Accessing Your Retirement Income: Sooner Or Later

FROM FORBES.COM-

Most business owners want to retire … eventually; some sooner than others. While some owners profess to never wanting to exit their businesses, we know that ultimately everyone must exit. A business owner who sold his business at age 54 never looked back. He’s living the good life, playing his guitar and enjoying his grandkids. In contrast, last month a business owner told me he has retired three times. He just keeps, “getting sucked back into the business world.” Even so, I know countless business owners who are doing well physically, mentally and financially; and are looking for ways to put off retirement. No matter where you stand in this continuum of desires, it’s wise to have a plan for how you can get at your retirement funds when you need them.     

Getting At Your Income SOONER

Successful business owners are more able to retire early than most employees. They have equity in their businesses, substantial control over their compensation and tax structures, and there is no upside limit to their earning ability. Early retirement — or at least a planned slowdown —is a payback for long hours worked and risks taken. There are a number of ways business owners can access retirement capital without having to necessarily sell their business. Consider these three popular approaches.    

1. Qualified Money:  As a business owner you may have built up a sizeable qualified retirement plan, but are frustrated by the fact that you can’t get at those funds. Taxable withdrawals from qualified plans before a participant attains age 59 ½ are subject to an early 10% withdrawal penalty. There is, however, an exception if taxable withdrawals are taken in the form of “substantially equal periodic payments.” Commonly referred to as a “72(t) plan” or a “SEPP.” A 10% penalty tax will not apply to these pre-59 distributions as long as you follow the rules. The amounts must be distributed at least annually, be calculated as a life expectancy payout and continue for a minimum of 5 years or until age 59 ½ (whichever is later). There are three methods for designing these payouts, each with their own advantages and disadvantages. All, however, have the benefit of allowing you to start drawing down your qualified plan money early. 
2. Life Insurance: Qualified plans are a great way to defer taxes on current income, but there are limits on how much you can put in a plan and distributions are generally taxed as ordinary income. There is a product you can add to your portfolio in which you pay your taxes now, are not limited in how much you put away, and can receive tax-free income in the future — cash value life insurance. Excess capital that has already been taxed can be used to fund a cash rich life insurance policy. The cash values will grow tax-deferred. Then, when you are ready to start taking an income, you can first withdraw your principal tax-free and then switch to loans against the policy’s death benefit. The remaining death benefit provides a source of income if you have a spouse or children to support in retirement. Since life insurance is subject to insurability, this is a tactic a business owner should address well before the need for retirement income is pressing.     
3. Recapitalization:  There are ways of leveraging your business equity that fall short of actually selling your entire business. With an improved economy, recapitalizations (recaps) are back in vogue, even for smaller companies. Essentially with a recap you are exchanging your business equity for a combination of cash and a piece of the capital stock of a new entity intended to support the company’s future growth. The concept can be analogized to taking some of the chips off the table, but letting you stay in the game. There are many uses for recaps, but one is to monetize some of the owner’s equity. It’s a way to “liquify” your business without liquidating the operation. Plenty of investment banks, private equity firms and other financers are structured for privately-held businesses. 

Delaying Your Income Until LATER

I had helped my father set up an IRA many years ago. Eventually he retired and, when he came into his 70s, found out he had to start taking required minimum distributions (RMDs). He was furious about being forced to take taxable distributions when he didn’t need the money. Back then, there weren’t many ways to avoid RMDs. Nowadays, there are a number of ways to structure a portfolio to delay the receipt of taxable income. Consider these three ideas. 

