Publication 590
Individual Retirement Arrangements (IRAs)

For use in preparing 2002 Returns

IRA as a holding account (conduit IRA) for rollovers to other eligible plans.   You can use a traditional IRA as a holding account (conduit) for assets you receive in an eligible rollover distribution from one employer's plan that you later roll over into a new employer's plan. The conduit IRA must be made up of only those assets and gains and earnings on those assets. A conduit IRA will no longer qualify if you mix regular contributions or funds from other sources with the rollover distribution from your employer's plan.

If you receive an eligible rollover distribution from your employer's plan and roll over part or all of it into one or more conduit IRAs, you can later roll over those assets into a new employer's plan.

Property and cash received in a distribution.   If you receive property and cash in an eligible rollover distribution, you can roll over part or all of the property, part or all of the cash, or any combination of the two that you choose.

Treatment if the same property is not rolled over.   Your contribution to a traditional IRA of cash representing the fair market value of property received in a distribution from a qualified retirement plan does not qualify as a rollover if you keep the property. You must either roll over the property or sell it and roll over the proceeds, as explained next.

Sale of property received in a distribution from a qualified plan.   Instead of rolling over a distribution of property other than cash, you can sell all or part of the property and roll over the amount you receive into a traditional IRA. You cannot substitute your own funds for property you receive from your employer's retirement plan.

Example.   You receive a total distribution from your employer's plan consisting of $10,000 cash and $15,000 worth of property. You decide to keep the property. You can roll over to a traditional IRA the $10,000 cash received, but you cannot roll over an additional $15,000 representing the value of the property you choose not to sell.

Treatment of gain or loss.   If you sell the distributed property and roll over all the proceeds into a traditional IRA, no gain or loss is recognized. The sale proceeds (including any increase in value) are treated as part of the distribution and are not included in your gross income.

Example.   On September 2, Mike received a lump-sum distribution from his employer's retirement plan of $50,000 in cash and $50,000 in stock. The stock was not stock of his employer. On September 24, he sold the stock for $60,000. On October 4, he rolled over $110,000 in cash ($50,000 from the original distribution and $60,000 from the sale of stock). Mike does not include the $10,000 gain from the sale of stock as part of his income because he rolled over the entire amount into a traditional IRA.

Note.   Special rules may apply to distributions of employer securities. For more information, get Publication 575.

Some sales proceeds rolled over.   If you roll over part of the amount received from the sale of property, see Publication 575.

Life insurance contract.   You cannot roll over a life insurance contract from a qualified plan into a traditional IRA.

Distributions received by a surviving spouse.   If you receive an eligible rollover distribution (defined earlier) from your deceased spouse's employer's qualified plan or a tax-sheltered annuity, you can roll part or all of it over into a traditional IRA. You can also roll over all or any part of a distribution of deductible employee contributions (DECs).

Distributions under divorce or similar proceedings (alternate payees).   If you are the spouse or former spouse of an employee and you receive a distribution from a qualified employer plan as a result of divorce or similar proceedings, you may be able to roll over all or part of it into a traditional IRA. To qualify, the distribution must be:

1. One that would have been an eligible rollover distribution (defined earlier) if it had been made to the employee, and
2. Made under a qualified domestic relations order.

Qualified domestic relations order.   A domestic relations order is a judgment, decree, or order (including approval of a property settlement agreement) that is issued under the domestic relations law of a state. A qualified domestic relations order gives to an alternate payee (a spouse, former spouse, child, or dependent of a participant in a retirement plan) the right to receive all or part of the benefits that would be payable to a participant under the plan. The order requires certain specific information, and it cannot alter the amount or form of the benefits of the plan.

Tax treatment if all of an eligible distribution is not rolled over.   Any part of an eligible rollover distribution that you keep is taxable in the year you receive it. If you do not roll any of it over, special rules for lump-sum distributions may apply. See Publication 575. The 10% additional tax on early distributions, discussed later under What Acts Result in Penalties or Additional Taxes, does not apply.

Keogh plans and rollovers.   If you are self-employed, you are generally treated as an employee for rollover purposes. Consequently, if you receive an eligible rollover distribution from a Keogh plan (a qualified plan with at least one self-employed participant), you can roll over all or part of the distribution (including a lump-sum distribution) into a traditional IRA. For information on lump-sum distributions, see Publication 575.

More information.   For more information about Keogh plans, get Publication 560.

Distribution from a tax-sheltered annuity.   If you receive an eligible rollover distribution from a tax-sheltered annuity plan, you can roll it over into a traditional IRA.

Receipt of property other than money.   If you receive property other than money, you can sell the property and roll over the proceeds as discussed earlier.

