
before RBD, subject to
Five-Year Rule • Yes, after owner's death, subject to the Five-Year Rule
• Yes. If owner dies after
RBD, subject to At Least
As Rapidly Rule
Accumulation of • Accumulate Tax Free • Accumulate Tax Free
• Tax DEFERRED • Tax FREE Growth
Tax-Free • None • Yes, but withdrawal is subject to penalties if made before the end
Distribution of of the 5-taxable-year period and withdrawal would have been
Principal? subject to penalties if not rolled over or converted to an IRA
Tax Free • None Distribution must satisfy 5-taxable-year period and must be for:
Earnings? • Attainment of age 59½ or later
• Permanent disability
• Qualified first-time home purchase ($10,000 lifetime cap)
10% Penalty-free • Attainment of age 59½ • Same
distribution events and later
• Permanent disability
• Series of substantially
equal periodic payments
• Qualified education
• Qualified first-time
home purchase ($10,000
• Medical Expenses
under IRC § 213
Traditional IRA Roth IRA
Annual Rollover Annual Rollover or Conversion
Appeal? CURRENT POSTPONE TAX SAVE NOW LOWER BRACKET NOW
• A Qualified Plan • A child who wants (a child whose • Taxpayer who expects to be in
• A child who wants (a distributee who wants to parents want him/her) to start saving the same or higher tax bracket
child whose parents want postpone tax or who early and doesn't want or need a later when funds will be
him/her) to start saving wants to rollover a deduction. withdrawn
early and wants a distribution to a Roth
deduction now IRA
LOWER BRACKET NOW LITTLE TAXES
• A taxpayer who prefers
a current deduction and is STRETCH-OUT • A taxpayer who doesn't want a • Taxpayer with little income
in higher tax bracket now current deduction and is in a lower taxes due because of the rollover
than when funds will be • A surviving spouse tax bracket now than when funds will or conversion
withdrawn who wants a Stretch-Out be withdrawn
THE ONLY GAME RETIREMENT
MORE OPTIONS • Taxpayer with separate funds
• A high income taxpayer • A taxpayer who has no other to pay income taxes because of
for whom a • A retiree who wants retirement plan or wants to rollover or conversion or who
nondeductible IRA is the more distribution options supplement a retirement plan has carryforward deductions or
only annual IRA credits
CONDUIT NONDEDUCTIBLE OK
• A taxpayer age 70½ and CUSTOMIZE
• An employee between • A taxpayer who was making
jobs who wants a conduit nondeductible contributions to a • A taxpayer who wants a
IRA Traditional IRA and who prefers a customized IRA which controls
Roth IRA which allows withdrawal of distributions
earnings which are not taxable
• A taxpayer who wants
a customized IRA which • Taxpayer with no plans to
controls distributions withdraw
• Young taxpayer with lots of
CORRECT A MISTAKE
• Taxpayer who wants to correct
a mistake and/or who wants to
name a new designated
beneficiary after such taxpayer's
• Taxpayer who wants to leave a
full exemption equivalent which
is not IRD to the beneficiaries
GIFT AT DEATH
• Taxpayer who wants to name
children or grandchildren as
beneficiaries now and who
intends never to withdraw from
the IRA during life
VI. THE FORMS: DEFAULT PROVISIONS
A. Lack of Uniformity. IRAs are not uniform. ASSUME NOTHING. If you want to be in control, you need to read
the IRA agreement. For example, the default provisions for recalculation of life expectancy will differ from IRA to
IRA. The distribution provisions will differ from IRA to IRA.
B. Calculating the MRD. All IRAs agree on one principle: the owner or beneficiary (not the IRA sponsor) is
responsible for calculating the MRD and for requesting a distribution. The owner or beneficiary must pay the 50%
excise tax for failure to withdraw all or a part of an MRD. IRC § 4974(a). On the other hand, the plan administrator
is responsible for calculating MRDs from a Qualified Plan and the employer must pay the 50% excise tax on behalf
of the participant under some circumstances. Rev. Proc. 94-62, IRB 1994-39, 11, Sep. 26, 1994.