1. Backdoor Roth: The Roth IRA concept has proved disappointing to many business owners because of the income limits placed on who can contribute ($191,000 income for a married couple) and how much you can contribute ($5,500 per year). Still, there is an approach that can help business owners who, like my father, want to put off receiving RMDs: A so-called “backdoor Roth” allows high income earners to delay receiving retirement income. With a backdoor Roth, the high income earner contributes to a traditional IRA and then converts that IRA to a Roth IRA. It accomplishes the same thing as opening a Roth directly, but avoids the limits on contributions.  The conversion will be taxed, but the account then grows tax-deferred and will pay out tax-free.  Think of it as paying tax on the seed and not on the harvest. Best of all, Roths are not subject to RMD rules, thereby allowing you to push off taking an income into the future. 
2. Deferred Income Annuities:  I recently discussed the trend towards using deferred income annuities (DIAs) as a safety net for retirement income. These contracts involve putting money away currently into a contract that will, later in life (say age 75 or 80), pay out an income you can’t outlive. For the business owner who wants to delay retirement and stay in the business, the DIA can be an effective way to lock in an income stream for the golden years. And, now you can use your qualified plan funds as the source of that income stream. On July 1 the Treasury issued final regulations amending RMD rules to allow annuity investors to start collecting later. If you want to delay receipt of qualified money, you can put some of the funds in a DIA, and thereby avoid being forced to receive taxable income in the form of RMDs. 
3. Your Business:  Finally, don’t forget that your business ownership offers tremendous flexibility in retirement income planning. You can structure cash flows and tax events so as to exit on your own terms. There are too many tactics to address here, but let me offer an example. Accumulate that income in your business as a way to delay receiving a retirement income. If you are an S Corp or LLC, your business income will be taxed to you as it is earned, but that also means you’re building an account of after-tax income. When you want to start slowing down at work, you can reduce your taxable salary, and instead start taking out tax-free dividends.   

Business equity is a wonderful thing to have, but some day you may also want retirement income.  You don’t have to decide now when you’ll receive retirement income, but it makes sense to have a plan for how to receive that income so it’s there when you need it.

Compare traditional and Roth IRA when building your nest egg

Saving enough money for retirement is the first step toward building your nest egg, but just as important is where you invest that money.

When it comes to investing your retirement dollars, consider not only your asset allocation, but also asset location. Should you put your money in a taxable or nontaxable account? Should you set up a traditional or Roth IRA?

Millions of Americans use IRAs to save for retirement. While the majority of retirement savers have traditional IRAs, Roth IRAs — only available since 1998 — have grown in popularity. New research shows savers contribute more readily to Roth IRAs than traditional IRAs, with more than 7 in 10 new Roth IRAs opened exclusively with contributions.

In contrast, traditional IRAs are largely created through rollovers from employer-sponsored retirement plans, according to new data from the Investment Company Institute.

Still many Americans may not understand the differences between traditional and Roth IRAs to determine which accounts may be best for them. Here are some key points to keep in mind:

Differences between traditional and Roth IRAs

Traditional IRAs offer the benefit of tax deferred growth since contributions are generally made with before-tax dollars and you don't pay taxes on that money until you take it out. Contributions are deductible, unless you are covered under an employer-retirement-plan and your income exceeds certain limits, but anyone can make a nondeductible IRA contribution. You're taxed at your ordinary income tax rate on the money when you take the money out. Distributions of nondeductible contributions are not taxable.

Roth IRAs are another terrific way to save and invest for retirement. But they work a bit differently. The benefit to a Roth is tax-free growth. You make after-tax contributions and earnings grow tax-free. Unlike regular IRAs, your contributions can be withdrawn tax free at any time. Earnings from a Roth account can also be withdrawn tax-free after age 59½, as long as you have held a Roth IRA for five years. You an also withdraw up to $10,000 for a first time home purchase before age 59½.

Income and contribution limits

Contributions to traditional and Roth IRAs are the same: $5,500 this year or $6,500 for those 50 or older.

Anyone under age 70½ with eligible compensation, such as wages, can contribute to a traditional IRA, but there are income limits if you are covered under an employer retirement plan and you want to take a tax deduction on your contributions. For married couples filing jointly, the income limits for deductible IRA contributions start at $96,000 (for a fully deductible IRA) and ends at $116,000 (for a partial deduction); for single filers it's $60,000 to $70,000. The closer you get to the end of the range, the lower the amount you are able to deduct.

