Category: IRA

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Income Tax Planning IRA

You Have 10 Years to Empty Your Beneficiary IRAs If You Aren’t an EDB

Attractive young woman looking frustrated with her hands in her hair

If you own or are the beneficiary of a retirement account or IRA, you’re probably familiar with the term, “required minimum distribution,” or “RMD.” Simply stated, this is the IRS rule that requires you to take minimum distributions from your retirement and IRA accounts each year beginning on a specified date. The amount of each annual distribution is calculated using the value of the accounts on December 31st of the prior year and an age factor from an IRS life expectancy table.

The RMD regime as it applies to IRAs is often referred to as the “stretch IRA” since it allows designated, or named, IRA beneficiaries to take, or stretch, distributions over their life expectancy. The stretch IRA was eliminated on January 1st for many individuals with the enactment of the SECURE Act.

If you are the beneficiary of a retirement or IRA account that you inherited after 2019, you need to familiarize yourself with the new rules in order to determine the applicable time frame for taking distributions from your account. Noncompliance can result in IRS assessment of an onerous penalty and interest in addition to income tax.

New 10-Year Payout Rule

Under the SECURE Act, most retirement and IRA account beneficiaries who inherit retirement and IRA accounts beginning in 2020 are subject to a new 10-year payout rule. The effective date for this rule is generally for deaths after December 31, 2019. Beneficiaries who are affected by this rule are no longer required to take RMDs from these accounts.

The 10-year payout rule requires retirement and IRA account beneficiaries to empty their accounts by the end of the tenth year after the employee or IRA owner’s death. The rule applies to defined contribution plans, including 401(k), 403(b) and 457(b) plans and traditional and Roth IRAs. It doesn’t apply to defined benefit plans.

Eligible Designated Beneficiaries Exempt from 10-Year Payout Rule

The SECURE Act created three new classes of beneficiaries. The three classes are used to determine the length of time over which each class must take distributions from their retirement and IRA accounts.

“Eligible designated beneficiaries,” or “EDBs,” are exempt from the 10-year rule. The stretch IRA still applies to these individuals since they take distributions using the RMD rules. EDB status is determined at the date of the owner’s, or plan participant’s, death and cannot be changed.

There are five classes of eligible designated beneficiaries, or “EDBs,” as follows:

  1. Surviving spouses
  2. Minor children up to the age of majority, excluding grandchildren
  3. Disabled individuals who qualify under strict IRS rules
  4. Chronically ill individuals
  5. Individuals not more than ten years younger than the IRA owner

In addition to the foregoing five classes, any designated beneficiary who inherited their retirement account or IRA before 2020 also qualifies as an EDB. These individuals are grandfathered under the pre-2020 stretch IRA rules.

Once EDBs no longer qualify as EDBs, e.g., minor child attaining the age of majority, or die, the 10-year rule is applied to them or to their beneficiaries.

Non-Eligible Designated Beneficiaries Subject to 10-Year Payout Rule

The second class of beneficiaries created by the SECURE Act are “non-eligible designated beneficiaries,” or “NEDBs.” These are designated, or named, beneficiaries who do not qualify as EDBs. Examples include children after reaching the age of majority, grandchildren, and some “look-through trusts,” a discussion of which is beyond the scope of this post.

NEDBs are no longer required to take RMDs from their retirement and IRA accounts. They are instead subject to the new 10-year rule whereby they must empty their accounts by the end of the tenth year after death.

Non-Designated Beneficiaries Continue to Follow Prior Law

Whereas EDBs and NEDBs are generally people, the third class of beneficiaries, “non-designated beneficiaries,” or “NDBs,” are entities. This includes estates, charities, or non-qualifying, i.e., “non-look-through” trusts.

The distribution rules for NDBs are unchanged. They are based on whether the IRA owner or plan participant dies before or after the owner’s “required beginning date,” or “RBD.” The RBD is generally April 1st after the year of the 72nd birthday.

If the owner dies before the RBD, the account must be withdrawn by the end of the fifth year after death. This is known as the 5-year rule. If the owner dies after the RBD, RMDs must be taken over the deceased IRA owner or plan participant’s remaining single life expectancy.

Distribution Shortfall Penalty

Whether you’re an EDB or NEDB or an NDB entity, the IRS penalty for shortfalls in meeting applicable distribution requirements is severe. The amount of the penalty, which is referred to by IRS as the “additional tax on excess accumulations,” is 50% of the shortfall. While a penalty waiver request can be submitted to IRS, it’s obviously better to avoid this situation.

The timing of potential penalties for eligible designated beneficiaries, or EDBs, continues to be determined and calculated based on annual RMDs since the stretch IRA rules still apply. The 50% penalty is relatively easy to avoid for EDBs since their distributions can be automatically calculated and distributed by financial institutions on the same day each year.

