Ten IRA Tasks To Do Before The Year Ends

This was a helpful that came from the FA Advisor by way of Dow Jones.

You can read the whole list yourself if you click the link below, but items 5 and 6 on the list that I thought were particularly useful:


5. Who's your beneficiary?


Here's some well-worn but can't-be-repeated-often-enough advice: Review your beneficiary designations. Make sure there is both a primary and a contingent beneficiary named on the beneficiary designation form.

"If there is no beneficiary named, the IRA proceeds will go to the estate and lose the tax advantage of the stretch," said Connor. "If there is no contingent beneficiary, and the primary beneficiary has died and no new primary beneficiary has been named, then the assets also go to the estate with the same negative result."

It's especially worth checking your beneficiary designations if you are divorced, recently or ever.

"Make sure your ex-spouse has been deleted as a beneficiary, unless you want them to remain as a beneficiary," said Connor. "The U.S. Supreme Court has recently ruled that the beneficiary named on the beneficiary designation form trumps divorce."

Connor also advised against naming a "living trust" as the beneficiary. "A living trust should not be the beneficiary because the living trust must qualify as a 'designated beneficiary' to receive favorable stretch and tax treatment," he said. "I find that most living trusts do not qualify, or lose their designated beneficiary status through later changes to the trust."

Make sure your custodian has a written copy of your beneficiary designations.


6. One last chance for Roth conversions


If you plan to do a Roth conversion in 2010, "the funds must leave the IRA by Dec. 31 to be reported and taxable as a 2010 distribution and conversion," DeVeny said. "The funds can then be rolled over to the Roth IRA up to 60 days after they are received by the account owner--up to March 1 if the distribution was received on Dec. 31."

Contrary to what some might believe, you do not have until April 15, 2011, to do a 2010 conversion, DeVeny said.

Here is another reason why you might want to convert some or all of your IRA to a Roth IRA: according to Connor, the Roth IRA could fund a credit shelter or by-pass trust.

"A Roth IRA is usually not subject to the trust tax rate," he said. Also, review your power of attorney to make sure the agent has authority to recharacterize the Roth, if needed, Connor said.

Remember, too, that anyone can convert their traditional IRAs to a Roth IRA in 2010 regardless of income. What's more, you can pay the taxes over two years, instead of one.


Ten IRA Tasks To Do Before The Year Ends

Tax Report: How the Experts Are Handling Their Own Roth IRA Conversions - WSJ.com

Interesting discussion on Roth IRA's.

This article originally appeared in the Saturday, August 14, edition of the Wall Street Journal.

What strikes me about this report is that none of the experts are simply converting all of their assets.

For example, while I am a fan of Ed Slott (I have read a couple of his books on IRA's), it seems to me that his conversion ideas involves a lot of paperwork, and lots of chances for administrative issues (6 different Roth accounts, plus keeping his original IRA open):

An IRA advisor and vocal Roth advocate, Slott, 56 years old, says he converted nearly all his six-figure IRA in January. With his advisor's help, he separated the funds into a half-dozen Roth accounts, each for a different asset class or sector such as energy, health care or real estate. Slott says he plans to monitor his Roths and then reverse the conversions (called "recharacterization") of accounts that have dropped in value or lagged behind. The tax law allows this move as late as Oct. 15 of the year after the conversion date. So he has a 21-month window to decide which accounts to undo, and how much tax to pay. Yet his taxes will be figured as of his conversion date last January. "It's the way to get the biggest bang for my tax buck," says the Long Island, N.Y., accountant. But he left a few hundred dollars in his regular IRA so that it could receive any money from reversed conversions, which cuts paperwork.

The other advisors all seem to be doing partial conversions or, in the case of Natalie Choate, not sure she will do the conversion process at all since she is reluctant to write the tax check.

As has been discussed several times here, the Roth conversion decision is more complex than it would appear, even to the experts.

Tax Report: How the Experts Are Handling Their Own Roth IRA Conversions - WSJ.com

Tax Report: Is a Roth IRA Safe From Taxes? - WSJ.com

Thoughtful piece from the Journal. While I agree with the article's conclusion - that a future tax on properly-qualified Roth IRA distributions seems unlikely - I was unaware that there was a short period of time when Congress did change the rules:

Given the desperate need for revenue, this isn't a totally idle fear. And unfortunately there is a precedent when it comes to taxing those who have saved what lawmakers think of as "excessive." From 1987 to 1997 they imposed a 15% excise tax on annual retirement-plan distributions over $150,000. The tax applied even if other rules forced the account holder to withdraw more than $150,000, and it could hit retirement assets in estates as well.

But then the article goes on to say:

This particular tax was so hated that it is hard to imagine its return. Michael Graetz of Columbia University, a former top tax official at the Treasury Department, also thinks it is unlikely that lawmakers would enact a wholesale levy on Roth assets. "That would be like taxing salary twice," he says. "Congress has never done this, and there's no reason to expect it will."

Something to think about.

Tax Report: Is a Roth IRA Safe From Taxes? - WSJ.com

Why You Shouldn't Convert to a Roth IRA - WSJ.com

Interesting piece from the Wall Street Journal.

