The Advisor's Professional Library

IRAs: In General

March 4, 2013

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What is an individual retirement account? What is a Roth individual retirement plan?

A traditional individual retirement plan is a personal retirement savings program toward which eligible individuals may contribute both deductible and nondeductible payments with the benefit of tax-deferred buildup of income.

A Roth individual retirement plan is a personal retirement savings program for which eligible individuals may contribute only nondeductible payments with the potential benefit of tax-free buildup of income. A Roth individual retirement plan must clearly be designated as such at the time of establishment, and that designation cannot later be changed; the recharacterization of a Roth IRA will require the execution of new documents.[1]

With respect to both traditional and Roth individual retirement plans, some individuals also may contribute to such plans for their spouses.

There are two kinds of traditional and Roth individual retirement plans: individual retirement accounts, and individual retirement annuities.

Individual Retirement Account

An individual retirement account is a written trust or custodial account.[2] Contributions to such accounts must be in cash (except for rollovers) and may not exceed the maximum annual contribution limit for the tax year – except for rollover contributions, for contributions to a SIMPLE IRA, and for employer contributions to simplified employee pensions.[3] A wire order from a broker to a custodian will constitute a “cash contribution” on the date payment and registration instructions are received by the broker, provided an agency arrangement recognized by and binding under state law exists between the broker and the custodian.[4]

The trustee or custodian of an individual retirement account must be a bank, a federally insured credit union, a building and loan association, or an entity that satisfies IRS requirements.[5] A trustee or custodian acceptable to the IRS cannot be an individual but can be a corporation or partnership that demonstrates that it has fiduciary ability (including continuity of life, established location, fiduciary experience, and fiduciary and financial responsibility), capacity to account for the interests of a large number of individuals, fitness to handle retirement funds, ability to administer fiduciary powers (including maintenance of a separate trust division), and adequate net worth (at least $250,000 initially).[6]

The interest of the individual in the balance of his or her individual retirement account must be nonforfeitable, and the assets must not be commingled with other property except in a common trust fund or common investment fund. In such a trust, they may be pooled with trust funds of regular qualified plans.[7] No part of the trust funds may be invested in life insurance.[8] An account generally may not invest in collectibles without adverse tax consequences. An account may invest in annuity contracts that, in the case of death prior to the time distributions commence, provide for a payment equal to the sum of the premiums paid or, if greater, the cash value of the contract.[9] An account may not use any part of its assets to purchase an endowment contract issued after November 6, 1978.[10] With respect to traditional individual retirement accounts, distribution of an individual’s interest must begin by April 1 of the year after the year in which he or she reaches age 70½ and must be made over a limited period. In addition, distributions must comply with the incidental death benefit requirements of IRC Section 401(a)(9).[11] With respect to both traditional and Roth accounts, required minimum distribution requirements must be met upon death of the owner.[12]

Planning Point: Effective for tax years beginning after December 31, 2012, distributions from individual retirement arrangements (as well as from qualified plans, Sec. 403(b) tax-sheltered annuities, and eligible 457 governmental plans) are excepted from the new unearned income Medicare contribution tax imposed under the Affordable Care Act[13]. The ACA imposes a tax of 3.8 percent on individuals, estates, and trusts on the lesser of net investment income, or the excess of modified adjusted gross income (AGI + foreign earned income) over a threshold of $200,000 (individual) or $250,000 (joint). Investors may therefore find it beneficial to direct wages and investments into IRAs to reduce income and remain below these thresholds.[14]

Individual Retirement Annuity

This may be an annuity or an endowment contract issued by an insurance company.[15] An endowment contract issued after November 6, 1978 will not qualify.[16] The contract must be nontransferable. A contract will be considered transferable if it can be used as security for any loan other than a loan from the issuer in an amount not greater than the cash value of the contract. Even so, a policy loan would cause the contract to cease to be an individual retirement annuity or endowment contract as of the first day of the owner’s tax year in which the loan was made.[17] Contracts issued after November 6, 1978, may not have fixed premiums.[18] The annual premium on behalf of any individual may not exceed the maximum annual contribution limit for the tax year except in the case of a SIMPLE IRA or a simplified employee pension.[19]

Any refund of premium must be applied to the payment of future premiums or the purchase of additional benefits before the close of the calendar year of the refund.[20] The interest of the owner must be nonforfeitable.[21] With respect to traditional individual retirement annuities, distribution must begin by April 1 of the year after the year in which the owner reaches age 70½ and the period over which distribution may be made is limited. In addition, distributions must comply with the incidental death benefit requirements of IRC Section 401(a)(9).[22] With respect to both traditional and Roth annuities, required minimum distribution requirements must be met on the owner’s death.[23]

The IRS has privately ruled that a contract that includes a substantial element of life insurance will not qualify as an individual retirement annuity.[24]

Proposed regulations state that for a flexible premium annuity to qualify as an individual retirement annuity, the contract must provide that (1) at no time after the initial premium has been paid will a specified renewal premium be required, (2) the contract may be continued as a paid-up annuity under its nonforfeiture provision if premium payments cease altogether, and (3) if the contract is continued on a paid-up basis, it may be reinstated at any date prior to its maturity date by a payment of premium to the insurer.

