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In General

  • 3641. What is an individual retirement plan? What is an individual retirement account and a Roth individual retirement account?

    • Individual retirement plans are tax favored personal savings arrangements that allow an individual to set aside money for retirement.

      A traditional individual retirement plan generally allows an individual to contribute both deductible (where eligible) and nondeductible payments to receive the benefit of tax-deferred buildup on income.

      Alternatively, a Roth individual retirement plan allows eligible individuals to contribute only nondeductible payments with the benefit of tax-free buildup of income (Q 3673). 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 (Q 3662).1 Note that tax reform eliminated the traditional ability to convert traditional IRA funds to a Roth account and later recharacterize the transaction for tax years beginning after 2017.

      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 (discussed below) and individual retirement annuities (Q 3642).

      An individual retirement account (IRA) is a written trust or custodial account created for the purpose of saving money for retirement that allows individuals to make yearly contributions, up to specific annual limits, that will grow tax-free.

      A “traditional” IRA allows an individual to make both pre-tax (where eligible) and after-tax contributions to the account, which will grow free of income taxes, but are taxable when distributed to the participant (see Q 3649, Q 3671). Alternatively, a Roth IRA only allows after-tax contributions, but such contributions also grow tax-free and usually can be distributed tax-free to the extent they are considered “qualified distributions” (see Q 3673).

      Contributions to such accounts must be in cash (except for rollovers) and may not exceed the maximum annual contribution limit for the tax year – $5,500 in 2018 and $6,000 in 2019-2022 (Q 3656) – except for rollover contributions (Q 3992), for contributions to a SIMPLE IRA (Q 3706), and for employer contributions to simplified employee pensions (Q 3701).2 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.3

      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 72 (70½ before 2020) 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) (Q 3686).4 With respect to both traditional and Roth accounts, required minimum distribution (RMD) requirements must be met upon death of the owner (Q 3687).5

      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.6 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).7

      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.8 No part of the trust funds may be invested in life insurance.9 An account generally may not invest in collectibles without adverse tax consequences (Q 3649). 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.10 An account may not use any part of its assets to purchase an endowment contract issued after November 6, 1978.11

      Planning Point: Effective for tax years beginning after December 31, 2012, distributions from individual retirement arrangements (as well as from qualified plans, Section 403(b) tax-sheltered annuities, and eligible 457 governmental plans) are exempted from the unearned income Medicare contribution tax imposed under the Affordable Care Act.12 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.13


      1. IRC Sec. 408A(b); Treas. Reg. §1.408A-2, A-2.

      2. IRC Sec. 408(a)(1).

      3. Let. Ruls. 9034068, 8837034.

      4. IRC Secs. 408(a)(6), 408A(c)(4).

      5. IRC Secs. 408(a)(6), 408A(c)(4).

      6. IRC Secs. 408(a)(2), 408(n).

      7. Treas. Reg. §§1.408-2(b)(2), 1.408-2(e).

      8. 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.

      9. IRC Sec. 408(a)(3).

      10. Treas. Reg. §1.408-2(b)(3).

      11. Treas. Reg. §§1.408-4(f), 1.408-3(e)(1)(ix).

      12. P.L. 111-148.

      13. See IRC Sec. 1411.

  • 3642. What is an individual retirement annuity?

    • An individual retirement annuity is an annuity or an endowment contract issued by an insurance company that is structured similarly to an individual retirement account, but must meet certain additional requirements to qualify as a retirement plan.1 An endowment contract issued after November 6, 1978 will not qualify.2

      To qualify as an individual retirement annuity, as provided by Code section 408(b):

      (1) The contract must be nontransferable.

      (2) Contracts issued after November 6, 1978 may not have fixed premiums.

      (3) 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 (Q 3706) or a simplified employee pension (Q 3701).

      (4) 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.

      (5) With respect to non-Roth individual retirement annuities, distribution must begin by April 1 of the year after the year in which the owner reaches age 72 (70½ prior to 2020) and the period over which distribution may be made is limited.

      (6) With respect to both traditional and Roth annuities, required minimum distribution requirements must be met on the owner’s death (Q 3687).3

      (7) Distributions must comply with the incidental death benefit requirements of Code section 401(a)(9) (Q 3686).4

      (8) The interest of the owner must be nonforfeitable.

      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 (Q 3649).5

      The Eighth Circuit has held that a premium was not fixed when a lump sum was rolled from an IRA into an individual retirement annuity because funds taken from an IRA did not constitute a premium if used to pay for an individual retirement annuity.6

      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).7

      The IRS has privately ruled that a contract that includes a substantial element of life insurance will not qualify as an individual retirement annuity.8

      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.9

      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.10

      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.11


      1. IRC Secs. 408(b), 408A(a).

      2. Treas. Reg. §1.408-3(e)(1)(ix).

      3. IRC Secs. 408(a)(6), 408A(c)(6).

      4. IRC Secs. 408(b)(3), 408A(c)(6).

      5. IRC Sec. 408(e)(3); Treas. Reg. §1.408-3(c).

      6Running v. Miller, 778 F.3d 711 (8th Cir. 2015).

      7. Prop. Treas. Reg. §1.408-3(f).

      8. Let. Rul. 8439026.

      9. Treas. Reg. §1.408-3(a).

      10. Rev. Rul. 81-225, 1981-2 CB 12, as clarified by Rev. Rul. 82-55, 1982-1 CB 12.

      11. Rev. Proc. 99-44, 1999-2 CB 598, modifying Rev. Rul. 81-225, 1981-2 CB 12.

  • 3643. What are some of the potential benefits and consequences of holding a fixed income annuity within an IRA?

    • The primary benefit of holding fixed income annuities within an IRA is the simplification of the required minimum distribution process. Fixed income annuities held inside a taxpayer’s IRA usually comply with the RMD rules automatically because their payments are determined in the same way that the RMD itself is calculated—using a formula based on the life expectancy of the individual and the amount invested.

      While a cash RMD is required each year after the taxpayer turns 72 (70½ before 2020) regardless of general market conditions, it is important to remember that IRA assets may be invested in a variety of holdings, including securities and funds that will fluctuate with the equity markets. Unfortunately, the RMD requirements may, depending on market performance, cause taxpayers to miss market upswings by requiring that the taxpayer liquidate securities held within the IRA to satisfy his or her RMDs. Using a fixed income annuity can help reduce this risk because the payments are fixed in advance. Note that RMD requirements were suspended for the 2020 tax year under the CARES Act.

      In other words, there is no investment decision required each year because the taxpayer has already determined the value of the payout (whether it is made monthly, quarterly or annually). While the RMD for any non-annuitized portion of the IRA will still have to be calculated, the value of the annuity is excluded from this calculation, thereby reducing the risk that the taxpayer will be forced to make an unfavorable investment decision simply to comply with the RMD rules.

      Further, the fixed income annuity actually allows the taxpayer to set an income level in advance—RMDs will fluctuate with the IRA value in any given year, but the annuity payments will remain constant regardless of the performance of the remaining underlying IRA assets. Taxpayers also have the option of adding a cost-of-living increase to the annuity payouts to ensure sufficient income during retirement.

      As with any planning strategy, however, there are potential objections. Most commonly, advisors may feel that it makes little sense for some taxpayers (especially younger individuals) to hold an annuity within the IRA because both types of investments are tax-deferred, so the annuity could be held separately from IRA assets with similar consequences. As a result, some might feel that the strategy is simply redundant.

      Additionally, amounts held in an annuity are more difficult to access than other IRA funds without incurring significant penalty charges—if the taxpayer has a financial emergency after age 72, he or she could access non-annuitized IRA funds without penalty. Taxpayers should, therefore, only consider purchasing the annuity with IRA funds if they have sufficient assets held outside of the annuity to cover any unforeseen expenses.

      Further, while holding an annuity within an IRA can allow the taxpayer to avoid selling IRA assets during unfavorable market swings, it can also mean that the taxpayer has no reason to liquidate those holdings when their value is high, potentially avoiding a loss if the value eventually falls.

      Planning Point: Advisors considering recommending that a client purchase an annuity inside of an IRA should carefully consider the costs and the benefits of the arrangement, and should carefully review and comply with any applicable fiduciary rules.

  • 3644. What are U.S. Individual Retirement Bonds?

    • Prior to TRA ’84, the IRC provided for the issuance of retirement bonds.1 These bonds were issued by the U.S. government, with interest to be paid on redemption. Sales of these bonds were suspended as of April 30, 1982.2 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 (Q 3677).3 Existing bonds also can be rolled over into other individual retirement plans under rules applicable to rollovers from individual retirement plans (Q 4004).4


      1. IRC Sec. 409, as in effect prior to repeal by TRA ’84.

      2. Treasury Release (4-27-82).

      3. Treasury Announcement (7-26-84).

      4. IRC Sec. 409(b)(3)(C), prior to repeal.

  • 3645. What is a “deemed IRA”?

    • A deemed IRA is an account or annuity created under an employer’s qualified retirement plan. A deemed IRA is treated as a traditional IRA or Roth IRA and is subject to the same rules regarding contributions and distributions.

      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 Code section 408 or for Roth IRAs under Code section 408A, then such account or annuity will be “deemed” an IRA and not a qualified employer plan.

      A voluntary employee contribution is any nonmandatory 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:

      (1) 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

      (2) Deemed IRA and qualified plan assets may be commingled. The prohibition against commingling in IRC section 408(a)(5) (Q 3641) does not apply to deemed IRA and qualified plan assets. Deemed IRA and qualified plan assets still may not be further commingled with nonplan assets.5

      (3) 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 Code 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 (Q 3838). Likewise, the disqualification of a plan can cause the individual accounts to no longer be considered 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 Code 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: The advantages of a deemed IRA as part of the employer plan include the ability of the employee to consolidate retirement investment savings, perceived ease of making additional contributions to retirement savings, and more investment options may be available with a deemed IRA than with a stand-alone IRA.

      However, a participant may prefer to create IRAs outside of a an employer’s 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).

  • 3646. What information must be provided to a buyer of an IRA?

    • The trustee or issuer (i.e. “the sponsor”) of an IRA must furnish the plan participant with a “disclosure statement” and a copy of the governing instrument at least seven days before the plan is purchased or established, whichever is earlier. Alternatively, the sponsor can wait to provide the disclosure statement to the participant until the time it is purchased or established, whichever is earlier, provided that the individual is permitted to revoke the plan within at least seven days from that date.

      The disclosure statement must include certain items in plain language such as provisions related to when and how the IRA can be revoked and the contact information for the person to receive the notice of cancellation. 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 sixty, sixty-five, and seventy.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 sixty, sixty-five, and seventy 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

      For the reporting requirements imposed on IRA trustees with respect to required minimum distributions, see Q 3698.