C. No Help. Most IRAs are provided at "no cost" by banks, mutual funds, brokerage companies and insurance
companies who make their profits on the investments. "No cost" can translate into "no help." Most fund or company
representatives don't have the slightest idea about MRDs, either what they are or how to calculate them. Most also
don't care whether or not a beneficiary is named. The default provisions will control.
D. No Election Forms. Many IRAs don't offer election forms for recalculating life expectancy. The default
provisions control if the owner fails to elect otherwise.
E. Customizing IRAs. At least one attorney recommends customizing IRAs by creating customized beneficiary
designations to be used with the usual IRA forms. These beneficiary designations deal with issues such as:
disability or incompetence of the owner; distribution directions; recalculation of life expectancy issues; investment
control; individuals as Trust Advisors to the IRA trustee or custodian; QTIP Trusts and the definition of income and
tax clauses. See "The Need For and Use of Customized IRAs, Parts I & II," by Mervin M. Wilf, Estate Planner's
Alert, Research Institute of America Group, April 8, 1997 and May 6, 1997.
F. IRS Forms.
1. Traditional IRAs. Form 5305 creates an IRA Trust. Form 5305-A creates an IRA Custodial Account. Forms
5305 and 5305-A were revised to reflect the rules regarding MRDs. Forms that are dated before October 1992
cannot be used to establish new IRAs.
NOTE: Some IRAs do not use Forms 5305 or 5305-A. Some may have been submitted to and approved by
the IRS. Others may not have been submitted to the IRS. A favorable determination letter from the IRS is not
required to obtain favorable tax treatment.
2. Roth IRAs. Form 5305-R creates a Roth Individual Retirement Account Trust. Form 5305-RA creates a Roth
Individual Retirement Account Custodial Account. Form 5305-RB creates a Roth Individual Retirement
3. What You Will Find
CHART 6: A SAMPLE OF TRADITIONAL IRAS
I. II. III. IV. V. VI.
IRAs Recalculation of Life What if surviving Applicable law Recipient if Available Forms of
Expectancy for Owner3 spous makes no (if federal law Beneficiary Distribution5 to the Owner
and Spouse election re not applicable) Dies before
options? Spendthrift Distribution Other Comments
1. Dain 4.02 Unless otherwise Silent Minnesota As Depositor S, I, A, C
Rauscher elected, life expectancies directs, or, if no
Incorporated are recalculated 8.3.05. Yes direction, to Sub-accounts required for
Unless the Custodian (or beneficiary's separate beneficiaries after
Form 5305- the Depositor, if the estate Depositor's death
A 1/98 Custodian permits) elects
expectancies are not Custodian will recognize
Custodial recalculated disclaimers
*CHANGE: was "may be Spousal consent required to
recalculated"! beneficiary designation unless
Agreement applies without
regard to community property
2. Dean Witter If no election, life If spouse fails to New York Silent except S, I, A, C
Reynolds Inc. expectancy is not elect any other surviving
recalculated provision or fails to spouse can Beneficiary can accelerate
take MRDs as Yes designate
Will be payments
submitted to IRS beneficiary, spouse beneficiary
for approval deemed to elect to
treat IRA as own QTIP provisions
Beneficiary may disclaim
Spousal consent required to
beneficiary designation in
community property state
3. Dreyfus IRA If no election, life If spouse fails to New York Silent S, I, A
expectancy is not elect any other
Will be recalculated provision or fails to Yes
submitted to IRS take MRDs as
for approval beneficiary, spouse
12/97 deemed to elect to
treat IRA as own
4. Fidelity Unless otherwise elected, Silent Mass. As Depositor S, I, A, C
Brokerage IRA life expectancies are directs, or, if no