Rollover from bond purchase plan.   If you redeem retirement bonds that were distributed to you under a qualified bond purchase plan, you can roll over tax free part of the amount you receive from the redemption into a traditional IRA.

Reporting rollovers from employer plans.   To report a rollover from an employer retirement plan to a traditional IRA, use lines 16a and 16b, Form 1040, or lines 12a and 12b, Form 1040A. Do not use lines 15a or 15b, Form 1040, or lines 11a or 11b, Form 1040A.

Transfers Incident To Divorce

If an interest in a traditional IRA is transferred from your spouse or former spouse to you by a divorce or separate maintenance decree or a written document related to such a decree, the interest in the IRA, starting from the date of the transfer, is treated as your IRA. The transfer is tax free. For information about transfers of interests in employer plans, see Distributions under divorce or similar proceedings (alternate payees) under Rollover From Employer's Plan Into an IRA, earlier.

Transfer methods.   There are two commonly-used methods of transferring IRA assets to a spouse or former spouse. The methods are:

1. Changing the name on the IRA, and
2. Making a direct transfer of IRA assets.

Changing the name on the IRA.   If all the assets are to be transferred, you can make the transfer by changing the name on the IRA from your name to the name of your spouse or former spouse.

Direct transfer.   Under this method, you direct the trustee of the traditional IRA to transfer the affected assets directly to the trustee of a new or existing traditional IRA set up in the name of your spouse or former spouse.

If your spouse or former spouse is allowed to keep his or her portion of the IRA assets in your existing IRA, you can direct the trustee to transfer the assets you are permitted to keep directly to a new or existing traditional IRA set up in your name. The name on the IRA containing your spouse's or former spouse's portion of the assets would then be changed to show his or her ownership.

If the transfer results in a change in the basis of the traditional IRA of either spouse, both spouses must file Form 8606 and follow the directions in the instructions for that form.

When Can I Withdraw or Use IRA Assets?

Because a traditional IRA is a tax-favored means of saving for your retirement, a 10% additional tax generally applies if you withdraw or use IRA assets before you are age 59½. This is explained under Age 591/2 Rule.

However, you generally can make a tax-free withdrawal of contributions if you do it before the due date for filing your tax return for the year in which you made them. This means that, even if you are under age 59½, the 10% additional tax may not apply. These withdrawals are explained later under Contributions Returned Before the Due Date.

Age 59½ Rule

Generally, if you are under age 59½ you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59½ are called early distributions.

The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.

A number of exceptions to this rule are discussed below under Exceptions. Also see Contributions Returned Before the Due Date, later, and Early Distributions under What Acts Result in Penalties or Additional Taxes, later.

You may have to pay a 25%, rather than 10%, additional tax if you receive distributions from a SIMPLE IRA before you are age 59½. See Additional Tax on Early Distributions under When Can I Withdraw or Use Assets? in chapter 4.

After age 59½ and before age 701/2.   After you reach age 59½, you can receive distributions from your traditional IRA without having to pay the 10% additional tax. Even though you can receive distributions after you reach age 59½, distributions are not required until you reach age 701/2. See When Must I Withdraw IRA Assets? (Required Distributions), later in this chapter.

Exceptions

There are several exceptions to the age 59½ rule. Even if you receive a distribution before you are age 591/2, you may not have to pay the 10% additional tax if you are in one of the following situations.

• You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance.
• You are disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a first home.
• The distribution is due to an IRS levy of the qualified plan.

Most of these exceptions are explained below.

Note.   Distributions that are timely and properly rolled over, as discussed earlier, are not subject to either regular income tax or the 10% additional tax. Certain withdrawals of excess contributions after the due date of your return are also tax free and therefore not subject to the 10% additional tax. (See Excess Contributions Withdrawn After Due Date of Return under What Acts Result in Penalties or Additional Taxes, later.) This also applies to transfers incident to divorce, as discussed earlier under Can I Move Retirement Plan Assets.

Unreimbursed medical expenses.   Even if you are under age 59½, you do not have to pay the 10% additional tax on distributions that are not more than:

1. The amount you paid for unreimbursed medical expenses during the year of the distribution, minus
2. 7.5% of your adjusted gross income (defined later) for the year of the distribution.

You can only take into account unreimbursed medical expenses that you would be able to include in figuring a deduction for medical expenses on Schedule A, Form 1040. You do not have to itemize your deductions to take advantage of this exception to the 10% additional tax.

Adjusted gross income.   This is the amount on Form 1040, line 36 or Form 1040A, line 22.

Medical insurance.   Even if you are under age 59½, you may not have to pay the 10% additional tax on distributions from your traditional IRA during the year that are not more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You will not have to pay the tax on these amounts if all four of the following conditions apply.