      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.

  • 3647. What is sequence of returns risk? How can sequence of returns risk affect a taxpayer’s retirement income strategy?

    • Sequence of returns risk is a market volatility issue surrounding the order in which returns on a taxpayer’s investments occur when the taxpayer is taking distributions or withdrawals from the portfolio.

      Essentially, if a greater proportion of low or negative returns occur during the early years of retirement, when taxpayer is taking withdrawals, the taxpayer’s overall returns are going to be lower than if those negative or low returns occurred at a later point in the taxpayer’s (and the investment’s) lifetime. Mathematically, this is because the withdrawal of a fixed dollar amount from a portfolio when the portfolio value is down requires the liquidation and distribution of a larger percentage of the portfolio than would be required when the portfolio value is high. These early low (or negative) returns and distributions have a larger impact on the compounded value of the portfolio if they occur in early years. Negative returns could even cause a portion of the principal investment to be lost.

      Even if the return is simply lower than average in the early years while distributions are being taken, the investment will generate an overall lower return because the investment will gain less value early on, meaning there will be a lower account value to generate growth even in later, higher return periods.

      When the taxpayer is making withdrawals from his or her investment accounts, the risk of outliving the retirement assets is magnified when negative returns occur in early years.

      Planning Point: Financial planners modeling sequence of returns risk for their clients can illustrate
      the potential impact of (1) reducing market volatility of the overall portfolio, (2) reducing withdrawal amounts in early years or delaying withdrawals from the portfolio in down markets, and (3) maintaining a balanced portfolio so that withdrawal amounts can be paid from assets with a stable asset value rather than from selling volatile assets in a depressed market – as strategies to mitigate the potential impact of sequence of returns risk.

  • 3648. What is the saver’s credit and who can claim it?

    • Editor’s Note: The 2017 Tax Act modified the rules governing ABLE accounts to permit a contributing beneficiary to claim the saver’s credit for tax years beginning after 2017 and before 2026. See Q 386 to Q 389.

      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 (Q 3752), an IRC Section 403(b) tax sheltered annuity (Q 4030), an eligible Section 457 governmental plan (Q 3584), a SIMPLE IRA (Q 3706), and a salary reduction SEP (Q 3705). 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.5

      Corrective distributions of excess contributions and excess aggregate contributions (Q 3808), excess deferrals (Q 3760), dividends paid on employer securities under Section 404(k) (Q 3824), and loans treated as distributions (Q 3949) are not taken into account.6

      To be eligible to claim the credit, the taxpayer must be at least eighteen as of the end of the tax year, cannot be claimed as a dependent on someone else’s tax return, and cannot 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 2022 are as follows:

      ADJUSTED GROSS INCOME

      Joint return

      Head of a household

      All other cases

      Applicable

      Over

      Not over

      Over

      Not over

      Over

      Not over

      Percentage

      0

      $41,000

      0

      $30,750

      0

      $20,500

      50%

      41,000

      44,000

      30,750

      33,000

      20,500

      22,000

      20%

      44,000

      68,000

      33,000

      51,000

      22,000

      34,000

      10%

      68,000

      51,000

      34,000

      0%

      The applicable percentages for 2021 are as follows:8

      ADJUSTED GROSS INCOME

      Joint return Head of a household All other cases Applicable
      Over Not over Over Not over Over Not over Percentage
      0 $39,500 0 $29,625 0 $19,750 50%
      39,500 43,000 29,625 32,250 19,750 21,500 20%
      43,000 66,000 32,250 49,500 21,500 33,000 10%
      66,000 49,500 33,000 0%

      The income limits are indexed for inflation.9 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 their tax filing deadline to contribute to traditional and Roth IRAs and still claim the credit on the prior year’s tax return.

      The maximum credit that can be claimed is $1,000, or $2,000 for married taxpayers filing jointly. For married couples, contributions by or for either or both spouses may give rise to the credit.11

      Example: Susan, who is married, earned $41,000 in 2021. Her husband did not have any earnings. During 2020, Susan contributed $1,200 to her IRA, which she deducted on her tax return, which reduced her adjusted gross income to $39,800. Susan is eligible to claim a 50 percent saver’s credit, or $600.


      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. See Ann. 2001-106 Q-4.

      6. IRC Sec. 25B(d)(2); Ann. 2001-106, above, A-4.

      7. IRC Sec. 25B(c); Ann. 2001-106, 2001-44 IRB 416, A-2.

      8. Notice 2020-79.

      9. IRC Sec. 25B(b)(3).

      10. IRC Sec. 25B(e).

      11. Ann. 2001-106, 2001-44 IRB 416, A-9.

  • 3649. When are funds in an IRA taxed?

    • Funds accumulated in a traditional IRA generally are not taxable until they are distributed (Q 3671). Funds accumulated in a Roth IRA may or may not be taxable on distribution (Q 3673). Special rules may treat funds accumulated in an IRA as a “deemed distribution” and, thus, includable in income under the rules discussed in Q 3671 for traditional IRAs and in Q 3673 for Roth IRAs.

      A distribution of a nontransferable, nonforfeitable annuity contract that provides for payments to begin by age 72 (70½ prior to 2020) and not to extend beyond certain limits is not taxable, but payments made under such an annuity would be includable in income under the appropriate rules.

      Contributions to an IRA may be returned to the participant in a tax-free manner if certain conditions are met as discussed in Q 3670 (provided, in the case of a traditional IRA that no deduction was allowed for the contribution). If net income allocable to the contribution is distributed before the due date for filing the tax return for the year in which the contribution was made, it must be included in income for the tax year for which the contribution was made even if the distribution actually was made after the end of that year.1 With respect to distributions of excess contributions after this deadline, the net income amount is included in income in the year distributed. Any net income amount also may be subject to penalty tax as an early distribution.

      Where a taxpayer transferred funds from a single IRA into two newly-created IRAs, the direct trustee-to-trustee transfers were not considered distributions under IRC Section 408(d)(1).2 The division of a decedent’s IRA into separate subaccounts does not result in current taxation of the IRA beneficiaries.3

      A distribution of any amount may be received free of federal income tax to the extent the amount is then contributed within sixty days to another plan under qualified rollover rules (Q 4004).

      For the penalty tax imposed on accumulated amounts not distributed in accordance with the required minimum distribution rules, see Q 3682.

      If any assets of an individual retirement account are used to purchase collectibles (works of art, gems, antiques, metals, etc.), the amount so used will be treated as distributed from the account (and also may be subject to penalty as an early distribution). A plan may invest in certain gold or silver coins issued by the United States, any coins issued under the laws of a state, and certain platinum coins. A plan may buy gold, silver, platinum, and palladium bullion of a fineness sufficient for the commodities market if the bullion remains in the physical possession of the IRA trustee.4 A plan may purchase shares in a grantor trust holding such bullion.5

      If any part of an individual retirement account is used by the individual as security for a loan, that portion is deemed distributed on the first day of the tax year in which the loan was made.6 Amounts rolled over into an IRA from a qualified plan by one of the twenty-five highest paid employees, however, may be pledged as security for repayments that may have to be made to the plan in the event of an early plan termination.7 A less-than-sixty-day interest-free loan from IRA accumulations is possible under the rollover rules (Q 4012).8

      If the owner of an individual retirement annuity borrows money under or by use of the contract in any tax year, including a policy loan, the annuity ceases to qualify as an individual retirement annuity as of the first day of the tax year and the fair market value of the contract would be deemed distributed on that day.9

      If an individual engages in a prohibited transaction (Q 3976) with his or her IRA, such IRA ceases to qualify as such as of the first day of that tax year when the prohibited transaction occurred; the individual, however, is not liable for a prohibited transaction tax.10 The fair market value of all the assets in the account is deemed distributed on that day.11 If the account is maintained by an employer, only the separate account of the individual involved is disqualified and deemed distributed.12

      The transfer to an individual retirement account of a personal note received in a terminating distribution from a qualified plan and the holding of that note is a prohibited transaction.13

      The use of IRA funds to invest in a personal retirement residence of the taxpayer is considered a prohibited transaction under IRC Section 4975(c)(1)(D) and, thus, is treated as a distribution.14

      Whether a purchase of life insurance in conjunction with an individual retirement plan but with non-plan funds constitutes a prohibited transaction apparently depends on the circumstances. The IRS has held that the purchase of insurance on the depositor’s life by thetrustee of the account with non-plan funds amounted to an indirect prohibited transaction by the depositor.15 The IRS also has ruled that the solicitation by an association of individuals who maintain individual retirement plans with the association for enrollment in a group life plan did not result in a prohibited transaction where premiums would be paid by the individuals and not out of plan funds.16

      Institutions may offer limited financial incentives to IRA and Keogh holders without running afoul of the prohibited transaction rules provided certain conditions are met. Generally speaking, the value of the incentive must not exceed $10 for deposits of less than $5,000 and $20 for deposits of $5,000 or more. These requirements also are applicable to SEPs that allow participants to transfer their SEP balances to IRAs sponsored by other financial institutions and to SIMPLE IRAs.17


      1. IRC Sec. 408(d)(4); Treas. Reg. §1.408-4(c).

      2. Let. Rul. 9438019. See also Rev. Rul. 78-406, 1978-2 CB 157; Let. Rul. 9433032.

      3. Let. Rul. 200008044.

      4. IRC Sec. 408(m); Let. Rul. 200217059.

      5. Let. Ruls. 200732026, 200732027.

      6. IRC Sec. 408(e)(4); Treas. Reg. §1.408-4(d)(2); Let. Ruls. 8335117, 8019103, 8011116.

      7. See, e.g., Let. Ruls. 8845060, 8803087, 8751049. See also Treas. Reg. §1.401-4(c).

      8. See Let. Rul. 9010007.

      9. See IRC Sec. 408(e)(3). See also Griswold v. Comm., 85 TC 869 (1985).

      10. IRC Sec. 4975(c)(3).

      11. See Treas. Reg. §1.408-1(c)(2).

      12. IRC Sec. 408(e)(2).

      13. TAM 8849001.

      14Harris v. Comm., TC Memo 1994-22.

      15. Let. Rul. 8245075.

      16. Let. Rul. 8338141.

      17. PTE 93-1, 58 Fed. Reg. 3567, 1-11-93; PTE 93-33, 58 Fed. Reg. 31053, 5-28-93, as amended at 64 Fed. Reg. 11044 (Mar. 8, 1999).

  • 3650. When are IRA funds transferred between spouses or incident to a divorce treated as taxable distributions?