"There is no age limit on Roth IRA contributions. You can contribute as long as you have eligible compensation, and your income does not exceed certain amounts," notes retirement expert Denise Appleby. The income limits for Roth IRAs are much higher, making them attractive to many higher income savers. Individuals filing as single and making less than $114,000 this year and married couples who make less than $181,000 and file taxes jointly are eligible to contribute the full amount to a Roth IRA. "The eligible contribution is reduced as the income gets closer to $129,000 for single filers and $191,000 for married-filing jointly. No contribution is allowed if income exceeds these amounts," Appleby said.

Why contribute to a Roth IRA

If you're deciding between contributing to a deductible IRA and Roth IRA, there a several things to keep in mind.

Roth IRAs are a great location for the assets of many savers, particularly if you think you may need to tap into those funds at some point before retirement because you can withdraw contributions from a Roth IRA tax-free at any time.

But even if you plan to keep your money earmarked for retirement, there are several reasons why Roth IRAs make sense. If you think you'll be in a higher tax bracket when you retire, especially if you're a younger worker and have yet to reach your peak earning years, then a Roth IRA is better than a traditional IRA from a tax standpoint. Also, you don't have to take required minimum distributions from a Roth IRA at age 70½ like you do from a traditional IRA. A Roth IRA is also a great estate planning tool, since you can leave the account to your heirs and stretch out distributions tax free.

On the other hand, if you think your income tax bracket will be much lower when you retire than it is now, you may be better off taking the upfront tax deduction of a traditional IRA. If you think your income tax bracket will be the same when you retire, then it's almost a wash for income tax purposes. 

Use A Roth Conversion to Achieve Lower Tax Bills

One of the planning options that most all folks have available to them is the Roth IRA Conversion.  For the uninitiated, a Roth IRA Conversion is a transaction where you move money from a Traditional IRA or a Qualified Retirement Plan (QRP) such as a 401(k) into a Roth IRA.  With this transaction, pre-tax amounts would be included in income as taxable in the year of the Conversion.

As you might expect, making a decision like this can result in a considerable tax impact, depending on the individual circumstances.  A Roth IRA Conversion may make a great deal of sense for one individual, while another may decide that the Conversion cost is too great for the result.  Detailed below is one specific circumstance that indicates a Roth IRA Conversion is a good move – although each individual needs to consider his or her situation carefully, because every situation is unique.

Protecting Non-Taxation of Social Security

In this situation, the individual has a very low taxable income, low enough that she would not likely need to include Social Security benefits as taxable income once she begins receiving the benefits.  However, once she reaches age 70½ and Required Minimum Distributions (RMDs) are necessary, the amount of these distributions will increase her overall provisional income to a point where Social Security benefits will be taxable at the highest rate, 85%.  Converting a portion of the IRA to Roth IRA will help to keep the RMDs low enough that SS benefits can be taxed at a lower (or zero) amount.

For example, Jane is 60, single, and has retired.  She intends to begin receiving Social Security benefits of $24,000 at her full retirement age of 66.  She needs a total of $40,000 each year to live on.  She presently withdraws that amount from her IRA on an annual basis.  Her IRA balance at this point is $600,000.

If she did nothing about converting to Roth, when she reaches 70½ the amount of her RMD will be large enough to bump up her provisional income to a point where her Social Security benefits will be taxable at the maximum 85% rate. This comes about because her balance in the IRA (after withdrawals and annual increases averaging 5%) is roughly $557,000 at her age 70½.  Using IRS Table I to calculate her Required Minimum Distribution, we see that her RMD would be $20,328.47 for the year.

If, however, Jane began a process of converting a small portion of her IRA to Roth IRA each year between now and when she reaches age 70½, she could reduce the size of her traditional IRA and therefore reduce the size of her future RMDs to a point where the tax impact on her SS benefits is eliminated.  In our example, if Jane withdrew an additional $15,000 from her IRA and converted the after-tax portion to a Roth IRA, this would reduce her IRA balance to a point where the RMD (when required at age 70½) would be low enough that her SS benefits would no longer be subject to taxation at all.

