Publication 17: Your Federal Income Tax; Chapter 18 - Individual Retirement Arrangements (IRAs)

This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

What's New for 2004

Modified AGI limit for traditional IRA contributions increased. For 2004, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified adjusted gross income (AGI) is:

More than $65,000 but less than $75,000 for a married couple filing a joint return or a qualifying widow(er),
More than $45,000 but less than $55,000 for a single individual or head of household, or
Less than $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range increased by $5,000. See How Much Can You Deduct? under Traditional IRAs, later.

New method for figuring net income on returned or recharacterized IRA contributions. There is a new method for figuring the net income on IRA contributions made after 2003 that are returned to you or recharacterized. For more information, see How Do You Recharacterize a Contribution or Contributions Returned Before the Due Date in chapter 1 of Publication 590.

What's New for 2005

Traditional IRA contribution and deduction limit. The contribution limit to your traditional IRA for 2005 will be increased to the smaller of the following amounts:

$4,000, or
Your taxable compensation for the year.

If you reach age 50 before 2006, the most that can be contributed to your traditional IRA for 2005 will be the smaller of the following amounts:

$4,500, or
Your taxable compensation for the year.

Roth IRA contribution limit. If contributions on your behalf are made only to Roth IRAs, your contribution limit for 2005 will generally be the lesser of:

$4,000, or
Your taxable compensation for the year.

If you are 50 or older in 2005 and contributions on your behalf are made only to Roth IRAs, your contribution limit for 2005 will generally be the lesser of:

$4,500, or
Your taxable compensation for the year.

However, if your modified AGI is above a certain amount, your contribution limit may be reduced.

Modified AGI limit for traditional IRA contributions increased. For 2005, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA will be reduced (phased out) if your modified adjusted gross income (AGI) is:

More than $70,000 but less than $80,000 for a married couple filing a joint return or a qualifying widow(er),
More than $50,000 but less than $60,000 for a single individual or head of household, or
Less than $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range will increase by $5,000.

Reminders

Statement of required minimum distribution. If a minimum distribution is required from your IRA, the trustee, custodian, or issuer that held the IRA at the end of the preceding year must either report the amount of the required minimum distribution to you, or offer to calculate it for you. The report or offer must include the date by which the amount must be distributed. The report is due January 31 of the year in which the minimum distribution is required. It can be provided with the year-end fair market value statement that you normally get each year. No report is required for IRAs of owners who have died.

IRA interest. Although interest earned from your IRA is generally not taxed in the year earned, it is not tax-exempt interest. Do not report this interest on your tax return as tax-exempt interest.

Form 8606. If you make nondeductible contributions to a traditional IRA and you do not file Form 8606, Nondeductible IRAs, with your tax return, you may have to pay a $50 penalty.

Roth IRA. You cannot claim a deduction for any contributions to a Roth IRA. But, if you satisfy the requirements, all earnings are tax free and neither your nondeductible contributions nor any earnings on them are taxable when you withdraw them. See Roth IRAs, later.

Introduction

An individual retirement arrangement (IRA) is a personal savings plan that gives you tax advantages for setting aside money for your retirement.

This chapter discusses:

The rules for a traditional IRA (any IRA that is not a Roth or SIMPLE IRA), and
The Roth IRA, which features nondeductible contributions and tax-free distributions.

Simplified Employee Pensions (SEPs) and Savings Incentive Match Plans for Employees (SIMPLEs) are not discussed in this chapter. For more information on these plans and employees' SEP-IRAs and SIMPLE IRAs that are part of these plans, see Publications 560 and 590.

Useful Items - You may want to see:

Publication

560 Retirement Plans for Small Business
590 Individual Retirement Arrangements (IRAs)

Form (and Instructions)

5329
Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts
8606
Nondeductible IRAs

Traditional IRAs

In this chapter the original IRA (sometimes called an ordinary or regular IRA) is referred to as a “traditional IRA.” Two advantages of a traditional IRA are:

You may be able to deduct some or all of your contributions to it, depending on your circumstances, and,
Generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.

What Is a Traditional IRA?

A traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA.

Who Can Set Up a Traditional IRA?

You can set up and make contributions to a traditional IRA if:

You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
You were not age 70½ by the end of the year.

What is compensation? Generally, compensation is what you earn from working. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans).

Scholarship and fellowship payments are compensation for this purpose only if shown in box 1 of Form W-2.

Compensation also includes commissions and taxable alimony and separate maintenance payments.

Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:

The deduction for contributions made on your behalf to retirement plans, and
The deduction allowed for one-half of your self-employment taxes.

Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs. See Publication 533, Self-Employment Tax, for more information.

What is not compensation? Compensation does not include any of the following items.

Earnings and profits from property, such as rental income, interest income, and dividend income.
Pension or annuity income.
Deferred compensation received (compensation payments postponed from a past year).
Income from a partnership for which you do not provide services that are a material income-producing factor.
Any amounts you exclude from income, such as foreign earned income and housing costs.

When and How Can a Traditional IRA Be Set Up?

You can set up a traditional IRA at any time. However, the time for making contributions for any year is limited. See When Can Contributions Be Made, later.

You can set up different kinds of IRAs with a variety of organizations. You can set up an IRA at a bank or other financial institution or with a mutual fund or life insurance company. You can also set up an IRA through your stockbroker. Any IRA must meet Internal Revenue Code requirements.

Kinds of traditional IRAs. Your traditional IRA can be an individual retirement account or annuity. It can be part of either a simplified employee pension (SEP) or an employer or employee association trust account.

How Much Can Be Contributed?

There are limits and other rules that affect the amount that can be contributed and the amount you can deduct. These limits and other rules are explained below.

Community property laws. Except as discussed later under Spousal IRA limit, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.

Brokers' commissions. Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit.

Trustees' fees. Trustees' administrative fees are not subject to the contribution limit.

Contributions to your traditional IRAs reduce your limit for contributions to Roth IRAs. (See Roth IRAs, later.)

General limit. The most that can be contributed to your traditional IRA is the smaller of the following amounts.

$3,000 ($3,500 if you are 50 or older in 2004). For 2005, this amount increases to $4,000 ($4,500 if 50 or older in 2005).
Your taxable compensation (defined earlier) for the year.

This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. (See Nondeductible Contributions, later.)

Example 1.

Betty, who is 34 years old and single, earned $24,000 in 2004. Her IRA contributions for 2004 are limited to $3,000.

Example 2.

John, an unmarried college student working part time, earned $1,500 in 2004. His IRA contributions for 2004 are limited to $1,500, the amount of his compensation.

Spousal IRA limit. If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following amounts.

$3,000 ($3,500 if you are 50 or older in 2004). For 2005, this amount increases to $4,000 ($4,500 if 50 or older in 2005).
The total compensation includible in the gross income of both you and your spouse for the year, reduced by the following two amounts.
1. Your spouse's IRA contribution for the year to a traditional IRA.
2. Any contribution for the year to a Roth IRA on behalf of your spouse.

This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $6,000 ($6,500 if only one of you is 50 or older, or $7,000 if both of you are 50 or older). For 2005, combined total contributions can be as much as $8, 000 ($8,500 if only one of you is 50 or older or $9,000 if both of you are 50 or older.

When Can Contributions Be Made?

As soon as you set up your traditional IRA, contributions can be made to it through your chosen sponsor (trustee or other administrator). Contributions to a traditional IRA must be in the form of money (cash, check, or money order). Property cannot be contributed.

Contributions must be made by due date. Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 2004 must be made by April 15, 2005, and contributions for 2005 must be made by April 17, 2006.