What I have found in conversations with clients is the decision to convert is never totally obvious.

The best candidates for conversion, in my opinion, tend to be older, usually widowed clients, who are looking to reduce their estate tax burden as well as give their heirs more assets tax-free. By converting to a Roth, and paying the taxes now, you take funds out of your estate to pay the taxes, which means the estate tax burden could conceivably be less. Moreover, the beneficiaries of the Roth will receive tax-free distributions, assuming all of the various Roth conversion rules are followed.

In other cases, however, it can be more complex, as this article suggests.

The whole piece is worth a read (it really isn't that long) but here are the five reasons cited:

1. The tax bite is too big.

Clients often come to advisers asking about the Roth IRA conversion opportunity without realizing the immediate tax implications: They will have to pay income tax on any money they move out of a traditional IRA into a Roth account.

2. Retirement is too close.

The problem here is that it can take 15 to 20 years for the tax-free growth of a Roth IRA to make up for the taxes paid at the time of conversion, advisers say. And that period can be extended if the investor starts withdrawing money from the account. That makes conversion an iffy proposition for people who are nearing retirement.

3. The investor's savings are too concentrated.

Age is even more of an issue for investors who are looking to their IRAs as their primary source of income in retirement. That's because they will need to take distributions from the fund sooner than investors who have other resources, and in larger installments—leaving less time for investment gains to offset the conversion's initial tax bite.

4. Tax brackets often change in retirement.

Interest in conversions is being spurred by anticipation of higher tax rates ahead. Some investors figure they will come out ahead by converting to a Roth IRA now and paying taxes at current rates on the amount they transfer, rather than leaving their money in a traditional IRA and paying taxes at a higher rate when they make withdrawals in the future.

But there's a catch in that scenario: Most people fall into a lower tax bracket when they retire.

5. The income can change your tax bracket now.

If an investor is receiving Social Security benefits, the spike in income could force them to pay taxes on their Social Security money, he says. It also could interfere with efforts to receive financial aid for children's college tuition. And, he adds, if an investor is going through a divorce, the additional income could affect the settlement.

Why You Shouldn't Convert to a Roth IRA - WSJ.com

Family Value: Leaving Your Roth IRA to the Kids - WSJ.com

Good post from Saturday's Wall Street Journal on Roth IRA's



Family Value: Leaving Your Roth IRA to the Kids - WSJ.com

Fidelity Investments: Roth IRA's

Good overview from Fidelity on Roth IRA converstions, answering some of the most common questions.

Fidelity Investments:

Roth IRA Rollovers Could Affect College Financial Aid

From Financial Advisor magazine. Honestly, this really hadn't occurred to me.

This also could affect people who receive Social Security - the higher income could reduce their monthly benefit.

Roth IRA Rollovers Could Affect College Financial Aid

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George W. Bush's 2010 Tax Miracle - WSJ.com

OK, I've been trying to avoid politics on this blog, so please don't take this post as a position for or against former President Bush.

Still, this article in today's Wall Street Journal highlights something that many have overlooked in their discussions of Roth IRA conversions.

Namely, the IRS is doing this to raise revenue, not to offer attractive retirement benefits to citizens.

And, according to this article, the possible tax revenues could be enormous, depending on how many people decide to do the conversion.

Quoting from the piece:

My firm, Trend Macrolytics, estimates that there is at least $9 trillion in these tax-deferred vehicles. About 60% of that, or $5.4 trillion, is in the hands of the wealthiest 10% of households, and most of that is eligible to be converted If just 10% of it is converted, then taxes would be paid on $540 billion at a 35% rate - generating a $189 billion revenue surprise for the US Treasury.

My point? If you think about the conversion as simply a vehicle for the government to get your tax dollars early - and not a benevolent windfall opportunity - the Roth conversion may not necessarily the golden opportunity that some are promoting.


George W. Bush's 2010 Tax Miracle - WSJ.com

Lots of bad advice given on Roth IRA rules - chicagotribune.com

Lots of bad advice given on Roth IRA rules - chicagotribune.com

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Interesting Strategy on Roth IRA's

This seems a little complex to me, frankly, but it illustrates some interesting ways that advisers are using the new Roth IRA rules.

From Saturday's Wall Street Journal:

Giving More to Both Kids and Charities

• By KELLY GREENE

Tax advisers are pushing new maneuvers that allow taxpayers to get more money to their children and to their favorite cause—at the same time.

Many involve converting an individual retirement account to a Roth IRA. The traditional IRA gets pretax contributions while a Roth gets after-tax contributions. Future withdrawals from a Roth are tax-free.

Until this year, only people with modified adjusted gross income of $100,000 or less could do Roth conversions. But the income limits have been lifted, and there has been a huge surge in conversions.

Roth conversions are especially attractive to retirees who hope to leave their IRAs largely untouched as an inheritance for their kids and grandkids. By converting to a Roth, the retirees can avoid having to make mandatory withdrawals each year. And the heirs' withdrawals will be income-tax free.

