Individual Retirement Accounts
Traditional IRAs
A traditional IRA is a way to save for retirement that gives you tax advantages.
Contributions you make to a traditional IRA may be fully or partially deductible, depending on your circumstances, and
Generally, amounts in your traditional IRA (including earnings and gains) are not taxed until distributed.
IRA Contribution Limits
For 2015 and 2016, your total contributions to all of your traditional and Roth IRAs cannot be more than:
$5,500 ($6,500 if you’re age 50 or older), or
your taxable compensation for the year, if your compensation was less than this dollar limit.
The IRA contribution limit does not apply to:
Rollover contributions
Claiming a tax deduction for your IRA contribution
Your traditional IRA contributions may be tax-deductible. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels.
IRA contributions after age 70½
You can’t make regular contributions to a traditional IRA in the year you reach 70½ and older. However, you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age.
Spousal IRAs
If you file a joint return, you may be able to contribute to an IRA even if you did not have taxable compensation as long as your spouse did. The amount of your combined contributions can’t be more than the taxable compensation reported on your joint return. If neither spouse participated in a retirement plan at work, all of your contributions will be deductible.
Can I contribute to an IRA if I participate in a retirement plan at work?
You can contribute to a traditional or Roth IRA whether or not you participate in another retirement plan through your employer or business. However, you might not be able to deduct all of your traditional IRA contributions if you or your spouse participates in another retirement plan at work. Roth IRA contributions might be limited if your income exceeds a certain level.
Who Can Open a Traditional IRA?
You can open 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.
You can have a traditional IRA whether or not you are covered by any other retirement plan. However, you may not be able to deduct all of your contributions if you or your spouse is covered by an employer retirement plan.
Both spouses have compensation. If both you and your spouse have compensation and are under age 70½, each of you can open an IRA. You cannot both participate in the same IRA. If you file a joint return, only one of you needs to have compensation.
What is Compensation?
Generally, compensation is what you earn from working. Compensation includes:
Wages, salaries, etc. Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services are compensation. 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 IRA purposes only if shown in box 1 of Form W-2.
Commissions. An amount you receive that is a percentage of profits or sales price is compensation.
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 the deductible part 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.
Self-employment loss. If you have a net loss from self-employment, do not subtract the loss from your salaries or wages when figuring your total compensation.
Alimony and separate maintenance. For IRA purposes, compensation includes any taxable alimony and separate maintenance payments you receive under a decree of divorce or separate maintenance.
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.
Conservation Reserve Program (CRP) payments reported on Schedule SE (Form 1040), line 1b.
Any amounts (other than combat pay) you exclude from income, such as foreign earned income and housing costs.
Individual Retirement Account An individual retirement account is a trust or custodial account set up in the United States for the exclusive benefit of you or your beneficiaries. The account is created by a written document. The document must show that the account meets all of the following requirements.
The trustee or custodian must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian.
The trustee or custodian generally cannot accept contributions of more than the deductible amount for the year. However, rollover contributions and employer contributions to a simplified employee pension (SEP) can be more than this amount.
Contributions, except for rollover contributions, must be in cash.
You must have a nonforfeitable right to the amount at all times.
Money in your account cannot be used to buy a life insurance policy.
Assets in your account cannot be combined with other property, except in a common trust fund or common investment fund.
You must start receiving distributions by April 1 of the year following the year in which you reach age 70½. See Publication 590-B for more information about Required Minimum Distributions (RMDs) and other distribution rules.
How Can a Traditional IRA Be Opened?
You can open different kinds of IRAs with a variety of organizations. You can open an IRA at a bank or other financial institution or with a mutual fund or life insurance company. You can also open 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.
SIMPLE IRA A SIMPLE IRA plan is a tax-favored retirement plan that certain small employers (including self-employed employees) can set up for the benefit of their employees. Your participation in your employer's SIMPLE IRA plan does not prevent you from making contributions to a traditional or Roth IRA. See Publication 560 for more information about SIMPLE IRAs.
Simplified Employee Pension (SEP) A simplified employee pension (SEP) is a written arrangement that allows your employer to make deductible contributions to a traditional IRA (a SEP IRA) set up for you to receive such contributions. Generally, distributions from SEP IRAs are subject to the withdrawal and tax rules that apply to traditional IRAs. See Publication 560 for more information about SEPs.
SIMPLE IRA Plan A SIMPLE IRA plan (Savings Incentive Match PLan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan.