recalculated Yes direction to
If a trust for a surviving spouse
Form 5305-A beneficiary's
is the beneficiary (such as a
QTIP or QDOT), all income of
Account must be paid to
Custodial Acct. spousal trust annually or more
frequently and no person has
the power to appoint any part of
the account to any person other
than the Spousal Trust
5. Franklin Unless otherwise elected, Silent California Silent S, I, C
Templeton life expectancies are
recalculated Silent Agreement applies without
Form 5305-A regard to community property
6. Invesco Unless otherwise elected, Silent Colorado Silent S, I, A
Funds life expectancies will not
be recalculated Silent
7. Janus Unless otherwise elected, Silent Missouri Beneficiary's S, I, A
Universal IRA life expectancies are not estate
2/98 *CHANGE: was "are
8. Merrill Lynch Unless otherwise elected, Silent New York Silent S, I, A, C
life expectancies are
Will be recalculated Yes Beneficiaries have all the
submitted to IRS distribution rights of the
for approval *CHANGE: was "may be Depositor
Agreement applies without
Custodial Acct. regard to community property
laws but written statement
needed if payment made to
spouse and not to named
Divorce or annulment cancels
designation of spouse as
beneficiary unless decree or
later designation provides
9. Schwab IRA Can elect not to recalculate If no election, California Silent S, I, C
life expectancies single payment to
IRS approved spouse by Dec. 31 Yes Equal or substantially equal
10/91 of calendar year payments at intervals we
containing the 5th determine
Custodial Acct. Depositor's death
10. Unless otherwise elected, If required amounts New York Silent S, I, C
SmithBarney life expectancies are are not distributed
recalculated within required time Yes Sub-accounts required for
IRS approved period, spouse separate beneficiaries after
12/96 deemed to elect to Grantor's death
treat IRA as own
Custodial Acct. If Marital Trust ("MT") is
beneficiary, the entire account
must be distributed to the MT
on death of surviving spouse
11. T. Rowe Unless otherwise elected, Silent Silent Silent S, I, C
Price IRA life expectancies are not
8/2/93 *CHANGE: was "may be
12. Vanguard Unless otherwise elected, If spouse fails to Pennsylvania Silent S, I, C
life expectancies are elect any other
IRS approved recalculated provisions or fails Yes
1/98 to take MRDs as a
deemed to elect to
Custodial Acct. treat IRA as own
* CHANGE means default provisions were changed from author's previous review of the form.
3 Owner means Grantor or Depositor
4 Some spendthrift clauses have exceptions for Qualified Domestic Relations Orders or "except to the extent as may be required by law."
5 Distributions: "S" means Single Sum Payment; "I" means Installment Payments, "A" means Annuity Payments; "C" means
combination of payments.
CHART 7: ROTH IRAs
I. II. III. IV. V. VI.
IRAs Recalculation of What If Surviving Applicable Recipient if Available Forms of
Life Expectancy Spouse is Sole Law (if Beneficiary Distributions to the
for Spouse Beneficiary? federal law Dies before Owner7
applicable) Distribution Other Comments
1. Dean Witter Life expectancy of If spouse fails to elect any New York Silent, except Five-Year Rule and
Reynolds Inc. beneficiary is not other provisions of rails to surviving spouse Exceptions
recalculated take MRDs as a Yes can designate
Will be submitted beneficiary, spouse deemed beneficiary S, I, A, C
to IRS for to elect to treat IRA as own
approval 1/98 Beneficiary can
Account> Beneficiary may disclaim
Spousal content required
to beneficiary designation
in community property
2. Dreyfus IRA Unless otherwise Spouse may elect to treat New York Silent Five-Year Rule and
elected, life account as own Exceptions
Will be submitted expectancy of Yes
to IRS for beneficiary is
