2006 Pension Protection Tax Act: IRAs, Charitable Gifts, Tax-Exempt Orgs, Other Changes

Pension act liberalizes IRA rules.

August 2007
from CPExpress

Adapted from AICPA CPExpress

Text Box: Adapted from CPExpress  For more on 2006 Pension Protection Tax Act: IRAs, Charitable Gifts, Tax-Exempt Orgs, Other Key Changes.  For more information on CPExpress, click here.The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (P.L.107–16) increased both the amount taxpayers could contribute to individual retirement accounts (IRAs) and the number of taxpayers who could make deductible contributions to IRAs. But these changes were temporary. The 2006 Pension Protection Act (Pension Act) makes these increases permanent and makes more IRA liberalizations. For example, the Pension Act creates a new exclusion that allows certain IRA participants to make tax-free charitable donations of IRA distributions. Other Pension Act provisions give taxpayers added flexibility when rolling over funds from employer-sponsored retirement plans into IRAs.


An IRA is a tax-exempt trust or custodial account set up for the exclusive benefit of the account owner and his or her beneficiaries. Individual retirement annuities can also be purchased from insurance companies (IRC Sec. 408(a)). The retirement account is created by a written document which 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 in excess of a specified limit. However, "rollover" contributions are not subject to the limit.
  • Contributions, except for rollover contributions, must be in cash.
  • No part of the trust funds will be invested in life insurance contracts.
  • Funds in the account are non-forfeitable at all times.
  • The account owner must start receiving distributions by April 1 of the year following the year in which he or she reaches age 70½ (IRC §408(a)).

Types of IRAs

There are two types of IRAs: The regular or traditional IRA and the Roth IRA. Qualifying taxpayers are entitled to deduct contributions to a regular IRA, but withdrawals are taxable. Contributions to a Roth IRA are nondeductible but distributions may qualify for a full tax exemption.

Except for rollover contributions, the maximum amount that may be contributed to a traditional or Roth IRA for any individual for a tax year is $4,000 for 2005–2007, and $5,000 for 2008 and later years (IRC Secs. 408(a)(1), 408(b)(4) and 219(b)).

Individuals who turn age 50 before the close of the tax year may increase the maximum permitted annual contribution by $1,000 for 2006 and later years (IRC Sec. 219(b)(5)(B)). This additional allowable amount is known as a "catch-up" contribution.

No tax is paid on income earned on contributions until the retirement savings are distributed (IRC Sec. 408(d)(1)).

Taxable IRA distributions are subject to a penalty tax of 10 percent of the distribution if received before age 59 ½, unless one of several exceptions applies.

Traditional IRAs

Generally speaking, for 2006 a taxpayer can deduct cash contributions to a traditional IRA up to the lesser of:

  1. $4,000 ($5,000 for those age 50 or older), or
  2. 100 percent of the compensation that's includible in his gross income for the year (IRC Sec. 219(b)).

“Compensation” means wages, salaries, commissions, tips, bonuses, professional fees and other amounts received for personal services. It doesn't include earnings from property, such as interest, rents and dividends, or pension and annuity payments or other deferred compensation. Compensation includes taxable alimony paid under a decree of divorce or separate maintenance (IRC Sec. 219(f)(1)).

The “compensation” of a self-employed individual includes net earnings from self-employment reduced by any allowable deduction for contributions on his or her behalf to a tax-qualified plan (e.g., a Keogh plan). A self-employed individual's net earnings from self-employment are also reduced by the deduction allowed for one-half of the self-employment tax.

No deduction is allowed for IRA contributions for the benefit of an individual in or after the tax year he or she attains age 70½ (IRC Sec. 219(d)(1)).

If an individual inherits an IRA from the individual's deceased spouse, the IRA may be treated as the IRA of the surviving spouse (IRC Sec. 402(c)(9)). Thus, for example, the spouse may make contributions to the IRA and roll over any amounts out of the inherited IRA. Like the original IRA owner, no amount is generally included in income until distributions are made from the IRA.

An IRA participant must begin making certain required minimum distributions beginning no later than April 1 of the calendar year following the year in which the participant reaches age 70½ (Reg. 1.408-8). The minimum distribution rules also apply to distributions following the death of the participant. If minimum distributions have begun prior to the participant's death, the remaining interest generally must be distributed at least as rapidly as under the minimum distribution method being used prior to the date of death. If the participant dies before minimum distributions have begun, then either (1) the entire remaining interest must be distributed within five years of the death, or (2) distributions must begin within one year of the death over the life (or life expectancy) of the designated beneficiary.

A beneficiary who is the surviving spouse of the participant is not required to begin distributions until the date the deceased participant would have attained age 70½. Alternatively, if the surviving spouse makes a rollover from the plan into his or her own IRA, minimum distributions generally would not need to begin until the surviving spouse attains age 70½.

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© 2007 The American Institute of Certified Public Accountants