    • An individual may transfer, without tax, the individual’s IRA to his or her spouse or former spouse under a divorce or separate maintenance decree or a written instrument incident to the divorce. The IRA then is maintained for the benefit of the former spouse.1 Any other assignment of an IRA is a deemed distribution of the amount assigned.2


      Planning Point: It is especially important for clients to revisit IRA beneficiary designations upon divorce.  The U.S. Supreme Court recently upheld a Minnesota law that operates to revoke a life insurance beneficiary designation in favor of an ex-spouse upon divorce.  In that case, the policy owner’s two children from a prior marriage claimed that they, not the owner’s ex-spouse, were the rightful beneficiaries and the Supreme Court agreed.  While this case involved life insurance policies, it is important to remember that it could also impact a client’s IRA.3


      Where an individual rolled over his interest in a tax sheltered annuity to an IRA, pursuant to a qualified domestic relations order (“QDRO”) (Q 3909), the subsequent transfer of the IRA to the individual’s spouse was considered a “transfer incident to a divorce” and, thus, nontaxable to either spouse.4

      A taxpayer was liable for taxes on a distribution from his IRA that he subsequently turned over to his ex-wife in satisfaction of a family court order because it was not a “transfer incident to divorce” and the family court order was not a QDRO because it did not specifically require the transfer of assets to come from the IRA.5 A transfer of funds between the IRAs of two spouses that does not come within the divorce exception is a deemed distribution despite IRC provisions that provide that no gain is recognized on transfers between spouses.6

      The transfer of a portion of a husband’s IRA to his wife to be placed in an IRA for her benefit that was the result of a private written agreement between the two that was not considered incident to a divorce was not eligible for nontaxable treatment under IRC section 408(d)(6).7

      Where a taxpayer received a full distribution from his IRA and endorsed the distribution check over to his soon-to-be-ex-wife, the husband was determined to have failed to satisfy the requirements for a nontaxable transfer incident to divorce and was liable for taxation on the entire proceeds of the IRA distribution.8

      State community property laws, although generally disregarded under IRC section 408(g) with respect to IRAs, are not always preempted by Section 408(g). Where two traditional IRAs were classified as community property, the distributions of the deceased spouse’s community property interest in the IRAs to relatives other than her surviving husband were taxable only to those recipients and not to the husband.9

      Conversely, in a case of first impression, the Tax Court ruled that the recognition of community property interests in IRAs would conflict with existing federal tax rules under Section 408(g) treating IRA accounts as separate property. In this case, the taxpayer transferred money from his IRA, which was considered community property under California law, to his former spouse pursuant to his divorce decree. By reason of IRC section 408(g), the Court held that the taxpayer, not the former spouse, was liable for the income taxes associated with the distribution because, despite the former spouse’s community property interest in the IRA, taxable IRA distributions are separate property.10

      Where taxpayers requested that an IRA be reclassified under state marital property law from individual property to marital property, no distribution under IRC section 408(d)(1) was deemed to have occurred.11

      The involuntary garnishment of a husband’s IRA and resulting transfer of such funds to the former spouse to satisfy arrearages in child support payments was a deemed distribution to the husband because it discharged a legal obligation owed by the husband.12

      Planning Point: An IRA being transferred to an ex-spouse pursuant to a divorce or separation agreement should made through a direct trustee-to-trustee transfer to avoid possible tax consequences.


      1. IRC Sec. 408(d)(6).

      2. Treas. Reg. §1.408-4(a)(2).

      3.  Sveen v. Melin, 138 S. Ct. 939 (2018).

      4. Let. Rul. 8916083.

      5Czepiel v. Comm., TC Memo 1999-289.

      6. See Let. Ruls. 9422060, 8820086.

      7. Let. Rul. 9344027.

      8Jones v. Comm., TC Memo 2000-219.

      9. Let. Rul. 8040101.

      10Bunney v. Comm., 114 TC 259 (2000). See also Morris v. Comm., TC Memo 2002-17.

      11. Let. Ruls. 199937055, 9419036.

      12Vorwald v. Comm., TC Memo 1997-15.

  • 3651. Are IRA distributions subject to the 3.8 percent net investment income tax?

    • Distributions from traditional and Roth IRAs are not subject to the 3.8 percent net investment income tax (also known as the Medicare contribution tax) imposed under the Affordable Care Act. The tax equals 3.8 percent of the lesser of a taxpayer’s net investment income for the taxable year, or the excess (if any) of the taxpayer’s modified adjusted gross income for the year, over a threshold amount ($200,000 for a taxpayer filing an individual return and $250,000 for a taxpayer filing jointly).1

      IRC Section 1411 specifically excludes distributions from both traditional and Roth IRAs and other qualified plans from the definition of “net investment income.”

      Planning Point: While taxable distributions from traditional IRAs are not subject to the net investment income tax, they do increase a taxpayer’s Modified Adjusted Gross Income (MAGI) for the year. A higher MAGI may expose taxpayer’s other investment income (or increase taxpayer’s exposure) to this 3.8 percent tax. Planners should consider the effect of an IRA distribution on a client’s MAGI and exposure to the net investment income tax.


      1. IRS Publication 550 (2018).

  • 3652. 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 (Q 3671). The earnings on a Roth IRA may or may not be taxed upon distribution (Q 3673). Like a trust that is part of a qualified plan, an individual retirement account is subject to taxes for its unrelated business income (Q 3974, Q 4098).

      Tax deferral is lost if an individual engages in a prohibited transaction (Q 3980) or borrows under 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.

      Planning Point:Prohibited transactions include: borrowing money from the IRA, selling property to it and using IRA assets for personal use or as security for a personal loan. Additionally an IRA is prohibited from investing in collectibles (e.g. artwork, antiques, stamps) and life insurance.


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

  • 3653. 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

      Although qualified retirement plans, SEP IRAs, SIMPLE IRAs, and elective deferral Roths are excluded from bankruptcy (i.e. not part of the bankruptcy estate), the same is not true for traditional IRAs and Roth IRAs.3 Traditional IRAs and Roth IRAs, however, may be exempted (i.e. protected) from bankruptcy depending on the size of these accounts (see below).

      A debtor can choose to exempt property from the bankruptcy estate using federal exemptions or state exemptions, but not both.4 Federal bankruptcy exemptions generally protect a debtor’s right to receive payments under a stock bonus, pension, profit-sharing, annuity or similar plan on account of illness, disability, age, or length of service under Section 522(d)(10)(E) of the federal Bankruptcy Code. The U.S. Supreme Court has ruled that assets in a traditional IRA are eligible for this exemption.5

      Although bankruptcy is governed by federal law, Congress has given states the power to create their own exemptions and to opt out of the federal exemption system. Each state now has its own set of exemptions and many, but not all, have opted out of the federal system entirely. For a debtor living in a state that has opted out, only applicable state law exemptions may be used in a bankruptcy proceeding to exempt assets. It should be noted, however, that many states also extend protections to IRAs and Roth IRAs and exempt (fully or partially) these accounts from attachment by creditors – even in non-bankruptcy cases.

      Editor’s Note: Note that inherited IRAs that are inherited by non-spouse beneficiaries are often not given the same bankruptcy protection.

      Planning Point: When available, a debtor choosing between the available federal and state exemptions should examine all of his or her assets, not just the IRA provisions, to determine which method is more beneficial in bankruptcy.

      The bankruptcy exemption for contributory (nonrollover) traditional and Roth IRAs is limited in the aggregate to $1 million (the amount is indexed every three years and the current limit (as adjusted April 1, 2019) is $1,362,800 per person, for 2016 through April 1, 2019, the amount was $1,283,025), unless the bankruptcy court determines that “the interests of justice” require otherwise.6 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, without regard to rollover contributions, and does not apply separately to each account. Amounts in excess of the limit are subject to the claims of creditors.7

      The Eighth Circuit has upheld a bankruptcy appellate panel decision, finding that an annuity purchased with funds rolled over from a taxpayer’s traditional IRA was exempt from the bankruptcy estate because the annuity complied with the IRC Section 408 requirements for qualified individual retirement annuities. This was held to be the case despite the fact that the taxpayer paid an initial lump sum for the annuity that exceeded the annual contribution limits under IRC Section 219(b). The court agreed with the taxpayer’s argument that the amounts rolled over from the IRA into the annuity did not constitute premium payments, so that the IRC Section 408(b) prohibitions against fixed premium amounts or premiums that exceed the Section 219 annual limits were not violated. As a result, under the Eighth Circuit’s logic, funds from a traditional IRA can be rolled over into a qualified individual retirement annuity without losing the bankruptcy exemption granted to IRA funds.8

      With respect to self-directed IRAs, the 11th Circuit recently confirmed that a taxpayer was not entitled to creditor protection in bankruptcy with respect to a self-directed IRA that he used for impermissible purposes.  In this case, the taxpayer withdrew IRA funds to purchase cars, real estate and other assets not specifically permitted by the IRA, which prohibited using the retirement funds for pre-retirement personal benefit.  The issue in this case was not whether IRA funds were used for prohibited personal use, however, but whether the assets left within the IRA could be protected from creditors in bankruptcy.  The court ruled that the creditors could access amounts left in the IRA, regardless of whether that IRA continued to be tax-exempt, because the taxpayer failed to properly maintain the IRA by withdrawing funds for prohibited reasons.9

      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.10 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.11


      1. ERISA Sec. 206(d)(1).

      2Patterson 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)(1).

      5Rousey v. Jacoway, 544 U.S. 320 (2005).

      6. 11 U.S.C. §§104 and 522(n).

      7. 11 U.S.C. §522(n).

      8Running v. Miller, 778 F.3d 711 (8th Cir. 2015).

      9. Yerian v. Webber, 2019 WL 2610751 (11th Cir. 2019).

      10Infelise v. U.S., 159 F.3d 300 (7th Cir. 1998).

      11Kane v. Capital Guardian Trust Co., 145 F.3d 1218 (10th Cir. 1998).

  • 3654. Who may establish an IRA?

    • Virtually any individual who wishes to do so may establish a traditional individual retirement plan. To deduct contributions to such a plan once it is established and avoid tax penalties for excess contributions, an individual must have compensation (either earned income of an employee or self-employed person, or alimony prior to 2019), and before 2020, must not have attained age 70½ during the taxable year for which the contribution is made.1

      Note that the SECURE Act eliminated the age cap on IRA contributions. Further, the 2017 Tax Act eliminated the deduction for alimony payments and provides that alimony is no longer includable in the recipient’s income for tax years beginning after 2018. Because only “taxable” alimony constitutes “compensation”, alimony is no longer included after 2018.