SIMPLE IRA plans can provide a significant source of income at retirement by allowing employers and employees to set aside money in retirement accounts. SIMPLE IRA plans do not have the start-up and operating costs of a conventional retirement plan.
Available to any small business – generally with 100 or fewer employees
Easily established by adopting Form 5304-SIMPLE, 5305-SIMPLE, a SIMPLE IRA prototype or an individually designed plan document
Employer cannot have any other retirement plan
No filing requirement for the employer
Contributions:
Employer is required to contribute each year either a:
Matching contribution up to 3% of compensation (not limited by the annual compensation limit), or
2% nonelective contribution for each eligible employee
Under the “nonelective” contribution formula, even if an eligible employee doesn’t contribute to his or her SIMPLE IRA, that employee must still receive an employer contribution to his or her SIMPLE IRA equal to 2% of his or her compensation up to the annual limit of $255,000 for 2013 (subject to cost-of-living adjustments in later years)
Employees may elect to contribute
Employee is always 100% vested in (or, has ownership of) all SIMPLE IRA money
SIMPLE IRA contributions include:
salary reduction contributions and
employer contributions: a. matching contributions or b. nonelective contributions.
No other contributions can be made to a SIMPLE IRA plan.
Salary reduction contributions The amount an employee contributes from their salary to a SIMPLE IRA cannot exceed $12,500 in 2015 and 2016.
If an employee participates in any other employer plan during the year and has elective salary reductions under those plans, the total amount of the salary reduction contributions that an employee can make to all the plans he or she participates in is limited to $18,000 in 2015 and 2016.
Catch-up contributions. If permitted by the SIMPLE IRA plan, participants who are age 50 or over at the end of the calendar year can also make catch-up contributions. The catch-up contribution limit for SIMPLE IRA plans is $3,000 in 2015 and 2016.
Employer matching contributions The employer is generally required to match each employee's salary reduction contributions on a dollar-for-dollar basis up to 3% of the employee's compensation. This requirement does not apply if the employer makes nonelective contributions instead.
Lower percentage. An employer may choose to make a matching contribution less than 3%, but it must be at least 1% and for no more than 2 out of 5 years. The employer must notify the employees of the lower match within a reasonable period before the 60-day election period for the calendar year.
Nonelective contributions Instead of matching contributions, an employer can choose to make nonelective contributions of 2% of each eligible employee’s compensation. If the employer makes this choice, it must make nonelective contributions whether or not the employee chooses to make salary reduction contributions. An employee's compensation up to $265,000 (for 2015 and 2016) is taken into account to figure the contribution limit.
If the employer chooses this 2% contribution formula, it must notify the employees within a reasonable period before the 60-day election period for the calendar year.
Choosing a Financial Institution
You’ll need to choose a financial institution to serve as trustee of the SIMPLE IRAs to hold each employee’s/participant’s retirement plan assets. These accounts will receive the contributions you make to the plan. Alternatively, you can decide to let employees choose the financial institution that will receive their contributions.
Three Steps to Set up a SIMPLE IRA Plan
There are three steps to establishing a SIMPLE IRA plan.
Execute a written agreement to provide benefits to all eligible employees
Give employees certain information about the agreement
Set up an IRA account for each employee
Execute a Written Agreement
You can use Form 5304-SIMPLE or Form 5305-SIMPLE to set up a SIMPLE IRA plan. Each form is a model Savings Incentive Match Plan for Employees (SIMPLE) plan document.
Use Form 5304-SIMPLE if you allow each plan participant to select the financial institution for receiving his or her SIMPLE IRA plan contributions.
Use Form 5305-SIMPLE if you will deposit all SIMPLE IRA plan contributions at an employer-designated financial institution.
You adopt the SIMPLE IRA plan when you have completed all appropriate boxes and blanks on the form and you (and the designated financial institution, if any) have signed it. Keep the original form. Do not file it with the IRS.
Alternatively, you may use a prototype document. A mutual fund, insurance company, bank or other qualified institution usually provides these. You may also have an individually designed plan.
Annual Notice to Eligible Employees
You must notify each employee before the beginning of the election period of:
The employee’s opportunity to make or change a salary reduction choice under the SIMPLE IRA plan;
The employees’ ability to select a financial institution that will serve as trustee of the employees’ SIMPLE IRA, if applicable;
Your decision to make either matching contributions or nonelective contributions;
A summary description (the financial institution should provide this information); and
Written notice that the employee can transfer his or her balance without cost or penalty if you are using a designated financial institution.