This series of conversions brings her Traditional IRA balance down to approximately $359,000.  Now her RMD computes to $13,102.  At the same time, she has amassed a Roth IRA with a balance of approximately $148,000 – so her total of the two accounts is approximately $507,000.  The tax cost of the conversions and the lost income/appreciation on the money used for taxes makes up the difference.

This conversion would cost her an additional $3,750 in taxes per year for ten years, but the effect of non-taxation of her future SS benefits would be a reduction in future tax of $5,100 – for the rest of her life.  With this in mind, approximately 10 years later, at her age 80, this strategy would have paid off.  If she died prior to that age, the Roth Conversion would have cost more than the benefit.

Note: the figures used in the examples do not include inflation, and are purposely rounded for simplification.  Real-world results will differ, perhaps significantly, from this example.

Conclusion


There are many other situations when a Roth Conversion makes a lot of sense, the above is one example of a very good scenario for the conversion.  As I mentioned previously, each individual’s situation will be different and may or may not result in the same decision to convert or not.  Watch for more examples in future posts!

Tax planning moves to consider for your new child

Now obviously, everybody’s situation is different, but below are 3 tax-planning moves you should  plan to make as soon as possible once you become a father. Perhaps one or more of them is relevant for you and your planning.

1. Fund a 529 Plan – 529 plans are great way to save money for a child’s education. These accounts, like IRAs, allow you to accumulate funds on a tax-favored basis. Although there is no federal income tax deduction for contributions to a 529 plan, funds grow tax-deferred while in a 529 account and, if distributions are used to pay qualified higher education costs, those distributions are tax-free. Plus, although there is no federal income tax deduction available, many states offer a state income tax break for contributions made by its residents to its own plan. Just like IRAs, the earlier one starts saving in a 529 plan, the better off they will be. With higher education costs continuing to sky rocket, I’m going to start as early as I can! 
2. Attempt to Establish a Roth IRA as Soon as Possible – There are no minimum age requirements to open a Roth IRA. In theory, even a newborn can have one. The key, however, is that a person, regardless of age, needs some sort of “compensation” to make a Roth IRA contribution. Usually, that compensation is some sort of earned income. Now you might ask, “How can a newborn have earned income?” Well, there are a number of ways. Perhaps you own a business and you use your child’s likeness on marketing material. You could pay them for that, legitimately of course. Then, an amount equal to that earned income could be contributed to their Roth IRA (provided they meet the other requirements). I personally have no idea when my child will generate earned income. Maybe it will be soon. Maybe not for 20 or more years. That said, whenever the time comes, I am going to do everything in my power to start his tax-free retirement savings off as early as possible, even if it means I have to make a contribution to his Roth IRA with my own money.
3. Update my Beneficiary Forms – Updating one’s beneficiary forms doesn’t sound like a tax-planning move, but instead, simply an estate planning move. In reality, it is both. Designated beneficiaries – generally living, breathing people named on the beneficiary form – are able to stretch distributions over their life expectancy. This helps an account grow tax-deferred as long as possible and minimize the tax impact on any distributions.

If something were to happen to me in the near future and my children were to inherit my retirement funds, they would be able to distribute those funds over more than an 80-year period. 

Why I Don’t Like Roth IRAs:

Tax planning for clients during tax season always generates new strategies and ideas, as unique situations tend to get my analytical wheels turning. From a risk/reward wealth management perspective, I like to look at tax planning with the actual cost to the client in mind, including what is the best cash flow option, because the most tax efficient savings strategy for each person’s situation is the ultimate wealth planning strategy. Here are a few thoughts that may also relate to your clients:

Negative Cash Flow Savings

I’ve never been a big proponent of the Roth IRA due to its drastic current negative cash flow. Here’s what I mean by negative cash flow savings: Let’s assume your client can put $6,000 in a Roth IRA, which costs them $7,800 in cash flow to save $6,000 (assuming a 25% federal and 5% state income tax bracket). Putting that same $6,000 in an IRA will only cost $4,200 in cash flow to save $6,000 - assuming the same tax rates above.

