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Traditional Individual Retirement Accounts

For 2001 and 2002

Did a recent federal tax bill contain some favorable IRA law changes?
Yes. President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) on June 7, 2001. The Act allows you and other taxpayers to make larger traditional IRA contributions which in turn will allow you to accumulate more funds for your retirement years.

What is the purpose of this brochure?
It summarizes the primary laws which govern traditional IRAs.

What is a traditional Individual Retirement Account (traditional IRA)?
A traditional IRA is a special tax-deferred savings account authorized by Internal Revenue Code section 408. It is a unique and simple way to encourage people to save money for retirement. This brochure discusses the features of the traditional IRA. Other brochures discuss the features of the Roth IRA, Coverdell Education Savings Accounts, SEP-IRA and the SIMPLE-IRA.

What are the tax benefits realized from a traditional IRA?
Generally you may add up to $2,000 of earned income to your IRA account each year and have it be either fully or partially tax deductible (see Deductibility Chart). If your contribution is tax deductible, then you receive two tax benefits: 1) an immediate tax savings because you will pay fewer taxes because of the deduction and 2) the earnings generated by the IRA funds are not taxed until distributed. If your contribution is not tax deductible, you still receive the tax benefit of tax deferral on the IRA’s earnings. You may also qualify for a new tax credit.

THE CONTRIBUTION RULES

When do I have to establish the traditional IRA?
You have until the due date (without extensions) for filing your federal income tax return, normally April 15, to establish and fund your traditional IRA for the previous tax year.

Am I eligible to contribute to a traditional IRA?
You are eligible for a regular contribution if you do not reach age 70 1/2 in the calendar year for which you wish to make the contribution, and you have compensation (income earned from performing material personal services). You may also qualify for a rollover or a transfer contribution.

How much can I contribute to my traditional IRA for the 2001 tax year?
You are eligible to contribute the lesser of 100% of your compensation, or $2,000, as reduced by any amount you contributed to your Roth IRA for the same tax year.

How much am I eligible to contribute to my traditional IRA for the 2002 tax year if I will NOT be at least age 50 as of December 31, 2002?
You are eligible to contribute the lesser of 100% of your compensation, or $3,000, as reduced by any amount you contributed to your Roth IRA for the same tax year.

How much am I eligible to contribute to my traditional IRA for the 2002 tax year if I will be at least age 50 as of December 31, 2002?
You are eligible to contribute the lesser of 100% of your compensation, or $3,500, as reduced by any amount you contributed to your traditional IRA for the same tax year.

For tax year 2001, may I contribute to my traditional IRA and also my Roth IRA?
Yes, but there is a combined limit of $2,000.

For tax years 2002-2004, may I contribute to my traditional IRA and also my Roth IRA?
Yes, but there is a combined limit of $3,000 (if not age 50 or older) or $3,500 (if age 50 or over). What are the contribution limits for a person who is not age 50 or older?

What are the contribution limits for a person who is not age 50 or older?

May my spouse or I use the spousal IRA contribution rules to make a contribution to our respective traditional IRA for the 2001 and/or 2002 tax year?
Yes. You (or your spouse) will be eligible to make a spousal contribution to a traditional IRA if the following rules are satisfied:

• You and your spouse must each have your own traditional IRA.
• You must be married as of the end of the tax year (i.e. December 31).
• You must file a joint income tax return.
• You must have compensation includible in gross income which is less than that of your spouse.

Your annual traditional IRA contribution will be limited to the lesser of (1) $2,000, $3,000 or $3,500, as applicable; or (2) the sum of your compensation which is includible in gross income for such year plus the compensation of your spouse as reduced by your spouse’s contribution to his or her own traditional IRA and Roth IRA. In addition, when your Roth IRA contribution is aggregated with your traditional IRA contributions and with the contributions of your spouse, the maximum permissible amount for all IRAs will be the lesser of $4,000, $6,000, $6,500 or $7,000, as applicable, or 100% of your combined incomes.

Does EGTRRA contain a Sunset provision?
Yes. The changes made by EGTRRA shall not apply to any tax year, plan year, or limitation year after December 31, 2010, or to the estates of individuals dying, gifts made, or generation-skipping transfers after December 31, 2010. Thus, the law which existed prior to EGTRRA will again be the law. For example, the IRA contribution limit will again be $2,000 for 2011.

