IRA Contribution Limits, Roth IRA Distribution Rules Highlight Mailbag

By Marvin Rotenberg, IRA Technical Expert

This week’s Slott Report Mailbag includes your questions (and our answers) on IRA contribution limits, Roth IRA distribution rules and using the pro-rata rule. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Dear Ed,

I recently bought a copy of your book, Parlay Your IRA into a Family Fortune, and I really appreciate you writing it and for the way you wrote it so I can understand what you are saying.

But I notice on page 18, Table 4 for the year 2009 there is a subscript that says, “The $5,000 contribution amount will be increased for inflation in $500 increments for years after 2008.” Is this statement still correct?

Thank you very much,

Roy Henderson

Answer:
The $5,000 contribution limit for IRAs is indexed for inflation in $500 increments. However, the inflationary increase in 2011 over 2010 was not high enough to increase the contribution level for 2012. The indexing of contributions was established by EGTRRA in 2001 and was scheduled to sunset after 2010. However, the Pension Protection Act of 2006 has made this provision permanent.

The contribution limit for 2012 is $5,000 or the amount of compensation, whichever is less. Taxpayers age 50 or older by 12/31 of the year the contribution is made for can add an additional $1,000 called a catch-up contribution.

2.

A client made after-tax contributions to an investment plan in his late 70’s and later in year 2000 the plan converted to a 401(k) and contributions to a 401(k) were pre tax. Now she can take a normal distribution from the account, but we would like to know how the distribution will be taxed.

Please let us know.

Thank you for your assistance.

Answer:
The general rule for taking a distribution from a 401(k) plan that contains both pre- and post-tax dollars is that you must use the pro-rata rule. The plan is responsible for tracking the after-tax amounts in the plan and for reporting those after-tax amounts to IRS. You will need to talk to the plan administrator to see what tax reporting will be done to IRS.

3.

Hello,

Can a Roth IRA owner (who is not 59½ or has not held the account for five years) remove basis contributions (not earnings) from the account without penalty?

Thanks for your help,

Randy

Answer:
Following are the general rules for Roth IRA distributions.

A qualified distribution (one that is not subject to income tax or penalty) is one that is made five years after a Roth IRA account is established and the taxpayer is over age 59 1/2 or if the distribution is due to death, disability or is for a first-time home purchase. There are ordering rules for distributions that assume that all Roth IRAs are treated as one account for tax purposes. The first funds distributed come from contributions, which are distributed with no tax and no penalty regardless of the account owner’s age or the status of the five-year holding period. Next out are the converted amounts, first in, first out. These distributions would be subject to the early distribution penalty if the conversion occurred less than five years ago and the account owner is under age 59 ½. Once all contribution and converted amounts have been distributed, then earnings are distributed. A non-qualified distribution of earnings will be subject to income tax and, if applicable, the 10% early distribution penalty.