Age 70½ rule. Contributions cannot be made to your traditional IRA for the year in which you reach age 70½ or for any later year.

You attain age 70½ on the date that is six calendar months after the 70th anniversary of your birth. If you were born on June 30, 1934, the 70th anniversary of your birth is June 30, 2004, and you attained age 70½ on December 30, 2004. If you were born on July 1, 1934, the 70th anniversary of your birth was July 1, 2004, and you attained age 70½ on January 1, 2005.

Designating year for which contribution is made. If an amount is contributed to your traditional IRA between January 1 and April 15, you should tell the sponsor which year (the current year or the previous year) the contribution is for. If you do not tell the sponsor which year it is for, the sponsor can assume, and report to the IRS, that the contribution is for the current year (the year the sponsor received it).

Filing before a contribution is made. You can file your return claiming a traditional IRA contribution before the contribution is actually made. However, the contribution must be made by the due date of your return, not including extensions.

Contributions not required. You do not have to contribute to your traditional IRA for every tax year, even if you can.

How Much Can You Deduct?

Generally, you can deduct the lesser of:

The contributions to your traditional IRA for the year, or
The general limit (or the spousal IRA limit, if it applies).

However, if you or your spouse was covered by an employer retirement plan, you may not be able to deduct this amount. See Limit If Covered by Employer Plan, later.

You may be eligible to claim a credit for contributions to your traditional IRA. For more information see chapter 39.

Trustees' fees. Trustees' administrative fees that are billed separately and paid in connection with your traditional IRA are not deductible as IRA contributions. However, they may be deductible as a miscellaneous itemized deduction on Schedule A (Form 1040). See chapter 30.

Brokers' commissions. Brokers' commissions are part of your IRA contribution and, as such, are deductible subject to the limits.

Full deduction. If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for total contributions to one or more traditional IRAs of up to the lesser of the following amounts.

$3,000 ($3,500 if you are 50 or older in 2004). For 2005, this amount increases to $4,000 ($4,500 if you are 50 or older in 2005).
100% of your compensation.

This limit is reduced by any contributions made to a 501(c)(18) plan on your behalf.

Spousal IRA. In the case of a married couple with unequal compensation who file a joint return, the deduction for contributions to the traditional IRA of the spouse with less compensation is limited to the lesser of the following amounts.

$3,000 ($3,500 if you are 50 or older in 2004). For 2005, this amount increases to $4,000 ($4,500 if you are 50 or older in 2005).
The total compensation includible in the gross income of both spouses for the year reduced by the following three amounts.
1. The IRA deduction for the year of the spouse with the greater compensation.
2. Any designated nondeductible contribution for the year made on behalf of the spouse with the greater compensation.
3. Any contributions for the year to a Roth IRA on behalf of the spouse with the greater compensation.

This limit is reduced by any contributions to a 501(c)(18) plan on behalf of the spouse with less compensation.

Note.

If you were divorced or legally separated (and did not remarry) before the end of the year, you cannot deduct any contributions to your spouse's IRA. After a divorce or legal separation, you can deduct only contributions to your own IRA. Your deductions are subject to the rules for single individuals.

Covered by an employer retirement plan. If you or your spouse was covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may be further limited. This is discussed later under Limit If Covered by Employer Plan. Limits on the amount you can deduct do not affect the amount that can be contributed. See Nondeductible Contributions, later.

Are You Covered by an Employer Plan?

The Form W-2 you receive from your employer has a box used to indicate whether you were covered for the year. The “Retirement plan” box should be checked if you were covered.

Reservists and volunteer firefighters should also see Situations in Which You Are Not Covered, later.

If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.

Federal judges. For purposes of the IRA deduction, federal judges are covered by an employer retirement plan.

For Which Year(s) Are You Covered?

Special rules apply to determine the tax years for which you are covered by an employer plan. These rules differ depending on whether the plan is a defined contribution plan or a defined benefit plan.

Tax year. Your tax year is the annual accounting period you use to keep records and report income and expenses on your income tax return. For almost all people, the tax year is the calendar year.

Defined contribution plan. Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year that ends with or within that tax year.

A defined contribution plan is a plan that provides for a separate account for each person covered by the plan. Types of defined contribution plans include profit-sharing plans, stock bonus plans, and money purchase pension plans.

Defined benefit plan. If you are eligible to participate in your employer's defined benefit plan for the plan year that ends within your tax year, you are covered by the plan. This rule applies even if you:

Declined to participate in the plan,
Did not make a required contribution, or
Did not perform the minimum service required to accrue a benefit for the year.

A defined benefit plan is any plan that is not a defined contribution plan. Defined benefit plans include pension plans and annuity plans.

No vested interest. If you accrue a benefit for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the account or the accrual.

Situations in Which You Are Not Covered

Unless you are covered under another employer plan, you are not covered by an employer plan if you are in one of the situations described below.

Social security or railroad retirement. Coverage under social security or railroad retirement is not coverage under an employer retirement plan.

Benefits from a previous employer's plan. If you receive retirement benefits from a previous employer's plan, you are not covered by that plan.

Reservists. If the only reason you participate in a plan is because you are a member of a reserve unit of the armed forces, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

The plan you participate in is established for its employees by:
1. The United States,
2. A state or political subdivision of a state, or
3. An instrumentality of either (a) or (b) above.
You did not serve more than 90 days on active duty during the year (not counting duty for training).

Volunteer firefighters. If the only reason you participate in a plan is because you are a volunteer firefighter, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

The plan you participate in is established for its employees by:
1. The United States,
2. A state or political subdivision of a state, or
3. An instrumentality of either (a) or (b) above.
Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement.

Limit If Covered by Employer Plan

If either you or your spouse was covered by an employer retirement plan, you may be entitled to only a partial (reduced) deduction or no deduction at all, depending on your income and your filing status.

Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches a higher amount. These amounts vary depending on your filing status.

To determine if your deduction is subject to phaseout, you must determine your modified adjusted gross income (AGI) and your filing status. See Filing status and Modified adjusted gross income (AGI), later. Then use Table 18-1 or 18-2 to determine if the phaseout applies.

Social security recipients. Instead of using Table 18-1 or 18-2, use the worksheets in Appendix B of Publication 590 if, for the year, all of the following apply.

You received social security benefits.
You received taxable compensation.
Contributions were made to your traditional IRA.
You or your spouse was covered by an employer retirement plan.

Use those worksheets to figure your IRA deduction, your nondeductible contribution, and the taxable portion, if any, of your social security benefits.

Deduction phaseout. If you were covered by an employer retirement plan and you did not receive any social security retirement benefits, your IRA deduction may be reduced or eliminated depending on your filing status and modified AGI as shown in Table 18-1.

Table 18-1. Effect of Modified AGI ¹ on Deduction if You Are Covered by Retirement Plan at Work

If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

IF your filing status is...	AND your modified AGI is...	THEN you can take...
single or head of household	$45,000 or less	a full deduction.
	more than $45,000 but less than $55,000	a partial deduction.
	$55,000 or more	no deduction.
married filing jointly or qualifying widow(er)	$65,000 or less	a full deduction.
	more than $65,000 but less than $75,000	a partial deduction.
	$75,000 or more	no deduction.
married filing separately ²	less than $10,000	a partial deduction.
married filing separately ²	$10,000 or more	no deduction.

¹Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI).

²If you did not live with your spouse at any time during the year, your filing status is considered Single for this purpose (therefore, your IRA deduction is determined under the “Single” column).

For 2005, if you are covered by a retirement plan at work, your IRA deduction will not be reduced (phased out) unless your modified AGI is:

More than $50,000 but less than $60,000 for a single individual (or head of household),
More than $70,000 but less than $80,000 for a married couple filing a joint return (or a qualifying widow(er)), or
Less than $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range for 2005 will increase by $5,000 from the limits for 2004.