I’ve learned that most clients want to save money for retirement, while also living a little along the way, traveling and enjoying quality time with kids/family as they age. The IRA savings example above gives families an extra $3,600 of cash flow per year, which they could further save or spend. Of course, many of you will argue that the Roth IRA is tax-free for life, while the other is taxable when withdrawn. That’s true, based on the current tax laws. However, in my experience many clients live on less money in retirement, usually dropping them at least one tax bracket below where they saved/contributed the money while working.

For example: Assuming the same tax rates above (25% federal and 5% state – for a total of 30%) for a client contributing to an IRA, in most cases, that client withdraws money out of an IRA during retirement at a total 15% bracket (15% federal with little or no state income tax on retirement assets, depending on the state of residency). This example provides long-term tax-free savings comparable to a Roth IRA when also considering the overall total cost of the long-term differing cash flow effects mentioned earlier. For further clarification on this point, you may want to read a past article of mine entitled: The Gamble of a Lifetime.

Income Qualifying Limits & Low Contribution Limits

The second reason I’m not a fan is the Roth IRA’s low income qualifying restrictions and the IRA’s low contribution limits. If an investor is not part of a 401(k) or covered pension plan where they work, the odds are pretty much stacked against them for retirement savings. In 2014, Roth IRA income limits for single filers are $114,000 to $129,000, and for joint filers it’s $181,000 to $191,000, with both IRA & Roth IRA contribution limits maxed out at $5,500 each unless over age 50.Therefore, if we still assume a 25% federal and 5% state tax bracket, plus a prudent low-end savings of 15% of income per year to fund a client’s retirement, the single filer can only invest $11,000 between both an IRA ($5,500) and a Roth IRA ($5,500) in retirement specific accounts, unless over age 50.

As such, a single filer is already short $6,100 (15% of $114,000 - $11,000) in retirement savings, if effectively using both an IRA and Roth IRA. If you compare the actual cash flow cost to saving 15% annually, it would roughly cost the non-401(k) covered single filer $18,930 (130% of $11,600 + 70% of $5,500) to save 15% of their $114,000 income or $17,100.

A covered 401(k) plan employee has contribution limits of up to $17,500, not including company matching contributions. The same single filer saving $17,100 in a 401(k) plan would have cash flow costs of only $11,970 (70% of $17,100) to save 15% of the $114,000 income or $17,100. The earlier contribution limits indirectly force a huge cash flow difference of $6,960 per year between the two examples. Joint filers are no different in like-kind comparisons, prompting the need to help clients decide where, how much and what works best to tax efficiently save 15% to 25% of income annually for retirement, and enjoy life along the way.      

Despite the fact that most clients want to save money, very few can tax efficiently save for retirement while optimizing their current lifestyle. They either save a lot, thereby significantly sacrificing their family’s ability to enjoy life along the way, or save too little, enabling them to experience more with their families, but leaving them on the job till 67 or 70 because they haven’t saved enough.

Tax Time IRA Questions and Answers

Q. Can I do a conversion now for 2013?

A. No. In order to have a 2013 conversion, the funds must leave the IRA or plan account in 2013. They don’t have to be in the Roth IRA in 2013 since you can take a withdrawal in December, 2013 and have 60 days to complete a rollover (conversion) to the Roth IRA in January or February, 2014. But the funds must leave the traditional IRA or the employer plan by December 31, 2013.

 Q. I am contributing to my employer plan. Can I also make an IRA contribution?

 A. Yes. As long as you have earned income or compensation and will not be 70 ½ or older during the year, you can make an IRA contribution. If your income exceeds certain limits you may not be able to deduct the contribution. You can also make a Roth IRA contribution even if you are 70 ½ or over unless your income exceeds certain limits. You can find all of those limits at IRAhelp.com/2014. A contribution can also be made for a non-working or lower wage spouse based on your earnings subject to the income limits noted above (known as a spousal IRA contribution).

