According to IRS SOI estimates, only  10 percent of those eligible contributed in 2004. Myriad of Rules Govern IRA Transactions, and IRS Provides Services to Educate Taxpayers

Individuals face a myriad of tax rules in using tax-advantaged traditional  and Roth IRAs, and noncompliance can trigger taxes and penalties that  may reduce their retirement savings. Contribution Rules

Both traditional and Roth IRAs have rules governing eligibility to  contribute, and all IRA contributions are subject to an annual limit. For a traditional IRA in tax year 2008, eligibility for a full  or partial deduction from taxable income depends on whether a taxpayer  or spouse is covered by an employer-sponsored retirement plan as well as  limits on modified adjusted gross income (AGI) and filing status, as  shown in table 2. Distribution Rules

Whereas both IRA types share a combined contribution limit and have  rules limiting eligibility, tax rules for distributions diverge for traditional  and Roth IRAs. Rollover and Conversion Rules

Rollovers, where a taxpayer moves money from a pension plan or an IRA  into another IRA, are also subject to rules specifying that a tax-free  rollover must be completed within 60 days of the taxpayer receiving the  money and that only one IRA-to-IRA rollover is allowed per traditional IRA  during a 1-year period. The NRP examination study of tax year  2001 returns, the most recent research results available, showed that  nearly 15 percent of those who made traditional IRA contribution  deductions misreported their deductions on their tax returns, and nearly  15 percent of taxpayers who took taxable distributions from traditional  IRAs misreported this information. IRS relies primarily on automated  enforcement to detect misreported IRA contribution deductions and  taxable distributions. Complexity Underlies the Challenges That Taxpayers Face in Complying with IRA Rules, and Some Options Could Bolster IRS Service While Other Options Would Require Legislative Change

In using traditional and Roth IRAs to save for their own retirement,  taxpayers face challenges in figuring how much they can contribute,  navigating the various distribution rules, and moving their IRAs between  custodians. Representatives of financial firms and advisors we  interviewed identified some options for IRS to clarify IRA guidance or  offer additional IRA service activities. For example, for tax year 2004,  IRS’s AUR program assessed $23.2 million in additional tax on nearly  24,000 taxpayers who overdeducted or ineligibly deducted traditional IRA  contributions. Challenges with IRA Distribution Rules

On the distribution end, some taxpayers may be confused about which  IRA distributions are taxable or subject to penalty, and older taxpayers in  particular may not understand when they must begin required minimum  distributions from traditional IRAs. Financial industry organization and advisor representatives generally  agreed that the required minimum distribution rule for traditional IRAs  was particularly challenging for older taxpayers in terms of both  determining the timing of the first distribution and calculating the correct  amount. IRS also could explore developing new tools to aid taxpayers in complying  with complex IRA rules. Options requiring additional reporting by IRA custodians could  improve information available to help taxpayers comply with IRA rules  and to help IRS detect noncompliance, but such options pose trade-offs in  terms of the added reporting burden for those parties and costs for IRS to  use the information. Broad IRA legislative options, such as eliminating limits on income  eligibility for traditional IRA contribution deductions or Roth IRA  contributions or eliminating the required minimum distribution rule, could  greatly simplify the rules for some taxpayers, such as older taxpayers who  do not need to draw down their IRAs to pay for retirement needs. IRS’s service efforts, such as  Publication 590, have been a positive step toward strengthening taxpayer  compliance. Appendix I: Scope and Methodology

The objectives of this report are to (1) provide an overview of key  individual retirement account (IRA) contribution, distribution, and other  rules and describe how the Internal Revenue Service (IRS) educates  taxpayers on these rules; (2) describe what IRS knows about the extent of  noncompliance for IRA transactions reported on tax returns; and   (3) describe the challenges taxpayers face with key IRA rules and some  options to strengthen taxpayer compliance. Annual  contributions are subject to a total limit. Roth Contribution

An after-tax contribution to a Roth IRA by eligible taxpayers. Excess accumulations are subject to a 50  percent penalty.
Why GAO Did This Study

Individual retirement accounts (IRA) allow individuals to save for retirement in a tax-preferred way. Traditional IRA contributions, subject to certain limitations, can be deducted from taxable earnings and taxes on earnings are deferred until distribution. In contrast, Roth IRA contributions are made after tax and distributions are tax-free. Faced with a myriad of rules covering IRA contributions and distributions, taxpayers may fail to comply with the rules. GAO was asked to (1) provide an overview of key rules and describe how the Internal Revenue Service (IRS) educates taxpayers about these rules, (2) describe what IRS knows about the extent of noncompliance with IRA transactions reported on taxpayer returns, and (3) describe challenges taxpayers face with key rules and some options for strengthening compliance. GAO reviewed IRS documents and compliance data. To identify challenges, GAO interviewed officials from the financial industry and advisor representatives.

What GAO Found

Taxpayers face a myriad of tax rules governing contributions to, distributions from, and rollovers between accounts for traditional and Roth IRAs. Both types of IRAs have rules governing eligibility to contribute, and all IRA contributions are subject to an annual limit. For example, eligibility to deduct (from taxable income) contributions to a traditional IRA and to contribute to a Roth IRA depends on taxpayer income and filing status, while coverage by an employer-sponsored retirement plan only affects eligibility for deductible contributions to a traditional IRA. Tax rules for distributions diverge for traditional and Roth IRAs, but both types are generally subject to a 10 percent early withdrawal penalty, with some exceptions. Further, traditional IRA owners over age 70? must take minimum distributions or face a 50 percent penalty on the required distribution amount. Rollovers, where a taxpayer moves money from one account into an IRA account, must be completed within 60 days, or the amounts are taxable and subject to penalty. To assist taxpayers in voluntarily complying with IRA rules, IRS offers special publications and telephone assistance for taxpayers with IRA questions. Even with IRS's service efforts, IRS data show that some taxpayers fail to comply with rules for reporting contribution deductions and taxable distributions from traditional IRAs. IRS's National Research Program showed that nearly 15 percent of taxpayers who took traditional IRA contribution deductions as well as 15 percent of those who took taxable distributions misreported on them on their tax returns in 2001 (the most recent data available). IRS has automated enforcement programs--matching tax returns with information reported by IRA custodians--to detect and correct these types of IRA misreporting. For tax year 2004, IRS assessed additional taxes of $23.2 million for ineligible traditional IRA contribution deductions or exceeding the deduction limits and $61.1 million in taxes and penalties for early withdrawals from traditional IRAs. As partly shown by taxpayer misreporting to IRS, taxpayers face challenges in figuring how much they can contribute, navigating the various distribution rules, and rolling over their IRAs between custodians. For example, according to representatives of financial firms and advisors GAO interviewed, taxpayers may not understand that the annual contribution limit applies across traditional IRAs and Roth IRAs in combination. On the distribution side, interviewees said that older taxpayers make mistakes in determining when they must start distributions and calculating the correct amount. Interviewees identified some options for IRS to clarify guidance, such as for the combined contribution limit rule, or develop tools to help taxpayers, such as a Webbased calculator for required minimum distributions. IRS could explore actions such as requiring additional reporting by custodians or simplifying the required minimum distribution rule to strengthen compliance with this complicated rule. Other options to reduce the complexity of IRA rules, such as eliminating income limits on eligibility, pose trade-offs and could be considered in the context of broader tax reform