If your spouse is covered. If you are not covered by an employer retirement plan, but your spouse is, and you did not receive any social security benefits, your IRA deduction may be reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table 18-2.

Table 18-2. Effect of Modified AGI ¹ on Deduction if You Are NOT Covered by Retirement Plan at Work

If you are not covered by a retirement plan at work, use this table to determine
if your modified AGI affects the amount of your deduction.

IF your filing status is...	AND your modified AGI is...	THEN you can take...
single, head of household, or qualifying widow(er)	any amount	a full deduction.
married filing jointly or separately with a spouse who is not covered by a plan at work	any amount	a full deduction.
married filing jointly with a spouse who is covered by a plan at work	$150,000 or less	a full deduction.
	more than $150,000 but less than $160,000	a partial deduction.
	$160,000 or more	no deduction.
married filing separately with a spouse who is covered by a plan at work ²	less than $10,000	a partial deduction.
	$10,000 or more	no deduction.

¹Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI).

²You are entitled to the full deduction if you did not live with your spouse at any time during the year.

Filing status. Your filing status depends primarily on your marital status. For this purpose, you need to know if your filing status is single or head of household, married filing jointly or qualifying widow(er), or married filing separately. If you need more information on filing status, see chapter 2.

Lived apart from spouse. If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.

Modified adjusted gross income (AGI). How you figure your modified AGI depends on whether you are filing Form 1040 or Form 1040A. If you made contributions to your IRA for 2004 and received a distribution from your IRA in 2004, see Publication 590.

Do not assume that your modified AGI is the same as your compensation. Your modified AGI may include income in addition to your compensation (discussed earlier), such as interest, dividends, and income from IRA distributions.

Form 1040. If you file Form 1040, refigure the amount on page 1 “adjusted gross income” line without taking into account any of the following amounts.

IRA deduction.
Student loan interest deduction.
Tuition and fees deduction.
Foreign earned income exclusion.
Foreign housing exclusion or deduction.
Exclusion of qualified savings bond interest shown on Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989 (For Filers With Qualified Higher Education Expenses).
Exclusion of employer-provided adoption benefits shown on Form 8839, Qualified Adoption Expenses.

This is your modified AGI.

Form 1040A. If you file Form 1040A, refigure the amount on page 1 “adjusted gross income” line without taking into account any of the following amounts.

IRA deduction.
Student loan interest deduction.
Tuition and fees deduction.
Exclusion of qualified savings bond interest shown on Form 8815.
Exclusion of employer-provided adoption benefits shown on Form 8839.

This is your modified AGI.

Both contributions for 2004 and distributions in 2004. If all three of the following apply, any IRA distributions you received in 2004 may be partly tax free and partly taxable.

You received distributions in 2004 from one or more traditional IRAs.
You made contributions to a traditional IRA for 2004.
Some of those contributions may be nondeductible contributions depending on whether your IRA deduction for 2004 is reduced.

If this is your situation, you must figure the taxable part of the traditional IRA distribution before you can figure your modified AGI. To do this, you can use Worksheet 1-5, Figuring the Taxable Part of Your IRA Distribution, in Publication 590.

If at least one of the above does not apply, figure your modified AGI using Worksheet 18-1 in this chapter.

How to figure your reduced IRA deduction. You can figure your reduced IRA deduction for either Form 1040 or Form 1040A by using the worksheets in chapter 1 of Publication 590. Also, the instructions for Form 1040 and Form 1040A include similar worksheets that you may be able to use instead.

Reporting Deductible Contributions

If you file Form 1040, enter your IRA deduction on line 25 of that form. If you file Form 1040A, enter your IRA deduction on line 17. You cannot deduct IRA contributions on Form 1040EZ.

Worksheet 18-1. Figuring Your Modified AGI

Use this worksheet to figure your modified adjusted gross income for traditional IRA purposes.

1.	Enter your adjusted gross income (AGI) shown on line 22, Form 1040A, or line 37, Form 1040 figured without taking into account line 17, Form 1040A, or line 25, Form 1040	1.
2.	Enter any Student loan interest deduction from line 18, Form 1040A, or line 26, Form 1040	2.
3.	Enter any Tuition and fees deduction from line 19, Form 1040A, or line 27, Form 1040	3.
4.	Enter any Foreign earned income and/or housing exclusion from line 18, Form 2555-EZ, or line 43, Form 2555	4.
5.	Enter any Foreign housing deduction from line 48, Form 2555	5.
6.	Enter any Excluded qualified savings bond interest shown on line 3, Schedule 1, Form 1040A, or line 3, Schedule B, Form 1040 (from line 14, Form 8815)	6.
7.	Enter any Exclusion of employer-provided adoption benefits shown on line 30, Form 8839	7.
8.	Add lines 1 through 7. This is your Modified AGI for traditional IRA purposes	8.

Nondeductible Contributions

Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA up to the general limit or, if it applies, the spousal IRA limit. The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.

Example.

Mike is 28 years old and single. In 2004, he was covered by a retirement plan at work. His salary was $52,312. His modified AGI was $60,000. Mike made a $3,000 IRA contribution for 2004. Because he was covered by a retirement plan and his modified AGI was over $55,000, he cannot deduct his $3,000 IRA contribution. He must designate this contribution as a nondeductible contribution by reporting it on Form 8606, as explained next.

Form 8606. To designate contributions as nondeductible, you must file Form 8606.

You do not have to designate a contribution as nondeductible until you file your tax return. When you file, you can even designate otherwise deductible contributions as nondeductible.

You must file Form 8606 to report nondeductible contributions even if you do not have to file a tax return for the year.

Failure to report nondeductible contributions. If you do not report nondeductible contributions, all of the contributions to your traditional IRA will be treated as deductible. All distributions from your IRA will be taxed unless you can show, with satisfactory evidence, that nondeductible contributions were made.

Penalty for overstatement. If you overstate the amount of nondeductible contributions on your Form 8606 for any tax year, you must pay a penalty of $100 for each overstatement, unless it was due to reasonable cause.

Penalty for failure to file Form 8606. You will have to pay a $50 penalty if you do not file a required Form 8606, unless you can prove that the failure was due to reasonable cause.

Tax on earnings on nondeductible contributions. As long as contributions are within the contribution limits, none of the earnings or gains on contributions (deductible or nondeductible) will be taxed until they are distributed. See When Can You Withdraw or Use IRA Assets, later.

Cost basis. You will have a cost basis in your traditional IRA if you made any nondeductible contributions. Your cost basis is the sum of the nondeductible contributions to your IRA minus any withdrawals or distributions of nondeductible contributions.

Inherited IRAs

If you inherit a traditional IRA, you are called a beneficiary. A beneficiary can be any person or entity the owner chooses to receive the benefits of the IRA after he or she dies. Beneficiaries of a traditional IRA must include in their gross income any taxable distributions they receive.

Inherited from spouse. If you inherit a traditional IRA from your spouse, you generally have the following three choices.

Treat it as your own by designating yourself as the account owner.
Treat it as your own by rolling it over into your traditional IRA, or to the extent it is taxable, into a:
1. Qualified employer plan,
2. Qualified employee annuity plan (section 403(a) plan),
3. Tax-sheltered annuity plan (section 403(b) plan), or
4. Deferred compensation plan of a state or local government (section 457 plan).
Treat yourself as the beneficiary rather than treating the IRA as your own.

