An Individual Retirement Account, otherwise known as IRA (named after Ira Cohen, an IRS Actuary who helped design the plan guidelines), is a tax advantaged trust allowed under US Code Title 26 (Internal Revenue Code) Section 408 (Individual Retirement Accounts and Annuities). Much like other plans under the Employee Retirement Income Security Act (ERISA), i.e. 401s, 403s, 457s, the purpose is for individuals and/or entities (referred to as individuals for purposes of this article) to have a tax advantage or incentive for saving money for retirement. So it is no surprise that many of the rules are to make sure participants and fiduciaries of the trust stay in line with this purpose. Although this sounds, and can be, relatively simple, one must be extremely cautious and seek professional advice before making legal and technical maneuvers with this type of entity. Section 408 is a long string of legal verbiage that refers to literally hundreds, if not thousands, of pages of tax code, and if the trust doesn’t stay within the regulations, you could be faced with your retirement account being distributed as a whole, taxed in the highest bracket, penalized and possibly penalized again for late reporting. Luckily, there are institutions and mechanics implemented to help individuals save and grow money for retirement without having to get a tax law degree. In fact, one is not even able to create or maintain an IRA for one’s self without a qualified financial institution having custody, overseeing and reporting on behalf of the account; these institutions are referred to as Trustees or Custodians.

But don’t be fooled by institutions who give you merely enough information to keep your account in their custody and discourage you from anything that may tempt you to leave their influence and control; there are many qualified IRA institutions and strategies that are allowed. Actually, in your research you will find that there is not a list of allowable transactions, only a list of disallowed transactions. For this reason alone, an IRA has the freedom to grow and evolve with the world it lives in.

So don’t take anybody’s word for it, do some research and see for yourself. Section 408 and the relevant supporting code is made available to the public by Congress at: www.uscode.house.gov This may be a tedious read, so we have identified 10 important and relevant aspects of an IRA and put them in layman’s terms.

1. Trustee

An IRA Trustee (Custodian) must be a bank, trust company, credit union,
brokerage firm, or other individual or entity who is independently approved by
the Secretary of Treasury and subject to regulation by their local State
Commissioner of Banking, or similar arm of state government. Although an
IRA can move from one trustee to another via transfer or rollover, the IRA is
always subject to the in-house rules and restrictions of the trustee. <<Title 26
Section 581>> <<Title 12 Section 101>>

2. Contributions

With the exception of rollovers, IRA Contributions must be made in cash, not
assets such as securities or real property, and may not exceed the allowable
contribution limit for the year <<Title 26 Section 219>>. Rollover contributions must
be made in the manner in which the rollover distribution was sent and within
60 days of the distribution<<Title 26 Section 402, 403, 457>>. Transfers and gains
through investments are not considered contributions.

3. Distributions

Any amount distributed from an IRA to the individual will be taxable income to
the individual the same year the distribution was made (with the exception of
Roth IRAs). This means that even though your IRA is making investments that
would normally fall under capital gains, the tax on distributions are taxed as
ordinary income. You get the maximum benefit from a tax-deferred plan when
you deduct your contributions in a higher tax bracket than you are in when
you take distributions. Although there are exceptions for distributions
(rollovers, annuitized distributions that apply section 72, inherited or Roth
IRAs, etc.), generally speaking, an IRA distribution has a 10% penalty on top of
the regular income tax if it is made before the age of 59½.

4. Required Distributions

For tax-deferred plans (exception for Roth under 408A) the IRA must make
required minimum distributions based on life expectancy and actuarial tables
(starting at 70½). The general idea of a tax-deferred retirement plan is to save
money for retirement but be fully distributed by the time you are expected to
die. If the average life expectancy is 81 years old, when you turn 70½ an
amount will be calculated every year as a plan to distribute your entire IRA by
the time you turn 81 years old. Although actuarial tables are applied to large
populations and you may not be retired by age 70½, RMD’s still apply to
Individual Retirement Accounts.

