11 IRAs Common Mistakes and Risks Judith A. Dorian

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

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

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

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

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

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

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

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

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

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

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

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

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

15 Prohibited Transaction Risk 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

16 Prohibited Transaction Risk 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

17 Prohibited Transactions Risk 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

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

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

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

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

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

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

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

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

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

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

28 Questions?