1. You lost your job.
2. You received unemployment compensation paid under any federal or state law for 12 consecutive weeks.
3. You receive the distributions during either the year you received the unemployment compensation or the following year.
4. You receive the distributions no later than 60 days after you have been reemployed.

Disabled.   If you become disabled before you reach age 59½, any distributions from your traditional IRA because of your disability are not subject to the 10% additional tax.

You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration.

Beneficiary.   If you die before reaching age 59½, the assets in your traditional IRA can be distributed to your beneficiary or to your estate without either having to pay the 10% additional tax.

However, if you inherit a traditional IRA from your deceased spouse and elect to treat it as your own (as discussed under What If I Inherit an IRA, earlier), any distribution you later receive before you reach age 59½ may be subject to the 10% additional tax.

Annuity.   You can receive distributions from your traditional IRA that are part of a series of substantially equal payments over your life (or your life expectancy), or over the lives (or the joint life expectancies) of you and your beneficiary, without having to pay the 10% additional tax, even if you receive such distributions before you are age 59½. You must use an IRS-approved distribution method and you must take at least one distribution annually for this exception to apply. The required minimum distribution method, when used for this purpose, results in the exact amount required to be distributed, not the minimum amount.

There are two other IRS-approved distribution methods that you can use. They are generally referred to as the fixed amortization method and the fixed annuitization method. These two methods are not discussed in this publication because they are more complex and generally require professional assistance. See Revenue Ruling 2002-62 in Internal Revenue Bulletin 2002-42 for more information on these two methods. To obtain a copy of this revenue ruling, see Mail in chapter 6. This revenue ruling can also be found in many libraries and IRS offices.

The payments under this exception must continue for at least 5 years, or until you reach age 59½, whichever is the longer period. This 5-year rule does not apply if a change from an approved distribution method is made because of the death or disability of the IRA owner.

If the payments under this exception are changed before the end of the above required periods for any reason other than the death or disability of the IRA owner, he or she will be subject to the 10% additional tax. However, if he or she began receiving a series of substantially equal periodic payments before 2003, he or she can change to the required minimum distribution method at any time without incurring the additional tax. Also, for distributions beginning in 2002 and for any series of payments beginning after 2002, if he or she began receiving distributions using either the fixed amortization method or the fixed annuitization method, he or she can make a one-time switch to the required minimum distribution method without incurring the additional tax.

For example, if you received a lump-sum distribution of the balance in your traditional IRA before the end of the required period for your annuity distributions and you did not receive it because you were disabled, you would be subject to the 10% additional tax. The tax would apply to the lump-sum distribution and all previous distributions made under the exception rule.

Higher education expenses.   Even if you are under age 59½, if you paid expenses for higher education during the year, part (or all) of any distribution may not be subject to the 10% additional tax. The part not subject to the tax is generally the amount that is not more than the qualified higher education expenses (defined later) for the year for education furnished at an eligible educational institution (defined later). The education must be for you, your spouse, or the children or grandchildren of you or your spouse.

When determining the amount of the distribution that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following funds.

• An individual's earnings.
• A loan.
• A gift.
• An inheritance given to either the student or the individual making the withdrawal.
• Personal savings (including savings from a qualified tuition program).

Do not include expenses paid with any of the following funds.

• Tax-free distributions from a Coverdell education savings account (formerly called education IRAs).
• Tax-free scholarships.
• Tax-free employer-provided educational assistance.
• Any tax-free payment (other than a gift, bequest, or devise) due to enrollment at an eligible educational institution.

Qualified higher education expenses.   Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses.

Eligible educational institution.   This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in the student aid programs administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

First home.   Even if you are under age 59½, you do not have to pay the 10% additional tax on distributions you receive to buy, build, or rebuild a first home. To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all the following requirements.

1. It must be used to pay qualified acquisition costs (defined later) before the close of the 120th day after the day you received it.
2. It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined later) who is any of the following.
   1. Yourself.
   2. Your spouse.
   3. Your or your spouse's child.
   4. Your or your spouse's grandchild.
   5. Your or your spouse's parent or other ancestor.
3. When added to all your prior qualified first-time homebuyer distributions, if any, the total distributions cannot be more than $10,000.

If both you and your spouse are first-time homebuyers (defined later), each of you can receive distributions up to $10,000 for a first home without having to pay the 10% additional tax.

Qualified acquisition costs.   Qualified acquisition costs include the following items.

1. Costs of buying, building, or rebuilding a home.
2. Any usual or reasonable settlement, financing, or other closing costs.

First-time homebuyer.   Generally, you are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.

Date of acquisition.   The date of acquisition is the date that:

1. You enter into a binding contract to buy the main home for which the distribution is being used, or
2. The building or rebuilding of the main home for which the distribution is being used begins.

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