SELF-DIRECTED IRA

Self-directed IRAs allow individuals to select, either alone or with the advice of a broker or investment advisor, those investments which they prefer for their IRA accounts. Permitted investments include not only bank certificates of deposit, stocks, bonds, and mutual funds, but also real estate, limited partnerships, private placements and deeds of trust, among others. Through such investments, individuals can plan their financial future and take advantage of the significant benefits that IRAs offer.

More and more individuals and their advisors are realizing that self-directed retirement accounts are compelling investment vehicles. IRAs can be the current investment vehicle of choice now as well as in the future.

Only a limited number of companies are authorized under the tax laws to provide retirement account custodial services. (References are available upon request.)


ABOUT TRANSFERS AND ROLLOVERS

If an individual desires to move an existing IRA from one institution to another, he or she can accomplish this by either a transfer or a rollover.

Transfers

A direct movement from one authorized IRA custodian or trustee to another, upon the request of the IRA owner, is called a transfer. This is a tax-free and penalty-free transfer of assets from one IRA to another.

Rollovers

A rollover is also a tax-free movement of funds or property. However, unlike a transfer, a rollover to an IRA may be from a qualified pension plan (Lump Sum distribution), another IRA, a tax-sheltered annuity (403(b)) plan or an eligible deferred compensation (457(b)) plan maintained by a governmental entity. Funds or assets distributed must be returned to the IRA custodian or trustee within 60 days from the day of receipt. (The IRS may extend this 60-day period in certain rare circumstances if the failure to complete the rollover in that time was beyond the control of the IRA owner.) If the rollover is not successfully completed within the required time period, the IRA owner will be subject to taxation and possible penalties.

Transfer Rules

Because the IRA owner does not actually receive the funds or property when a direct IRA to IRA transfer is executed, a transfer is not an IRS reportable event and no tax consequences will result. If funds are involved, the check is made payable to the new custodian or trustee. Stock or other non-cash property will be reregistered in the name of the new custodian or trustee. There is no limit on the number of transfers an IRA owner may conduct during a year. In addition, partial transfers are permitted. Once the current custodian or trustee is presented with a transfer from the successor custodian or trustee (authorized by the IRA owner), the transactions are handled by the respective institutions.

Rollover Rules

IRA to IRA - The IRA owner should complete a withdrawal form and send it to the IRA custodian or trustee. The check issued by the custodian or trustee should be made payable to (or assets retitled in the name of) either the new IRA custodian or trustee, or the IRA owner for later retitling in the name of the new IRA. The current custodian or trustee will report this transaction to the IRS as a distribution because the IRA owner is directly receiving the funds or assets. If a rollover is made from an IRA, another rollover may not be made from that same IRA for at least twelve months after the rollover distribution is made.

Retirement Plan To IRA - Under the tax laws, lump sum and certain other types of distributions from qualified plans (Xerox Pension, and 401K plans Qualify), 403(b) plans or 457(b) plans are eligible for rollover to an IRA. The plan administrator of any such plan will let you know if a distribution is an eligible rollover distribution. For an eligible rollover distribution, an individual can then choose between a direct or indirect rollover. A direct rollover is much like a direct IRA transfer, in that funds or assets move directly from the plan to the IRA in the name of the IRA custodian or trustee. Amounts which are directly rolled over are not subject to federal income tax withholding.

Retirement Plan to IRA Indirect Rollovers - If the individual chooses to have the eligible rollover distribution paid personally (i.e., not go into an IRA), the plan administrator is required to withhold 20% from the distribution for federal income taxes before issuing the distribution. The IRA owner can still roll over an amount equal to the entire amount of the distribution, but must make up the 20% withheld with other funds to avoid being subject to tax (and possible penalties) on the amount not rolled over. Because of this, indirect rollovers generally are not desirable.

CONTRIBUTIONS AND DEDUCTIONS

New Limits on Traditional and Roth IRAs

IRA contribution limit increased to $3,000 in 2002 - 2004; $4,000 in 2005 - 2007 and $5,000 in 2008; and then indexed thereafter in $500 increments.

For individuals age 50 or older, the limit increased by $500 in 2002 through 2005; and by $1,000 in 2006 and thereafter.