The election period is generally the 60-day period immediately preceding January 1 of a calendar year (November 2 to December 31). However, the dates of this period are modified if you set up a SIMPLE IRA plan in mid-year or if the 60-day period falls before the first day an employee becomes eligible to participate in the SIMPLE IRA plan.
If you set up your SIMPLE IRA plan using either Form 5304-SIMPLE or Form 5305-SIMPLE, you can give each employee a copy of the signed forms to satisfy the notification requirement.
Set Up a SIMPLE IRA for Each Eligible Employee
A SIMPLE IRA must be set up by or for each eligible employee and all contributions to the plan must go to it.
A SIMPLE IRA cannot be a Roth IRA.
Financial institutions authorized to hold and invest SIMPLE IRA plan contributions include banks, savings and loan associations, insurance companies, certain regulated investment companies, federally-insured credit unions and brokerage firms. SIMPLE IRA plan contributions can be put into stocks, mutual funds and other similar types of investments. The investment options available at the institution where the SIMPLE IRA is located will determine what kinds of investment choices are available to the employee as he or she makes decisions about investing his or her SIMPLE IRA accounts.
You and your employees will receive a statement from the financial institutions investing your SIMPLE IRA plan contributions both at the time you make the first SIMPLE IRA plan contributions and at least once a year after that. Each institution must provide a plain-language explanation of any fees and commissions it imposes on SIMPLE IRA assets.
Who Can Participate in a SIMPLE IRA Plan? An employee (including a self-employed individual) who:
earned at least $5,000 in compensation during any 2 years before the current calendar year and
expects to receive at least $5,000 during the current calendar year.
An employer can use less restrictive participation requirements, but not more restrictive ones. For example, an employer can eliminate or reduce the prior or current year compensation amounts. Employers cannot impose any other conditions for participating in a SIMPLE IRA plan.
An employer can exclude the following employees from a SIMPLE IRA plan:
Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and the employer
Nonresident alien employees who do not have U.S. wages, salaries or other personal services compensation from the employer
Simplified Employee Pension Plan (SEP)
A SEP plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP.
Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.
Available to any size business
Easily established by adopting Form 5305-SEP, a SEP prototype or an individually designed plan document
If Form 5305-SEP is used, cannot have any other retirement plan (except another SEP)
No filing requirement for the employer
Only the employer contributes
To traditional IRAs (SEP-IRAs) set up for each eligible employee
Employee is always 100% vested in (or, has ownership of) all SEP-IRA money
Pros and Cons:
Easy to set up and operate
Low administrative costs
Flexible annual contributions – good plan if cash flow is an issue
Employer must contribute equally for all eligible employees
Who Contributes: Employer contributions only
SEP Contribution Limits Contributions
an employer can make to an employee's SEP-IRA cannot exceed the lesser of:
25% of the employee's compensation, or
$53,000 (for 2015 and 2016)
Note: Elective salary deferrals and catch-up contributions are not permitted in SEP plans.
Filing Requirements: An employer generally has no filing requirements.
Participant Loans: Not permitted. The assets may not be used as collateral.
In-Service Withdrawals: Yes, but includible in income and subject to a 10% additional tax if under age 59 1/2.
Establishing a SEP
The first action you'll need to take is to choose a financial institution to serve as trustee of the SEP-IRAs that will hold each employee's retirement plan assets. These accounts will receive the contributions you make to the plan.
Set-up steps for a SEP
There are three steps to establishing a SEP.
Execute a written agreement to provide benefits to all eligible employees.
Give employees certain information about the agreement.
Set up an IRA account for each employee.
Written agreement
The written agreement must include the name of the employer, the requirements for employee participation, the signature of a responsible official and a definite allocation formula.
The IRS has a model SEP plan document, Form 5305-SEP, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement. Do not file this form with the IRS.
You may not use Form 5305 - SEP if you:
Maintain any other qualified plan (except another SEP - a plan is "maintained" even if no contributions were made during the year),
Use the services of leased employees,
Want a plan year other than the calendar year, or
Want an allocation formula that takes into account Social Security contributions you made for your employees.
If you can't use the Form 5305-SEP, you may use a prototype document. A mutual fund, insurance company, bank or other qualified institution usually provides these. You may also have a SEP individually designed for your business.
