Some Government Changes To IRA Deductions

It's been a few months since the Internal Revenue Service (IRS) released its model Roth and Education individual retirement account (IRA) agreements, and aside from IRS Notice 97-60, very little guidance has been forthcoming from the IRS. As a result, IRA administrators are left with many unanswered questions regarding the application of certain provisions of the Taxpayer Relief Act of 2006 to traditional, Roth, and 2006 Education IRAs.

Although there are unanswered questions now, guidance will be forthcoming over the next few months. Shortly after passage of TRA '06, which created the Roth and Education IRAs, Congress began work on the Tax Technical Corrections Act of 2006 to refine many of the rules.

The House passed the technical corrections bill last year, but the Senate adjourned prior to taking action on the bill. The Senate is expected to vote on the bill later this year. Once passed, any changes resulting from passage will likely be retroactive to Jan. 1, 2007. Therefore, there is some uncertainty as to whether to follow the existing IRA rules, or the rules that will apply if the technical corrections bill passes in its present form. Among the proposed changes included in the bill sent to the Senate:

*Transfers from simplified employee pension (SEP) and savings incentive match plan for employees (SIMPLE) plans not permitted. Currently, money in any traditional IRA can be transferred to a Roth IRA, regardless of the source of funds in the traditional IRA. However, the technical corrections bill would remove the ability to transfer money from an IRA funded by a SEP or SIMPLE plan to a Roth IRA. Since this change will likely be retroactive to Jan. 1, we recommend that members refrain from transferring traditional IRAs funded by a SEP or SIMPLE plan until Congress acts on the TTC '07.

* Conversion amounts must be held separately under the IRS model agreement. The technical corrections bill will require that amounts converted from a traditional IRA to a Roth IRA during 2007 be held in the Roth IRA for five years, or an additional 10% penalty will apply. In addition, the conversion IRA for each year will have its own five-year exclusion period. If traditional IRA contributions are commingled with Roth IRA contributions, then the five-year test is applied by looking at the most recent year in which a traditional-to-Roth IRA transfer was made. We recommend that members establish a separate Roth Conversion IRA for each year in which conversions occur in order to better track the fiveyear period.

* Taxes due upon death.

The TRA '06 permits an individual who converts a traditional IRA to a Roth IRA prior to Dec. 31, 2007, to spread the taxable income evenly over four years. The technical corrections bill clarifies that if the individual dies during this four-year period, any remaining taxable income from the conversion will be added to the deceased owner's final tax return.

Education IRA distributions required by age 30. Under the technical corrections bill, all funds from an Education IRA must be distributed within 30 days after the designated beneficiary reaches age 30. This provision was contained in the original House and Senate bills but it was not included in the TRA '06.

Education IRA