But there is a catch: When you convert to a Roth, you have to pay income tax on assets you are moving from the traditional IRA. Financial planners and accountants usually discourage conversions unless clients can pay those taxes from a separate account.

That is where charitable contributions come into play. If done correctly, the donation can reduce your tax bill.

All in the Family

How to give to charity and leave money to your kids at the same time.

• Start with a $500,000 traditional IRA when both parents are 65.
• Use the IRA assets to fund a charitable remainder annuity trust with a 10-year term (assuming a 5% return).
• Income tax on IRA withdrawal is $200,000, but the charitable gift cuts it to $105,440.
• Use the annuity payments of $32,500 a year to buy $1.6 million worth of second-to-die permanent life insurance for your heirs.
• At age 75, annuity trust ends, and $405,665 in proceeds go to a charitable-gift fund earning 5% a year and making $20,280 a year in gifts.
• End result at age 85: Charity gets $608,465. When you die, your heirs get a tax-free insurance trust worth $1.6 million.

Source: Daniel Nigito, Market Street Philanthropic Advisors Inc.

Martin James, a 51-year-old certified public accountant in Mooresville, Ind., is crunching the numbers to figure out how much his mother, who is 70, can convert to a Roth and give to charity without bumping her and his father into a higher tax bracket. He expects them to use this strategy for a few years, spreading the conversions out to keep the taxes as low as possible. Each year that they declare conversion-related income, his parents will contribute to a donor-advised fund and count it as a charitable contribution, he says.

"You want income-tax deductions in the year you do a Roth conversion, because it might be the most income you ever have in your whole life," says Christopher Hoyt, a law professor at the University of Missouri-Kansas City.

Even if you are converting a smaller IRA, you could set up a donor-advised fund—taking a tax deduction now and recommending the actual grants later—at a mutual-fund company for as little as $5,000. If you convert $5,000 and put $5,000 in the donor-advised fund in the same year, in most cases you pay no additional tax (as long as you itemize).

If you have highly appreciated stock, consider using that to fund the donor-advised fund, Mr. Hoyt suggests. That way, you avoid paying capital-gains tax on the stock but can use its full value to help offset your conversion income.

Roth conversions aren't the only tactic. Daniel Nigito, a certified financial planner in Bethlehem, Pa., often advises people converting at least $200,000 to use a charitable remainder trust to maximize guaranteed contributions to family and charity.

Here is how it works: The parents withdraw the IRA assets they intend to go to their children, and then use them to fund a charitable remainder annuity trust that would make payments to the parents for 10 years. The parents then use those payments to fund permanent, second-to-die life insurance in an irrevocable trust that would go to their children.

Suppose the parents want to convert a $500,000 IRA. Normally, that would generate about a $200,000 tax bill. But they could chop that bill to $105,000 by investing the $500,000 in a charitable remainder annuity trust.

If the trust paid the parents $32,500 a year, they could buy $1.6 million in life insurance that would ultimately go to their children. That is more than three times the value of the $500,000 IRA. Meanwhile, the trust would ultimately leave $600,000 to the charity, assuming 5% returns, says Mr. Nigito.

Glenn Ed and Janet Maurer, a retired couple in their 60s in New Tripoli, Pa., are using this strategy to fund life insurance for their two daughters and four grandchildren, and also to make donations to their church, a food bank and elsewhere. "Why not take control of our money and direct it where we want it to go?" Mr. Maurer says.

Write to Kelly Greene at familyvalue@wsj.com

http://online.wsj.com/article/SB10001424052748704059004575127882645277968.html?mod=WSJ_PersonalFinance_PF4#articleTabs%3Darticle

Possible Pitfalls in Roth IRA Conversions

From last week's New York Times:

March 3, 2010

For Shift to Roth I.R.A., Know the Pitfalls to Avoid

By DEBORAH L. JACOBS

CONVERTING a traditional individual retirement account to a Roth I.R.A. is a widely discussed financial planning tool right now, but the mechanics can be tricky. The process is new to many people, because until this year, you were shut out of a Roth if your adjusted gross income was more than $100,000.

Those who make the shift must pay income tax on the amount converted, which can be the whole account or just part of it. Still, the benefits are enticing: with a Roth, you are not required to take yearly minimum distributions starting at age 70 1/2, and future withdrawals are not taxed, whether you use the money yourself or leave it to beneficiaries. Knowing the pitfalls to look for can help you steer around them.

TAKE A DISTRIBUTION FIRST If you are required to take distributions because of your age, take the payout for 2010 before converting the entire I.R.A. to a Roth, said Natalie B. Choate, a Boston lawyer and author of “Life and Death Planning for Retirement Benefits” (2006, Ataxplan Publications). Unless you do, the money is considered an excess Roth contribution, and you must withdraw it by the next April 15 or face a 6 percent penalty.

CHOOSE THE BEST PATH Most people open a Roth at the same financial institution where they already have a traditional I.R.A. In that case, they can simply transfer investments from one account to the other. But to move money between institutions, you may need to cash out investments, said Michael J. Jones, a lawyer and certified public accountant with Thompson Jones in Monterey, Calif. One possibility is to withdraw the funds and redeposit them, but you must do this within 60 days or it is considered a taxable withdrawal.