5. Transfers

The interest of an individual in the balance in his or her account is non-
forfeitable, meaning you cannot forfeit or gift your IRA to an individual or
entity. In the event of a divorce or death your IRA can be distributed or
transferred to a spouse, descendants or other beneficiaries. Your IRA can
transfer directly to another institution without being considered a distribution
or as a 60 day rollover (distribution from one institution and deposit within 60
days to another institution). Rollovers are only allowed once every 12 months.

6. Prohibited Transactions

If a prohibited transaction under Title 26 Section 4975 is made it distributes
the entire IRA account at the time the prohibited transaction was made. 4975
lists prohibited transactions as “any direct or indirect…prohibited
transaction…between a plan (the IRA) and a disqualified person”. Below is a
list of the actual prohibited transactions in 4975 and the people or entities that
are considered disqualified:
Prohibited Transactions
Sale or exchange, or leasing, of any property between a plan and a
disqualified person;
Lending of money or other extension of credit between a plan and a
disqualified person;
Furnishing of goods, services, or facilities between a plan and a
disqualified person;
Transfer to, or use by or for the benefit of, a disqualified person of the
income or assets of a plan;
Act by a disqualified person who is a fiduciary whereby he deals with the
income or assets of a plan in his own interests or for his own account; or
Receipt of any consideration for his own personal account by any
disqualified person who is a fiduciary from any party dealing with the
plan in connection with a transaction involving the income or assets of
the plan
Disqualified People/Entities
A disqualified person is the IRA Participant or anyone who is legally “close to”
the IRA Participant, namely:
You
Your ascendants and descendants (vertical bloodline: mother/father,
daughter/son)
Your spouse or the spouse of your “descendants”
Fiduciaries to your IRA, i.e., custodian or others who provides services to
the IRA
Companies owned or controlled 50% or more by the disqualified people
listed above
Note: Spouses of ascendants, i.e., stepmother/stepfather, and your siblings are
not disqualified.

7. Comingling of Property

The assets of the trust will not be commingled with other property except in a
common trust fund or common investment fund, meaning you cannot combine
personal or other property with IRA property except through a common
investment or fund. For example, you cannot have your IRA and your personal
bank account in one account; or if an IRA owns a building outright, you cannot
own a room in that building personally unless it is legally a separate unit or
parcel to the building, i.e. condos, time shares, shares in an entity that owns
the building, etc.

8. Taxable Investments/Transactions

There are a few investments that would cause the IRA to be taxed as a
distribution. Again, the IRA is a trust that has a tax advantage for the purpose
of saving (and growing through investments) money for retirement. If an
individual used IRA funds to buy a piece of art for their house, or as security
for a home loan, or to pay a life insurance premium, this would not be in line
with the purpose of an IRA and therefore would cause the trust or a portion of
the trust to be distributed to the individual. There are also situations in which
an IRA itself may pay a tax (UBIT – Unrelated Business Income Tax) on an
unrelated trade or business: if it ran an operating business vs. passive
investments, or if profits were realized by debt financing vs. capital in the IRA.
Just like a nonprofit organization receives a tax incentive for its purpose, it
would not have the same tax advantage if it went outside the nonprofit realm
and started competing with for-profit, tax-paying businesses. Some of these
disallowed or taxable situations include:
The IRA invests into a life insurance contract
The IRA invests into a collectible defined as:

  • Any work of art
  • Any rug or antique
  • Any alcoholic beverage
  • Any gem and certain metals
  • Any stamp and certain coins

Note: “Collectible metals” generally refers to jewelry, not precious
metal commodities, and “collectible coins” are generally special issues,
such as those you may find on infomercials, not investment-grade
precious-metal bullion coins. These exceptions are covered in Title 26
Section 408(m)(3)(A) and Title 31 Section 5112(k).
An individual uses all or a portion of the IRA as collateral for a loan.
The IRA enters into a trade or business that is unrelated to its tax
advantaged purpose, i.e. using debt financing, selling products and
goods or providing services.