      If an individual is an “active participant” (Q 3666), the deduction may be limited (Q 3656). Any individual who can make a rollover contribution (Q 3992) may establish an individual retirement plan (or more than one plan) to receive it (Q 3996 to Q 4012).2

      To establish and contribute directly to a Roth individual retirement plan, an individual (1) must have compensation (either earned income of an employee or self-employed person, or alimony (but see above)), and (2) must not have adjusted gross income (for 2022) (a) of $214,000 or above in the case of a taxpayer filing a joint return, (b) of $144,000 or above in the case of a taxpayer filing a single or head-of-household return,3 or (c) of $10,000 or above in the case of a married individual filing separately (Appendix E – 01).4 An individual who satisfies these requirements may establish and contribute to a Roth IRA (Q 3659).5

      Planning Point: For taxpayers who exceed the income limits and are thus prohibited from contributing directly to a Roth IRA, a Roth IRA may still be established to receive rollover distributions from other IRAs or qualified plans (this strategy is commonly referred to as the backdoor Roth IRA).

      As to what constitutes “compensation,” see Q 3665.

      An estate may not make a contribution on behalf of the decedent.6


      1. IRC Sec. 219.

      2. Special Ruling 9-28-76.

      3. Notice 2021-61.

      4. IRS Pub. 590.

      5. IRC Secs. 219, 408A; IR-2011-103.

      6. Let. Rul. 8439066.

  • 3655. When must contributions to IRAs be made?

    • Contributions to both a traditional IRA and Roth IRA must be made by the tax filing deadline for the tax year in question, not including extensions. For example, a taxpayer who wishes to contribute to an IRA must do so prior to April 15 (July 15 in 2020 and May 17 in 2021) of the following year. This rule applies whether the IRA is an existing or new plan.

      With respect to traditional IRAs, contributions may be deducted for that tax year if the contribution is made on account of that year. This applies both to contributions to individual plans and contributions to spousal plans.1 A postmark is evidence of the timeliness of the contribution.2


      1. IRC Secs. 219(f)(3), 408A(c)(6).

      2. Let. Ruls. 8633080, 8611090, 8536085.

  • 3656. How much may an individual contribute to a traditional IRA? How much may be deducted?

    • Contributions to traditional IRAs are limited at two levels. First, there is a limit on the amount of contributions that may be deducted for income tax purposes. Second, there is a limit with respect to the amount of total contributions that can be made, including both deductible and nondeductible contributions.

      Contributions to an individual retirement plan are not subject to the general limits on contributions and benefits of Code section 415 (Q 3868). (See Q 3701 for the effect of Code section 415 on simplified employee pensions.) The source of the funds contributed to an IRA is not determinative as to eligibility or deductibility so long as the contributing individual has includable compensation at least equal to the amount of the contribution.1

      The IRA contribution limit does not apply to qualified rollovers into an IRA.2

      Deductible Contributions

      If an eligible individual contributes on his own behalf to a traditional IRA, he generally may deduct amounts contributed in cash up to the lesser of the “deductible amount” for the taxable year or 100 percent of compensation includable in his gross income for such year.3

      The “deductible amount” is $6,000 for 2019-2022. It was also $5,500 in 2014-2018 (Appendix E – 01).4 This amount is indexed for inflation.

      Example 1: Danny, an unmarried college student working part-time, earns $4,500 in 2022. Danny can contribute up to $4,500, the amount of his compensation (rather than the deductible amount), to his IRA in 2022.

      Example 2: George, who is 34 years old and single, earns $24,000 in 2021. His IRA contributions for 2022 are limited to $6,000 (the deductible amount).

      The “deductible amount” is increased by a $1,000 catch-up contribution for individuals who have attained age 50 before the close of the tax year.5

      Example: Samantha, who is single, turned 50 in October of 2022. She earns $30,000 in 2021. Her IRA contributions for 2021 are limited to $7,000 ($6,000 plus a $1,000 catch-up).

      Employer contributions to a simplified employee pension and any amounts contributed to a SIMPLE IRA are subject to different limitations.

      Planning Point: Before 2020, contributions could not be made to a traditional IRA for the year in which the IRA participant reaches age 70½ or for any later year. The age cap was removed beginning in 2020 by the SECURE Act. 

      The overall maximum contribution limit is also equal to the “deductible amount.”6Contributions made to Roth IRAs for the taxable year reduce both deductible and overall contribution limits (Q 3659). As to what constitutes “compensation,” see Q 3665.

      In taxable years beginning in 2007 through 2009, the “deductible amount” was increased by $3,000 for former employees of bankrupt companies with indicted executives (e.g., Enron), if the employer matched 50 percent or more of employee 401(k) contributions in the form of employer stock. For taxpayers age 50 or older, the enhanced catch-up contribution was available instead of the usual $1,000 catch-up provision.7

      If a married couple files a joint return, both spouses may contribute to an IRA even if only one spouse has taxable compensation. The maximum deduction allowed to an individual for a cash contribution to a traditional IRA for a nonworking spouse for a taxable year is the lesser of (1) the “deductible amount” or (2) 100 percent of the nonworking spouse’s includable compensation, plus 100 percent of the working spouse’s includable compensation minus (a) the amount of any IRA deduction taken by the working spouse for the year, and (b) the amount of any contribution made to a Roth IRA by the working spouse.8

      Example: Sarah, age 52, is married with no taxable compensation for 2021. She and her husband reported taxable compensation of $60,000 on their 2022 joint return. Sarah may contribute $7,000 to her IRA for 2022 ($6,000 plus an additional $1,000 contribution for age 50 and over).

      While two spouses who file jointly are permitted a maximum deduction of up to $12,000 in 2022 (the amount is increased to $14,000 to include catch up contributions if they are both over 50), the deduction for each spouse is computed separately.9

      The deduction is taken from gross income so that an individual who does not itemize his deductions may take advantage of the retirement savings deduction.10 Prior to 2020, no deduction could be taken for a contribution on behalf of an individual who had attained age 70½ before the end of the tax year.11 An individual over age 70½ could also take a deduction for a contribution made on behalf of a spouse who was under age 70½. An excess contribution made in one year can be deducted in a subsequent year to the extent the excess is absorbed in the later year (Q 3669).

      The cost of a disability waiver of premium feature in an individual retirement annuity is deductible under Code section 219, but where an individual contributes to an annuity for the benefit of himself and his nonemployed spouse, the waiver of premium feature may only be allocated to the working spouse’s interest.12

      No deduction is allowed for contributions to an IRA if the individual for whose benefit the IRA is maintained acquired that IRA by reason of the death of another individual after 1983. But this does not apply where the acquiring individual is the surviving spouse of the deceased individual.13

      For the limits on contributions to Roth IRAs, see Q 3659. For limits on contributions to simplified employee pensions, see Q 3701. For limits on contributions to a SIMPLE IRA, see Q 3706. For a discussion of the nondeductible contributions that may be made to an IRA, see Q 3658.


      1. See Let. Rul. 8326163.

      2. IRC. Sec 408(a)(1).

      3. IRC Sec. 219(b)(1).

      4. IRC Sec. 219(b)(5)(A)); Notice 2013-73, IR-2014-99, Notice 2016-62, Notice 2017-64, Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021-61.

      5. IRC Sec. 219(b)(5)(B).

      6. IRC Sec. 408(a)(1).

      7. IRC Sec. 219(b)(5)(C).

      8. IRC Sec. 219(c)(1).

      9. Notice 2021-61.

      10. IRC Sec. 62(a)(7).

      11. IRC Sec. 219(d)(1), prior to repeal by the SECURE Act.

      12. Let. Rul. 7851087.

      13. IRC Secs. 219(d)(4), 408(d)(3)(C)(ii).

  • 3657. What are the active participant rules that can impact an individual’s IRA contribution limit?

    • The deduction for contributions made to individual and spousal plans may be reduced or eliminated if the individual or his spouse is an “active participant” (Q 3666). The amount of the reduction is the amount that bears the same ratio to the overall limit as the taxpayer’s adjusted gross income (AGI) in excess of an “applicable dollar amount” bears to $10,000 ($20,000 in the case of a joint return for taxable years beginning after 2006).1 Applicable dollar amounts are indexed for inflation. Thus, the amount of the reduction is calculated as follows:

      “deductible amount”

      x

      AGI – “applicable dollar amount”

      $10,000 (or $20,000 for joint return)

      In the case of a taxpayer who is an active participant and files a single or head-of-household return, the “applicable dollar amount” is $68,000 in 2022 ($66,000 in 2021, $65,000 in 2020, and $64,000 in 2019 (Appendix E – 01)).2

      In the case of married taxpayers who file a joint return, where one or both spouses are active participants, the “applicable dollar amount” for a spouse who is an active participant is $109,000 in 2022 ($105,000 in 2021, $104,000 in 2020, and $103,000 in 2019 (Appendix E – 01)).3

      In the case of married taxpayers who file a joint return, where only one is an active participant, the “applicable dollar amount” for the nonactive participant spouse is $204,000 in 2022 ($198,000 in 2021, $196,000 in 2020, and $193,000 in 2019 (Appendix E – 01)).4 The denominator in the fraction remains at $10,000 (it does not increase to $20,000).5

      In the case of a married individual filing a separate return where either spouse is an active participant, the “applicable dollar amount” is $0.6

      Example: Jack and Jill are married and file a joint tax return for 2022. Jack is an active participant, but Jill is not. Their modified adjusted gross income is $115,000. Jack is under age 50 and is therefore able to contribute $6,000 to a traditional IRA.

      Using the formula above, Jack calculates his maximum deductible amount:

      = $6,000 × ($115,000−$109,000)/ $20,000

      = $1,800, which represents the amount of the reduction

      = $6,000 (the maximum contribution amount) minus $1,800 (the reduction amount)

      Answer = $4,200

      Because Jill is the nonactive participant with an active participant spouse, the “applicable dollar amount” for Jill is $204,000 (for 2022), well above Jack and Jill’s AGI. Accordingly, a $6,000 contribution to Jill’s IRA is fully deductible.

