Taxpayer Relief Act -- Expansion of IRA Options
The recent passage of the Taxpayer Relief Act of 1997 made some important changes to the IRA rules that impacts on individual taxpayers. The new law liberalizes the rules for current IRAs, creates new "backloaded" IRAs called "Roth IRAs," and provides for penalty-free withdrawals from IRAs for first-time homebuyers.
The new law makes deductible contributions to an IRA available to more individuals by indexing the present-law income thresholds for IRA deduction for inflation.
Specifically, the new law increases the phase-out ranges for deductible IRA contributions. For taxable years beginning in 1998, the phase-out range for single taxpayers is between $30,000 and $40,000 of adjusted gross income (AGI) and between $50,000 and $60,000 of AGI for joint filers. The phase-out range for single filers is scheduled to increase to AGI of between $50,000 and $60,000 in 2005 and thereafter. For joint filers, the phase-out range is scheduled to increase to AGI of between $80,000 and $100,000 in 2007 and thereafter.
Under the new law, an individual is not considered an active participant in an employer-sponsored retirement plan merely because the individual's spouse is an active participant. Thus, a non-active participant, whose spouse is an active participant, can make deductible IRA contributions. However, these deductible IRA contributions are phased-out for taxpayers with AGI between $150,000 and $160,000.
Beginning in 1998, the new law permits the establishment of "backloaded" IRAs, called "Roth IRAs," into which taxpayers may make nondeductible contributions of up to $2,000 per year. However, in no case can contributions to all an individual's IRAs, including Roth IRAs, for a taxable year exceed $2,000. The earnings build up tax-free. Qualified distributions from a Roth IRA are not included in gross income. In addition, a spouse may contribute up to $2,000 to a Roth IRA. Taxpayers who cannot (or do not) make contributions to a deductible IRA or a Roth IRA can make contributions to a nondeductible IRA.
The maximum contribution that can be made to a Roth IRA is phased out for individuals with AGI between $95,000 and $110,000, and for joint filers with AGI between $150,000 and $160,000. Contributions can be made to a Roth IRA even after the individual account holder has reached age 70 1/2. Further, the mandatory distribution rules do not apply to Roth IRAs.
As noted above, distributions from a Roth IRA are tax-free if they are qualified. This means they must be made after the 5-taxable year period beginning with the first taxable year for which a contribution was made to a Roth IRA. In addition, the tax-free distribution may only be made on or after the individual has reached age 59 1/2, or earlier if: (1) made to a beneficiary on or after the death of the individual; (2) attributable to the individual's being disabled; or (3) for a qualified special purpose distribution, i.e., a distribution for first-time homebuyers.
Taxpayers with AGI of $100,000 or less may roll over or convert amounts to a Roth IRA from a traditional IRA during any taxable year without incurring the 10% early withdrawal penalty. However, the amounts rolled over are included in gross income. If the rollover is before January 1, 1999, any amounts required to be included in gross income will be spread out ratably over the 4-taxable year period beginning with the taxable year in which the distribution is made. Married taxpayers who file separate returns cannot rollover amounts to a Roth IRA from a traditional IRA.
Excess contributions to a Roth IRA are subject to the 6% excess contribution tax.
The new law permits a first-time homebuyer, beginning in 1998, to withdraw up to $10,000 (during the individual's lifetime) from his or her IRA for expenses of purchasing a home for the first time without incurring the 10% early withdrawal penalty.
The new law requires the amounts be used within 120 days to pay costs (such as any reasonable settlement, financing or other closing costs) of acquiring, constructing, or reconstructing a principal residence of a first-time homebuyer. The first-time homebuyer must not have had an ownership interest in a principal residence during the two-year period ending on the date of acquisition of the principal residence. The acquisition date is the date on which the individual enters a binding contract to acquire the principal residence, or begins construction or reconstruction of that principal residence. The individual's spouse also must satisfy the ownership interest requirement as of the date the contract is entered into or construction commences.
Any amount withdrawn from an IRA to purchase a principal residence must be used for this purpose within 120 days of the date of withdrawal. The 10% additional income tax on early withdrawals applies to any amount not so used. If the 120-day rule cannot be satisfied due to a delay or cancellation of the acquisition or construction of the residence, the taxpayer may recontribute the amount withdrawn to an IRA before the end of the 120-day period without incurring adverse tax consequences.
If you would like to discuss these, or any other, changes made by the Taxpayer Relief Act of 1997, please telephone my office so that we could set up an appointment.