If you open a Roth at the company receiving the funds and ask it to retrieve the money, he said, there is less room for foul-ups. At many institutions, you can open the necessary accounts and make the conversions online, over the phone or by filling out a form.

OPT OUT OF WITHHOLDING Financial institutions are required to withhold at least 10 percent for federal income taxes unless you ask them not to. On their Roth conversion forms, you indicate your preference by checking (or, in some cases, not checking) a box.

Read the instructions carefully and specify that you do not want taxes withheld, said Barry C. Picker, an accountant and financial planner with Picker & Auerbach in Brooklyn. Otherwise, the money withheld is subject to tax and, of course, goes to the government rather than into your Roth account. People under 59 1/2 are hit with a 10 percent penalty in addition because the amount withheld is considered an early withdrawal.

That’s what happened to Kathleen Wasescha Clifford, 56, of Edina, Minn., who worked as an institutional investor for 18 years before retiring. She failed to check the appropriate box when she converted her $450,000 I.R.A. to a Roth in September 2008. As a result, $45,000 was automatically withheld for taxes, reducing the sum in the Roth account to $405,000.

You have the right to undo a conversion through Oct. 15 of the next year, and after the market swooned, Ms. Clifford did, turning the account back into a traditional I.R.A. last spring. So she no longer owed taxes on the $405,000, but she could not get back the tax she had to pay on that $45,000 or the 10 percent penalty for early withdrawal. Ms. Clifford figures this cost her a total of $20,000. The remaining $25,000 now sits in a nonretirement account.

If you make this mistake but catch it within 60 days of when the money was taken out, said Ms. Choate, you can substitute money from another source for what was withheld. For example, Ms. Clifford could have taken $45,000 out of a nonretirement account and deposited it in the Roth. However, by the time she discovered her mistake, it was too late.

SELECT BENEFICIARIES Money in an I.R.A. cannot be distributed by a will. Rather, it goes to the people you name on the beneficiary designation form you fill out for each account. When setting up a Roth, you need to complete a new form, said Christopher R. Hoyt, a professor at the University of Missouri-Kansas City School of Law. You cannot use the beneficiary form from the traditional I.R.A.

TRACK THE MONEY Confirm that the balance in the traditional I.R.A. has been reduced by the amount you converted, and that a corresponding amount appears in a separate account that is clearly labeled a Roth. Most errors (like accidental deposits into a checking account) can be fixed if you catch them within 60 days, said Ed Slott, a certified public accountant and I.R.A. specialist in Rockville Centre, N.Y.

http://www.nytimes.com/2010/03/04/business/retirementspecial/04ROTH.html?ref=retirementspecial

12 Traps With Roth IRA Conversions

12 Traps With Roth IRA Conversions

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More on Roth IRA Conversions

This letter - which appeared in today's Wall Street Journal - has a fairly detailed description of some of the issues involved with the new Roth IRA regulations.

Ready to Roth: How You Fund an IRA Conversion Through the 'Back Door'


By KELLY GREENE

My wife and I have been unable to contribute to Roth IRAs for the past several years due to the Roth IRA income limits. We have Roth IRAs from years that we were eligible, and we both have rolled over 401(k)s from previous employers to IRAs. I was planning to take advantage of the back door into the Roth IRA for people like ourselves. We were going to fund after-tax , traditional IRAs for 2009 and 2010 this month, and then immediately convert them to Roth IRAs, which we had hoped would be tax-free, since all of the money converted would be after-tax money. However, I read in a Wall Street Journal article that you can't convert only your nondeductible contributions. You have to calculate your "basis" and deduct that portion.

My follow-up question is: Are my rollover IRAs from previous 401(k) plans considered part of my total balance in IRAs? Or can I only count the traditional IRAs that I'm converting as my IRA balance?
—Swastik Lahiri, Plano, Texas

Individual retirement accounts funded with 401(k) assets count among your traditional IRA assets during a Roth IRA conversion.

The language is confusing, since many custodians refer to such accounts as rollover IRAs. But they are technically traditional IRAs. Any IRA labeled as a SEP, SIMPLE or contributory is included, as well.

As you point out, you could fund traditional IRAs for 2009 and 2010 anytime between now and April 15 (and you could fund a 2010 IRA contribution up through April 15, 2011). There are no income limits for making nondeductible IRA contributions. But there are income limits for making Roth IRA contributions: Individuals whose modified adjusted gross income for 2010 is $120,000 or more can't contribute. For couples who file joint tax returns, the cutoff is $177,000. (You can figure out your modified adjusted gross income using a work sheet on page 59 of Publication 590 at www.irs.gov.)

Here is where the "back-door" method comes into play: As of Jan. 1, the federal government has lifted the $100,000 household income limit (again, modified adjusted gross income) on converting traditional IRA assets to a Roth. Having that limit removed makes it possible for people with higher incomes to move assets from traditional IRAs to Roth IRAs. First, you would fund a traditional IRA and then you could convert those assets to a Roth.

