TAX TIPS FOR TODAY’S IRAS

By Beth Steele, J.D., Editor, CCH Individual Retirement Plans Guide; Contributing Author, CCH Focus.
 

The April 2001 tax season is here. It’s time to save taxes — and stretch IRA dollars. This article explains several tax tips that financial officers can convey to their IRA customers.

You Can Make IRA Contributions for last year NOW:

Take the last chance for 2000 contributions. Make contributions to traditional IRAs and/or Roth IRAs for 2000 by April 16, 2001. (When the regular April 15th due date falls on a Saturday, Sunday or legal holiday, the due date advances to the next business day.)

Note: Some financial organizations will take IRA contributions for 2000 only if they’re made several days before this year’s April 16th deadline — to allow for internal processing. So, the diligent contributor will want to plan ahead.

One advantage of contributing later (now), rather than earlier (during 2000), is hindsight as to last year’s income through statements like W-2s and 1099s. Now IRA owners know their proximity to income ceilings and can figure contributions accordingly.

For example, if a Roth IRA owner’s income in 2000 ended up topping the $160,000 income limit for joint filers, knowing this fact currently can avoid excess contributions. On the other hand, suppose the Roth IRA owner made a contribution in November 2000, expecting her income for 2000 to be $140,000. She was not cognizant of a $20,000 bonus that would put her over the income ceiling by year-end. (The resulting excess contribution must be undone to avoid penalties.)

RMD Has a Refreshing Twist This Year:

New rules from the IRS simplify required minimum distributions. RMD refers to the dollar amounts that a traditional IRA owner must withdraw each year beginning soon after age 70-1/2.

There is bad news for those turning age 70-1/2 in 2000 who delay taking their first RMD applying to 2000 until 2001 (they have until April 1, 2001, to take that first distribution): They should stick with the old RMD rules.

The old rules stipulate beneficiary designations, special rules when a trust is a beneficiary, and electing recalculation or nonrecalculation.

The good news is that when it comes to taking RMD applying to 2001, IRA owners have a lot to look forward to with the new rules. For starters, generally lower dollar amounts may be withdrawn. That’s a boon to folks who want to take the least possible amount from their traditional IRAs. A uniform table of life expectancy lowers this amount for most people.

Then, there is no need to determine the designated beneficiary, and there is no need to make a cast-in-concrete (irrevocable) election to recalculate or not to recalculate life expectancy. Also, special rules for trusts are eliminated.

For 2001 distributions, IRA owners may elect either the old rules or the new.

Change Your Mind about a Roth Conversion:

Recharacterize a conversion of a traditional IRA to a Roth IRA made in 2000 by April 16, 2001, or extended due dates. All that’s needed is an election to recharacterize, a transfer of funds and IRS reporting.

Contribute to a Traditional IRA in the 70-1/2 year:

This is not a problem for persons reaching age 70-1/2 during the 2001 tax year. Although they cannot contribute to a traditional IRA for 2001, a contribution for 2000 to the traditional IRA is okay. In other words, make a traditional IRA contribution by April 16, 2001, that applies to the prior year. (Note that there is no age restriction on those making Roth IRA contributions.)

Undo Over-Contributions:

Drain excess contributions to a traditional IRA, Roth IRA or education IRA. Over-contributing leads to a 6-percent penalty. The excise tax will be due if excess contributions are not corrected by April 16th (the return filing deadline) or extended due dates. The penalty is due every year until the overage is corrected. Pay the penalty by filing IRS Form 5329 with IRS Form 1040; or skirt the penalty by one of three methods: removal, carry-forward or recharacterization.

One way to avoid the 6-percent penalty is to simply remove the excess contribution by April 16th or extended Form 1040 due dates. Or, correct the too-big contribution by carry-forward of the excess and under-contributing in the next year. Or, correct the overage by recharacterization of the contribution, for instance, from a Roth IRA to a traditional IRA. Recharacterize by April 16th or extended due dates. While all three methods apply to traditional and Roth IRA excess contributions, only the first two are possible for education IRA over-contributions

Pour Over Contributions:

Maybe your income is too high to make a full $2,000 contribution to a Roth IRA. Pour the remainder into nondeductible contributions to a traditional IRA. For instance, a single person with an income of $100,000 may want to invest $2,000 in a Roth IRA, but due to his income level is only eligible to make a phase-out donation of $1,340. He could pour over the remainder of $660 to a traditional IRA as a nondeductible contribution ($2,000 minus $1,340 equals $660). Of course, he must be under age 70-1/2 to contribute to the traditional IRA. Fortunately, the pension-coverage restriction does not apply to nondeductible contributions. If making nondeductible contributions, be sure to file IRS Form 8606.

Don’t File IRS Form 1040 on April 16th:

Consider an extension. Re-target the tax filing date to August 15th. Extensions can add flexibility — expand options — stretch IRA dollars. Take up to four months or more — to gather paperwork, get advice and plan some IRA strategies.

An extension can relieve the time crunch for an IRA owner who needs more time to: 

The four-month extension is automatic. Just fill out IRS Form 4868 and file it with the IRS by April 16th, and the due date moves to August 15th. Form 4868 is an extension to file, not an extension to pay. So, a close approximation of actual tax due must be made to avoid interest and penalties. Beth Steele, J.D.; Editor, CCH Individual Retirement Plans Guide 

[These tips are not intended to be tax advice. For applicability of the tax rules to an IRA owner’s particular tax situation, advice of a tax professional is recommended.] 

[CCH’s INDIVIDUAL RETIREMENT PLANS GUIDE covers traditional, Roth and education IRAs, Keoghs, SEPs and SIMPLEs. The monthly updates include IRS issuances, Congressional action and court developments and are available in four formats: print, CD-ROM, online and Internet. For more information, call CCH at 800-449-6435.]