      Due to these “active participant” limitations, a deduction for contributions made to an IRA in 2022 will be eliminated for:

      (1) individuals who are active participants and file a single or head-of-household return with AGI of $78,000 and above;

      (2) married individuals who are active participants and file a joint return with AGI of $129,000 and above;

      (3) married individuals where only one spouse is an active participant and file a joint
      return with AGI of $214,000 and above; and

      (4) married individuals who are active participants or their spouses are active participants and file separately with AGI of $10,000 and above (Appendix E – 01).7

      The amount of the reduction is rounded to the next lowest multiple of $10.8 Unless the individual’s deduction limit is reduced to zero, the IRC permits a minimum deduction of $200.9

      For this purpose, AGI is calculated without regard to the exclusions for foreign earned income, qualified adoption expenses paid by the employer and interest on qualified United States savings bonds used to pay higher education expenses. Social Security benefits includable in gross income under IRC Section 86 and losses or gains on passive investments under IRC Section 469 are taken into account. Also for this purpose, contributions to a traditional IRA are not deducted in determining AGI.10

      __________________

      1. IRC Sec 219(g)(2).

      2. IRC Sec. 219(g)(3)(B)(ii); IR-2015-118, Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021-61.

      3. IRC Sec. 219(g)(3)(B)(i); IR-2015-118, Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021-61.

      4. IR-2015-118, Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021-61.

      5. IRC Sec. 219(g)(7)(B); Notice 2013-73, IR-2014-99.

      6. IRC Sec. 219(g)(3)(B)(iii).

      7. IR-2015-118, Notice 2021-61.

      8. IRC Sec. 219(g)(2)(C).

      9. IRC Sec. 219(g)(2)(B).

      10. IRC Sec. 219(g)(3)(A); See Treas. Reg. §1.408A-3, A-5.

  • 3658. What nondeductible contributions may be made to a traditional IRA?

    • Nondeductible contributions can also be made to a traditional IRA. The limit on nondeductible contributions is equal to the excess of the “deductible amount,” discussed in Q 3656, over the actual maximum deduction allowed.1 Contributions made to Roth IRAs for the taxable year reduce this limit (Q 3659). This limit is not reduced because an individual’s AGI exceeds certain limits (in contrast, see Q 3659 with respect to contributions to Roth IRAs). A taxpayer may elect to treat contributions that would otherwise be deductible as nondeductible.2 Nondeductible contributions must be reported on the individual’s tax return and penalties apply if the required form is not filed or the amount of such contributions is overstated (Q 3699).

      Planning Point: It is generally better to make nondeductible contributions to a Roth IRA (Q 3659) rather than nondeductible contributions to a traditional IRA because of the way the earnings are taxed.


      Endowment Contracts

      Endowment contracts issued after November 6, 1978 do not qualify as individual retirement annuities; therefore, contributions to such contracts are not deductible.3 Furthermore, in the case of contributions to an endowment contract individual retirement annuity issued before November 7, 1978, no deduction is allowed for contributions that are allocable to the purchase of life insurance protection. The amount allocable to life insurance protection is determined by multiplying the death benefit payable during the tax year less the cash value at the end of the year by the net premium cost. (See Q 620 for purposes of valuing the economic benefit of current life insurance protection.) The nondeductible amount may be contributed to another funding medium and a deduction taken so that the maximum deduction may be used, but it may not be used to pay the premium for an annuity if the total premium on behalf of any one individual would then exceed the maximum annual contribution limit.


      1. IRC Sec. 408(o)(2)(B)(i).

      2. IRC Sec. 408(o)(2)(B)(ii).

      3. See Treas. Reg. §§1.408-4(f), 1.408-3(e)(1)(ix).

  • 3659. How much may an individual contribute to a Roth IRA?

    • An eligible individual may contribute cash to a Roth IRA on his own behalf up to the lesser of the maximum annual contribution limit (equal to the “deductible amount” under IRC section 219(b)(5)(A)) or 100 percent of compensation includable in his gross income for the taxable year. The amount that can be contributed, however, is reduced by any contributions made to traditional IRAs for the taxable year on his own behalf.1

      The maximum annual contribution limit is $6,000 in 20222 (Appendix E – 01). This amount is indexed for inflation. The maximum annual contribution limit is increased by $1,000 for individuals who have attained age 50 before the close of the tax year (i.e. $7,000 in 2020-2022) (Appendix E – 01).3

      SEPs and SIMPLE IRAs may not be designated as Roth IRAs, and contributions to a SEP or SIMPLE IRA will not affect the amount that an individual can contribute to a Roth IRA.4 Qualified rollover contributions (Q 3662) do not count towards this limit.5 As to what constitutes “compensation,” see Q 3665. Roth IRA contributions are not deductible and can be made at any age.6

      In taxable years beginning in 2007 through 2009, the maximum annual contribution limit was increased by $3,000 for former employees of bankrupt companies with indicted executives (e.g., Enron), if the employer matched 50 percent or more of employee 401(k) contributions in the form of employer stock. For taxpayers age 50 or older, the enhanced catch-up contribution was available instead of the usual $1,000 catch-up provision.7

      An individual may contribute cash to a Roth IRA for a non-working spouse for a taxable year up to the maximum deductible limit (disregarding active participant restrictions) permitted with respect to traditional IRAs for such non-working spouse (Q 3656), reduced by any such contributions made to traditional IRAs for the taxable year on behalf of the non-working spouse.8 Thus, a married couple (both spouses under age 50) may be permitted a maximum contribution of up to $12,000 for 2020-2022 ($6,000 for each spouse).

      The maximum contribution permitted to an individual Roth IRA or a spousal Roth IRA is reduced or eliminated for certain high-income taxpayers. The amount of the reduction is the amount that bears the same ratio to the overall limit as the taxpayer’s adjusted gross income (AGI) in excess of an “applicable dollar amount” bears to $15,000 ($10,000 in the case of a joint return).9 Thus, the amount of the reduction is calculated as follows:

      maximum contribution

      x

       AGI – “applicable dollar amount”


      $15,000 ($10,000 if a joint return)

      The “applicable dollar amount” in 2022 is (1) $129,000 in the case of an individual ($125,000 in 2021, $124,000 in 2020), (2) $204,000 ($198,000 in 2021, $196,000 in 2020) in the case of a married couple filing a joint return, and (3) $0 in the case of a married person filing separately.10 (Appendix E – 01.)

      Thus in 2022, the Roth IRA contribution limit is $0 for (1) individuals with AGI of $144,000 and above ($140,000 in 2021, $139,000 in 2020), (2) married couples filing a joint return with AGI of $214,000 and above ($208,000 in 2021, $206,000 in 2020), and (3) a married individual filing separately with AGI of $10,000 and above (Appendix E – 01).11 Except for married individuals filing separately, the “applicable dollar amount” is indexed for inflation. The amount of the reduction is rounded to the next lowest multiple of $10. Unless the individual’s contribution limit is reduced to zero, the IRC permits a minimum contribution of $200.12

      For this purpose, AGI is calculated without regard to the exclusions for foreign earned income, qualified adoption expenses paid by the employer, and interest on qualified United States savings bonds used to pay higher education expenses. Social Security benefits includable in gross income under IRC Section 86 and losses or gains on passive investments under IRC Section 469 are taken into account. Also for this purpose, deductible contributions to a traditional IRA plan are not taken into account in determining AGI; amounts included in gross income as a result of a rollover or conversion from a traditional IRA to a Roth IRA are not taken into account for purposes of determining the maximum contribution limit for a Roth IRA.


      1. IRC Sec. 408A(c)(2).

      2. Notice 2019-59, Notice 2020-79, Notice 2021-61.

      3. IRC Sec. 219(b)(5); Notice 2019-59, Notice 2020-79, Notice 2021-61.

      4. IRC Sec. 408A(f).

      5. IRC Sec. 408A(c)(6).

      6. IRC Secs. 408A(c)(1).

      7. IRC Sec. 219(b)(5)(C).

      8. See IRC Secs. 408A(c)(2), 219(b)(1), 219(c).

      9. IRC Sec. 408A(c)(3).

      10. Notice 2019-59, Notice 2020-79, Notice 2021-61.

      11. IR-2015-118, Notice 2019-59, Notice 2020-79, Notice 2021-61.

      12. IRC Sec. 408A(c)(3)(A).

  • 3660. What is the difference between a Roth IRA and a traditional IRA?

    • The primary difference between a Roth IRA and a traditional IRA is the tax treatment of contributions to, and withdrawals from, the account. “Qualified distributions” (see Q 3673) from a Roth IRA are not includable in gross income. Thus, earnings are tax-free, not tax deferred, as is the case with traditional IRAs. Any nonqualified distribution from a Roth IRA will be includable in income, but only to the extent that the distribution, along with all previous distributions from the Roth IRA, exceeds the aggregate amount of contributions to the Roth IRA.

      Contributions from a traditional IRA are contributed on a pre-tax basis (i.e., they are deductible up to the annual contribution limit), while Roth IRA contributions are not deductible. Before 2020, contributions to a traditional IRA had to cease when the account owner reached age 70½.  The age limitation was eliminated by the SECURE Act.[1] An individual may make both pre-tax and after-tax (Q 3659) contributions to a traditional IRA, but may only make after-tax contributions to a Roth IRA.


      Planning Point: Note that while the SECURE Act eliminated the age restriction for traditional IRA contributions, financial institutions are not required to accept post-age 70½ contributions.  In other words, it is up to the specific institution to determine whether to accept these contributions beginning in 2020.[2]


      Further, amounts accumulated in a traditional IRA or annuity must be distributed in compliance with the minimum distribution requirements (see Q 3684).[3] Roth IRAs are not subject to the lifetime minimum distribution requirements, but are subject to certain after-death distribution requirements (Q 3687).  The chart below summarizes the primary differences between a traditional IRA and a Roth IRA.

      Traditional IRA Roth IRA
      Contribution Limit[4] $6,000 + $1,000 catch-up if 50 or older. $6,000 + $1,000 catch-up if 50 or older.
      Taxation of Contributions Made with pre-tax dollars Made with after-tax dollars.
      Age Limit for Contributions None. None.
      Taxation of Distributions Taxed at ordinary income tax rates. Tax-free if certain conditions are met.
      Required Distributions Distributions must begin April 1 of the year after the owner turns 72. No lifetime distribution requirements for original account owner

      For more information on the contribution limit that applies to both traditional IRAs and Roth IRAs, see Q 3656 and Q 3659. Also, Q 3659 and Q 3661 discuss the income limits that apply to Roth IRAs, and Q 3662 discusses the rules governing converting traditional IRA funds to Roth accounts.

      _______________

      [1].     IRC Secs. 408A(c)(1), 408A(c)(4), prior to repeal by the SECURE Act.

      [2]      Notice 2020-68.

      [3].     IRC Secs. 408(a)(6), 408(b)(3), 401(a)(9).

      [4].     Notice 2019-59.

  • 3661. Can a taxpayer whose income level exceeds the limitations for Roth IRA contributions maintain a Roth IRA?

