11

IRAsCommon Mistakes and

Risks

IRAsCommon Mistakes and

Risks

Judith A. DorianJudith A. Dorian

22

AgendaAgenda

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

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

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Historical BackgroundHistorical Background

Established in ERISA Legislation 1974

Recognition that pension coverage voluntary for employers Some employees without coverage

Encourage personal savings Defined contribution model

Investment risk borne by IRA owner

Established in ERISA Legislation 1974

Recognition that pension coverage voluntary for employers Some employees without coverage

Encourage personal savings Defined contribution model

Investment risk borne by IRA owner

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IRA DocumentationIRA Documentation

Prototype Document Typical Drawn and approved by each

institution Trustee/Custodian Differentiation

Prototype Document Typical Drawn and approved by each

institution Trustee/Custodian Differentiation

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Types of IRAsTypes of IRAs

Traditional/Conventional Deductible Contributions Taxable Distributions Premature withdrawal subject to 10%

penalty Required minimum distributions at

age 70 1/2

Traditional/Conventional Deductible Contributions Taxable Distributions Premature withdrawal subject to 10%

penalty Required minimum distributions at

age 70 1/2

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Types of IRAsTypes of IRAs

Roth After tax contributions Tax free distributions No penalty for early withdrawal No forced distributions

Roth After tax contributions Tax free distributions No penalty for early withdrawal No forced distributions

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Types of IRAsTypes of IRAs

SEP Simplified Employer Plan Established and funded by small

employer for employees

SEP Simplified Employer Plan Established and funded by small

employer for employees

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IRA ContributionsIRA Contributions

Traditional IRA Owner must be younger than 70 1/2 For 2006, lesser of:

$4,000 ($5,000 over 50) OR Owners taxable comp for year

Deductibility subject to limits Must File Form 8606 for non-deductible

contributions

Traditional IRA Owner must be younger than 70 1/2 For 2006, lesser of:

$4,000 ($5,000 over 50) OR Owners taxable comp for year

Deductibility subject to limits Must File Form 8606 for non-deductible

contributions

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IRA ContributionsIRA Contributions

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

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

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Contribution RisksContribution Risks

Contributions must be in cash - except rollover property

Non cash contributions are excess contributionsContributions by others are excess contributions

Trustee/Custodian generally cannot accept excess contributions

Penalty 6% per year until withdrawn IRA owner responsible for penalty

Contributions must be in cash - except rollover property

Non cash contributions are excess contributionsContributions by others are excess contributions

Trustee/Custodian generally cannot accept excess contributions

Penalty 6% per year until withdrawn IRA owner responsible for penalty

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Contribution Risk ControlContribution Risk Control

Ensure that documentation is drawn to place responsibility for monitoring contribution amount on IRA owner instead of financial institution

Ensure that documentation is drawn to place responsibility for monitoring contribution amount on IRA owner instead of financial institution

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IRA InvestmentsIRA Investments

Prohibited Transaction Any improper use of an IRA account by the

IRA owner, beneficiary or any disqualified person

Disqualified Persons IRA Owner IRA Fiduciary Member of IRA owner’s family

Spouse, ancestor, lineal descendant, spouse of linear descendant

Prohibited Transaction Any improper use of an IRA account by the

IRA owner, beneficiary or any disqualified person

Disqualified Persons IRA Owner IRA Fiduciary Member of IRA owner’s family

Spouse, ancestor, lineal descendant, spouse of linear descendant

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Prohibited TransactionsProhibited Transactions

Borrowing from the IRA Selling property to the IRA Receiving unreasonable

compensation for managing the IRA Using the IRA as security for a loan Buying property for personal use -

present or future- with IRA funds

Borrowing from the IRA Selling property to the IRA Receiving unreasonable

compensation for managing the IRA Using the IRA as security for a loan Buying property for personal use -

present or future- with IRA funds

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Prohibited Transaction Penalties

Prohibited Transaction Penalties

Account loses IRA status as of 1st day of year in which PT occurs

Funds treated as distributed at fair market value on 1st day of year If amount exceed basis, taxable gain may

be includable in income Distribution may be subject to 10%

early distribution tax Additional penalties for financial

institution

Account loses IRA status as of 1st day of year in which PT occurs

Funds treated as distributed at fair market value on 1st day of year If amount exceed basis, taxable gain may

be includable in income Distribution may be subject to 10%

early distribution tax Additional penalties for financial

institution

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Prohibited TransactionRisk Control

Prohibited TransactionRisk Control

Staff training Design documentation to prohibit

all loans from IRAs Pre-empt “dear friend” possibility

Staff training Design documentation to prohibit

all loans from IRAs Pre-empt “dear friend” possibility

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Prohibited TransactionRisk Control