Treating it as your own. You will be considered to have chosen to treat the IRA as your own if:

Contributions (including rollover contributions) are made to the inherited IRA, or
You do not take the required minimum distribution for a year as a beneficiary of the IRA.

You will only be considered to have chosen to treat the IRA as your own if:

You are the sole beneficiary of the IRA, and
You have an unlimited right to withdraw amounts from it.

However, if you receive a distribution from your deceased spouse's IRA, you can roll that distribution over into your own IRA within the 60-day time limit, as long as the distribution is not a required distribution, even if you are not the sole beneficiary of your deceased spouse's IRA.

Inherited from someone other than spouse. If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA. However, you can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of you as beneficiary.

For more information, see the discussion of inherited IRAs under Rollover From One IRA Into Another, later.

Can You Move Retirement Plan Assets?

You can transfer, tax free, assets (money or property) from other retirement plans (including traditional IRAs) to a traditional IRA. You can make the following kinds of transfers.

Transfers from one trustee to another.
Rollovers.
Transfers incident to a divorce.

Transfers to Roth IRAs. Under certain conditions, you can move assets from a traditional IRA to a Roth IRA. See Can You Move Amounts Into a Roth IRA under Roth IRAs, later.

Trustee-to-Trustee Transfer

A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee's request, is not a rollover. Because there is no distribution to you, the transfer is tax free. Because it is not a rollover, it is not affected by the 1-year waiting period required between rollovers, discussed later under Rollover From One IRA Into Another. For information about direct transfers to IRAs from retirement plans other than IRAs, see Publication 590.

Rollovers

Generally, a rollover is a tax-free distribution to you of cash or other assets from one retirement plan that you contribute (roll over) to another retirement plan. The contribution to the second retirement plan is called a “rollover contribution.”

Note.

An amount rolled over tax free from one retirement plan to another is generally includible in income when it is distributed from the second plan.

Kinds of rollovers to a traditional IRA. You can roll over amounts from the following plans into a traditional IRA:

A traditional IRA,
An employer's qualified retirement plan for its employees,
A deferred compensation plan of a state or local government (section 457 plan), or
A tax-sheltered annuity plan (section 403(b) plan).

Treatment of rollovers. You cannot deduct a rollover contribution, but you must report the rollover distribution on your tax return as discussed later under Reporting rollovers from IRAs and under Reporting rollovers from employer plans.

Kinds of rollovers from a traditional IRA. You may be able to roll over, tax free, a distribution from your traditional IRA into a qualified plan. These plans include the federal Thrift Savings Fund (for federal employees), deferred compensation plans of state or local governments (section 457 plans), and tax-sheltered annuity plans (section 403(b) plans). The part of the distribution that you can roll over is the part that would otherwise be taxable (includible in your income). Qualified plans may, but are not required to, accept such rollovers.

Time limit for making a rollover contribution. You generally must make the rollover contribution by the 60th day after the day you receive the distribution from your traditional IRA or your employer's plan.

The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control. For more information, see Publication 590.

Extension of rollover period. If an amount distributed to you from a traditional IRA or a qualified employer retirement plan is a frozen deposit at any time during the 60-day period allowed for a rollover, special rules extend the rollover period. For more information, see Publication 590.

More information. For more information on rollovers, see Publication 590.

Rollover From One IRA Into Another

You can withdraw, tax free, all or part of the assets from one traditional IRA if you reinvest them within 60 days in the same or another traditional IRA. Because this is a rollover, you cannot deduct the amount that you reinvest in an IRA.

Waiting period between rollovers. Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover.

The 1-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA.

Example.

You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA.

However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.

Exception. There is an exception to the rule that amounts rolled over tax free into an IRA cannot be rolled over tax free again within the 1-year period beginning on the date of the original distribution. The exception applies to a distribution which meets all three of the following requirements.

It is made from a failed financial institution by the Federal Deposit Insurance Corporation (FDIC) as receiver for the institution.
It was not initiated by either the custodial institution or the depositor.
It was made because:
1. The custodial institution is insolvent, and
2. The receiver is unable to find a buyer for the institution.

Partial rollovers. If you withdraw assets from a traditional IRA, you can roll over part of the withdrawal tax free and keep the rest of it. The amount you keep will generally be taxable (except for the part that is a return of nondeductible contributions). The amount you keep may be subject to the 10% additional tax on early distributions, discussed later under What Acts Result in Penalties or Additional Taxes.

Required distributions. Amounts that must be distributed during a particular year under the required distribution rules (discussed later) are not eligible for rollover treatment.

Inherited IRAs. If you inherit a traditional IRA from your spouse, you generally can roll it over, or you can choose to make the inherited IRA your own. See Treating it as your own, earlier.

Not inherited from spouse. If you inherit a traditional IRA from someone other than your spouse, you cannot roll it over or allow it to receive a rollover contribution. You must withdraw the IRA assets within a certain period. For more information, see Publication 590.

Reporting rollovers from IRAs. Report any rollover from one traditional IRA to the same or another traditional IRA on lines 15a and 15b, Form 1040 or lines 11a and 11b, Form 1040A.

Enter the total amount of the distribution on Form 1040, line 15a, or Form 1040A, line 11a. If the total amount on Form 1040, line 15a, or Form 1040A, line 11a, was rolled over, enter zero on Form 1040, line 15b, or Form 1040A, line 11b. If the total distribution was not rolled over, enter the taxable portion of the part that was not rolled over on Form 1040, line 15b, or Form 1040A, line 11b. Put “Rollover” next to Form 1040, line 15b, or Form 1040A, line 11b. See the forms instructions.

If you rolled over the distribution in 2005 or from an IRA into a qualified plan (other than an IRA), attach a statement explaining what you did.

Rollover From Employer's Plan Into an IRA

You can roll over into a traditional IRA all or part of an eligible rollover distribution you receive from your (or your deceased spouse's):

Employer's qualified pension, profit-sharing or stock bonus plan,
Annuity plan,
Tax-sheltered annuity plan (section 403(b) plan), or
Governmental deferred compensation plan (section 457 plan).

A qualified plan is one that meets the requirements of the Internal Revenue Code.

Eligible rollover distribution. Generally, an eligible rollover distribution is any distribution of all or part of the balance to your credit in a qualified retirement plan except the following.

A required minimum distribution (explained later under When Must You Withdraw IRA Assets? (Required Minimum Distributions).
Hardship distributions.
Any of a series of substantially equal periodic distributions paid at least once a year over:
1. Your lifetime or life expectancy,
2. The lifetimes or life expectancies of you and your beneficiary, or
3. A period of 10 years or more.
Corrective distributions of excess contributions or excess deferrals, and any income allocable to the excess, or of excess annual additions and any allocable gains.
A loan treated as a distribution because it does not satisfy certain requirements either when made or later (such as upon default), unless the participant's accrued benefits are reduced (offset) to repay the loan.
Dividends on employer securities.
The cost of life insurance coverage.
Generally, a distribution to the plan participant's beneficiary.

Reporting rollovers from employer plans. Enter the total distribution (before income tax or other deductions were withheld) on Form 1040, line 16a or Form 1040A, line 12a. This amount should be shown in box 1 of Form 1099-R. From this amount, subtract any contributions (usually shown in box 5 of Form 1099-R) that were taxable to you when made. From that result, subtract the amount that was rolled over either directly or within 60 days of receiving the distribution. Enter the remaining amount, even if zero, on Form 1040, line 16b, or Form 1040A, line 12b. Also, enter "Rollover" next to Form 1040, line 16b, or Form 1040A, line 12b.

Converting From Any Traditional IRA to a Roth IRA

You can convert amounts from a traditional IRA into a Roth IRA if, for the tax year you make the withdrawal from the traditional IRA, both of the following requirements are met.