approval 12/97 notrecalculated
3. Fidelity Life expectancy of Spouse is treated as Massachusetts As Depositor Five-Year Rule and
Brokerage IRA beneficiary is not Depositor directs, or, if no Exceptions
recalculated Yes direction to
Will be submitted beneficiary's Rollover contributions
to IRS for estate from other Roth IRAs are
approval 12/97 distinguished from
Custodial from an IRA other than a
Account Roth IRA
4. Franklin Life expectancy of Spouse treated as Depositor California Silent Five-Year Rule and
Templeton beneficiary is not Exceptions
Form Agreement applies
5305RA 2/98 without regard to
community property laws
5. Invesco Silent Spouse may elect to treat Law of Silent S, I, A, C
Funds account as own Custodian's
domicile Five-Year Rule and
Custodial If no election, payable to
Account surviving spouse over life
or life expectancy and to
other beneficiaries within
6. Janus Life expectancy of Spouse treated as depositor Missouri Beneficiary's Five-Year Rule and
Universal IRA beneficiary is not Estate Exceptions
7. Merrill Lynch Unless otherwise Spouse may elect to treat New York Silent Five-Year Rule and
elected, life account as own Exceptions
Will be submitted expectancy of Yes
to IRS for spouse is S, I, A, C
approval 1/98 recalculated
Beneficiaries have all the
Custodial distribution rights of the
without regard to
community property laws
but written statement
needed if payment made
to spouse and not to
Divorce or annulment
cancels designation of
spouse as beneficiary
unless decree or later
8. SmithBarney Unless otherwise If required amounts are not New York Silent Five-Year Rule and
elected, life distributed within required Exceptions
Has been expectancy of time period, spouse Yes
submitted to IRS spouse is deemed to elect to treat
for approval recalculated IRA as own
9. T. Rowe Price Life expectancy of Silent Maryland Silent Five-Year Rule and
beneficiary is not Exceptions
Not IRS recalculated Silent
approved 1/98 or
Custodial At Least as rapidly Rule
10. Vanguard Life expectancy of Art V: Spouse is treated as Pennsylvania Silent Five-Year Rule and
beneficiary is not Depositor Exceptions
Not IRS recalculated Yes
Approved 1/98 Section 9: If spouse fails to
elect any other provisions
or fails to take MRDs as a
Custodial beneficiary, spouse deemed
Account to elect to treat IRA as own
6 Some spendthrift clauses have exceptions for Qualified Domestic Relations Orders or "except to the exten as may be required by law."
7 Distributions: "S" means Single Sum Payment; "I" means Installment Payments; "A" means Annuity Payments; "C" means
combination of payments.
VII. SEP-IRAs and SIMPLE IRAs
A. What are They?
1. The SEP-IRA. The SEP-IRA is a Simplified Employee Pension Plan established pursuant to IRC § 408(k).
The Employer makes contributions to Traditional IRAs which are established and maintained by eligible
Employees. The Employer's contributions must be allocated on a nondiscriminatory basis. SAR-SEPs or
salary reduction SEPs allow employees to make salary reduction contributions. They may not be established
after December 31, 1996 so they are not considered here.
2. The SIMPLE IRA. The SIMPLE IRA is a Savings Incentive Match Plan for Employees established pursuant
to IRC § 408(p) . The Plan requires the Employer to make contributions to Employees' IRAs and allows
Employees to make salary reduction contributions. A similar kind of plan allows contributions to a 401(k)
Trust. Only the IRA form of plan is considered here.
1. SEP-IRAs. Form 5305-SEP creates a Simplified Employee Pension.
2. SIMPLE IRAs. Form 5305-SA creates a SIMPLE Individual Retirement Custodial Account. Form 5305-S
creates a SIMPLE Individual Retirement Trust Account. Form 5305-Simple creates a Savings Incentive
Match Plan Account.