Q. I was told I can still set up a SEP IRA for 2013 and fund it up to October 15th. Is this right?

 A. Yes. As long as you meet the criteria for establishing an employer plan, you can establish and fund a SEP IRA up to the tax filing deadline, plus extensions, for your business. We examined that issue in more detail here. Keep in mind that if you have any employees, including your spouse, whatever contribution is made to your SEP must also be made for any eligible employees. You cannot fund just your own account.

Q. Someone died last year. She had earned income. Can we make a contribution to her IRA or Roth IRA account for last year?

 A. No. You can only make a contribution for someone who is alive. The theory behind this is that if someone dies during the tax year, they no longer have a need to save for retirement.

Traditional IRAs and Roth IRAs

Question Asked:

Should my wife and I contribute to a Roth IRA or a traditional IRA? We both participate in our respective employer's 401(k) plan. What if our income is too high?

Answer:  You are wise to augment your 401(k) retirement plans by saving additional retirement funds in your IRAs. After all, you are responsible to save for your own retirement. The extra $5,500 you contribute to an IRA every year may not seem like much now, but you will be surprised what compound growth can do over time.

If you and your wife save $11,000 at the beginning of every year in an IRA that grows at 7 percent per year, after 20 years your contributions of $220,000 will be worth more than $482,000. After 30 years, your contributions of $330,000 will be worth over $1.1 million. If that IRA is a Roth, your withdrawals will be tax-free.

Everyone with earned income is eligible to contribute to a traditional IRA. Income limitations only dictate how much is tax-deductible. Roth IRAs have different rules. If your income is too high, you can't contribute directly to a Roth. Contribution eligibility in 2014 begins to phase out for married couples when their adjusted gross income reaches $181,000, and eligibility ends at $191,000. The phase-out range for single taxpayers is $114,000 to $129,000.

If your income is higher than the above limits, there is a back door. IRS rules allow traditional IRA owners to convert their IRA to a Roth without regard to income. If you want to contribute to a Roth in 2014 but your income is too high, you can first contribute to a traditional IRA and then convert it to a Roth.

But be careful. No problem if you don't already have an IRA. But if you do, the IRS says you can't pick and choose which IRA you convert. You must prorate and pay tax on any previously untaxed amounts in all your IRAs.

Untaxed amounts include dollars you rolled over from a retirement plan and dollars that you contributed and deducted on your income tax return. Previously taxed amounts — your cost basis — equal the total of the non-deductible contributions you made.

Here's an example. Let's say you have a $50,000 rollover IRA from a former retirement account, a separate $50,000 traditional IRA that holds $25,000 of cost-basis (non-deductible) contributions and $25,000 of earnings, and a new $5,000 IRA with a $5,000 cost basis.

Your total IRA value is $105,000 and your total cost basis is $30,000. If you convert your new $5,000 traditional IRA to a Roth, you will owe tax on $3,572 (subtract $30,000 from $105,000, divide by $105,000, and multiply by $5,000).

High income earners without traditional or rollover IRAs can open an IRA, contribute $5,500 ($6,500 if age 50 or older), and then convert the whole $5,500 to a Roth with no tax consequence. If you are a high-income earner with IRA accounts you should check with your current 401(k) plan administrator and ask if the plan allows you to move your pre-tax IRA money into your 401(k). Some plans will allow this, and if so, you can move the pre-tax money to your 401(k) and convert the remaining non-deductible money and future annual traditional IRA contributions tax-free.

Looking For A Tax Shelter?

It’s not too late!

The best way to beat taxes is by investing in your retirement plan. The IRS gives you until you file your tax return this year to contribute to your IRAs for last year.

 If you are covered by a retirement plan at work, you are limited to what you can contribute to a deductible IRA. The deduction goes away if you make too muchmoney: for single taxpayers phase out is between $59,000 and $69,000 and for married individuals its $95,000 to $115,000. 

 If your employer did not offer a retirement plan during 2013, you can contribute to a deductible IRA no matter how much money you earned. You can put away up to $5,500 and if you were 50 or older last year you can add another $1,000.