How do the larger contribution limits impact a person who is only age 20 in the year 2002?
A person will receive the larger standard contribution limits (i.e. $3,000, $4,000 and $5,000) for the first 30 years, and then will receive the 50+ contribution limits for the next 21 years. The chart below shows that $1,098,186 will be accumulated under the EGTRRA contribution limits as compared to $463,712 if the contribution limit had remained at $2,000. This difference of $634,474 is very substantial. Of this amount, $165,000 is due to the increase in the contribution limits and the remainder is due to accumulated earnings. For purposes of preparing this chart, it has been assumed that the Sunset provision will not go into effect and the IRA earns 5% per year.

What will be the result if I am age 50 in 2002, and I elect to contribute the maximum amount permitted by EGTRRA to a traditional IRA?
The following chart shows how a person’s IRA balance will be larger with the new contribution limits than with the $2,000 limit, and how the IRA balance will be larger for a 50+ person than for a person younger than age 50. The following assumptions apply to the preparation of this chart: (1) the contribution amount is deposited January 1 of each year (2) interest of 5% is compounded and paid annually on December 31 (3) the maximum allowable contribution is made under EGTRRA, and (4) the contribution limits will remain the same and the sunset rules will not go into effect in 2011.

Should I take advantage of these higher contribution limits even if they are in effect for only 9 years?
Definitely. Because there is no certainty that the higher contribution limits will be available after December 31, 2010, you will want to be sure to use the higher contribution limits when you can. This is true whether you are age 20 or age 50. You may not get this chance again. The following two charts illustrate the increase in the account balances over the period of 2002-2022 if you, as either a person age 20 or as a person aged 50, make the higher contributions limits for 2002-2010 versus not making such contributions (i.e. only contribute $2,000).

To what extent will I be entitled to a tax deduction for my IRA contribution?
The answer depends upon your filing status, whether or not you and/or your spouse is covered by an employer sponsored retirement plan at work, and your modified adjusted gross income (AGI). The amount you can deduct, for tax year 2001, in general, is $2,000 as reduced by the amount you cannot deduct. The amount you can deduct for tax year 2002 is $3,000 or $3,500, as applicable as reduced by the amount you cannot deduct.

• If you are single and you are not covered under an employer-sponsored retirement plan, then you are entitled to a full deduction to the extent of your contributions, regardless of your income.
• If you are married and neither you nor your spouse is covered under an employer-sponsored retirement plan, then you are entitled to a full deduction to the extent of your contributions, regardless of your income.
• If you are single and you are covered under an employer-sponsored retirement plan, or if you are married and either you or your spouse is covered under an employer-sponsored retirement plan, then you will be entitled to only a partial deduction or no deduction, as summarized in the following chart.
• If you are a married person who is not covered by a pension plan at work, you may well be entitled to deduct your IRA contribution even though your spouse is covered by a pension plan. See the “married - joint return, but only your spouse is covered” section of the chart.

Can I make nondeductible contributions?
Yes. You may make nondeductible contributions either because you are not eligible for a deduction or because you want them to be nondeductible. You would wish to do this if you would receive no tax benefit from claiming the deduction.

To what extent may I be entitled to a new tax credit for my IRA contributions for the 2002-2006 tax years?
A formula is used to calculate your credit. Your credit may vary from $1 to $1,000, depending on the amount you contribute to your IRA, your filing status and your modified adjusted gross income. If you meet the following requirements for a given tax year, then you will qualify for this new credit:

1. Be at least 18 years of age as of December 31 of such year.
2. Not be a dependent on someone else’s tax return
3. Not be a student as defined in Internal Revenue Code section 25B(c)
4. Have adjusted gross income under certain limits which are based on your filing status:
   • Joint filers - $50,000.01
   • Head-of-Household - $37,500.01
   All other filers (including Married, filing separately) - $25,000.01
5. Must not have received certain distributions which disqualify you from claiming the credit, or certain distributions which were made to your spouse.

Because of the complexity of this credit, you will want to review IRS Publication 590 for a complete explanation.

Am I eligible to roll over or convert part or all of my traditional IRA to a Roth IRA?
Maybe. Only certain people qualify for such a rollover or conversion. This situation presents a new and unique meaning of “rollover.” Normally, there is no taxation when a rollover occurs. This is not the case with this type of rollover. You may find it advantageous to incur the tax consequences of a present distribution in order to qualify to earn the right to have no taxation when the earnings are ultimately distributed from the Roth IRA.