C. A Comparison
CHART 8: A COMPARISON OF SEP-IRAs AND SIMPLE IRAs
SEP-IRA SIMPLE IRA
1. Who can • Corporation: "C" or "S" • Corporation: "C" or "S"
• Partnership • Partnership
• Self-Employed individual • Self-Employed individual
• Nonprofit organization • Nonprofit organization
• Business must have 100 or fewer employees in
the preceding year who earned at least $5,000 in
• Business may not maintain any other qualified
retirement plan unless it is for collectively
2. Elegibility to • Must include all employees over age • Must include any employee who earned $5,000
participate 21 who have worked for employer for or more during any two preceding years and is
any part of three of last five calendar expected to earn $5,000 or more in the current
• May exclude employees earning less • No age limit: Eligible employee includes an
than $400 in the current year. employee over age 70½
• No age limit: Eligible employee • May exclude union employees and certain
includes an employee over age 70½ nonresident aliens
• May exclude union employees and
certain nonresident aliens
3. Employer • Employer can make voluntary • Employer must make an annual contribution
Contributions, contributions which are allocated as a equal to: (1) a dollar-for-dollar matching
Limitations and percent of compensation. contribution up to 3% of an eligible employee's
Vesting compensation (can be lowered to 1% in two out of
• Employer can change or discontinue five years), or (2) a nonelective, nonmatching
contributions each year. contribution of 2% of compensation for each
• If the Plan is Top-Heavy (i.e. 60% of
aggregate contributions are made for • Contributions cannot exceed the 3% matching or
Key Employees), employer must make 2% nonmatching contribution.
a contribution of up to 3% of
compensation to all non-key employee • Employer contributions are deductible.
• 100% vested
• Employer deduction cannot exceed
15% of the eligible participants'
• Contribution cannot exceed the lesser
of 15% of an eligible participant's
compensation or $30,000 (reduced to
$24,000 in 1998 because of $160,000
limitation on compensation)
• 100% vested
4. Discrimination • Not required • Not required
5. Employee • None • Employee salary reduction contributions cannot
Contributions exceed $6,000 as adjusted for cost-of-living.
Contributions are deductible.
6. Timing to • Must be established and contributions • Must be established and employer contributions
Create must be made by the due date of must be made by due date of employer's tax return,
employer's tax return, including including extensions.
• Employee salary reduction contributions must be
taken out of current compensation during the tax
7. Earnings • Not taxed until withdrawn. • Not taxed until withdrawn.
8. Withdrawals • Distributions are taxable as ordinary • Distributions are taxable as ordinary income.
• 25% penalty applies to withdrawals before two
• 10% penalty applies to withdrawals years' participation; 10% rules apply after.
before age 59½ unless certain
exceptions apply. • Penalty-free distributions for:
• Penalty-free distributions for: • Attainment of age 59½ and later
• Attainment of age 59½ and • Death
• Permanent disability
• Series of substantially equal periodic
• Permanent disability payments
• Series of substantially equal • Qualified education expenses
• Qualified first-time home purchase
• Qualified education expenses ($10,000 lifetime cap)
• Qualified first-time home • Medical expenses under IRC § 213
purchase ($10,000 lifetime cap)
• Tax-free rollover or transfer to a Traditional IRA
• Medical expenses under IRC § is permitted only after two years of participation in
213 the SIMPLE IRA.
• Minimum required distribution based • Minimum required distribution based on life
on life expectancy. Must begin by expectancy. Must begin by April 1 of the year
April 1 of the year following the year following the year in which the employee attains
in which the employee attains age 70½ age 70½ even if the employee has not retired.
even if the employee has not retired.
9. Loans • None allowed. • None allowed.
10. Reporting and • Minimal: No IRS or DOL reporting. • Minimal: No IRS or DOL reporting. Employer
Disclosure Employer fills out SEP agreement and fills out SIMPLE agreement.
gives copy to employee when
employee becomes eligible. • Employee fills out salary reduction form.
11. Other IRA • Yes, up to $2,000 a year. • Yes, up to $2,000 a year.
12. Appeal? • Small business owner who wants • Small business owner with 100 or fewer eligible
simplicity and a retirement plan for employees who wants an alternative to a 401(k)
employees without costly plan and who wants simplicity in a retirement plan
administration. for employees without costly administration.
• Small business owner who wants to • Small business owner who wants to encourage
contribute only if the company can employees to reduce salaries to save for retirement
afford it. and doesn't mind making annual contributions.
• Works well with start-up and small • Self-employed individuals with modest incomes
companies with roller-coaster profits (no employees are required)
and low employee turnover.