9. Types of IRAs

Although you may hear coined phrases about the type of IRA, e.g., Self Directed
IRA, Conduit IRA, checkbook IRA, Rollover IRA, IRA LLC, Truly Self Directed
IRA…there are technically only a few types of IRAs; everything else just refers
to where the IRA came from or the level of flexibility one has over the account.
The types of IRAs are:

Traditional IRA

A traditional IRA is a tax-deferred IRA meaning that it was originally funded by
a contribution that was tax-deductible or written off of by an individual or their
previous employer. As long as the funds stay within the IRA and are not
distributed, they will not be taxed until a distribution is made out of the IRA
(with the exception of UBIT). Traditional IRAs are typically funded through
individual contributions, rollovers from a company sponsored plan – 401(k),
403(b) or 457, or a transfer from another traditional or SIMPLE IRA.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) is a tax-deferred,
employer sponsored plan, meaning that contributions are tax-deductible or
written off of both an individual’s and the company’s taxes. A SIMPLE IRA can
roll into a traditional IRA but cannot accept rollovers or transfers from a
traditional IRA, only another SIMPLE IRA. The SIMPLE IRA give small
employers a simplified method to make contributions toward their employees’
retirement and their own retirement and has less administrative burdens than
other employer sponsored plans. Under a SIMPLE IRA plan, employees may
choose to make salary reduction contributions and the employer makes
matching or non-elective contributions (whether employee contributes or not).
An employer may only establish and contribute to SIMPLE IRA’s if they have
100 or less employees.

SEP IRA

A Simplified Employee Pension (SEP) IRA is a traditional IRA in which an
employer makes the contributions and receives the tax deduction. Much like a
SIMPLE, a SEP IRA is a simplified method for an employer to make
contributions toward their employees retirement account and has less
administrative burdens than other employer sponsored plans; however, there
are many differences between the two. A SEP IRA is owned and controlled by
the employee (who could also be the employer if they are self-employed); it is
merely funded by the employer. SEP IRAs allow large contributions, up to 25%
or $49,000 (the lesser of the two) of the employee’s annual salary, and any
employer can contribute to a SEP plan. Because SEP IRAs are considered
traditional IRAs, they may transfer or roll into other traditional IRAs.

Roth IRA

A Roth IRA is much like a traditional IRA in the way it is run, but very different
in the way contributions and distributions are taxed. A contribution to a Roth
IRA is not tax-deductible, meaning that there is no tax deduction from an
individual or employer when the contribution is made. The benefit is that
qualified distributions (if an individual is over 59½ and the plan has been in
existence for 5 or more years) are tax-free. A Roth IRA can be funded through
individual contributions, rollovers from Roth 401(k)s, or taxable conversions
from a traditional IRA. Conversions from a traditional IRA are taxed at the
individual’s tax rate at the time of the conversion, which could spike if a larger
conversion is made. Although it appears that a Roth IRA is a better vehicle
than a traditional IRA because of its tax free growth, this is only true if the
Roth IRA actually grows over the contributions. Unlike traditional IRAs, Roth
IRA’s are not required to take required minimum distributions at age 70 ½.

10. 2013 Contribution Limits

Traditional and Roth
You can contribute up to $5,500 between a Roth and a Traditional IRA, but not
over $5,500 between the two. If you are over 50 years of age the limit is up to
$6,500.
You can determine your deduction or contribution limits by going to:
www.irs.gov

SIMPLE IRA
An employee can contribute to a SIMPLE IRA through a salary reduction up to
$11,500 or $14,000 if they are over 50 years of age. The employer can match
the employee’s contribution dollar for dollar up to 3% of the employee’s salary.
There may be deduction restrictions if the employee is also covered by another
plan. If an employee is not contributing to their SIMPLE plan, the employer
can make a non-elective contribution of 2% the employee’s salary.
SEP IRA
An employer can contribute the lesser of 25% of the employee’s compensation or
$51,000 to the employees SEP IRA.

New Standard IRA
Under the IRA LLC structure, these are the only rules that apply to your IRA;
you will not have added restrictions put into place by any particular custodian
and can move freely between various institutions and investments. A TSD IRA
can be setup under a Traditional, SIMPLE, SEP or Roth IRA.
Need help facilitating your IRA LLC?
Give us a call and your New Standard IRA Specialist can answer any questions you have
and help you move down the path to true financial freedom with your IRA.