The 50% penalty for distribution shortfalls for non-eligible designated beneficiaries, or NEDBs, is more problematic. NEDBs are subject to the new 10-year rule that requires them to empty their accounts by the end of the tenth year after death.

Given what’s at stake, it’s imperative for NEDBs to track the 10-year rule as it pertains to each of their IRA and retirement plan accounts. This includes Roth IRA and Roth 401(k) plan beneficiary accounts. While distributions from the latter accounts are exempt from taxation, distribution shortfalls are subject to the 50% penalty.

Required Minimum Distributions Waived in 2020

Eligible designated beneficiaries, including surviving spouses and minor children, are exempt from the 10-year payout rule and must take distributions using the RMD rules. The good news is that the CARES Act which was signed on March 27th waives required minimum distributions, or RMDs, for 2020. The waiver applies to inherited traditional and Roth IRAs.

Which Type of Beneficiary Are You?

As strange as it seems, if you are the beneficiary of a retirement plan or IRA account that you inherited after 2019, you must first determine which of the three classes of beneficiaries you fall into in order to determine the required time frame for taking distributions from your account. This can be tricky and will likely require the assistance of a professional advisor who is familiar with the applicable rules.

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Income Tax Planning IRA Retirement Income Planning Roth IRA

Contribute Your 2020 RMD to a Roth IRA

Childlike seniors wearing superhero costumes

Less than four weeks ago on March 27th, President Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This 880-page legislation includes four pages that waive required minimum distributions, or RMDs, for 2020 for traditional IRAs, workplace retirement plans, and inherited traditional and Roth IRAs.

As was the case in 2009 when RMDs were also waived, if this wasn’t done in 2020, many individuals, especially older ones, would be upset that they would be forced to sell deflated assets to satisfy their RMD and avoid a 50% penalty.

What if you have already taken your 2020 RMD, a portion of your RMD, or IRA or other retirement plan distributions greater than your RMD? You have three options, with #2 and #3 inapplicable to distributions from inherited traditional and Roth IRAs:

  1. Keep
  2. Return
  3. Contribute to a Roth IRA

Let’s examine the pros and cons of each of the three options.

Keep

If you have already taken distributions from taxable retirement accounts, including RMDs, you can simply keep them. If you took a distribution before February 1st, this is your only option.

Any distributions that you keep are subject to ordinary income tax to the extent that the distribution exceeds your basis. Basis includes a pro-rata amount of nondeductible contributions in the case of an IRA and after-tax contributions if the distribution came from a 401(k).

Options #2 and #3 generally aren’t viable planning strategies for retirees who depend on RMDs to cover basic expenses. Although the amount changes from year to year, it’s a systematic payout and, as such, is comparable to a structured distribution from a variable annuity.

Return

As discussed in my April 6th post, 2020 Required Minimum Distributions Waived, the CARES Act applies the “60-day rollover rule” to determine if you can return your RMD to your Traditional IRA or other retirement plan account. Under this rule, you can rollover, or return, your distribution to the account from which it came within 60 days from the date that you received it provided that you haven’t done any other rollovers within the previous 365 days.

It’s critical to review all IRA and retirement plan transactions within the previous 365 days to determine if any other rollovers have occurred. If there was another rollover, the return of your 2020 distribution will be taxable and will be subject to a potential 10% early distribution penalty and a 6% per year excess accumulation penalty if it isn’t timely removed from the account.

On April 9th, IRS released Notice 2020-23, one of the sections of which supersedes the 60-day rollover rule, indirectly extending the 2020 RMD waiver to distributions taken between February 1, 2020 and May 15, 2020 to July 15th. As noted in the “Keep It” section, if you took distributions before February 1st, your only choice is to keep it and include it in your 2020 gross income.

The advantage of rolling over, or returning, distributions to IRAs or other retirement plan accounts is that they won’t be subject to taxation in 2020. Distributions that are rolled over, or returned, to IRAs will continue to enjoy tax-deferred growth provided that there have been no other rollovers within the previous 365 days.

Potential disadvantages of returning distributions to retirement plans outnumber those of keeping them depending upon one’s situation. They include the following:

  • Increased RMDs in subsequent years
  • Increased income tax liability in subsequent years due to increased RMDs
  • Potential increased Medicare Part B Premiums and taxable Social Security due to increased RMDs
  • Increased exposure to likely higher income tax rates for you and your heirs beginning in 2026 when current tax rates expire or potentially sooner depending upon results of the upcoming presidential election
  • Increased exposure to increased income tax liability in future years for surviving spouses due to the widow(er)’s penalty
  • Increased exposure to 10-year vs. lifetime distribution requirement and associated potential increased income tax liability for non-minor children, grandchildren, and other nonspouses who inherit traditional IRAs and other retirement plans resulting from the SECURE Act that went into effect on January 1st

Contribute to a Roth IRA

When most people think about doing a Roth IRA conversion, they expect to transfer assets directly from a traditional IRA account to a Roth IRA account. Furthermore, while it’s possible to do a transfer between accounts located at different financial institutions, most transfers are done within the same financial institution.