But people, including our readers here, who have rollover IRAs from past employment will have to include those assets when they figure out how much tax they owe on such a conversion. You can convert all, or part of, your traditional IRA assets to a Roth, but you owe tax proportionately on the amount that wasn't taxed previously.

That is where the Internal Revenue Service's pro rata rule comes into play. Basically, you can't cherry-pick the assets you convert. Instead, the IRS says you must first take the balance in your IRA, or the combined balances of multiple IRAs, and then divide any nondeductible contributions by that balance. This gives you the percentage of any conversion that is tax-free.

Let's say your rollover IRA has a balance of $23,000, and the new IRAs you fund are worth $13,000, including $12,000 in nondeductible contributions. You would divide $12,000 by $36,000, to find that 33%, or one-third, of your conversion would be tax-free.

There is one possible way around the tax. If your current employer has a retirement plan, you may be able to roll the pretax assets from your rollover IRA into it, if the plan's rules allow such a move, leaving only your nondeductible contributions subject to the pro rata rule. Remember, the pro rata rule is tied, in large part, to the balance of all your IRAs (except for Roth and inherited IRAs). So, the smaller the proportion of tax-deferred assets and earnings in the accounts, the more money you can convert tax-free. And some company retirement plans do let participants roll assets from an IRA back into a 401(k). The key: Assets in a 401(k) or similar retirement plan aren't included in pro rata calculations.

Even if you work part-time as an independent contractor, it may be worth it to open an individual 401(k) for that side business, says Julie Schatz, a certified financial planner in Menlo Park, Calif. That way, you could roll some IRA assets into your own 401(k) to help limit the tax bite on a conversion.

Of course, some employer-sponsored 401(k)s may have fewer investment options than an IRA, and many people want to move as much money as possible into a Roth, where withdrawals eventually can be tax-free. (once you meet the holding requirements). So this is mainly a strategy to consider if you are facing a significant tax bill.

There is more information about Roth IRA conversions in IRS Publication 590 at www.irs.gov.

From Ed Slott and Company: Several Good Points on IRA's

Thursday, January 14, 2010

Slott Report Mailbag: January 14th

It is time for another edition of The Slott Report Mailbag with three consumer questions and answers from our IRA Technical Consultants.

1.

Thanks for your very informative website, which was recommended by The Wall Street Journal. Just to be sure, I have two questions: My wife and I are both age 72 and in very good health. I manage her traditional IRA through TD-AMERITRADE and have quite well in the past (easily beat the S&P) but don't do anything unsound, safety first by all means.

I do so by virtue of well accepted and proven "swing" trading methods spelled out in various Dr. Alexander Elder Publications, you may have heard of him. This helps me to remain active (still up at 5 am - old habits die heard), while making gains in finances if she survives me. At this time we are considering converting her traditional IRA account entirely to a Roth. We have solid, six-figure retirement income from a source separate from my wife's IRA. So, we don't anticipate needing the money from her Roth IRA anytime soon and the Roth tax advantage is very attractive to us. But one can never be sure of the future, though so we have two questions as indicated.

1. I am well aware of the 5-year rule for Roth withdrawals, but I have gotten the opinion elsewhere that the original conversion funds (what I call seed money), can be withdrawn once taxes have been paid, at least for someone aged 70 or older. Meaning that the 5-year rule only applies to earning after conversion. Am I correct in this thinking?

2. What are the rules for withdrawals of all money in a Roth, including earnings; for example, say 5 years from now she had some kind of catastrophic and debilitating illness? We use her money as a sort of life insurance/long-term-health care combo account. Thanks for your time and expertise.

Answer:

Congratulations on doing a good investment job on your IRAs. The fact that you don't think you will need the funds from your IRAs to live on is an excellent reason to consider converting to a Roth IRA. There are no required minimum distributions during the Roth owner's lifetime.

Here are the rules concerning distributions and the five-year rule for Roth IRAs:

You can always take a distribution of basis from the Roth IRA. Basis is annual contributions and converted amounts. Those distributions will not be income taxed when they are withdrawn as they were subject to income tax when they went into the Roth IRA (or they were after-tax amounts).

There are what is called ordering rules for Roth IRA distributions. Contribution amounts come out first, converted amounts come out next (first in, first out) and earnings come out last.

Distributions must be qualified distributions to be free of all takes and penalties. To be considered a qualified distribution, you must have had a Roth IRA for five years AND you must be at least 59 1/2, or the distribution is due to death, or the distribution is due to the disability of the account owner, or the distribution qualifies for the first time home buyer exemption.

The five years start with the establishment of your first Roth IRA and covers all future Roth IRAs you may establish. In other words, it only runs once. If a distribution is qualified (see above), all funds come out of the Roth IRA income tax and penalty free. If the distribution is not qualified, a distribution of earnings (see ordering rules above) will be subjected to income tax and the early distribution penalty, if applicable.

2.

Can a 50-year-old who has been in a 72(t) for 18 months do a partial conversion to a Roth? Could the above person return all funds to the IRA and "erase" the effects of the 72(t)? Then do a conversion?

Thank you!