    • Yes. Despite the fact that a taxpayer whose income level exceeds the Roth IRA contribution limits cannot contribute directly to a Roth IRA, he or she is permitted to maintain a Roth account. In 2022 the ability to make contributions to a Roth IRA begins to phase out for married taxpayers with income over $204,000 ($129,000 for single taxpayers). Roth contributions are completely disallowed for married taxpayers who earn over $214,000 and single taxpayers who earn over $144,000.1

      While contributions cannot be made directly to the Roth IRA if the taxpayer’s income exceeds the annual income threshold, for tax years beginning in 2010 and after, the income limits that applied to prevent high-income taxpayers from making rollovers from traditional IRAs were eliminated.2

      Therefore, many high-income taxpayers may make contributions indirectly to a Roth account, via a series of rollovers from traditional IRAs. The taxpayer must first open a traditional IRA if he or she does not already maintain such an account (in 2022, each taxpayer can contribute up to $6,000 to an IRA ($7,000 if the taxpayer is 50 or older).3 Using the so-called “backdoor” Roth IRA technique, the taxpayer can then roll a portion of the traditional IRA into a Roth IRA account each year, though taxes must be paid on the amounts that are rolled over. See Q 3662 for rules regarding rollovers from an IRA to a Roth IRA.


      1. Notice 2021-61.

      2. IRC Secs. 408A(c)(3)(B), 408A(e).

      3. Notice 2021-61.

  • 3662. Can an individual roll over or convert a traditional IRA or other eligible retirement plan into a Roth IRA?

    • Editor’s Note: The 2017 Tax Act eliminates the ability of taxpayers to recharacterize Roth IRA conversions for tax years beginning after 2017.  Taxpayers were entitled to recharacterize 2017 conversions through October 15, 2018.

      Yes.

      A “qualified rollover contribution” can be made from a traditional IRA or any eligible retirement plan (Q 3996) to a Roth IRA.1

      Amounts that are held in a SEP or a SIMPLE IRA that have been held in the account for two or more years also may be converted to a Roth IRA.2

      The taxpayer must include in income the amount of the distribution from the traditional IRA or other eligible retirement plan that would be includable if the distribution were not rolled over.3 (See Q 3671 for taxation of amounts distributed from such IRAs.) Thus, if only deductible contributions were made to an eligible retirement plan, the entire amount of the distribution would be includable in income in the year rolled over or converted. (Special rules apply for conversions made in 2010.) While the 10 percent early distribution penalty (Q 3677) does not apply at the time of the conversion to a Roth IRA, it does apply to any converted amounts distributed during the five-year period beginning with the year of the conversion.4

      When an individual retirement annuity is converted to a Roth IRA, or when an individual retirement account that holds an annuity contract as an asset is converted to a Roth IRA, the amount that is deemed distributed is the fair market value of the annuity contract on the date of the (deemed) distribution. If, in converting to a Roth IRA, an IRA annuity contract is completely surrendered for its cash value, regulations provide that the cash received will be the conversion amount.5

      Nonrollover contributions made to a traditional IRA for a taxable year (and any earnings allocable thereto) may be transferred to a Roth IRA on or before the due date (excluding extensions of time) for filing the federal income tax return of the contributing individual and no such amount will be includable in income, provided no deduction was allowed with respect to such contributions.6 Such contributions would be subject to the maximum annual contribution limits (Q 3659).

      A “qualified rollover contribution” is any rollover contribution to a Roth IRA from a traditional IRA or other eligible retirement plan that meets the requirements of IRC section 408(d)(3) (Q 4004). A rollover or conversion of a traditional IRA to a Roth IRA does not count in applying the one IRA-to-IRA rollover in any twelve month period limit (Q 4004).7

      For years prior to 2010, the taxpayer’s AGI was calculated without regard to the exclusions for foreign earned income, qualified adoption expenses paid by the employer, and interest on qualified United States savings bonds used to pay higher education expenses. Deductible contributions to a traditional IRA also were not taken into account in determining AGI. Amounts included in gross income as a result of a rollover or conversion from a traditional IRA or other eligible retirement plan to a Roth IRA were not taken into account.8 Social Security benefits includable in gross income under Code section 86 and losses or gains on passive investments under Code section 469 were taken into account. The definition of AGI excludes minimum required distributions to IRA owners, solely for purposes of determining eligibility to convert a regular IRA to a Roth IRA.9

      An eligible retirement plan, for this purpose, includes a qualified retirement plan, a Code section 403(b) tax sheltered annuity, or an eligible Code section 457 governmental plan. Taxpayers, including plan beneficiaries, can directly transfer (and thereby convert) money from these plans into a Roth IRA without the need for a conduit traditional IRA (as was required prior to 2008).10 (Other than by direct conversion from an eligible non-IRA retirement plan, a beneficiary may not convert to a Roth IRA.)11

      Unless a taxpayer elects otherwise, income from conversions to Roth IRAs occurring in 2010 were to be reported ratably in 2011 and 2012.12

      Qualified rollover contributions do not count toward the annual maximum contribution limit applicable to Roth IRAs (Q 3659).13

      A rollover from a Roth IRA or a designated Roth account to a Roth IRA is not subject to the adjusted gross income limitation and is not subject to tax.14

      Planning Point: Major reasons for converting to a Roth IRA often include obtaining tax-free qualified distributions from the Roth IRA and greater stretch from the Roth IRA because distributions from a Roth IRA are not required until after the death of the owner (or the death of the IRA owner’s spouse if the spouse is the sole designated beneficiary and elects to treat the IRA as the spouse’s own), rather than starting at age 72. A conversion also may make sense if it is expected that tax rates will increase (from the time of conversion to the time of distribution), but not if tax rates will decrease. Consider whether any special tax benefits, such as net unrealized appreciation, would be lost if a qualified plan is converted to a Roth IRA. Also, a qualified plan may offer better asset protection than a Roth IRA. State laws vary on this issue. If a taxpayer cannot qualify under the Roth AGI limitations, perhaps he or she can establish a traditional IRA, and then convert that into a Roth IRA. While this has not yet been addressed by the IRS, the strategy was blessed by Congress in its commentary to the 2017 tax reform legislation.


      1. IRC 408A(e).

      2. Treas. Reg. §1.408A-4, A-4.

      3. IRC Secs. 408A(d)(3)(A)(i), 408A(d)(3)(C).

      4. IRC Sec. 408A(d)(3)(F).

      5. Treas. Reg. § 1.408A-4.

      6. IRC Sec. 408(o)(3) and 408A(c)(6).

      7. IRC Sec. 408A(e).

      8. IRC Sec. 408A(c)(3)(B)(i).

      9. IRC Sec. 408A(c)(3)(B)(i).

      10. IRC Sec. 408A(d)(3); Notice 2008-30, 2008-1 CB 638, A-7.

      11. IRC 402(c)(11).

      12. IRC Sec. 408A(d)(3)(A)(iii).

      13. IRC Sec. 408A(c)(5)(B).

      14. IRC Secs. 408A(c)(3)(B); 408A(d)(3)(B).

  • 3663. What should an individual consider when choosing whether to convert retirement funds to a Roth IRA or to a Roth 401(k)?

    • Editor’s Note: The 2017 Tax Act eliminates the ability of taxpayers to recharacterize Roth IRA conversions for tax years beginning after 2017.  Taxpayers were entitled to recharacterize 2017 conversions through October 15, 2018.

      Prior to 2018, one important characteristic of a Roth IRA conversion was the taxpayer’s ability to undo the transaction through a recharacterization transaction that moves the funds back into the traditional account, eliminating the tax liability that the initial conversion created.1 This option was unavailable if the individual chooses to convert to a Roth 401(k).

      If the taxpayer’s account performed poorly in the months after the conversion took place, or if the taxpayer otherwise found that he or she was unable to pay the tax bill that results from a Roth conversion, the taxpayer had until October 15 of the year following the conversion to recharacterize the funds. The tax reform changes to the recharacterization rules placed Roth IRAs on par with Roth 401(k)s, where once the conversion takes place, the taxpayer is required to pay the associated taxes regardless of any events that occur post-conversion.

      A taxpayer who converts to a Roth IRA is able to escape the IRS’s required minimum distribution (RMD) rules so that the funds in the account are permitted to grow tax-free over a longer period of time. Taxpayers who use Roth 401(k)s are often required to comply with the RMD rules when they turn 72 (70½ before 2020), possibly reducing the account’s growth potential if the taxpayer does not need to access the funds.2 A taxpayer who plans to use a Roth account as a wealth transfer vehicle may also prefer the Roth IRA because the entire account value can be passed to heirs upon his or her death.

      Taxpayers who anticipate that they will need access to the funds before retirement should also consider how the application of the “five year rule” could impact the tax-free availability of these funds. To access the funds, a qualifying event must have occurred and the Roth must be at least five years old before a qualified distribution is permitted. However, if the taxpayer has multiple Roth IRAs, only one of the taxpayer’s IRAs must be five years old before a tax-free withdrawal is permitted.3 With a Roth 401(k), the particular account must be five years old or a penalty tax will apply.4

      Importantly, for high-income taxpayers, post-conversion contributions may be limited or blocked entirely because of the income limits that apply to Roth IRA contributions (but not to Roth 401(k) contributions). In 2022, the ability to make contributions to a Roth IRA begins to phase out for married taxpayers with income over $204,000 ($129,000 for single filers). Roth IRA contributions are completely blocked for married taxpayers who earn over $214,000 and single filers who earn over $144,000.5

      Stronger creditor protection rules also apply to Roth 401(k) accounts. While Roth IRAs are protected under state law, the rules that apply in some states offer much less in the way of creditor protection than can be found in others. Roth 401(k)s are always protected by ERISA-mandated federal creditor protection rules regardless of where the taxpayer lives.


      1. IRC Sec. 408A(d)(6).

      2. Treas. Reg. §1.401(k)-1(f)(3).

      3. IRC Secs. 408A(d).

      4. Treas. Reg. §1.402A-1, A-4.

      5. IRC Sec. 408A(c)(3); IR-2014-99 (Oct. 23, 2014), Notice 2021-61.

  • 3664. Can an individual correct a Roth conversion? What is a recharacterization?

    • Editor’s Note: The 2017 Tax Act eliminates the ability of taxpayers to recharacterize Roth IRA conversions for tax years beginning after 2017. The IRS released a FAQ confirming that taxpayers were entitled to recharacterize 2017 conversions through October 15, 2018.

