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There are individual retirement accounts (IRAs) other than the traditional and the Roth. To learn about traditional and Roth IRAs, please read their respective tutorials. They will provide background information that will help you to better understand the alternative IRAs discussed below.
The other types of IRAs were designed to meet certain needs of investors. This tutorial describes three:
Let's begin with the E-IRA.
EDUCATIONAL INDIVIDUAL RETIREMENT ACCOUNT (E-IRA)
The educational retirement account is not a way to plan for retirement. It is so called because it is a modification of the traditional IRA that uses tax-free growth of money to fund a child's education. The E-IRA is a relatively new way to save money for college expenses. The E-IRA tutorial will cover four topics, all of which are modifications of the traditional IRA:
1. Contribution Rules
2. Penalties On Non-Qualified Withdrawals
3. Rollovers Between E-IRAs
Read below to learn about the contribution rules for a child's E-IRA.
CONTRIBUTION RULES
Anyone may fund an E-IRA for a child. More than one person may also fund an account, although only one account is allowed for each child. The maximum allowed contribution is $500 per year, up until the child's 18th birthday. The earnings remain tax-free when they are withdrawn and used for qualified educational expenses. After the beneficiary attains age 30, withdrawals are no longer tax-free.
The full $500 may be contributed each year by a single person or married person filing separately as long as the contributor has an adjusted gross income (AGI) less than or equal to $95,000. As soon as the AGI exceeds $95,000, a phase out will begin. The phase out will be $10 for each $300 of additional adjusted gross income and will decline to $0 when the AGI reaches $110,000.
For married couples filing jointly, the phase out starts at $150,000. The contribution allowance drops by $10 for every $200 of extra AGI, falling to $0 at $160,000.
The restrictions discussed above apply for each contributor.
PENALTIES ON NON-QUALIFIED WITHDRAWALS
Non-qualified withdrawals are those that are not withdrawn for qualified educational expenses. The IRS will consider any non-qualified withdrawal to be taxable income. All such withdrawals are subject to income tax on their earnings as well as the 10 percent penalty on early distributions. In the event of the death or disability of the beneficiary, the 10-percent penalty will not apply.
A 6-percent penalty tax is charged on excess contributions (contributions over the legal maximum); this tax will apply to each year that the excess remains. If there are any unused funds in the account when the beneficiary reaches age 30, they must be distributed to him or her as a taxable withdrawal. Rolling these funds over to another E-IRA can preserve their tax-free status.
ROLLOVERS
Rollovers may take place without tax consequences in four ways:
- They are rolled over to other children in the same family.
- If rolled over into new investments, they are for the same beneficiary.
- They are rolled over to the children of the original beneficiary.
- They are rolled over within 60 days.
There is no limit on the amount that may be rolled over.
This concludes our look at the educational IRA.
SIMPLE RETIREMENT ACCOUNTS (SIMPLE IRAs)
The Simple Retirement Account (SIMPLE IRA) is sponsored by employers and is a replacement for salary reduction SEPs (SARSEPS). The employer may set up IRAs for individual employees up to a maximum of $6,000 for each worker. The employees' salary reductions fund these plans, but the employees are not allowed to make additional voluntary contributions.
Employers, unless they choose to make non-elective contributions, must make contributions equal to the salary reduction contributions chosen (or elected) by the employee, but only up to certain limits. These contributions are in addition to the salary reduction contributions. They must be made to the SIMPLE IRAs of all eligible employees who chose salary reductions. These contributions are called matching contributions.
Generally, an employer must make matching contributions to the SIMPLE IRA of each eligible employee in an amount equal to the employee's salary reduction contributions. These matching contributions cannot be more than 3% of the employee's compensation for the calendar year.
Read below for eligibility requirements.
ELIGIBILITY REQUIREMENTS FOR SIMPLE IRAs
Employees (including self-employed individuals who received earned income) must be allowed to participate in the employer's SIMPLE plan if they:
- Received at least $5,000 in compensation from the employer during any 2 years prior to the current year, and
- Are reasonably expected to receive at least $5,000 in compensation during the calendar year for which contributions are made.
An employer may exclude from eligibility the following:
- Employees whose retirement benefits are covered by a union contract.
- Employees who are nonresident aliens and received no earned income from sources within the United States.
- Employees who would not have been eligible employees if an acquisition, disposition or similar transaction had not occurred during the year.
SIMPLIFIED EMPLOYEE PENSION PLANS (SEP-IRAs)
A simplified employee pension (SEP) plan is an individual retirement account to which employers can contribute. Employees with retirement benefits already established by union agreements may not participate in SEP-IRAs. Other employees may participate if they meet the following qualifications:
- They are at least 21.
- They have performed services for their company for at least three years during the immediately preceding five years.
- They have received from the employer at least $400 in compensation during the tax year.
An employer can establish less restrictive participation requirements for its employees than those listed, but not more restrictive ones.
The SEP rules permit an employer to contribute (and deduct) each year to each participating employee's SEP-IRA up to 15% of the employee's compensation or $30,000, whichever is less. The employer funds these contributions.
An employer who signs a SEP agreement does not have to make any contribution to the SEP-IRAs that are set up. But, if the employer does make contributions, the contributions must be based on a written allocation formula and must not discriminate in favor of highly compensated employees.
This concludes our study of other types of IRAs.
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