Prohibited TransactionRisk Control

Beware of any transactions requiring assets not purchased on a regulated exchange Personally owned stock Vacation home Real estate/limited partnerships - may

be permissible, but can cause problems

Beware of any transactions requiring assets not purchased on a regulated exchange Personally owned stock Vacation home Real estate/limited partnerships - may

be permissible, but can cause problems

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Prohibited TransactionsRisk Control

Prohibited TransactionsRisk Control

When permitting or accepting assets about which there may be any question, place the burden of decision making on the IRA owner Require the IRA owner to sign a

statement that describes the regs and the assets and states that the IRA owner certifies that the asset is permissible

When permitting or accepting assets about which there may be any question, place the burden of decision making on the IRA owner Require the IRA owner to sign a

statement that describes the regs and the assets and states that the IRA owner certifies that the asset is permissible

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Investment in CollectiblesInvestment in Collectibles

Amounts invested in collectibles are deemed distributed in the year in which invested at fair market value at the time of acquisition Failure to pay tax when due triggers

monthly percentage penalty up to a 25% maximum

Also possible 10% early withdrawal tax if under 59 1/2

Amounts invested in collectibles are deemed distributed in the year in which invested at fair market value at the time of acquisition Failure to pay tax when due triggers

monthly percentage penalty up to a 25% maximum

Also possible 10% early withdrawal tax if under 59 1/2

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Investment in CollectiblesInvestment in Collectibles

Collectibles Defined Art works Rugs Antiques Metals Gems Stamps Coins Alcoholic beverages Certain other tangible personal property

Collectibles Defined Art works Rugs Antiques Metals Gems Stamps Coins Alcoholic beverages Certain other tangible personal property

2020

Investment in CollectiblesInvestment in Collectibles

Exception: 1, 1/2 1/4 or 1/10 ounce US gold coins

or 1 ounce silver coins minted by the US Treasury Department and certain platinum coins and certain gold, silver, palladium and platinum bullion

Exception: 1, 1/2 1/4 or 1/10 ounce US gold coins

or 1 ounce silver coins minted by the US Treasury Department and certain platinum coins and certain gold, silver, palladium and platinum bullion

2121

Collectibles - Risk ControlCollectibles - Risk Control

Staff training

Same certification from IRA owner suggested for possible prohibited transaction

Staff training

Same certification from IRA owner suggested for possible prohibited transaction

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Unrelated Business Taxable Income

Unrelated Business Taxable Income

Definition Income from a trade or business

regularly carried on by the IRA not substantially related to the exercise by the IRA of its tax exempt purpose

UBTI is subject to tax Filing 990-T usually responsibility

of financial institution

Definition Income from a trade or business

regularly carried on by the IRA not substantially related to the exercise by the IRA of its tax exempt purpose

UBTI is subject to tax Filing 990-T usually responsibility

of financial institution

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UBTI - Risk ControlUBTI - Risk Control

Do not allow the IRA to hold assets which might produce UBTI

Ensure that documentation requires IRA owner to file 990-T

Do not allow the IRA to hold assets which might produce UBTI

Ensure that documentation requires IRA owner to file 990-T

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DistributionsDistributions

Traditional/Conventional IRA Can be withdrawn at any time subject

to 10% penalty if before 59 1/2. Must begin withdrawals at age 70 1/2 Taxable as ordinary income in the

year in which withdrawn Nondeductible contributions cause

partly taxable distributions

Traditional/Conventional IRA Can be withdrawn at any time subject

to 10% penalty if before 59 1/2. Must begin withdrawals at age 70 1/2 Taxable as ordinary income in the

year in which withdrawn Nondeductible contributions cause

partly taxable distributions

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DistributionsDistributions

Roth Qualified Distributions not taxable Distribution made after the 5-year period

beginning with the 1st taxable year for which Roth contribution made

Payment or distribution is: Made after 59 1/2 Due to disability To beneficiary after death of IRA owner Meets requirements for First Home

Exceptions

Roth Qualified Distributions not taxable Distribution made after the 5-year period

beginning with the 1st taxable year for which Roth contribution made

Payment or distribution is: Made after 59 1/2 Due to disability To beneficiary after death of IRA owner Meets requirements for First Home

Exceptions

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Exceptions to Distribution Rules

Exceptions to Distribution Rules

There are exceptions for both Traditional and Roth IRA distribution rules.

Listed in IRS Publication 590 Some examples:

Medical insurance IRS levy First home buying

There are exceptions for both Traditional and Roth IRA distribution rules.

Listed in IRS Publication 590 Some examples:

Medical insurance IRS levy First home buying

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Distribution Risk ControlDistribution Risk Control

Maintain some methodology of determining when IRA owners attain age 70 1/2 50% excise tax on amounts not

distributed as required (excess accumulations)

Be mindful of beneficiary IRAs

Maintain some methodology of determining when IRA owners attain age 70 1/2 50% excise tax on amounts not

distributed as required (excess accumulations)

Be mindful of beneficiary IRAs

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Questions?Questions?