Two exceptions allow the insurer to set a minimum premium, not in excess of $50, and to terminate certain contracts where premiums have not been paid for an extended period and the paid-up benefit would be less than $20 a month.

A flexible premium contract will not be considered to have fixed premiums merely because a maximum annual premium is set, an annual charge is placed against the policy value, or because the contract requires a level annual premium for supplementary benefits (such as a waiver of premium feature).[25]

A participation certificate in a group annuity contract meeting the above requirements will be considered an individual retirement annuity if there is a separate accounting for the benefit allocable to each participant-owner and the group contract is for the exclusive benefit of the participant-owners and their beneficiaries.[26]

A “wraparound annuity” contract entered into on or before September 25, 1981, as an individual retirement annuity will continue to be treated for tax purposes as an individual retirement annuity provided no contributions are made on behalf of any individual who was not included under the contract on that date. “Wraparound annuity” refers to an insurance company contract containing typical deferred annuity provisions but that also promises to allocate net premiums to an account invested in shares of a specific mutual fund that is available to the general public without purchase of the annuity contract.[27]

Effective November 16, 1999, annuity contracts in which the premiums are invested at the direction of the IRA owners in “publicly available securities” (i.e., mutual funds that are available for public purchase) will be treated as an individual retirement annuity contract if no additional federal income tax liability would have been incurred if the owner had instead contributed such amount into an individual retirement account where the funds were commingled in a common investment fund.[28]

Retirement Bonds

Prior to TRA ’84, the IRC provided for the issuance of retirement bonds.[29] These were issued by the U.S. government, with interest to be paid on redemption. Sales of these bonds were suspended as of April 30, 1982.[30] Subsequently, the Treasury Department announced that existing bonds could be redeemed by their holders at any time without being subject to an early distribution penalty.[31] Existing bonds also can be rolled over into other individual retirement plans under rules applicable to rollovers from individual retirement plans.[32]

[1] .IRC Sec. 408A(b); Treas. Reg. §1.408A-2, A-2.
[2] .IRC Secs. 408(a), 408(h), 408A(a).
[3] .IRC Sec. 408(a)(1).
[4] .Let. Ruls. 9034068, 8837034.
[5] .IRC Secs. 408(a)(2), 408(n).
[6] .Treas. Regs. §§1.408-2(b)(2), 1.408-2(e).
[7] .IRC Secs. 408(a)(4), 408(a)(5), 408(e)(6); Rev. Rul. 81-100, 1981-1 CB 326; see also Nichola v. Comm., TC Memo 1992-105.
[8] .IRC Sec. 408(a)(3).
[9] .Treas. Reg. §1.408-2(b)(3).
[10] .Treas. Regs. §§1.408-4(f), 1.408-3(e)(1)(ix).
[11] .IRC Secs. 408(a)(6), 408A(c)(5).
[12] .IRC Secs. 408(a)(6), 408A(c)(5).
[13] .P.L. 111-148.
[14] .See IRC Sec. 1411.
[15] .IRC Secs. 408(b), 408A(a).
[16] .Treas. Reg. §1.408-3(e)(1)(ix).
[17] .IRC Sec. 408(e)(3); Treas. Reg. §1.408-3(c).
[18] .IRC Sec. 408(b)(2)(A).
[19] .IRC Sec. 408(b)(2)(B).
[20] .IRC Sec. 408(b)(2)(C).
[21] .IRC Sec. 408(b)(4).
[22] .IRC Secs. 408(b)(3), 408A(c)(5).
[23] .IRC Secs. 408(a)(6), 408A(c)(5).
[24] .Let. Rul. 8439026.
[25] .Prop. Treas. Reg. §1.408-3(f).
[26] .Treas. Reg. §1.408-3(a).
[27] .Rev. Rul. 81-225, 1981-2 CB 12, as clarified by Rev. Rul. 82-55, 1982-1 CB 12.
[28] .Rev. Proc. 99-44, 1999-2 CB 598, modifying Rev. Rul. 81-225, 1981-2 CB 12.
[29] .IRC Sec. 409, as in effect prior to repeal by TRA ’84.
[30] .Treasury Release (4-27-82).
[31] .Treasury Announcement (7-26-84).
[32] .IRC Sec. 409(b)(3)(C), prior to repeal.