Answer:
If you are taking payments under the 72(t) exemption you can convert all of your traditional IRA to a Roth IRA. There is no consensus of opinion as to whether you can do a partial conversion. You will, however, have to continue to take the full 72(t) payments on the account after the conversion. You can not erase the effects of the 72(t) payments when you do a conversion to a Roth IRA. Any 72(t) payments from the Roth will be income tax free because you would have paid the income tax due when you converted.

3.

Ed and Company --

I have several of your books. Can you explain the rules or choices on when income taxes are due when converting IRA(s) to Roth IRA(s) in 2010 both a)if you choose to defer to 2011 and 2012 and b)if you decide to pay in 2010?

If you are not required to make quarterly payments, are the payments only 90% required by January 15th and the remainder (<10%) style="font-weight: bold;">

Answer:
For Roth IRA conversions in 2010, the income tax on the conversion can be paid in 2010 (your 2010 income tax return) or you could chose not to pay the income tax in 2010 and pay it in 2011 and 2012. For example, if you converted $100,000 to a Roth IRA in 2010 and decide to pay the income tax due in 2011 and 2012 you would add $50,000 to your 2011 income and $50,000 to your 2012 income to compute the income tax due. The deferral to 2011 and 2012 is only for Roth conversions completed in 2010.

Regarding the payment of estimated income tax, which may or may not be due, you should consult a tax advisor.


By IRA Technical Consultant Marvin Rotenberg and Jared Trexler

More Questions on the Roth IRA Conversion Option

The more I study this whole issue, the more questions I have.

I've been trying out different sets of numbers - time horizon, tax rates, etc. Not surprisingly, the answer to the conversion question is "It depends".

A lot of the decision boils down to: (a) what assumptions are you making on future tax rates; (b) what is the assumed rate of return (i.e. opportunity cost) on the funds that you are using to pay the tax on the Roth IRA conversion; (c) what is the likelihood that the rules for IRA distributions might change by the time you begin to make withdrawals (e.g. last year Congress suspended RMD's for the year).

This last point, I think, is not discussed enough. Congress has shown a remarkable ability over the years to change the tax rules as situations seem to warrant. We already have different tax rates for different types of income, for example; what if Congress decides 10 years from now that IRA distributions are taxed at a lower rate than ordinary income?

In any event, I'm sure there is more discussion to follow.

January 9, 2010

New Rules Ease Roth Conversions, but Benefits Vary

By TARA SIEGEL BERNARD

Don’t be surprised if your broker calls in the next few months and asks if you have thought about converting your traditional individual retirement account to a Roth I.R.A.

That’s because as of Jan. 1, anyone can convert their regular I.R.A. into a Roth regardless of income. Before the rules changed, only people with modified adjusted gross incomes of $100,000 or less could convert their accounts.

So should you consider it?

Anyone who expects to land in a higher tax bracket in retirement should think about converting. With a Roth I.R.A., you pay taxes on your contributions now so you can withdraw money tax-free later. Regular I.R.A.’s, on the other hand, allow you to take a tax deduction on eligible contributions, but you pay taxes when you take out the money.

But the Roth’s benefits extend beyond its possible tax advantages. Unlike traditional I.R.A.’s, you are not required to take required minimum distributions once you turn 70 ½, which makes the Roth an effective way to leave money to heirs — or to save for emergency expenses later in life. And because withdrawals are not counted as income, what you take out won’t affect whether your Social Security benefits are taxed. (Some people with high retirement income must pay taxes on a percentage of their benefits.) So some longtime teachers and doctors with substantial pensions may benefit from converting even a portion of their I.R.A.’s.

There is one exception. If you live in Wisconsin, you will face stiff penalties if you convert your I.R.A.’s. More on that later.

But as with most money-related matters, deciding to convert is not simple. It requires a fair bit of guesswork, namely, trying to foretell your tax bracket in retirement. Many retirees expect to pay less. But with soaring federal deficits and the rising costs of programs like Social Security and Medicare, most everyone agrees that taxes will increase — though by how much and for how long is anyone’s guess.

“It’s not just a function of your own income expectations, it’s also a function of government policy,” said Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research. “There are a lot of intricacies and nuances not only with the tax law itself, but with your unique situation.”

And that’s why many financial planners recommend hedging your bets or keeping your retirement money in accounts that are taxed in different ways — much as you diversify your investments. That way, if the government changes the rules of the Roth itself (or changes the tax code in any number of ways), at least you have your bases covered. “The more uncertainty I may feel about the future, the more likely I might be to go halfway with a strategy and not jump in with both feet,” said Christine Fahlund, senior financial planner for T. Rowe Price.

There are a few caveats. Experts generally do not recommend acting unless you have the money to pay the tax bill for the conversion without dipping into your I.R.A. (If you’re under 59 ½, you’ll also face a 10 percent penalty for tapping your I.R.A.)

You may also be wondering if this is yet another ploy by the investment industry to make more money. The Roth I.R.A.’s do, after all, present an opportunity for the industry to collect and manage more of your assets and charge commissions if you are moving from one investment company to another. But if your I.R.A. is already at a company, like, say, Fidelity or Vanguard and you keep it there, the conversion should not cost you anything.