• Self-employed individuals with
variable income (no employees
13. Drawbacks • No salary reduction allowed • Maximum contribution is $12,000 per year
($6,000 by employee salary reduction and $6,000
by employer match)
14. Convert to • Yes • Yes, but only after expiration of two years'
Roth IRA? participation
• After conversion, the Roth IRA
ceases to be part of the SEP-IRA • After conversion, the Roth IRA ceases to be part
of the SIMPLE-IRA
VIII. EDUCATION IRAs
A. What are They? An Education IRA is a trust or custodial account created or organized in the U.S. exclusively
for paying "Qualified Higher Education Expenses" of a beneficiary. IRC § 530. The requirements for eligibility as a
trustee or custodian, the prohibition against investment in life insurance and against commingling property are the
same for the Education IRA as for Traditional and Roth IRAs. An Education IRA is not an individual retirement
plan within the meaning of IRC § 7701(a)(37). Amounts contributed to an Education IRA should not be treated as a
contribution to another individual retirement plan maintained for a taxpayer.
B. Forms. Form 5305-EA creates an Education Individual Retirement Custodial Account. Form 5305-E creates
an Education Individual Retirement Trust Account.
C. Beneficiary. The beneficiary must be a life-in-being.
D. Limitations in Contributions.
1. Up to $500 in the Aggregate per Beneficiary. Beginning in 1998, taxpayers can contribute up to $500 in the
aggregate per beneficiary in cash until the beneficiary reaches the age of 18, to an Education IRA.
2. Over $500. Contributions over $500 per beneficiary for a taxable year are subject to the 6% tax on excess
contributions under IRC § 4973(a) for each year that the excess contribution remains in the IRA.
E. Deductibility. Contributions are not deductible.
F. Tax-Free Withdrawals. Withdrawals to pay the cost of a beneficiary's Qualified Higher Education Expenses
are tax-free so long as a HOPE credit or lifetime learning credit is not claimed for the beneficiary for the same tax
year and so long as the withdrawals are made before the beneficiary reaches age 30.
1. "Qualified Higher Education Expenses" mean tuition, fees, books, supplies and equipment required for the
enrollment or attendance of a designated beneficiary at an eligible educational institution. IRC §§ 529(e)(3)
(A) and 530(b)(2)(A). Qualified higher education expenses include expenses for undergraduate or graduate-
level courses, and generally include only out-of-pocket costs. For a beneficiary who is an eligible student, the
term also includes reasonable costs incurred for room and board expenses while attending the educational
institution. IRC §§ 529(e)(3)(A) and 530(b)(2)(A).
2. To be an "eligible student," a beneficiary must be at least a half-time student in a degree or certificate
undergraduate or graduate program at an eligible institution.
3. An "eligible educational institution" generally is an accredited post-secondary educational institution offering
credit toward a bachelor's degree, an associate's degree, a graduate-level or professional degree, or another
recognized post-secondary credential.
G. Annual Exclusion. For federal estate and gift tax purposes, contributions to an education savings account are
eligible for the $10,000 per donor annual gift tax exclusion.
1. Not Taxable. Earnings on contributions are not taxable until distribution, .unless the UBIT rules apply.
2. 10% Additional Tax. Any earnings from an Education IRA distribution that are not used to pay a
beneficiary's education expenses prior to the beneficiary's 30th birthday are included in the distributee's gross
income and subject to a 10% additional income tax.
3. Exceptions. There are some exceptions to the 10% additional tax if the beneficiary is deceased, disabled or
receives a scholarship, allowance or other payment or if distribution of a contribution is made on or before
the due date of the beneficiary's return including extensions.
4. Distributions. Distributions from Education IRAs are treated as representing a pro rata share of contributions
and earnings in the account pursuant to IRC § 72.
I. Rollover. Account balances may be rolled over tax-free from an Education IRA benefitting one family member
to an Education IRA benefitting another family member without triggering taxes or penalties.
1. Different Generations. If the beneficiaries are not of the same generation, $50,000 of the transferred amount
is exempt from gift and generation-skipping transfer taxes.