What is a “deemed IRA”?

For plan years beginning after December 31, 2002, a qualified plan, Section 403(b) tax sheltered annuity plan, or eligible Section 457 governmental plan may allow employees to make voluntary employee contributions to a separate account or annuity established under the plan. If such account or annuity meets the rules for traditional IRAs under IRC Section 408 or for Roth IRAs under IRC Section 408A, then such account or annuity will be “deemed” an IRA and not a qualified employer plan. A voluntary employee contribution is any non-mandatory contribution that the individual designates as such. Such “deemed IRAs” will not be subject to the IRC rules governing the employer plan, but they will be subject to the exclusive benefit and fiduciary rules of ERISA to the extent they otherwise apply to the employer plan.[1]

Under final regulations, a deemed IRA and the plan under which it is adopted generally are treated as separate entities, with each subject to the rules generally applicable to that type of entity.[2] The regulations further provide that the “availability of a deemed IRA is not a benefit, right, or feature of the qualified employer plan,” meaning that eligibility for and contributions to deemed IRAs are not subject to the general nondiscrimination requirements applicable to qualified plans.[3]

The regulations provide three exceptions to treating a qualified plan and deemed IRAs as separate entities.

First, the qualified plan documents must contain the deemed IRA provisions and be in effect at the time the deemed IRA contributions are accepted. {Plans offering deemed IRAs for the 2002 or 2003 plan years had until the plan year beginning in 2004 to have such provisions in writing.}[4]

Second, deemed IRA and qualified plan assets may be commingled. The prohibition against commingling in IRC Section 408(a)(5)  does not apply to deemed IRA and qualified plan assets. Deemed IRA and qualified plan assets still may not be further commingled with non-plan assets.[5]

Third, if deemed IRA and qualified plan assets are commingled in a single trust, the failure of any of the deemed IRAs maintained by a plan to meet the requirements of IRC Section 408 (traditional IRAs) or IRC Section 408A (Roth IRAs) can disqualify the qualified plan, requiring correction through the Employee Plans Compliance Resolution System or another administrative procedure. Likewise, the disqualification of a plan can cause the individual accounts to be no longer deemed IRAs.[6]

If deemed IRA and qualified plan assets are maintained in separate trusts, a qualified plan will not be disqualified solely because of the failure of any of the deemed IRAs to meet the requirements of IRC Section 408 (traditional IRAs) or IRC Section 408A (Roth IRAs). Likewise, if separate trusts are maintained, individual accounts will not fail to be deemed IRAs solely because of the disqualification of the plan.[7]

Planning Point: It may be preferable to create IRAs outside a qualified plan or use separate trusts to avoid any possibility of either the IRA or the qualified plan causing disqualification of the other.


[1] .IRC Sec. 408(q). See Rev. Proc. 2003-13, 2003-1 CB 317.
[2] .Treas. Reg. §1.408(q)-1.
[3] .Treas. Reg. §1.408(q)-1(f)(6).
[4] .Treas. Reg. §1.408(q)-1(d)(1).
[5] .Treas. Reg. §1.408(q)-1(d)(2).
[6] .Treas. Reg. §1.408(q)-1(g).
[7] .Treas. Reg. §1.408(q)-1(g).

What information must be provided to a buyer of an IRA?

A “disclosure statement” and a copy of the governing instrument must be furnished to the individual at least seven days before the plan is purchased or established, whichever is earlier, or as late as the time it is purchased or established, whichever is earlier, if the individual is permitted to revoke the plan within at least seven days. An individual revoking his or her plan is entitled to the return of the full amount he or she paid without adjustment for sales commission, administrative expenses, or fluctuation in market value. If the governing instrument is amended after the IRA is no longer subject to revocation, a copy of the amendment (and possibly a “disclosure statement”) must be furnished to the individual not later than the 30th day after the later of the date the amendment is adopted or becomes effective.[1]