Each individual is limited to making a contribution to the lesser of the new limits or the amount of his or her "compensation." In general, "compensation" is income you receive from working, such as wages, salary, tips, commissions, and self-employment income. "Compensation" also includes alimony or separate maintenance payments received.

The following are among the types of income which are not "compensation":

• rental income
• interest and dividend income
• pension annuity payments " deferred compensation
• income from a partnership or limited liability company in which you do not provide material income-producing services.

The deductibility of IRA contributions for any year can be affected by whether or not the individual is a participant in a tax-favored retirement plan, the individual's tax return filing status, as well as the amount of the individual's "adjusted gross income" for that year. However, to the extent an individual is not eligible to make a full deductible contribution for any year, he or she can still make a nondeductible contribution to an IRA and have the earnings on those contributions grow on the same tax-favored basis as earnings on deductible contributions.

Spousal IRA

A spousal IRA enables an earning spouse to fund an IRA for the other spouse, with certain limitations on deductions.

Among the important spousal IRA conditions are the following :

• the couple must be married
• at least one spouse must have compensation
• a joint federal tax return must be filed
• an IRA must be established for the non-compensated spouse
• the non-compensated spouse must be under the age of 70 1/2

A working spouse over age 70 1/2 can contribute up to maximum allowed on behalf of the non-compensated spouse, if the non-compensated spouse is under age 70 1/2 and the above requirements are met, even if the working spouse cannot on account of age contribute to his or her own IRA.

Each spouse must have his or her separate IRA; both spouses cannot contribute to the same IRA. If the non-compensated spouse later receives compensation, he or she does not have to open another IRA for future contributions. Those future contributions can be deposited in the spousal IRA which has already been established.

IRAs SUMMARIZED

Limits on Traditional and Roth IRAs

IRA contribution limit increased to $3,000 in 2002 - 2004; $4,000 in 2005 - 2007 and $5,000 in 2008; and then indexed thereafter in $500 increments.

For individuals age 50 or older, the limit increased by $500 in 2002 through 2005; and by $1,000 in 2006 and thereafter.

SIMPLE IRA

A SIMPLE (Savings Incentive Match Plan for Employees) IRA may be established by employers with fewer than 100 employees, provided certain requirements in the tax laws are met. A SIMPLE IRA is essentially a more limited version of a 401(k) and an expanded version of a SEP IRA.

The structure of a SIMPLE IRA allows for a mandatory employer contribution and optional employee deferrals. All contributions must be made to a SIMPLE IRA, not a regular IRA. Conversely, regular contributions must not be made to a SIMPLE IRA.

SEP IRA

A SEP (Simplified Employee Pension) IRA is an employee benefit plan with compliance and reporting requirements simpler than those for qualified plans. For that reason, SEP IRAs are attractive for sole proprietors and small companies. Contributions (tax deductible to employers) must be made to IRAs because IRAs are the funding vehicle for SEPs.

Contributions are limited to 25% of adjusted gross income or $41,000 ($40,000 for 2003), whichever is less.

SEP participants can still contribute up to the new limits to an IRA. However, because a SEP is an employee benefit retirement plan, an active participant in a SEP may not be able to deduct non-SEP contributions.

The employer has until its tax filing date for its business, including any extensions, to make SEP contributions.

Conduit IRA

A conduit IRA is an IRA which is funded solely from amounts attributable to a rollover from a qualified retirement plan, tax-sheltered annuity (403(b)) plan or governmental eligible deferred compensation (457(b)) plan and earnings on those amounts.

Recent changes to the tax laws permit plans to accept rollovers from IRAs funded with any type of before-tax contributions. However, many plans choose to accept rollovers from an IRA only if the IRA is funded exclusively with amounts rolled in from one of the plans mentioned above. For that reason, conduit IRAs are useful because they preserve an IRA owner's option to roll back funds into a plan that so limits rollovers from IRAs.

IRA to Plan Rollover

When the IRA owner desires to roll an IRA back to a plan, a distribution may be made from the IRA custodian or trustee to the IRA owner. The IRA owner then has 60 days to deposit the amount in a plan to avoid taxation and possible penalties. (The IRS may extend this 60-day period if the failure to complete the rollover in that time was beyond the control of the IRA owner.) The IRA custodian or trustee will treat this rollover as a distribution by reporting it on Form 1099-R. The receiving plan will report this to the IRS as an incoming rollover contribution.