Your modified AGI (explained later under Roth IRAs) is not more than $100,000.
You are not a married individual filing a separate return.

Note.

If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.

Required distributions. You cannot convert amounts that must be distributed from your traditional IRA for a particular year (including the calendar year in which you reach age 70½) under the required distribution rules (discussed later).

Inherited IRAs. If you inherited a traditional IRA from someone other than your spouse, you cannot convert it to a Roth IRA.

Income. You must include in your gross income distributions from a traditional IRA that you would have to include in income if you had not converted them into a Roth IRA. You do not include in gross income any part of a distribution from a traditional IRA that is a return of your basis, as discussed later.

If you must include any amount in your gross income, you may have to increase your withholding or make estimated tax payments. See chapter 5.

Recharacterizations

You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution. More detailed information is in Publication 590.

No deduction allowed. You cannot deduct the contribution to the first IRA. Any net income you transfer with the recharacterized contribution is treated as earned in the second IRA.

How to recharacterize a contribution. To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. If you recharacterize your contribution, you must do all three of the following.

Include in the transfer any net income allocable to the contribution. If there was a loss, the net income you must transfer may be a negative amount.
Report the recharacterization on your tax return for the year during which the contribution was made.
Treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA.

Required notifications. To recharacterize a contribution, you must notify both the trustee of the first IRA (the one to which the contribution was actually made) and the trustee of the second IRA (the one to which the contribution is being moved) that you have elected to treat the contribution as having been made to the second IRA rather than the first. You must make the notifications by the date of the transfer. Only one notification is required if both IRAs are maintained by the same trustee. The notification(s) must include all of the following information.

The type and amount of the contribution to the first IRA that is to be recharacterized.
The date on which the contribution was made to the first IRA and the year for which it was made.
A direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income (or loss) allocable to the contribution to the trustee of the second IRA. If both IRAs involved in the trustee-to-trustee transfer are maintained by the same trustee, you need only direct that trustee to transfer the contribution.
The name of the trustee of the first IRA and the name of the trustee of the second IRA.
Any additional information needed to make the transfer.

Reporting a recharacterization. If you elect to recharacterize a contribution to one IRA as a contribution to another IRA, you must report the recharacterization on your tax return as directed by Form 8606 and its instructions. You must treat the contribution as having been made to the second IRA.

Transfers Incident to Divorce

If an interest in a traditional IRA is transferred from your spouse or former spouse to you by a divorce or separate maintenance decree or a written document related to such a decree, the interest in the IRA, starting from the date of the transfer, is treated as your IRA. The transfer is tax free. For detailed information, see Publication 590.

When Can You Withdraw or Use IRA Assets?

There are rules limiting use of your IRA assets and distributions from it. Violation of the rules generally results in additional taxes in the year of violation. See What Acts Result in Penalties or Additional Taxes, later.

Contributions returned before the due date of return. If you made IRA contributions in 2004, you can withdraw them tax free by the due date of your return. If you have an extension of time to file your return, you can withdraw them tax free by the extended due date. You can do this if, for each contribution you withdraw, both of the following conditions apply.

You did not take a deduction for the contribution.
You withdraw any interest or other income earned on the contribution. You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income earned on the contribution may be a negative amount.

Note.

To calculate the amount you must withdraw, see Publication 590.

Generally, except for any part of a withdrawal that is a return of nondeductible contributions (basis), any withdrawal of your contributions after the due date (or extended due date) of your return will be treated as a taxable distribution. Excess contributions can also be recovered tax free as discussed under What Acts Result in Penalties or Additional Taxes, later.

Earnings includible in income. You must include in income any earnings on the contributions you withdraw. Include the earnings in income for the year in which you made the contributions, not in the year in which you withdraw them.

Early distributions tax. The 10% additional tax on distributions made before you reach age 59½ does not apply to these tax-free withdrawals of your contributions. However, the distribution of interest or other income must be reported on Form 5329 and, unless the distribution qualifies as an exception to the age 59½ rule, it will be subject to this tax.

When Must You Withdraw IRA Assets? (Required Minimum Distributions)

You cannot keep funds in your traditional IRA indefinitely. Eventually they must be distributed. If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required. See Excess Accumulations (Insufficient Distributions), later. The requirements for distributing IRA funds differ depending on whether you are the IRA owner or the beneficiary of a decedent's IRA.

Required minimum distribution. The amount that must be distributed each year is referred to as the required minimum distribution.

Required distributions not eligible for rollover. Amounts that must be distributed (required minimum distributions) during a particular year are not eligible for rollover treatment.

IRA owners. If you are the owner of a traditional IRA, you must start receiving distributions from your IRA by April 1 of the year following the year in which you reach age 70½. April 1 of the year following the year in which you reach age 70½ is referred to as the required beginning date.

Distributions by the required beginning date. You must receive at least a minimum amount for each year starting with the year you reach age 70½ (your 70½ year). If you do not (or did not) receive that minimum amount in your 70½ year, then you must receive distributions for your 70½ year by April 1 of the next year.

If an IRA owner dies after reaching age 70½, but before April 1 of the next year, no minimum distribution is required because death occurred before the required beginning date.

Even if you begin receiving distributions before you attain age 70½, you must begin calculating and receiving required minimum distributions by your required beginning date.

Distributions after the required beginning date. The required minimum distribution for any year after the year you reach 70½ must be made by December 31 of that later year.

Beneficiaries. If you are the beneficiary of a decedent's traditional IRA, the requirements for distributions from that IRA generally depend on whether the IRA owner died before or after the required beginning date for distributions.

More information. For more information, including how to figure your minimum required distribution each year and how to figure your required distribution if you are a beneficiary of a decedent's IRA, see Publication 590.

Are Distributions Taxable?

In general, distributions from a traditional IRA are taxable in the year you receive them.

Exceptions. Exceptions to distributions from traditional IRAs being taxable in the year you receive them are:

Rollovers,
Tax-free withdrawals of contributions, discussed earlier, and
The return of nondeductible contributions, discussed later under Distributions Fully or Partly Taxable.

Although a conversion of a traditional IRA is considered a rollover for Roth IRA purposes, it is not an exception to the rule that distributions from a traditional IRA are taxable in the year you receive them. Conversion distributions are includible in your gross income subject to this rule and the special rules for conversions explained in Publication 590.

Ordinary income. Distributions from traditional IRAs that you include in income are taxed as ordinary income.

No special treatment. In figuring your tax, you cannot use the 10-year tax option or capital gain treatment that applies to lump-sum distributions from qualified employer plans.

Distributions Fully or Partly Taxable

Distributions from your traditional IRA may be fully or partly taxable, depending on whether your IRA includes any nondeductible contributions.

Fully taxable. If only deductible contributions were made to your traditional IRA (or IRAs, if you have more than one), you have no basis in your IRA. Because you have no basis in your IRA, any distributions are fully taxable when received. See Reporting taxable distributions on your return, later.

Partly taxable. If you made nondeductible contributions to any of your traditional IRAs, you have a cost basis (investment in the contract) equal to the amount of those contributions. These nondeductible contributions are not taxed when they are distributed to you. They are a return of your investment in your IRA.

Only the part of the distribution that represents nondeductible contributions (your cost basis) is tax free. If nondeductible contributions have been made, distributions consist partly of nondeductible contributions (basis) and partly of deductible contributions, earnings, and gains (if there are any). Until all of your basis has been distributed, each distribution is partly nontaxable and partly taxable.