IRS regulations also provide that, if values under an individual retirement arrangement are guaranteed or can be projected, the trustee or issuer must in certain instances disclose to an IRA purchaser the amounts guaranteed or projected to be withdrawable. Basically, these regulations provide that the trustee must show the owner the amount the owner could receive if he or she closed the account and paid any surrender charges or penalties, at the end of each of the first five years after the initial contribution and at ages 60, 65, and 70.[2] In making the disclosure, the trustee must show the amount guaranteed (or projected) to be withdrawable, after reduction for all charges or penalties that may be applied. The disclosures required for values at an owner’s ages 60, 65, and 70 must be based on the actual age of the individual at the time of the disclosure. If a guaranteed rate is actually lower than the rate currently being paid on an account, the disclosure statement may use the higher rate, but must clearly indicate that the guaranteed rate is lower.[3]

[1] .Treas. Reg. §1.408-6(d)(4).
[2] .Treas. Reg. §1.408-6(d)(4)(v).
[3] .Rev. Rul. 86-78, 1986-1 CB 208.

What is the saver’s credit and who can claim it?

The Saver’s Credit (formally known as the Retirement Savings Contributions Credit) permits certain lower-income taxpayers to claim a nonrefundable credit for qualified retirement savings contributions.[1] Qualified retirement savings contributions include contributions to Roth or traditional IRAs, as well as elective deferrals to a 401(k) plan, an IRC Section 403(b) tax sheltered annuity, an eligible Section 457 governmental plan, a SIMPLE IRA, and a salary reduction SEP. Voluntary after-tax contributions to a qualified plan or Section 403(b) tax sheltered annuity are also eligible for the credit.[2] The fact that contributions are made pursuant to a negative election (i.e., automatic enrollment) will not preclude a participant from claiming the saver’s credit.[3] Contributions made to an IRA that are withdrawn, together with the net income attributable to such contribution, on or before the due date (including extensions of time) for filing the federal income tax return of the contributing individual are not considered eligible contributions.[4]

To prevent churning (simply switching existing retirement funds from one account to another to qualify for the credit), the total of qualified retirement savings contributions is reduced by certain distributions received by the taxpayer during the prior two taxable years and the current taxable year for which the credit is claimed, including the period up to the due date (plus extensions) for filing the federal income tax return for the current taxable year. Distributions received by the taxpayer’s spouse during the same time period are also counted if the taxpayer and spouse filed jointly both for the year during which a distribution was made and the year for which the credit is taken.

Corrective distributions of excess contributions and excess aggregate contributions, excess deferrals, dividends paid on employer securities under Section 404(k), and loans treated as distributions are not taken into account.[5]

The credit is allowed against the sum of the regular tax and the alternative minimum tax (minus certain other credits) and is allowed in addition to any other deduction, exclusion, or other tax benefit a taxpayer may receive for retirement contributions that would otherwise apply.[6] For example, most workers at these income levels may deduct all or part of their contributions to a traditional IRA. Contributions to a regular 401(k) plan are not subject to income tax until withdrawn from the plan.

To be eligible to claim the credit, the taxpayer must be at least 18 as of the end of the tax year and must not be claimed as a dependent by someone else or be a full-time student. Full-time students include any individual who is enrolled in school during some part of each of five months during the year and is enrolled for the number of hours or courses the school considers to be full-time.[7]

The amount of the credit is limited to an applicable percentage of IRA contributions and elective deferrals up to $2,000. The applicable percentages for 2012 are as follows:[8]


Joint return

Head of a household

All other cases



Not over


Not over


Not over































The income limits are indexed for inflation.[9] For 2013, the maximum AGI for joint returns will be $59,000, $44,250 for heads of households, and $29,500 for all others. For this purpose, adjusted gross income is calculated without regard to the exclusions for income derived from certain foreign sources or sources within United States possessions.[10]

Taxpayers have until April 15, 2013, to contribute to traditional and Roth IRAs and still claim the credit on their 2012 tax returns.

For married taxpayers filing jointly, contributions by or for either or both spouses, up to $2,000 per year for each spouse, may give rise to the saver’s credit.[11]

[1] .IRC Sec. 25B.
[2] .IRC Sec. 25B(d)(1); Ann. 2001-106, 2001-44 IRB 416, A-5.
[3] .See Ann. 2001-106, 2001-44 IRB 416.
[4] .See Ann. 2001-106, 2001-44 IRB 416, A-5.
[5] .IRC Sec. 25B(d)(2); Ann. 2001-106, above, A-4.
[6] .IRC Sec. 25B(g); Ann. 2001-106, 2001-44 IRB 416, A-7 and A-8.
[7] .IRC Sec. 25B(c); Ann. 2001-106, 2001-44 IRB 416, A-2.
[8] .IR-2011-103.
[9] .IRC Sec. 25B(b)(3).
[10] .IRC Sec. 25B(e).
[11] .Ann. 2001-106, 2001-44 IRB 416, A-9.