The rollover can also be made directly from the IRA to the recipient plan. Either way, there is no mandatory federal income tax withholding, as there may be with distributions from retirement plans.

EXAMPLES OF TACTICAL PROVISIONS OF IRA TAX LAW:

• You can withdraw cash from your custodial IRA account and use it any way (tax-free and penalty-free) for up to sixty days, as long as you re-deposit the cash in an IRA account within 60 days. The only restriction is that you can not perform another "IRA to IRA rollover" from the distributing or the receiving IRA until at least twelve months after the withdrawal.


• If you take a distribution from a qualified retirement plan, tax-sheltered annuity (403(b)) plan or governmental eligible deferred compensation (457(b)) plan which is eligible for a rollover, 20% of the amount which is not directly rolled over to another plan or IRA must be withheld for federal income tax purposes. If you do not deposit an amount equal to the full value of your distribution into another plan or IRA within 60 days of your distribution, you will be liable for income taxes (and possibly an additional 10% penalty tax) on the amount you do not roll over. You can avoid all withholding, income taxes and penalties by establishing an IRA account and instructing the plan to directly roll over the full amount of the distribution to your IRA.


• Recent tax law changes have added two new exceptions to the 10% penalty tax on early (pre-age 59 1/2) withdrawals from IRAs. The 10% penalty tax will not apply to IRA distributions used to pay "qualified higher education expenses" of the IRA owner, his or her spouse, or the child or grandchild of the IRA owner or his or her spouse. The 10% penalty tax will also not apply to IRA distributions that are "qualified first-time home buyer distributions" (not to exceed $10,000 during the recipient's lifetime).


• If you are not eligible to deduct an IRA contribution on your personal income tax form, you can still make a NONDEDUCTIBLE contribution of up to the new limits if you are at least age 50) to your IRA account. Although these are after-tax dollars, you will not have to pay taxes on the earnings until you withdraw them from your IRA. Even better, if you qualify for a Roth IRA and satisfy certain other requirements, you won't even pay taxes on the earnings of your Roth IRA when you withdraw them. This has an even greater long-term impact on your account earnings because of the avoidance of higher taxes on savings grown and compounded over many years in your account. However, you must keep track of the nondeductible amounts separately from your tax-deductible contributions and earnings. IMPORTANT NOTE: Because this can be tricky, it is advisable to set up a separate account for your nondeductible contributions. One more point: you still cannot contribute more than the new limits total and deductible and nondeductible contributions in any combination.

Useful Knowledge for "Self Directed" Retirement Planning

• SEP IRAs. If you are self-employed or you have a small business with a few employees, you may want to consider a SEP IRA. An employer or self-employed individual who establishes a SEP IRA can contribute (tax-deductible) for each employee (including the individual) up to $41,000 for 2004 ($40,000 for 2003) or 25% of net compensation, whichever is less) each year under a SEP IRA. SEP IRAs can be treated just like regular IRAs. That's because the rules for investing SEP IRAs are the same as those for regular IRAs, and each employee has his or her own separate IRA to hold the employer's contributions. Other specific rules deal with an employee's required tenure, income and minimum age for participation, which are established through a simple two page standard IRS form (form 5305 SEP). Because there are no additional reporting requirements for SEP IRAs, the benefits that accrue to SEP IRA participants are the same as for IRA account owners (e.g., compounded tax-deferred savings). Of course, the SEP IRA has the added benefit of larger annual contributions.
• Many people are not aware that there is not a limit on the number of IRAs one can have. For example, you could open and maintain 5, 10, or even 100 separate IRAs. Of course, there are certain disadvantages of doing so. You'll receive up to 12 statements per year for each IRA. If you're taking your investments seriously, you'll need to examine each of these statements and calculate the changes in net gain or loss across all accounts each reporting period. The administrative burden causes many to give up, usually resulting in poor investment performance due to neglect. Probably more significant, is the fact that you may have multiple custodial fees, and companies to deal with, plus more complicated calculations when you start taking distributions.