Provide information to participants
You must furnish your eligible employees:
Notice that you have adopted the SEP
Requirements for receiving an allocation
The basis on which the employer contribution will be allocated
If you use Form 5305-SEP, you must give your employees a copy of the form and its instructions. The model SEP is not considered adopted until each employee is provided with the following information:
A statement that IRAs other than the one the employer contributes to may provide different rates of return and contain different terms.
A statement that the administrator of the SEP will provide a copy of any amendments within 30 days of the effective date along with a written explanation of its effects.
The administrator will give written notification to the participant of any employer contributions made to a participant's IRA by January 31 of the following year.
If you use a prototype or individually designed plan you must give all eligible employees similar information.
Set up a SEP IRA for each employee
A SEP-IRA must be set up by or for each eligible employee. They may be set up with banks, insurance companies or other qualified financial institutions. All SEP contributions must go to traditional IRAs. Employees are responsible for making investment decisions about their SEP-IRA accounts.
You and your employees will receive a statement from the financial institutions investing your SEP contributions both at the time you make the first SEP contributions and at least once a year after that. Each institution must provide a plain-language explanation of any fees and commissions it imposes on SEP assets withdrawn before the expiration of a specified period of time.
Who Can Participate in a SEP?
An eligible employee is an individual (including a self-employed individual) who meets all the following requirements:
Has reached age 21
Has worked for the employer in at least 3 of the last 5 years
Received at least $600 in compensation from the employer during the year (for 2015 and 2016)
An employer can use less restrictive participation requirements than those listed, but not more restrictive ones.
An employer can exclude the following employees from a SEP:
Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and the employer
Nonresident alien employees who do not have U.S. wages, salaries or other personal services compensation from the employer
Required Minimum Distributions (RMDs)
You cannot keep retirement funds in your account indefinitely. You generally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account when you reach age 70½. Roth IRAs do not require withdrawals until after the death of the owner.
Your required minimum distribution is the minimum amount you must withdraw from your account each year.
You can withdraw more than the minimum required amount.
Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts).
Tax on Early Distributions
Most retirement plan distributions are subject to income tax and may be subject to an additional 10% tax.
Generally, the amounts an individual withdraws from an IRA or retirement plan before reaching age 59½ are called ”early” or ”premature” distributions. Individuals must pay an additional 10% early withdrawal tax unless an exception applies.
Operating a SEP
Generally, any employee who is at least age 21 and performed services for your business in three of the last five years is eligible to participant in the employer's SEP plan.
Employer contributions for each eligible employee must be:
Based only on the first $265,000 of compensation for 2015 and 2016
The same percentage of compensation for every employee
Limited annually to the smaller of $53,000 for 2015 and 2016 or 25% of compensation
Paid to the employee’s SEP-IRA
In plan operation, you must follow the definition of compensation stated in the document. Compensation generally includes the pay a participant received from you for personal services for a year.
Special computations for self-employed individuals. When figuring the contribution for your own SEP-IRA, compensation is your net earnings from self-employment, less the following deductions:
one-half of your self-employment tax and
contributions to your own SEP-IRA.
You do not have to contribute every year. When you contribute, you must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made, even employees who die or terminate employment before the contributions are made.
When and where are contributions made? Employer contributions must be made by the due date (including extensions) for filing your federal income tax return for the year.
You can deduct your contributions and your employees can exclude these contributions from their gross income. SEP contributions are not subject to federal income tax withholding, social security, Medicare and federal unemployment (FUTA) taxes.
After you send the SEP contributions to the financial institution you selected, that institution will manage the funds. Employees can move their SEP-IRA assets from one traditional IRA to another. SEP contributions can be put into stocks, mutual funds, money market funds, savings accounts and other similar types of investments. Each employee makes the investment decisions for his or her own account.
Who owns SEP contributions? Contributions to SEP accounts are always 100 percent vested, or owned, by the employee.
What are the basic withdrawal rules?
SEP contributions and earnings are held in SEP-IRAs and can be withdrawn at any time, subject to the general limitations imposed on traditional IRAs. A withdrawal is taxable in the year received. If a participant makes a withdrawal before age 59½, generally a 10% additional tax applies. SEP contributions and earnings may be rolled over tax-free to other IRAs and retirement plans. SEP contributions and earnings must eventually be distributed following the IRA required minimum distribution rules.
Participant loans are not permitted.
Rollovers You may roll over your SEP-IRA into most IRAs and qualified plans.