IRA Knowledge 3 — Questions and Answers
Question 1: What is a 'backdoor Roth IRA' strategy used for?
- Withdrawing Roth funds before retirement without penalty
- Allowing high earners who exceed Roth income limits to indirectly contribute to a Roth IRA (Correct answer)
- Converting a 401(k) directly into a Roth without taxes
- Bypassing the 5-year rule on Roth contributions
Correct answer: Allowing high earners who exceed Roth income limits to indirectly contribute to a Roth IRA
A backdoor Roth IRA involves making a non-deductible traditional IRA contribution and then converting it to a Roth, bypassing income limits.
Question 2: What is the 5-year rule for Roth IRA earnings?
- You must hold a Roth IRA for 5 years before making any contributions
- Earnings can be withdrawn tax-free only if the account has been open at least 5 years and you are 59½ or older (Correct answer)
- You must wait 5 years between Roth conversions
- Contributions can only be withdrawn after 5 years
Correct answer: Earnings can be withdrawn tax-free only if the account has been open at least 5 years and you are 59½ or older
The 5-year rule requires a Roth IRA to be open for at least 5 years before earnings can be withdrawn tax-free, combined with meeting the age requirement.
Question 3: How are traditional IRA contributions treated for tax purposes if you are covered by a workplace retirement plan and earn above the phase-out threshold?
- They are fully tax-deductible
- They are non-deductible but grow tax-deferred (Correct answer)
- They are taxed twice — once now and once at withdrawal
- They are not allowed at all
Correct answer: They are non-deductible but grow tax-deferred
If you're covered by a workplace plan and exceed income limits, traditional IRA contributions are non-deductible but still grow tax-deferred.
Question 4: Which statement about IRA rollovers is correct?
- You can do unlimited direct rollovers per year
- You are limited to one indirect (60-day) rollover per 12-month period across all IRAs (Correct answer)
- Rollovers from a 401(k) to an IRA count against the annual contribution limit
- Indirect rollovers are always tax-free with no time limit
Correct answer: You are limited to one indirect (60-day) rollover per 12-month period across all IRAs
The IRS limits indirect (60-day) rollovers to once per 12-month period across all of an individual's IRAs combined.
Question 5: What happens if you fail to complete a 60-day IRA rollover within the deadline?
- The funds are returned to the original IRA automatically
- The distribution is treated as taxable income and may be subject to a 10% penalty (Correct answer)
- The IRS grants a standard 90-day grace period
- The account is frozen for one year
Correct answer: The distribution is treated as taxable income and may be subject to a 10% penalty
Missing the 60-day rollover window makes the distribution taxable income, and if under age 59½, the 10% early withdrawal penalty also applies.
Question 6: What is a SIMPLE IRA designed for?
- Self-employed individuals with no employees
- Small businesses with 100 or fewer employees (Correct answer)
- Government employees only
- Individuals who want simplified tax filing
Correct answer: Small businesses with 100 or fewer employees
A SIMPLE IRA (Savings Incentive Match Plan for Employees) is designed for small businesses with 100 or fewer employees.
Question 7: When can Roth IRA contributions (not earnings) be withdrawn?
- Only after age 59½
- Only after the account has been open for 5 years
- At any time, tax-free and penalty-free (Correct answer)
- Only for qualified expenses like education or home purchase
Correct answer: At any time, tax-free and penalty-free
Roth IRA contributions (not earnings) can always be withdrawn at any time, tax-free and penalty-free, since they were made with after-tax dollars.
IRA Knowledge 3
What is a 'backdoor Roth IRA' strategy used for?