 You can also use the Roth IRA. No upfront tax break for the contribution, but when you do retire, the money the Roth has earned will be free from federal income taxes. The government has set income limits here also.

 If you are single, your ability to contribute to a Roth IRA is phased out if you make more than $112,000 and goes away entirely if you earn over $127,000. Married filing jointly its $178,000 and goes away at $188,000 of Adjusted Gross Income (AGI). Limit is $5,500 and if you hit that magic age of 50 last year the IRS allows you catch-up contribution and you can add another $1,000 to the account.

 If you were self-employed last year, you still have time to set up a SEP-IRA, a Simplified Employee Pension plan. A SEP allows you to contribute up to 25% of your net income up to a maximum of $51,000 whichever is less.

 The contributions are deductible to your business helping you with your tax planning and you have until you file your tax return this year to contribute. You have to include any employees you have who are over 21. If you plan to use a SEP, I would suggest setting it up immediately!

 If you are self-employed with a SIMPLE IRA in place, this is a Savings Incentive Match Plan for Employees, you have until you do your tax return to make your contributions for last year. This plan had to have been set up by October 1 of the year you are implementing it.

 You can contribute the lesser of $12,000 or 100% percent of your compensation. And if you are over 50, you can add an additional $2,500. But you would need to have income equal to the amount you wish to contribute.

 Get publication 590 from the IRS to help on IRAs and check out publication 560 for help with the SEPs and SIMPLE plans.

 One more thing:  Do you want to contribute to an IRA this year? Start making the contributions now so that you don’t have to scramble to come up with a lump sum next spring.

 Does your company offer the new Roth 401(k) plan? Here you contribute after tax dollars to your retirement account and in retirement are allowed to withdraw the dollars free of federal income taxes. Sounds like a good deal and it may be, but the older you are the less attractive it is and the better deal would be contributing dollars pre-tax to your account

Roth IRAs – Market Sell-offs Prompt Two Vital Questions

The planning topic du jour in 2010 involved converting traditional IRAs to Roth IRAs, capitalizing on favorable tax laws effective in 2010 and depressed market values. Despite all the press and attention devoted to the issue in 2010, very little discussion touched on the importance of 2011.

Recharacterization Opportunity – Must be on or before 10/17/11!
Roth IRA conversions can be viewed as a short-term,“heads you win, tails you tie” wager. Specifically, 2010 conversions can be recharacterized back to a traditional IRA for any reason, as long as the recharacterization occurs on or before 10/17/11.  This is the extended due date for 2010 returns; however, you have until this date even if you did not extend your return or have already filed.

As an example, assume you converted a $50,000 IRA to a Roth in December 2010, and it is now worth $30,000 because of market declines. If you do not recharacterize the conversion, your 2010 return will report ordinary income of $50,000. Unique rules in 2010 allowed you to report this income all in 2010 or half ($25,000) in 2011 and half ($25,000) in 2012,deferring the tax hit. With recent market declines, you may wish to recharacterize the conversion now.

Note: If you do recharacterize some or all of a 2010 conversion, you may still re-convert that money back to a Roth in 2011. However, you must wait at least 30 days to convert the same amounts. In addition, 2011 conversions may not be spread over future years. In other words, you will have to report all of the income resulting from the conversion in 2011. Of course, you now have until October 15, 2012, to determine whether the 2011 conversion worked well or whether to recharacterize again.

2011 Conversion – Must be on or before 12/31/11!
Starting in 2010, anyone could convert to a Roth IRA, regardless of filing status or income level. That opportunity continues in 2011 (and all future years). The only unique feature about 2010 conversions involved the option to defer income into 2011 and 2012. The extension of the Bush Tax Cuts,  coupled with declining market values, make 2011 Roth conversions worthy of discussion. Also, as discussed above, 2011 conversions offer the same “heads you win, tails you tie” feature via the recharacterization rules.

What to do?
Whether you converted in 2010 or are considering a 2011 conversion, please contact us tax benefits and choices you have.