Answers to your tax questions . . . On retirement plans and IRAs

By Lawrence Farber
Contributing Writer

I retired on my 71st birthday in November 2001 and rolled over my entire pension plan distribution to an IRA at a brokerage firm. I intend to take my first required minimum distribution by April 1. Will it be taxable for 2002, rather than 2001?

Yes. Now for the bad news: You'll owe a 50 percent penalty tax on the minimum distribution. Although those who turned 70 1/2 last year generally have until April 1 of 2002 to withdraw the minimum distribution required for 2001, they must take the distribution before making any tax-free rollovers. Since you rolled your whole account balance into an IRA in 2001, you violated that rule.

The instructions for Form 5329, which you must file with your return for 2002, explain how to report the error and figure the penalty.

The bank that holds my IRA account figured my required minimum distribution for 2001 using the old rules and sent me a check in December. When I found out in January that the new rules would have let me take a smaller amount, I immediately redeposited the excess. But the bank says it can't change the record for last year. Where do I stand?

In the clear. It doesn't matter that the two transactions took place in different years, as long as the rollover was completed within 60 days. Show the total distribution on line 15a of your 2001 Form 1040 and "0" as the taxable amount on line 15b. Be sure to write "Rollover" next to it.

I contributed $2,000 to a 401(k) plan early last year, then changed jobs and put $10,000 into my new employer's 401(k). Have I overcontributed? If so, how do I correct the mistake?

You've exceeded the $10,500 limit for 2001 by $1,500. To avoid a penalty, arrange to withdraw $1,500 from one or both plans by April 15, and include this amount in your income for 2001. (The plans must comply with your request, but may require that you make it in writing.) You must also withdraw the earnings attributable to the excess, but they'll count for 2002.

One cheerful note: Even if you're younger than 59 1/2, you won't have to pay the 10 percent tax on early distributions.

Last year, I started my own practice but I didn't set up a profit-sharing plan, because I thought I couldn't afford the contributions. Now I wish I had. Is it too late?

It's too late for a full-fledged profit-sharing plan; you'd have had to establish that by the end of last year. But you have until your 2001 return's due date (April 15, plus extensions) to start a Simplified Employee Pension plan and contribute to a SEP-IRA for 2001. Contribution limits are the same for both types.

I converted a $50,000 traditional IRA to a Roth IRA last year, but now I'm not sure I can afford the extra tax I'd have to pay on the converted amount. Can I change my mind, and, if so, will I owe tax on the $2,000 the account has earned since the conversion?

You can recharacterize—that is, undo the conversion—by putting the entire $52,000 back into a traditional IRA via a trustee-to-trustee transfer. You won't owe tax if you do so by April 15. If you want to buy yourself some more time to decide, another option is to leave the Roth IRA intact temporarily and pay your tax by April 15, including the amount due on the $50,000 you converted. You could still undo the conversion as late as Oct. 15, 2002, but you'd then have to file an amended 2001 return to get a refund of the conversion tax.

While employed by a nonprofit organization, I contributed part of my salary to its tax-sheltered annuity plan. I left last year and took the full value of my account in a lump sum. I'm told that all of it is taxable, except for any part considered an "investment in the contract." What does that cover?

It comprises amounts you previously paid tax on, such as voluntary contributions you made (other than deferred salary), employer contributions included in your income, and loans from the plan that were treated as distributions. The balance of your account is taxable.

Last year, I deferred $6,000 of my $200,000 net from my unincorporated practice into a SIMPLE plan and made a matching employer contribution of $6,000—3 percent of my earnings. I've since learned that no more than $170,000 of compensation could be used as a basis for pension plan contributions in 2001. Am I in trouble?

No. The $170,000 limit doesn't apply to SIMPLEs (Savings Incentive Match Plans for Employees). You're not required to subtract the $6,000 deferral from your compensation base, either, so you were within your rights to match it with an additional $6,000 employer contribution.

I contributed $20,000 after taxes to an IRA over 10 years. In 2001, I closed the account, ending up with $15,000 cash. Can I deduct my loss?

Yes, if you have no other IRA. Because your contributions were nondeductible and all of your IRA funds were distributed, you can deduct the difference between the amount you put in and what you received. However, you must claim it as a miscellaneous expense, not a capital loss, so it won't do you any good if your total miscellaneous deductions don't top 2 percent of your adjusted gross income.

As usual, I contributed $2,000 to an IRA in 2001 for my wife, who doesn't work, and I deducted it on our return, which I've already filed. Now it occurs to me that I shouldn't have made that contribution, because I turned 71 last year. What do I do?

You can breathe easy if your wife was younger than 70 1/2 at year-end. You can't contribute to a traditional IRA for yourself once you've reached that age, but as long as your wife hasn't and you continue working, you can keep contributing to a spousal IRA. If your wife was over-age, you can avoid a 6 percent penalty by withdrawing the contribution and the related earnings by April 15 and filing an amended return.

I began contributing $2,000 a year to a Roth IRA in 1998. I know you're supposed to wait until a Roth account is five years old before taking money out of it, but I withdrew $3,000 in 2001 because I needed fast cash. Do I owe any tax on that?

No. Roth contributions aren't deductible when made, so you don't owe tax when you withdraw them. Had you taken out more than you'd contributed, you'd be taxed on the excess, which would come from previously untaxed account earnings.

Contributions withdrawn from a traditional IRA converted to a Roth, however, may be subject to 10 percent tax if they're made within five years of the conversion.

In our next issue:
Answers to your tax questions on special situations.

 

Lawrence Farber. Answers to your tax questions. . .On retirement plans and IRAs. Medical Economics 2002;5:74.