      Prior to 2018, if a taxpayer rolled over funds from a traditional IRA or other eligible retirement plan to a Roth IRA during the taxable year, and later discovered that for any reason he or she wanted the transaction undone, the taxpayer generally had until the due date for filing his or her return (including extensions) to correct the conversion without penalty, to the extent all earnings and income allocable to the conversion were also transferred back to the original IRA, and no deduction had been allowed with respect to the original conversion.1 This “recharacterization” in the form of a trustee-to-trustee transfer resulted in the recharacterized contribution being treated as a contribution made to the transferee IRA, instead of to the transferor IRA.2 A taxpayer was able to apply to the IRS for relief from the time limit for making a recharacterization.3


      Planning Point: After tax reform, if a taxpayer makes a Roth contribution, he or she is permitted to recharacterize the transaction as a contribution to a traditional IRA before the due date for his or her income tax return for the year.4


      For purposes of a recharacterized contribution, the net income attributable to a contribution made to an IRA was determined by allocating to the contribution a pro-rata portion of the earnings or losses accrued by the IRA during the period the IRA held the contribution. This allowed the taxpayer to claim any net income that is a negative amount.5

      A time restriction was placed on reconversions (i.e., converting to a Roth IRA a second time after recharacterizing a first conversion). A person could reconvert back to a Roth IRA but only after the later of the beginning of the next year or thirty days after the recharacterization.6

      Planning Point: Prior to 2018, where the value of converted property dropped after a conversion to a Roth IRA, it was often useful to recharacterize the contribution back to a traditional IRA and then reconvert to a Roth IRA to reduce the amount taxable on converting to a Roth IRA. The time restriction on reconversions reduced, but did not eliminate, the potential value of this technique.

      Reconversions and recharacterizations had to be reported to the IRS on Form 1099-R and Form 5498. Prior year recharacterizations had to be reported under separate codes. All recharacterized contributions received by an IRA in the same year were permitted to be totaled and reported on a single Form 5498.7


      1. IRC Sec. 408A(d)(6); Notice 2008-30, 2008-1 CB 638, A-5.

      2. See Treas. Reg. §1.408A-5.

      3. See Let. Ruls. 200234073, 200213030.

      4. IRC Sec. 408A(d)(6)(B)(iii).

      5. Treas. Reg. §1.408A-5; Notice 2000-39, 2000-2 CB 132.

      6. Treas. Reg. §1.408A-5, A-9.

      7. Notice 2000-30, 2000-1 CB 1266.

  • 3665. What is “compensation” for purposes of IRA eligibility rules and deduction limits?

    • Editor’s Note: The SECURE Act also modified the definition of compensation so that certain stipends provided to graduate students can be counted as compensation for IRA contribution purposes after December 31, 2019. Similarly, qualified foster care payments (excluded from income) can be treated as compensation for plan years effective after December 31, 2015 (retroactively) for defined contribution plans and after 2019 for IRAs.1

      For purposes of the eligibility rules and deduction limits applicable to traditional and Roth IRAs, “compensation” means wages, salary, professional fees, or other amounts derived from, or received for, personal services actually rendered. “Compensation” also typically included alimony paid under a divorce or separation agreement that is includable in the income of the recipient under IRC Section 71.2 Because of the changes to the tax treatment of alimony payments following enactment of the 2017 tax reform legislation, non-taxable alimony payments are no longer “compensation” for these purposes.

      In the case of a self-employed individual, “compensation” includes earned income from personal services, but in computing the maximum IRA or SEP contribution, such income must be reduced by (1) any qualified retirement plan contributions made by such individual on his or her own behalf and (2) the 50 percent of self-employment taxes deductible by the individual.

      Earned income not subject to self-employment tax because of an individual’s religious beliefs is “compensation.”3

      An individual whose income for the tax year consists solely of interest, dividend, and pension income has no “compensation” and cannot deduct any portion of a traditional IRA contribution.4 In addition, such a person may not make a Roth IRA contribution.5

      Compensation does not include earnings and profits from property, such as rental income, interest, and dividend income, or any amount received as pension or annuity income, or as deferred compensation (see IRS Tax Topics No. 451).

      Further, “compensation” does not include any Social Security or railroad retirement benefits required to be included in gross income.6 Payments made to employees terminated because of a restructuring of the company are deferred compensation and may not be used as a basis for IRA contributions.7 Amounts received from an employer as deferred incentive awards, whether in the form of cash, stock options, or stock appreciation rights, also are not “compensation.”8 However, incentive pay awarded in one year for services performed in that year but paid in the following year is considered “compensation” in that second year.9

      The IRS has ruled that disability income payments, whether made under public or private plans, do not constitute “compensation.”10 Also, unemployment benefits do not constitute “compensation” because they are paid due to an inability to earn wages and not for personal services actually rendered.11

      Additionally, the IRS has issued a compensation “safe harbor.” The amount properly shown in the box for “wages, tips, other compensation,” less any amount properly shown in the box for “nonqualified plans,” on Form W-2 is considered compensation for purposes of calculating an individual’s IRA contribution.12

      Amounts paid by one spouse to another spouse to manage their jointly-owned investment property may not be treated by the spouse, on a joint return, as compensation for purposes of an IRA contribution.13 Similarly, wages paid to one spouse by another spouse and deposited in their joint account are not considered compensation because deposit in a joint account does not constitute actual payment of wages.14

      Payment in hogs rather than cash by a husband to his wife for her services in running their farm, however, was considered to be compensation for purposes of making an IRA contribution.15

      A self-employed individual who shows a net loss for the tax year cannot take any IRA deduction.16 A salaried employee who also is self-employed should disregard net losses from self-employment when computing his or her maximum deduction.17


      1. SECURE Act, Sec. 106, Sec. 116.

      2. IRC Secs. 219(f)(1), 408A(a); Treas. Reg. §1.408A-3, A-4.

      3. IRC Sec. 219(f)(1).

      4King v. Comm., TC Memo 1996-231.

      5. IRC Sec. 408A(c)(2).

      6. IRC Secs. 86(f)(3), 219(f)(1); Treas. Reg. §1.219-1(c)(1).

      7. Let. Ruls. 8534106, 8519051.

      8. Let. Rul. 8304088.

      9. Let. Rul. 8707051.

      10. See Let. Ruls. 8331069, 8325080, 8014110.

      11Russell v. Comm., TC Memo 1996-278.

      12. See Rev. Proc. 91-18, 1991-1 CB 522.

      13. Let. Rul. 8535001.

      14. Let Rul. 8707004.

      15. TAM 9202003.

      16Est. of Hall v. Comm., TC Memo 1979-342.

      17. Rev. Rul. 79-286, 1979-2 CB 121.

  • 3666. Who is an “active participant” for purposes of IRA eligibility rules and deduction limits?

    • Suppose an individual is an “active participant” in:

      (1) a qualified corporate or Keogh pension, profit sharing, stock bonus, or annuity plan;

      (2) a simplified employee pension or SIMPLE IRA;

      (3) a Section 403(b) tax sheltered annuity; or

      (4) a government plan.

      In those instances, the individual’s deduction limit for contributions to a traditional IRA may be reduced or eliminated (Q 3657). The limitation applies if the individual or the individual’s spouse was an active participant for any part of the plan year that ended with or withinthe taxable year.1

      Participation in Social Security, Railroad Retirement (tier I or II), or in an eligible Code section 457 deferred compensation plan (Q 3581) is not taken into consideration.2 Federal judges are treated as active participants.3 Active participants include any individual who is an active participant in a plan established for employees by the United States, a state or political subdivision thereof, or an agency or instrumentality of any of the foregoing.4

      A district court judge in the state of Nebraska who participated in the Nebraska Retirement Fund for Judges was found to be an employee of the state (not an officer of the state) and, thus, was an active participant.5

      Full-time active duty officers in the U.S. Air Force were found to be active participants.6 Certain members of the armed forces reserves and certain volunteer firemen covered under government plans are not considered active participants.7

      A teacher employed by a municipal school district in Michigan was found to be an active participant in the employment-based, qualified retirement plan provided by the state based upon his being an employee of a state or political subdivision through his employment in the school district.8

      Active participant status for a tax year must be reported by the employer on the employee’s Form W-2.

      Active participant status is determined without regard to whether such individual’s rights under the plan, trust, or contract are nonforfeitable.9 Active participant status is further determined under the rules provided in Notice 87-1610 and Treasury Regulation Section 1.219-2 (active participant rules in effect prior to the Economic Recovery Tax Act of 1981).

      In the case of a defined benefit plan, an individual who is not excluded under the eligibility provisions of the plan for the plan year ending with or within the individual’s taxable year is an active participant in the plan, regardless of whether such individual has elected to decline participation in the plan, has failed to make a mandatory contribution specified under the plan, or has failed to perform the minimum service required to accrue a benefit under the plan.11 An individual in a plan under which accruals all have ceased is not an active participant. Where benefits may vary with future compensation, all accruals are not considered to have ceased.12

      In the case of a profit sharing or stock bonus plan, an individual is an active participant if any employer contribution is deemed added or any forfeiture is allocated to the individual’s account during the individual’s taxable year.13 A contribution is treated as made to an individual’s account on the later of the date the contribution is made or allocated.14

      If the right to an allocation is conditioned on the performance of a specified number of hours (or on the employment of the participant on a specified day) and the individual does not meet the condition for a particular year, the individual is not an active participant with respect to the taxable year within which such plan year ends.15

      Where contributions to a plan are purely discretionary and no amount attributable to forfeitures or contributions has been allocated to an individual’s account by the last day of the plan year, the individual is not an active participant for the taxable year in which the plan year ends. If the employer contributes an amount after the end of the plan year for that prior plan year, however, the individual generally is an active participant for the taxable year in which the contribution is made.16

      An individual is an active participant in a money purchase pension plan if any contribution or forfeiture is required to be allocated to his or her account for the plan year ending with or within his or her taxable year, even if the individual was not employed at any time during the taxable year.17

      An individual is an active participant for any taxable year in which the individual makes a voluntary or a mandatory contribution.18 The individual is not treated as an active participant if only earnings (rather than contributions or forfeitures) are allocated to his or her account.19

      An individual is not considered an active participant in a plan integrated with Social Security if his or her compensation is less than the minimum needed to accrue a benefit or to be eligible for an allocation in the plan.20

      There is no de minimis rule for active participant status. An individual may be an active participant even if no money is allocated to his or her account.21 Active participant status is determined without regard to whether the individual is vested in any portion of his or her benefit.


      1. IRC Sec. 219(g)(1); see Wartes v. Comm., TC Memo 1993-84.

      2. IRC Sec. 219(g)(5); Notice 87-16, 1987-1 CB 446, A-7; Notice 89-25, 1989-1 CB 662; Notice 98-49, 1998-2 CB 365.

      3. OBRA ’87, Sec. 10103.

      4. IRC Sec. 219(g)(5)(A)(iii).

      5Fuhrman v. Comm., TC Memo 1997-34.

      6Morales-Caban v. Comm., TC Memo 1993-466.

      7. IRC Sec. 219(g)(6).

      8Neumeister v. Comm., TC Memo 2000-41.

      9. IRC Sec. 219(g)(5), flush language; see Nicolai v. Comm., TC Memo 1997-108; Wartes v. Comm., TC Memo 1993-84.

      10. 1987-1 CB 446.