Form 8606. You must complete Form 8606 and attach it to your return if you receive a distribution from a traditional IRA and have ever made nondeductible contributions to any of your traditional IRAs. Using the form, you will figure the nontaxable distributions for 2004 and your total IRA basis for 2004 and earlier years.

Note.

If you are required to file Form 8606, but you are not required to file an income tax return, you still must file Form 8606. Send it to the IRS at the time and place you would otherwise file an income tax return.

Distributions reported on Form 1099-R. If you receive a distribution from your traditional IRA, you will receive Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., or a similar statement. IRA distributions are shown in boxes 1 and 2a of Form 1099-R. A number or letter code in box 7 tells you what type of distribution you received from your IRA.

Withholding. Federal income tax is withheld from distributions from traditional IRAs unless you choose not to have tax withheld. See chapter 5.

IRA distributions delivered outside the United States. In general, if you are a U.S. citizen or resident alien and your home address is outside the United States or its possessions, you cannot choose exemption from withholding on distributions from your traditional IRA.

Reporting taxable distributions on your return. Report fully taxable distributions, including early distributions on Form 1040, line 15b, or Form 1040A, line 11b (no entry is required on Form 1040, line 15a, or Form 1040A, line 11a). If only part of the distribution is taxable, enter the total amount on Form 1040, line 15a, or Form 1040A, line 11a, and the taxable part on Form 1040, line 15b, or Form 1040A, line 11b. You cannot report distributions on Form 1040EZ.

What Acts Result in Penalties or Additional Taxes?

The tax advantages of using traditional IRAs for retirement savings can be offset by additional taxes and penalties if you do not follow the rules.

There are additions to the regular tax for using your IRA funds in prohibited transactions. There are also additional taxes for the following activities.

Investing in collectibles.
Making excess contributions.
Taking early distributions.
Allowing excess amounts to accumulate (failing to take required distributions).

There are penalties for overstating the amount of nondeductible contributions and for failure to file a Form 8606, if required.

Prohibited Transactions

Generally, a prohibited transaction is any improper use of your traditional IRA by you, your beneficiary, or any disqualified person.

Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendent, and any spouse of a lineal descendent).

The following are examples of prohibited transactions with a traditional IRA.

Borrowing money from it.
Selling property to it.
Receiving unreasonable compensation for managing it.
Using it as security for a loan.
Buying property for personal use (present or future) with IRA funds.

Effect on an IRA account. Generally, if you or your beneficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that year.

Effect on you or your beneficiary. If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you will have a taxable gain that is includible in your income. For information on figuring your gain and reporting it in income, see Are Distributions Taxable, earlier. The distribution may be subject to additional taxes or penalties.

Taxes on prohibited transactions. If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected.

More information. For more information on prohibited transactions, see Publication 590.

Investment in Collectibles

If your traditional IRA invests in collectibles, the amount invested is considered distributed to you in the year invested. You may have to pay the 10% additional tax on early distributions, discussed later.

Collectibles. These include:

Art works,
Rugs,
Antiques,
Metals,
Gems,
Stamps,
Coins,
Alcoholic beverages, and
Certain other tangible personal property.

Exception. Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.

Excess Contributions

Generally, an excess contribution is the amount contributed to your traditional IRA(s) for the year that is more than the smaller of the following amounts.

The maximum deductible amount for the year. For 2004, this is $3,000 ($3,500 if 50 or older).
Your taxable compensation for the year.

Tax on excess contributions. In general, if the excess contributions for a year are not withdrawn by the date your return for the year is due (including extensions), you are subject to a 6% tax. You must pay the 6% tax each year on excess amounts that remain in your traditional IRA at the end of your tax year. The tax cannot be more than 6% of the value of your IRA as of the end of your tax year.

Excess contributions withdrawn by due date of return. You will not have to pay the 6% tax if you withdraw an excess contribution made during a tax year and you also withdraw interest or other income earned on the excess contribution. You must complete your withdrawal by the date your tax return for that year is due, including extensions.

How to treat withdrawn contributions. Do not include in your gross income an excess contribution that you withdraw from your traditional IRA before your tax return is due if both the following conditions are met.

No deduction was allowed for the excess contribution.
You withdraw the interest or other income earned on the excess contribution.

You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income earned on the contribution may be a negative amount.

How to treat withdrawn interest or other income. You must include in your gross income the interest or other income that was earned on the excess contribution. Report it on your return for the year in which the excess contribution was made. Your withdrawal of interest or other income may be subject to an additional 10% tax on early distributions, discussed later.

Excess contributions withdrawn after due date of return. In general, you must include all distributions (withdrawals) from your traditional IRA in your gross income. However, if the following conditions are met, you can withdraw excess contributions from your IRA and not include the amount withdrawn in your gross income.

Total contributions (other than rollover contributions) for 2003 to your IRA were not more than $3,000 ($3,500 if 50 or older).
You did not take a deduction for the excess contribution being withdrawn.

The withdrawal can take place at any time, even after the due date, including extensions, for filing your tax return for the year.

Excess contribution deducted in an earlier year. If you deducted an excess contribution in an earlier year for which the total contributions were not more than the maximum deductible amount for that year ($2,000 for 2001 and earlier years, $3,000 for 2002 and 2003 ($3,500 for 2002 and 2003 if 50 or older)), you can still remove the excess from your traditional IRA and not include it in your gross income. To do this, file Form 1040X, Amended U.S. Individual Income Tax Return, for that year and do not deduct the excess contribution on the amended return. Generally, you can file an amended return within 3 years after you filed your return, or 2 years from the time the tax was paid, whichever is later.

Excess due to incorrect rollover information. If an excess contribution in your traditional IRA is the result of a rollover and the excess occurred because the information the plan was required to give you was incorrect, you can withdraw the excess contribution. The limits mentioned above are increased by the amount of the excess that is due to the incorrect information. You will have to amend your return for the year in which the excess occurred to correct the reporting of the rollover amounts in that year. Do not include in your gross income the part of the excess contribution caused by the incorrect information.

Early Distributions

You must include early distributions of taxable amounts from your traditional IRA in your gross income. Early distributions are also subject to an additional 10% tax. See the discussion of Form 5329 under Reporting Additional Taxes, later, to figure and report the tax.

Early distributions defined. Early distributions generally are amounts distributed from your traditional IRA account or annuity before you are age 59½.

Age 59½ rule. Generally, if you are under age 59½, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59½ are called early distributions.

The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.

Exceptions. There are several exceptions to the age 59½ rule. Even if you receive a distribution before you are age 59½, you may not have to pay the 10% additional tax if you are in one of the following situations.

You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
The distributions are not more than the cost of your medical insurance.
You are disabled.
You are the beneficiary of a deceased IRA owner.
You are receiving distributions in the form of an annuity.
The distributions are not more than your qualified higher education expenses.
You use the distributions to buy, build, or rebuild a first home.
The distribution is due to an IRS levy of the qualified plan.

Most of these exceptions are explained in Publication 590.

Note.

Distributions that are timely and properly rolled over, as discussed earlier, are not subject to either regular income tax or the 10% additional tax. Certain withdrawals of excess contributions after the due date of your return are also tax free and therefore not subject to the 10% additional tax. (See Excess contributions withdrawn after due date of return, earlier.) This also applies to transfers incident to divorce, as discussed earlier.

Additional 10% tax. The additional tax on early distributions is 10% of the amount of the early distribution that you must include in your gross income. This tax is in addition to any regular income tax resulting from including the distribution in income.

Nondeductible contributions. The tax on early distributions does not apply to the part of a distribution that represents a return of your nondeductible contributions (basis).

More information. For more information on early distributions, see Publication 590.