2. Same Generations. Transfers within the same generation are exempt from gift tax. IRC § 530(d)(3).
3. Includible in Gross Estate. The value of any interest in an Education IRA is includable in the estate of a
J. Eligibility of Donor. Eligibility is phased out for donors who are single taxpayers with modified adjusted gross
income between $95,000 and $110,000 and for married taxpayers with modified adjusted gross income between
$150,000 and $160,000. IRC § 530(b)(1)(A)(iii) and (c).
1. IT'S COMPLICATED: Modified AGI applies per donor, $500 limitation applies per beneficiary and the 6%
penalty applies per beneficiary. Q: Who pays the penalty?
2. In each tax year, taxpayers can opt either to take the Lifetime Learning Credit (20% tax credit for up to
$5,000 per year for qualified tuition and related expenses) or the Hope Tax Credit (100% credit for first
$1,000 of qualified tuition and related expenses and a 50% credit for next $1,000 of eligible expenses up to
$1,500 a year) or tax-free distributions from an Education IRA. Probably, it will be a long time before
Education IRAs accumulate enough earnings to make them preferable. However, if a donor contributed $500
a year from the date a child was born to the child's 18th birthday, the Education IRA (assuming nothing is
spent) would be worth:
Growth Rate Value at 18th Birthday Value at 29th Birthday
6% $16,878 $32,039
8% $20,721 $48, 314
10% $25,581 $72,986
3. If the beneficiary waives the rule to exclude earnings from gross income, the grantor of the Education IRA
may claim a HOPE Scholarship Credit or Lifetime Learning Credit during that year. IRC §§ 25A(e)(2) and
530(d)(2)(C). The waiver can be made without the 10% additional tax.
L. Investment. Assets may not be invested in life insurance contracts. Assets may not be commingled with other
property except in a common trust fund or common investment fund. IRC § 530(b)(1)(A)-(E).
M. Limitations. A taxpayer cannot make contributions on behalf of a beneficiary both to an Education IRA and a
state tuition program under IRC § 529(b) in the same tax year. (IRC § 530).
N. Termination. Any balance remaining in an Education IRA is deemed distributed within 30 days after the
beneficiary reaches age 30 or dies, whichever is earlier. On death, the surviving spouse or family member who
acquires the beneficiary's interest in the Education IRA is treated as the beneficiary.
O. No Rollover. An amount transferred from an Education IRA may not be rolled over to a Roth IRA. Prop Reg
§ 1.408-A-6, Q&A 18.
IX. SOME CONCLUSIONS
A. In General. IRAs don't require costly administration for the owner. They beat Qualified Plans when it comes
to ease of administration. No 5500's and no discrimination tests are required.
B. Traditional and Roth IRAs
1. Start Early. A little goes a long way when it compounds tax free and can be withdrawn tax free. Annual Roth
IRAs for children and grandchildren are attractive. All you need is an employer. Dad? Mom? Grandpa?
Grandma? Traditional IRAs make sense if the taxpayer wants a deduction now.
2. Low Tax Brackets. Lower tax brackets at time of withdrawal favor Traditional IRAs. Aren't most retirees
likely to be in lower tax brackets? Is the rollover/conversion to a Roth IRA just a revenue raiser designed to
collect taxes early? A retiree who needs the funds probably should not rollover or convert to a Roth IRA.
3. No Need. Taxpayers who don't need the funds, who can control their AGI and limit it to $100,000 or less can
convert a portion or all their Traditional IRAs to Roth IRAs, allow the funds to grow tax free and provide a
wonderful inheritance to their children and issue without IRD consequences. The rollover/conversion Roth
IRA is an excellent vehicle to accumulate funds to pass to beneficiaries at your death if you qualify for it.
C. SEP-IRAs/SIMPLE IRAs
Easy to establish for the employer. Q: Are the benefits enough?
D. Education IRA
Requires close monitoring regarding contributions. Q: Is it worth it? Could be.