      11. Notice 87-16, 1987-1 CB 446, A-15; Treas. Reg. §1.219-2(b)(1); see Nicolai v. Comm., TC Memo 1997-108.

      12. Notice 87-16, 1987-1 CB 446, A-16; Treas. Reg. §1.219-2(b)(3); Let. Rul. 8948008.

      13. Treas. Reg. §1.219-2(d)(1); see Tolley v. Comm., TC Memo 1997-244.

      14. Treas. Reg. §1.219-2(d)(1).

      15. Notice 87-16, 1987-1 CB 446, A-20; Let. Rul. 8919064.

      16. Notice 87-16, 1987-1 CB 446; Let. Rul. 9008056.

      17. Treas. Reg. §1.219-2(c).

      18. Treas. Reg. §1.219-2(e); see Felber v. Comm., TC Memo 1992-418; Wade v. Comm., TC Memo 2001-114.

      19. Notice 87-16, 1987-1 CB 446, A-16, A-19.

      20. Notice 87-16, 1987-1 CB 446, A-9.

      21Colombell v. Comm., TC Summ. Op. 2006-184.

  • 3667. Are fees or commissions paid in connection with an IRA deductible?

    • The IRS has ruled that the payment of administrative or trustee fees incurred in connection with an individual retirement account may be claimed as a miscellaneous itemized deduction (i.e., for the production or collection of income) if such fees are separately billed and paid.1 However, the 2017 tax reform legislation suspended all miscellaneous itemized deductions subject to the 2 percent floor for 2018-2025. Furthermore, if separately billed and paid, the payment of such fees does not constitute a contribution to the individual retirement account and thus will not be an excess contribution or reduce the amount that may be contributed to the account or, in the case of a traditional IRA, deducted (Q 3656).2 Deduction of administrative fees is subject to the 2 percent floor on miscellaneous itemized deductions (prior to 2018).

      Sales commissions on individual retirement annuities that are billed directly by an insurance agent to the client and paid separately by the client are not separately deductible, but are subject to the overall limits on contributions and deductions.3

      Similarly, broker’s commissions incurred in connection with the purchase of securities on behalf of an IRA are not separately deductible, but are subject to the overall limits.4

      An annual maintenance fee charged for self-directed brokerage accounts that did not vary with the number of transactions, the number of securities involved, or the dollar amount and that was paid to the trustee, not the broker, was not treated as a commission but was separately deductible as an administrative fee.5

      In addition, brokerage account “wrap fees” that were based on a percentage of assets under  management, but that did not vary based on the number of trades in the account, were not treated as a commission and were separately deductible as an administrative fee.6

      The IRS has held that the payment of fees associated with flexible premium variable annuity contracts that are paid directly from subaccounts within the contract would not be considered a distribution from the contract.

      The IRS ruled that assessing expenses against the contract is unrelated to whether or not the participant is currently entitled to benefits under the contract. Therefore, such payments are an expense of the contract and not a distribution.7


      1. Rev. Rul. 84-146, 1984-2 CB 61; Let. Ruls. 9005010, 8951010.

      2. See Let. Ruls. 8432109, 8329058, 8329055, 8329049.

      3. Let. Rul. 8747072.

      4. Rev. Rul. 86-142, 1986-2 CB 60; Let. Rul. 8711095.

      5. Let. Rul. 8835062.

      6. Let. Rul. 200507021.

      7. Let. Rul. 9845003.

  • 3668. Is interest paid on amounts borrowed to fund an IRA deductible?

    • The IRS has ruled that interest paid on amounts borrowed to fund an IRA is not allocable to tax-exempt income (Q 3652). Therefore, the deduction of such interest is not subject to the general prohibition against deducting interest incurred or carried to purchase tax-exempt assets.1 Because such interest is “on amounts borrowed to buy or carry property held for investment,” it would seem that it should be classified as “investment interest expense” and the deduction limited.

      Interest paid on money borrowed to buy property held for investment is investment interest. Such interest is deductible but generally limited to the taxpayer’s net investment income for the year.2  Generally, interest incurred to produce tax-exempt income is not deductible.

      Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which the taxpayer did not materially participate (other than a passive activity).3


      1. Let. Rul. 8527082. See IRC Secs. 163(a), 265.

      2. IRC Sec 163(d).

      3. IRS Publication 550 (2018).

  • 3669. What is the penalty for making excess contributions to an IRA?

    • If contributions are made in excess of the maximum contribution limit for traditional IRAs (Q 3656) or for Roth IRAs (Q 3659), the contributing individual is liable for a nondeductible excise tax of six percent of the amount of the excess for every year the excess contribution remains in the IRA (not to exceed six percent of the value of the account or annuity, determined as of the close of the tax year).1 A contribution by a person ineligible to make the contribution is an excess contribution even if it is made through inadvertence.2

      In the case of an endowment contract described in IRC Section 408(b), the tax does not apply to amounts allocable to life, health, accident, or other insurance.3 It also does not apply to premiums waived under a disability waiver of premium feature in an individual retirement annuity.4

      The penalty tax does not apply to “rollover” contributions to a traditional IRA or “qualified rollover contributions” to a Roth IRA.5 It does apply, however, if the “rollover” contribution does not qualify for rollover. The Tax Court did not accept the argument that an IRA created in a failed rollover attempt is not a valid IRA and, thus, the six percent penalty should not apply.6 Likewise, a failed Roth IRA conversion that is not recharacterized is subject to the 6-percent penalty (the right to recharacterize IRA-to-Roth IRA conversions has generally been eliminated for tax years beginning after 2017, although recharacterizations to correct an excess contribution should remain permissible absent further guidance to the contrary).7

      The IRS has ruled that earnings credited to an IRA that are attributable to a non-IRA companion
      account maintained at the same financial institution (a “super IRA”) are treated as contributions to the IRA; when coupled with a cash contribution, these amounts may represent excess contributions subject to the penalty tax.8 An interest bonus credited to an individual retirement account, however, is not included in the calculation of an excess contribution.9


      1. IRC Sec. 4973(a).

      2Orzechowski v. Comm., 69 TC 750 (1978), aff’d 79-1 USTC ¶9220 (2nd Cir. 1979); Tallon v. Comm., TC Memo 1979-423; Johnson v. Comm., 74 TC 1057 (1980).

      3. IRC Sec. 4973(a).

      4. See Let. Rul. 7851087.

      5. IRC Secs. 4973(b)(1)(A), 4973(f)(1)(A).

      6Martin v. Comm., TC Memo 1993-399; Michel v. Comm., TC Memo 1989-670.

      7. SCA 200148051.

      8. Rev. Rul. 85-62, 1985-1 CB 153.

      9. Let. Rul. 8722068.

  • 3670. When can IRA contributions be withdrawn or reduced?

    • A taxpayer who wants to withdraw or reduce a contribution – whether to correct a problem, such as an excess or impermissible contribution, or merely because the taxpayer has changed his or her mind – generally may do so without recognizing income tax or penalties.

      If the contribution is 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, the amount distributed will be treated as if never contributed, regardless of the size of the contribution.1 Thus, such a distribution is not included in gross income and is not subject to the 10 percent early distribution excise tax. A distribution of an excess contribution also is not subject to the 6 percent excess contribution excise tax. Moreover, no income tax deduction may be taken for such
      contribution (Q 3669).2

      If there is net income included with the accompanying distribution, such income is includable in income and may be subject to penalty as an early distribution (Q 3671, Q 3677).3 Net income attributable to a contribution is determined by allocating to the contribution a pro-rata portion of the earnings or losses accrued by the IRA during the period the IRA held the contribution. Net income may be a negative amount.4

      Relief may be granted for failure to meet the above deadline if the taxpayer has taken all necessary and reasonable steps, such as properly notifying the financial institution, to comply with the law.5 Excess amounts that are not withdrawn by this method are subject to the 6 percent excise tax (Q 3669) in the year of contribution and are carried over and taxed each year until the year the excess is eliminated.6

      By contributing less than the maximum limit in a year, an excess contribution in a previous year may be absorbed up to the unused maximum limit for the year.7 With respect to traditional IRAs, both the amount contributed and the amount of excess absorbed may be deductible subject to the active participant rules (Q 3656) and no taxable income or early distribution tax is involved. The deduction must be reduced if the excess was improperly deducted in a year closed to IRS challenge.8

      Where all or a portion of the excess is attributable to an excess “rollover” contribution that resulted from the individual’s reliance on erroneous information supplied by the plan, trust, or institution making the distribution, distribution of the portion of the excess attributable to the erroneous information is not included in income and is not subject to the 10 percent early distribution tax.9 It is not necessary to withdraw earnings on the excess, but any earnings withdrawn would be taxable income and subject to the 10 percent tax if early.

      The excess also may be reduced by a distribution includable in income. Such a distribution is subject to the 10 percent excise tax if it is an early distribution, as well as income tax.

      Where a taxpayer amended his tax return to include an excess contribution in income in the year contributed, the Tax Court ruled that the distribution of the excess in a later year was not includable under the rules of IRC Section 72, that the excess contribution included in income in the prior year constituted an “investment in the contract,” and that as a result it was not taxable a second time on the actual distribution of such excess.10 The phrase “aggregate amount of * * * consideration paid for the contract” found in IRC Section 72(e)(6) encompassed the excess contribution made by the taxpayer. The contribution was therefore considered to be an amount paid in consideration for an IRA and, thus, an “investment in the contract.” As a consequence, section 72 would provide a basis for the excess contribution and, upon distribution, such amount would be distributed tax-free.11

      For purposes of the excess contribution rules, if an excess contribution is invested in a time deposit (such as a CD) that is subject to an early withdrawal penalty, the amount reportable as an excess contribution on distribution of the excess is the total amount actually distributed from the plan after the imposition of the early withdrawal penalty.12

      A decline in asset value does not remove an excess contribution.13


      1. IRC Secs. 4973(b), 408(d)(4).

      2. IRC Sec. 408(d)(4)(B).

      3. IRC Sec. 408(d)(4).

      4. Treas. Reg. §1.408-11; Notice 2000-39, 2000-2 CB 132.

      5Childs v. Comm., TC Memo 1996-267; Thompson v. Comm., TC Memo 1996-266.

      6. IRC Sec. 4973(a)

      7. IRC Secs. 4973(b)(2), 4973(f)(2).

      8. IRC Sec. 219(f)(6); Prop. Treas. Reg. §1.219-1(e).

      9. IRC Sec. 408(d)(5)(B).

      10Campbell v. Comm., 108 TC 54 (1997).

      11. Id.

      12. Let. Ruls. 8643070, 8642061.

      13. H. R. Conf. Rep. 93-1280 (ERISA ’74) reprinted in 1974-3 CB 501-502.