Excess Accumulations (Insufficient Distributions)

You cannot keep amounts in your traditional IRA indefinitely. Generally, you must begin receiving distributions by April 1 of the year following the year in which you reach age 70½. The required minimum distribution for any year after the year in which you reach age 70½ must be made by December 31 of that later year.

Tax on excess. If distributions are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not distributed as required.

Request to excuse the tax. If the excess accumulation is due to reasonable error, and you have taken, or are taking, steps to remedy the insufficient distribution, you can request that the tax be excused.

If you believe you qualify for this relief, do the following.

File Form 5329 with your Form 1040.
Pay any tax you owe on excess accumulations.
Attach a letter of explanation.

If the IRS approves your request, it will refund the excess accumulations tax you paid.

Exemption from tax. If you are unable to take required distributions because you have a traditional IRA invested in a contract issued by an insurance company that is in state insurer delinquency proceedings, the 50% excise tax does not apply if the conditions and requirements of Revenue Procedure 92-10 are satisfied.

More information. For more information on excess accumulations, see Publication 590.

Reporting Additional Taxes

Generally, you must use Form 5329 to report the tax on excess contributions, early distributions, and excess accumulations. If you must file Form 5329, you cannot use Form 1040A or Form 1040EZ.

Filing a tax return. If you must file an individual income tax return, complete Form 5329 and attach it to your Form 1040. Enter the total amount of additional taxes due on Form 1040, line 59.

Not filing a tax return. If you do not have to file a tax return but do have to pay one of the additional taxes mentioned earlier, file the completed Form 5329 with the IRS at the time and place you would have filed your Form 1040. Be sure to include your address on page 1 and your signature and date on page 2. Enclose, but do not attach, a check or money order payable to the United States Treasury for the tax you owe, as shown on Form 5329. Enter your social security number and “2004 Form 5329” on your check or money order.

Form 5329 not required. You do not have to use Form 5329 if either of the following situations exist.

Distribution code 1 (early distribution) is correctly shown in box 7 of all Forms 1099-R. If you do not owe any other additional tax on a distribution, multiply the taxable part of the early distribution by 10% and enter the result on Form 1040, line 59. Put “No” to the left of line 59 to indicate that you do not have to file Form 5329. However, if you also owe any other additional tax on a distribution, do not enter this 10% additional tax directly on your Form 1040. You must file Form 5329 to report your additional taxes.
You rolled over a distribution from a qualified retirement plan.

Roth IRAs

Regardless of your age, you may be able to establish and make nondeductible contributions to a retirement plan called a Roth IRA.

Contributions not reported. You do not report Roth IRA contributions on your return.

What Is a Roth IRA?

A Roth IRA is an individual retirement plan that, except as explained in this chapter, is subject to the rules that apply to a traditional IRA (defined earlier). It can be either an account or an annuity. Individual retirement accounts and annuities are described in Publication 590.

To be a Roth IRA, the account or annuity must be designated as a Roth IRA when it is set up. A deemed IRA can be a Roth IRA, but neither a SEP-IRA nor a SIMPLE IRA can be designated as a Roth IRA.

Unlike a traditional IRA, you cannot deduct contributions to a Roth IRA. But, if you satisfy the requirements, qualified distributions (discussed later) are tax free. Contributions can be made to your Roth IRA after you reach age 70½ and you can leave amounts in your Roth IRA as long as you live.

When Can a Roth IRA Be Set Up?

You can set up a Roth IRA at any time. However, the time for making contributions for any year is limited. See When Can You Make Contributions, later under Can You Contribute to a Roth IRA.

Can You Contribute to a Roth IRA?

Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:

$160,000 for married filing jointly or qualifying widow(er),
$10,000 for married filing separately and you lived with your spouse at any time during the year, or
$110,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year.

You may be eligible to claim a credit for contributions to your Roth IRA. For more information, see chapter 39.

Is there an age limit for contributions? Contributions can be made to your Roth IRA regardless of your age.

Can you contribute to a Roth IRA for your spouse? You can contribute to a Roth IRA for your spouse provided the contributions satisfy the spousal IRA limit (discussed in How Much Can Be Contributed under Traditional IRAs), you file jointly, and your modified AGI is less than $160,000.

Compensation. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services. It also includes commissions, self-employment income, and taxable alimony and separate maintenance payments.

Modified AGI. Your modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your return modified as follows.

Subtract conversion income. This is any income resulting from the conversion of an IRA (other than a Roth IRA) to a Roth IRA.
Add the following deductions and exclusions:
1. Traditional IRA deduction,
2. Student loan interest deduction,
3. Tuition and fees deduction,
4. Foreign earned income exclusion,
5. Foreign housing exclusion or deduction,
6. Exclusion of qualified savings bond interest shown on Form 8815, and
7. Exclusion of employer-provided adoption benefits shown on Form 8839.

You can use Worksheet 18-2 to figure your modified AGI.

Worksheet 18-2. Modified Adjusted Gross Income for Roth IRA Purposes

Use this worksheet to figure your modified adjusted gross income for Roth IRA purposes.

1.	Enter your adjusted gross income (Form 1040, line 37, or Form 1040A, line 22)		1.
2.	Enter any income resulting from the conversion of an IRA (other than a Roth IRA) to a Roth IRA		2.
3.	Subtract line 2 from line 1		3.
4.	Enter any traditional IRA deduction (Form 1040, line 25, or Form 1040A, line 17)		4.
5.	Enter any student loan interest deduction (Form 1040, line 26, or Form 1040A, line 18)		5.
6.	Enter any tuition and fees deduction (Form 1040, line 27, or Form 1040A, line 19)		6.
7.	Enter any foreign earned income and/or housing exclusion (Form 2555, line 43, or Form 2555-EZ, line 18)		7.
8.	Enter any foreign housing deduction (Form 2555, line 48)		8.
9.	Enter any exclusion of bond interest (Form 8815, line 14)		9.
10.	Enter any exclusion of employer-provided adoption benefits (Form 8839, line 30)		10.
11.	Add the amounts on lines 3 through 10		11.
12.	Enter: •$160,000 if married filing jointly or qualifying widow(er) •$10,000 if married filing separately and you lived with your spouse at any time during the year •$110,000 for all others		12.
	Next. Yes. No.	Is the amount on line 11 more than the amount on line 12? See the Note below. The amount on line 11 is your modified AGI for Roth IRA purposes.
	Note. If the amount on line 11 is more than the amount on line 12 and you have other income or loss items, such as social security income or passive activity losses, that are subject to AGI-based phaseouts, you can refigure your AGI solely for the purpose of figuring your modified AGI for Roth IRA purposes. Refigure your AGI without taking into account any income from conversions. (If you receive social security benefits, use Worksheet 1 in Appendix B of Publication 590 to refigure your AGI.) Then go to list item (2) under Modified AGI or line 4 above in Worksheet 18-2 to refigure your modified AGI. If you do not have other income or loss items subject to AGI-based phaseouts, your modified AGI for Roth IRA purposes is the amount on line 11.

How Much Can Be Contributed?

The contribution limit for Roth IRAs depends on whether contributions are made only to Roth IRAs or to both traditional IRAs and Roth IRAs.

Roth IRAs only. If contributions are made only to Roth IRAs, your contribution limit generally is the lesser of the following amounts.

$3,000 ($3,500 if you are 50 or older in 2004). For 2005, this amount increases to $4,000 ($4,500 if 50 or older in 2005).
Your taxable compensation.

However, If your modified AGI is above a certain amount, your contribution limit may be reduced, as explained later under Contribution limit reduced.

Roth IRAs and traditional IRAs. If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your contribution limit for Roth IRAs generally is the same as your limit would be if contributions were made only to Roth IRAs, but then reduced by all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.