Though your decision to convert should be based on your circumstances, there are a number of factors that can influence your decision, including these:

Consider If ...

YOU MAY NOT NEED THE MONEY For people who are unsure whether they will need all of their retirement money, it could pay to convert a portion of their I.R.A. for large or unanticipated expenses later in life. After all, Roths do not require account owners to withdraw any money, ever. “Leaving the Roth I.R.A. untapped for as long as possible — as a hedge against longevity or to cover medical or long-term care expenses — can be an appealing strategy for investors, including the huge middle class,” Ms. Fahlund said. “If they never have to tap into the Roth I.R.A., it becomes an attractive legacy.”

YOU HAVE A TAXABLE ESTATE ...Roths are useful tools for people with taxable estates. By paying the tax on the conversion, you are also effectively reducing the amount of taxes you will owe on your estate. Financial planners also recommend that people in the top tax brackets choose to pay the taxes in 2010 to avoid the higher income tax rates scheduled for 2011. Otherwise, the Internal Revenue Service will automatically charge you half the tax in 2011 and half in 2012, when rates are higher.

... OR NONDEDUCTIBLE I.R.A.’S If you earned too much money to contribute to a traditional I.R.A., you may have made contributions with after-tax money. In that situation, the contributions can eventually be withdrawn tax-free and only investment earnings are taxed. Likewise, you would be taxed only on those earnings in a conversion. “It’s a slam-dunk if your I.R.A.’s contain nothing but nondeductible contributions with minimal investment earnings,” said Helen Huntley, a financial adviser in St. Petersburg, Fla.

Nondeductible I.R.A.’s also provide a backdoor entry into the Roth I.R.A. for people who make too much money to contribute directly. Higher earners can make nondeductible contributions to traditional I.R.A.’s and convert them to a Roth I.R.A. each year — and pay little or nothing in taxes because the tax is only on earnings. (In 2010, married taxpayers who earn up to $167,000 can each make the full $5,000 contribution to a Roth, or $6,000 for people over the age of 50. Couples who earn up to $177,000 can make partial contributions. Single taxpayers who earn less than $105,000 can make a full contribution, though it phases out above $120,000.)

YOU ARE YOUNG OR ENGAGED Younger people have an advantage because they have more time for tax-free growth — and to earn back the taxes paid upfront. Another strong candidate for conversion is someone engaged or soon to be engaged whose tax bracket is lower than the combined household’s bracket will be, said Jennifer Lazarus, a financial planner in Durham, N.C. “This person will benefit from locking in lower tax rates, and the converted balance will grow tax-free over the course of their marriage,” she said. “The younger the couple, the greater the tax-free benefit.”

That does not mean that older people should rule out converting. If, for instance, you are required to take sizable minimum distributions from your regular I.R.A., which then push you into a higher tax bracket, it may pay to convert part of your I.R.A., even over a series of years, said Mr. Spiegelman of Schwab. This is especially useful for anyone with sizable pensions.

Think Twice If ...

There are several specific situations where you should not convert. If you expect you will need every penny of your retirement money and you think you will land in a much lower tax bracket than you are in now, it does not pay.

That is also true if you plan to leave your I.R.A. to charity. It will inherit the account and its contents free of tax, said Therese Govern, an accountant and financial planner in Seattle.

Wisconsin residents, meanwhile, should not convert — or at least not yet. The state has not yet adopted the federal tax rules, which means that people with taxable income over $100,000 who convert face stiff penalties. The State Legislature is expected to act by April to eliminate the penalties.

Also keep in mind that if you are under 59 ½, converted Roths must be open at least five years before you can make penalty-free withdrawals. So if you need the money before then and still want to convert, keep enough in your traditional I.R.A. to tide you over. Once you are over 59 ½, there are no withdrawal penalties.

Given the complexity of the tax code, you should work with a tax adviser.

Of course, you should also feel comfortable with your decision. “The process of determining whether or not to convert is not just about economics,” said Terry Donahe, a financial planner in Lake Oswego, Ore. “How does the individual feel about paying taxes now? Given the fragile state of our economy in general and the financial markets in particular, many individuals are reluctant to part with cash.”