How are earnings on an IRA taxed?

An IRA offers tax-free build up on contributions. The earnings on a traditional IRA are tax deferred to the owner; that is, they are not taxed until the owner begins receiving distributions. The earnings on a Roth IRA may or may not be taxed upon distribution. Like a trust that is part of a qualified plan, an individual retirement account is subject to taxes for its unrelated business income.

Tax deferral is lost if an individual engages in a prohibited transaction or borrows under or by use of an individual retirement annuity. The loss occurs as of the first day of the tax year in which the prohibited transaction or borrowing occurred.[1] For an account established by an employer or association of employees, only the separate account of the individual loses its deferred status.

[1] .IRC Sec. 408(e); Treas. Reg. §1.408-1.

Are IRAs subject to attachment?

ERISA provides that benefits under “pension plans” must not be assigned or alienated.[1] This provision has been construed as protecting pension benefits from claims of creditors. ERISA defines a “pension plan” as a plan established or maintained by an employer to provide retirement income to employees. An individual retirement plan generally is not maintained by an employer and, thus, is not protected under federal law by ERISA’s anti-alienation clause.[2]

Exclusions from bankruptcy are provided for qualified retirement plans, SEP IRAs, SIMPLE IRAs, and elective deferral Roths, but not for traditional IRAs and Roth IRAs.[3] In addition, exemptions from bankruptcy may be available for qualified retirement plans, SEP IRAs, SIMPLE IRAs, elective deferral Roths, traditional IRAs, and Roth IRAs. A debtor can choose to exempt property from the bankruptcy estate under either of two methods. Under the nonlist method, these exemptions are available if the debtor chooses not to list property that is exempt under federal, state, or local law.[4]Under the list method, these exemptions are available unless applicable state law does not so authorize.[5] (The U.S. Supreme Court has ruled that assets in a traditional IRA are eligible for the list exemption under Section 522(d)(10)(E) of the federal Bankruptcy Code.)[6] Many states provide that the federal list exemptions are not available but instead provide their own state law exemptions in bankruptcy.

Planning Point: A debtor choosing between the list or nonlist methods should examine all of his or her assets, not just the IRA provisions, to determine which method would be more beneficial in bankruptcy. The debtor also should determine whether additional protection is provided by the law of the state (or states) that have jurisdiction over the debtor’s assets.

The bankruptcy exemption for contributory (non-rollover) traditional and Roth IRAs is limited in the aggregate to $1 million (the amount is indexed and the current limit is, $1,171,650 per person), unless the bankruptcy court determines that “the interests of justice” require otherwise.[7] The exemption for IRA balances rolled over from other retirement accounts with an unlimited exemption is unlimited.

The exemption limit applies to the aggregate of all retirement accounts in combination, without regard to rollover contributions, and does not apply separately to each. Amounts in excess of the limit are subject to the claims of creditors.[8]

Planning Point: Although assets rolled over from non-Roth IRA retirement accounts, and future earnings on those assets, do not lose their unlimited exemption by virtue of a rollover, taxpayers with significant IRA balances are advised to keep their contributory and rollover IRA accounts segregated. Otherwise, to the extent that rollover IRA assets are commingled with contributory IRA assets, it may be difficult to calculate the value of the assets attributable to the rollover.

Outside the bankruptcy context, the U.S. Court of Appeals for the Seventh Circuit has ruled that because ERISA’s anti-alienation provisions do not apply to assets contained in IRAs, such assets may be seized under criminal forfeiture proceedings brought by the federal government.[9] The Tenth Circuit Court of Appeals has held that an IRA trustee was not in breach of its fiduciary duty to an IRA account holder when the trustee responded to an IRS service of notice of levy for delinquent taxes owed by the account holder by turning over to the IRS assets held in the account.[10] 

[1] .ERISA Sec. 206(d)(1).
[2] .Patterson v. Shumate, 504 U.S. 753 (1992).
[3] .11 U.S.C. §§541(b)7), 541(c)(2).
[4] .11 U.S.C. §522(b)(2).
[5] .11 U.S.C. §§522(b)(1), 522(d)(10)(E), 522(d)(12).
[6] .Rousey v. Jacoway, 544 U.S. 320 (2005).
[7] .11 U.S.C. §522(n).
[8] .11 U.S.C. 522(n).
[9] .Infelise v. U.S., 159 F.3d 300 (7th Cir. 1998).
[10] .Kane v. Capital Guardian Trust Co., 98-2 USTC (10th Cir. 1998).

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