This means that your contribution limit is the lesser of the following amounts.

$3,000 ($3,500 if you are 50 or older in 2004). For 2005, $4,000 ($4,500 if 50 or older in 2005) minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.
Your taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.

However, if your modified AGI is above a certain amount, your contribution limit may be reduced, as explained later under Contribution limit reduced.

Contribution limit reduced. If your modified AGI is above a certain amount, your contribution limit is gradually reduced. Use Table 18-3 to determine if this reduction applies to you.

Table 18-3. Effect of Modified AGI on Roth IRA Contribution

This table shows whether your contribution to a Roth IRA is affected by the amount of your modified adjusted gross income (modified AGI).

IF you have taxable compensation and your filing status is...	AND your modified AGI is...	THEN...
married filing jointly, or qualifying widow(er)	less than $150,000	you can contribute up to $3,000 ($3,500 if age 50 or older in 2004). For 2005, this amount is $4,000 ($4,500 if 50 or older in 2005).
	at least $150,000 but less than $160,000	the amount you can contribute is reduced as explained under Contribution limit reduced in Publication 590.
	$160,000 or more	you cannot contribute to a Roth IRA.
married filing separately and you lived with your spouse at any time during the year	zero (-0-)	you can contribute up to $3,000 ($3,500 if age 50 or older in 2004). For 2005, this amount is $4,000 ($4,500 if 50 or older in 2005).
	more than zero (-0-) but less than $10,000	the amount you can contribute is reduced as explained under Contribution limit reduced in Publication 590.
	$10,000 or more	you cannot contribute to a Roth IRA.
single, head of household, or married filing separately and you did not live with your spouse at any time during the year	less than $95,000	you can contribute up to $3,000 ($3,500 if age 50 or older in 2004). For 2005, this amount is $4,000 ($4,500 if 50 or older in 2005).
	at least $95,000 but less than $110,000	the amount you can contribute is reduced as explained under Contribution limit reduced in Publication 590.
	$110,000 or more	you cannot contribute to a Roth IRA.

Figuring the reduction. If the amount you can contribute to your Roth IRA is reduced, see Publication 590 for how to figure the reduction.

When Can You Make Contributions?

You can make contributions to a Roth IRA for a year at any time during the year or by the due date of your return for that year (not including extensions).

You can make contributions for 2004 by the due date (not including extensions) for filing your 2004 tax return. This means that most people can make contributions for 2004 by April 15, 2005.

What If You Contribute Too Much?

A 6% excise tax applies to any excess contribution to a Roth IRA.

Excess contributions. These are the contributions to your Roth IRAs for a year that equal the total of:

Amounts contributed for the tax year to your Roth IRAs (other than amounts properly and timely rolled over from a Roth IRA or properly converted from a traditional IRA, as described later) that are more than your contribution limit for the year, plus
Any excess contributions for the preceding year, reduced by the total of:
1. Any distributions out of your Roth IRAs for the year, plus
2. Your contribution limit for the year minus your contributions to all your IRAs for the year.

Withdrawal of excess contributions. For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment applies only if any earnings on the contributions are also withdrawn. The earnings are considered to have been earned and received in the year the excess contribution was made.

Applying excess contributions. If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year.

Can You Move Amounts Into a Roth IRA?

You may be able to convert amounts from either a traditional, SEP, or SIMPLE IRA into a Roth IRA. You may be able to recharacterize contributions made to one IRA as having been made directly to a different IRA. You can roll amounts over from one Roth IRA to another Roth IRA.

Conversions

You can convert a traditional IRA or a SIMPLE IRA to a Roth IRA. The conversion is treated as a rollover, regardless of the conversion method used. Most of the rules for rollovers, described earlier under Rollover From One IRA Into Another under Traditional IRAs, apply to these rollovers. However, the 1-year waiting period does not apply.

Conversion methods. You can convert amounts from a traditional IRA to a Roth IRA in any of the following ways.

Rollover. You can receive a distribution from a traditional IRA and roll it over (contribute it) to a Roth IRA within 60 days after the distribution.
Trustee-to-trustee transfer. You can direct the trustee of the traditional IRA to transfer an amount from the traditional IRA to the trustee of the Roth IRA.
Same trustee transfer. If the trustee of the traditional IRA also maintains the Roth IRA, you can direct the trustee to transfer an amount from the traditional IRA to the Roth IRA.

Same trustee. Conversions made with the same trustee can be made by redesignating the traditional IRA as a Roth IRA, rather than opening a new account or issuing a new contract.

Converting from a SIMPLE IRA. Generally, you can convert an amount in your SIMPLE IRA to a Roth IRA under the same rules explained earlier under Converting From Any Traditional IRA to a Roth IRA.

However, you cannot convert any amount distributed from the SIMPLE IRA during the 2-year period beginning on the date you first participated in any SIMPLE IRA plan maintained by your employer.

More information. For more detailed information on conversions, see Publication 590.

Failed Conversions

If, when you converted amounts from a traditional IRA or SIMPLE IRA into a Roth IRA, you expected to have modified AGI of less than $100,000 and a filing status other than married filing separately, but your expectations did not come true, you have made a failed conversion.

Results of failed conversions. If the converted amount (contribution) is not recharacterized (explained earlier), the contribution will be treated as a regular contribution to the Roth IRA and subject to the following tax consequences.

A 6% excise tax per year will apply to any excess contribution not withdrawn from the Roth IRA.
The distributions from the traditional IRA must be included in your gross income.
The 10% additional tax on early distributions may apply to any distribution.

How to avoid. You must move the amount converted (including all earnings from the date of conversion) into a traditional IRA by the due date (including extensions) for your tax return for the year during which you made the conversion to the Roth IRA. You do not have to include this distribution (withdrawal) in income. See Recharacterizations, earlier, for more information.

Rollover From a Roth IRA

You can withdraw, tax free, all or part of the assets from one Roth IRA if you contribute them within 60 days to another Roth IRA. Most of the rules for rollovers, explained earlier under Rollover From One IRA Into Another under Traditional IRAs, apply to these rollovers.

Are Distributions Taxable?

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s). You also do not include distributions from your Roth IRA that you roll over tax free into another Roth IRA. You may have to include part of other distributions in your income. See Ordering rules for distributions, later.

What are qualified distributions? A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and
The payment or distribution is:
1. Made on or after the date you reach age 59½,
2. Made because you are disabled,
3. Made to a beneficiary or to your estate after your death, or
4. To pay up to $10,000 (lifetime limit) of certain qualified first-time homebuyer amounts. See Publication 590 for more information.

Additional tax on distributions of conversion contributions within 5-year period. If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted (the conversion contribution) that you had to include in income. A separate 5-year period applies to each conversion. See Ordering rules for distributions, later, to determine the amount, if any, of the distribution that is attributable to the part of the conversion contribution that you had to include in income.

Additional tax on other early distributions. Unless an exception applies, the taxable part of other distributions from your Roth IRA(s) that are not qualified distributions is subject to the 10% additional tax on early distributions. See Publication 590 for more information.

Ordering rules for distributions. If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions) and earnings are considered to be distributed from your Roth IRA. Regular contributions are distributed first. See Publication 590 for more information.

Must you withdraw or use Roth IRA assets? You are not required to take distributions from your Roth IRA at any age. The minimum distribution rules that apply to traditional IRAs do not apply to Roth IRAs while the owner is alive. However, after the death of a Roth IRA owner, certain of the minimum distribution rules that apply to traditional IRAs also apply to Roth IRAs.

More information. For more detailed information on Roth IRAs, see Publication 590.

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