More on Roth IRA Conversions

December 29, 2009

Advisors Caution Against Rush To Roth IRA

(Dow Jones) While high-income investors can convert certain retirement savings to a Roth individual retirement account for the first time beginning next year, careful thought is required. For example, moving all eligible assets at once may be a bad idea for some, financial advisors say. "Just because you can doesn't mean you should," says Stuart Ritter, a certified financial planner with T. Rowe Price Group Inc. "It's potentially a great opportunity. You need to investigate." Brokerage firms and financial advisors have been scrambling to educate investors about the conversion opportunity arising when, effective Jan. 1, the U.S. government eliminates the $100,000 income limit for converting money to a Roth IRA from a traditional IRA or certain tax-deferred employer-sponsored retirement plans. Research shows that many investors are unfamiliar with, or confused by, the new rule. Moving money to a Roth IRA won't necessarily be appropriate for all investors, so analyzing one's specific circumstances is crucial. One key––and difficult to predict––consideration is future tax rates. Investors will need to pay ordinary income tax on the taxable amount they convert but future withdrawals will be tax-free if the money has been in the Roth IRA at least five years and the withdrawal meets other qualifications, such as the account holder being at least 59 1/2. Unlike traditional IRA holders, investors with a Roth aren't required to start making withdrawals when they reach age 70 1/2. The law applies only to Roth IRA conversions. Income limits still prevent high earners from making new contributions to a Roth IRA. One widely misunderstood provision applies only to conversions made in 2010. Investors can either include the taxable conversion amount in their 2010 income and pay the taxes then, or they can divide the taxable income equally between 2011 and 2012 and pay whatever tax is generated by the income in those years. Investors should also consider state tax rates and treatment of conversions, Ritter says. Wisconsin, for example, may not allow taxpayers to divide and defer their taxable income for conversions made in 2010. And state taxpayers with modified adjusted gross incomes over $100,000 will be subject to certain penalties. For some investors, making partial Roth IRA conversions over time can make sense. Converting a large amount could push someone into a higher tax bracket for that year. Smaller conversions mean smaller tax hits. Also, having money in various types of accounts can provide a hedge against the future. Paying taxes on a conversion now may benefit investors who expect their tax rate to be higher when they withdraw money from the account. Those who expect their tax rates to be lower in the future might prefer to wait. As a general rule, the further an investor is from withdrawing money from an IRA, the more advantageous paying taxes on a Roth conversion now may be because the money has more years to grow tax-free, T. Rowe Price says. Michael Beriss, a senior financial advisor with Ameriprise Financial Inc. in Bethesda, Md. and a former tax attorney, says he rarely advises clients to convert their entire IRA to a Roth. One of his clients retired after making millions of dollars from the technology bubble early this decade. The client still works as a consultant and his income varies widely from year to year. Beriss has been helping him shift a portion of his IRA to a Roth during the low-income, low-tax-rate years. "It's not a one-time question," Beriss says of a conversion. "It's not an all-or-nothing question. It's an ongoing process." Copyright (c) 2009, Dow Jones. For more information about Dow Jones' services for advisors, please click here.

Roth IRA Conversions - More Questions and Likely Candidates for Conversion

Other questions:

1. Most calculations don't include the effect of state income taxes;
2. Social security benefits could be cut. For example, beneficiaries under full retirement age have $1 in benefits deducted for each $2 earned above an annual limit. That limit in 2009 is $14,160. A large conversion to a Roth could push incomes well above the Social Security limit.

For certain investors the conversion does seem to make sense. For example, for estate planning, an IRA owner with a large balance may wish to convert to a Roth, and pay the taxes out of other funds. This reduces the taxable estate, and gives his heirs a tax-free "gift" since they would inherit a Roth IRA on which taxes have already been paid.

Another situation could be an IRA owner who has a fairly aggressive investment portfolio with concentrated positions in one or two holdings. In this case, the owner could set up two Roth IRA's, and convert. Someone who converts has until October 15, 2011, to decide whether to recharacterize their new Roth IRA's back to traditional IRA's. If one of the Roth IRA investments soar in value, and the other goes lower, the owner keeps the one Roth IRA with the appreciated asset, and switches the other one back to the traditional IRA. Of course, the owner still has to pay estimated taxes along the way, but these could be recovered when the final taxes are filed.

The Time Value of Money and Roth IRA 2010 Converstions

The more I get into this discussion with clients, attorneys and accountants, the less clear the answers become. This post doesn't provide any answers, but starts a series of posts that should help in the discussion.

Richard Savoy, one of our senior trust attorneys pointed out, this change in Roth IRA eligibility was originally proposed by the government as a way to raise revenue - not as a way to simply provide a benefit to hardworking savers and investors. True, for certain people, converting makes sense, but there is a cost.

Take for example someone who is 50 years, working, and does not plan on taking any distributions until she turns 70 1/2, i.e. she has 20 years to go before needing the money. She has a significant traditional IRA, and is considering converting.

In the media, the conversion is a "no-brainer". Pay the tax today, let the account grow for 20 years, and enjoy tax-free withdrawals for the rest of her life.

But ignored in this conversation are two factors. First, even if she takes advantage of the deferred tax proposal in the bill (taxes paid on a conversion done in 2010 are due in two installments, in tax years 2011 and 2012), she is still paying taxes using today's money, not future funds. In other words, this calculation is ignoring the time value of money.

For example, let's just say she takes the funds to pay the tax due on the conversion from her municipal bond account. If the overall yield on the portfolio is 3% (using double-tax free municipal bonds), $100 invested at 3% for 20 years grows to $180 through compound interest. Paying the taxes today ignores this.

The second feature not considered is the simple fact that even moderate inflation rates over the next 20 years reduces the "value" of the funds used to pay taxes. In other words, let's just say inflation runs at 2% pa for the next 20 years. This means that the "real" (i.e., inflation-adjusted) value of a dollar would be nearly 50% less vs. today's value.