In order to roll over or convert traditional IRA funds to a Roth IRA, you must have adjusted gross income of $100,000 or less in the year of the rollover, and if married, you must file a joint tax return. Special warning: The IRS has stated that they construe the Code section 408A(c)(3)(B) requirement that the taxpayer’s adjusted gross income must not exceed $100,000 to mean that the combined adjusted gross income of persons who are married and who file a joint return must not exceed $100,000.

There are three ways to accomplish a conversion from a traditional IRA to a Roth IRA.

• Method #1. An amount distributed from a traditional IRA is contributed (i.e. rolled over) to a Roth IRA within 60 days of the distribution.
• Method #2. An amount in a traditional IRA is transferred to a Roth IRA maintained by the same custodian or trustee.
• Method #3. An amount in a traditional IRA is transferred in a custodian/trustee-to-custodian/trustee transfer from the custodian/
  trustee of the traditional IRA to the custodian/trustee of the Roth IRA.

Whatever conversion method is used, the custodian/trustee of the traditional IRA will prepare a Form 1099-R to report the distribution, and the custodian/trustee of the Roth IRA will prepare a 5498 to report the conversion contribution.

What are the consequences of receiving a distribution from a traditional IRA and “rolling over” the distribution to a Roth IRA?
In general, the amount distributed to you from your traditional IRA will be included in your income in the year of receipt and will be subject to income taxes for that year. The 10% premature distribution excise tax, however, will not be owed even if you are younger than age 59 1/2.

THE WITHDRAWL RULES

When may I start to withdraw money or assets from my traditional IRA?
You may begin withdrawals at any time. However, you will want to understand the income tax consequences of taking distributions at certain times.

What are the tax consequences of an IRA distribution?
If you have not made any nondeductible contributions, then the distributions will be taxable as ordinary income. However, if you have made both deductible and nondeductible contributions, you will not generally have to pay income tax pro rata on the part of your distribution representing your nondeductible contributions. Consult your tax preparer or see IRS Publication 590. However, withdrawals from your IRA before you reach age 59 1/2 will generally result in an additional tax of 10% of the amount withdrawn. This 10% tax is in addition to the regular income tax on the amount withdrawn.

Are there exceptions to the age 59 1/2 rule?
Yes. You may qualify for an exception if you are in one of the following situations. Refer to IRS Publication 590 for an explanation of the exceptions.

• You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance.
• You are disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving periodic distributions over a term equal to your life expectancy.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a first home.
• The distribution is of contributions returned before the due date of your tax return.
• The distribution is due to an IRS levy.

When am I required to start withdrawing the money in my IRA?
You must make a withdrawal of a minimum amount by April 1 of the year following the calendar year in which you reach age 70 1/2, and by each December 31 thereafter. The minimum amount is calculated using the IRA minimum distribution rules then in effect.

What happens if I fail to withdraw the required minimum distribution?
Current federal income tax law provides a penalty tax of 50% of the amount which was required to be distributed, but which was not. For example, if your required minimum distribution for a year is $900, and you withdrew nothing, you would owe a tax of $450.

Is my IRA insured by the FDIC?
Yes, if you have invested your IRA funds in savings or time deposits as offered by an insured institution. FDIC insurance applies to certain “ deposits” of an insured institution such as saving accounts and time deposits. Some investments, such as mutual funds, stocks, and bonds are not eligible for FDIC insurance coverage. The insured amount for a qualifying depositor with IRAs, Roth IRAs, SEPs, SIMPLEs, self-directed Keogh accounts, 457 plans and certain self-directed employee benefit plan accounts is $100,000. All such accounts must be aggregated. Amounts in excess of $100,000 are not insured. However, separate coverage will apply for your other non-IRA/pension accounts and Coverdell Education Savings Accounts, because such deposits are held in a different right and capacity.

What happens to my IRA when I die?
The funds in your IRA will be paid to your beneficiaries. Depending on various factors, your beneficiaries may have the potential to withdraw the funds over a number of years. You will want to understand the various distribution alternatives available on behalf of your beneficiary(ies). You will want to discuss this subject with your legal or tax advisor.

How do I establish my IRA?
Just come in and talk with us.