IRA Basic Skills 4 — Questions and Answers
Question 1: What is the five-year rule for Roth IRA earnings?
- You must hold the Roth IRA for 5 years before any contribution
- Earnings can only be withdrawn tax-free if the account is at least 5 years old (Correct answer)
- You must contribute for 5 consecutive years
- RMDs begin 5 years after account opening
Correct answer: Earnings can only be withdrawn tax-free if the account is at least 5 years old
To withdraw Roth IRA earnings tax-free, the account must be at least 5 years old and the owner must be 59½ or older.
Question 2: What type of income qualifies for IRA contributions?
- Rental income
- Earned income such as wages, salaries, and self-employment income (Correct answer)
- Dividend income
- Interest income
Correct answer: Earned income such as wages, salaries, and self-employment income
IRA contributions must be funded with earned income—money received for work performed, such as wages, salaries, tips, or self-employment income.
Question 3: If you are self-employed, what is the maximum percentage of net self-employment income you can contribute to a SEP IRA?
- 10%
- 15%
- 25% (Correct answer)
- 50%
Correct answer: 25%
Self-employed individuals can contribute up to 25% of their net self-employment income to a SEP IRA, subject to annual dollar limits.
Question 4: What is a SIMPLE IRA designed for?
- Individuals with simple tax situations
- Small businesses with 100 or fewer employees (Correct answer)
- Single-income households
- Retirees looking to simplify their accounts
Correct answer: Small businesses with 100 or fewer employees
A SIMPLE (Savings Incentive Match Plan for Employees) IRA is designed for small businesses with 100 or fewer employees as an easy-to-administer retirement plan.
Question 5: What is 'recharacterization' in the context of IRAs?
- Changing the beneficiary of an IRA
- Reversing or redesignating a contribution from one IRA type to another (Correct answer)
- Converting a traditional IRA to a Roth IRA
- Rolling an IRA into a 401(k)
Correct answer: Reversing or redesignating a contribution from one IRA type to another
Recharacterization allows you to redesignate a contribution made to one type of IRA (e.g., Roth) as a contribution to another type (e.g., traditional).
Question 6: How does contributing to a traditional IRA reduce your current tax bill?
- It provides a direct tax credit
- Deductible contributions reduce your taxable income (Correct answer)
- It eliminates capital gains taxes
- It defers payroll taxes
Correct answer: Deductible contributions reduce your taxable income
Deductible traditional IRA contributions lower your adjusted gross income (AGI), reducing the amount of income subject to federal income tax.
Question 7: Which of the following best describes 'tax-deferred growth' in a traditional IRA?
- You never pay taxes on IRA gains
- Investment gains are not taxed until you withdraw the money (Correct answer)
- Taxes are paid annually on dividends
- Growth is taxed at the capital gains rate
Correct answer: Investment gains are not taxed until you withdraw the money
In a traditional IRA, investment earnings compound without being taxed each year; taxes are only owed when you take distributions.
IRA Basic Skills 4
What is the five-year rule for Roth IRA earnings?