There’s another way to do a Roth IRA conversion that can be used to leverage its benefits in light of the waiver of 2020 RMDs. It’s a strategy that’s been part of the income tax law since the Taxpayer Relief Act of 1997 which created the Roth IRA. If you receive a distribution from a traditional IRA, you can contribute, or roll it over, to a Roth IRA within 60 days after the distribution as a Roth IRA conversion.

The once-per-year rule discussed in the “Return” section doesn’t apply to rollovers to Roth IRAs. Furthermore, the 60-day rollover time frame has been extended to July 15th for 2020 Roth IRA conversions of distributions taken from IRAs and other retirement plans between February 1st and May 15th by IRS Notice 2020-23.

There are many advantages of employing this strategy, the first several of which are mirror images of the disadvantages of returning distributions to retirement plans discussed in the previous section. The advantages of contributing or rolling over 2020 distributions to a Roth IRA include the following:

  • Reduced RMDs in subsequent years
  • Reduced income tax liability in subsequent years due to reduced RMDs
  • Potential reduced Medicare Part B Premiums and taxable Social Security due to reduced RMDs
  • Reduced exposure to likely higher income tax rates for you and your heirs beginning in 2026 when current tax rates expire or potentially sooner depending upon results of the upcoming presidential election
  • Reduced exposure to increased income tax liability in future years for surviving spouses due to the widow(er)’s penalty
  • Reduced exposure to 10-year vs. lifetime distribution requirement and associated potential increased income tax liability for non-minor children, grandchildren, and other nonspouses who inherit Traditional IRAs and other retirement plans resulting from the SECURE Act that went into effect on January 1st
  • Elimination of taxation on appreciation of funds used for the Roth IRA conversion
  • Opportunity to do a market-sensitive Roth IRA conversion to optimize lifetime after-tax distributions to the extent that the conversion is done before the stock market recovers from its recent 38.4% downturn

The primary disadvantage of rolling over a distribution from a traditional IRA to a Roth IRA vs. returning it to the traditional IRA is that it will be subject to taxation in 2020. The other potential disadvantage is increased Medicare Part B monthly premiums in 2022 if the conversion is done when you’re 63 or older depending upon the conversion amount and your adjusted gross income in 2020.

Given the prospects for higher income tax rates in the future, the potential long-term benefits of doing a Roth IRA conversion are likely to exceed additional 2020 income tax liability and potential increased 2022 Medicare Part B premiums attributable to the conversion.

The Three Options Aren’t Mutually Exclusive

As is often the case with income tax planning strategies, the three options discussed in this post aren’t mutually exclusive. It may be in your best interest to use a combination of two or three of them to optimize your and your heirs’ lifetime after-tax retirement income depending upon your situation.

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Income Tax Planning IRA Retirement Income Planning

2020 Required Minimum Distributions Waived

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We didn’t have to wait long for the answer to the question posed in the title of my March 16th blog, Will Congress Suspend 2020 Required Minimum Distributions?

On March 27th, President Trump signed the $2.2 trillion, 880-page Coronavirus Aid, Relief, and Economic Security (CARES) Act. Buried in the act is a four-page provision that waives required minimum distributions, or RMDs, for 2020.

The waiver applies to traditional IRAs and workplace retirement plans including 401(k), 403(b), and 457(b) plans. 2020 RMDs are also waived for inherited traditional and Roth IRAs.

What If You Have Already Taken Your 2020 RMD?

As pointed out in my March 16th blog, there’s precedent for waiving RMDs. This was last done in response to the economic downturn in 2008 with the enactment of the Worker, Retiree, and Employer Recovery Act. The Act was signed on December 23, 2008 and was effective for 2009.

One of the issues discussed in my blog post was that any 2020 RMD suspension would need to be retroactive. Retroactive suspension of RMDs would give individuals who have already taken their 2020 RMD the opportunity to return the full amount to the retirement plan account from which it was withdrawn.

The CARES Act waives 2020 RMDs retroactively, however, there’s a catch. You must apply the “60-day rollover rule” to determine if you can return your RMD to your Traditional IRA or other retirement plan account. Under this rule, you have 60 days from the date you received your distribution to return it back to the account from which it came. You can do this provided you haven’t done any other rollovers within the previous 365 days.

As an example, assuming that you withdrew your 2020 RMD of $20,000 from your IRA on February 10th and you did no other IRA rollovers in the previous 365 days, you have until April 10th to return the funds to your IRA.

Let’s assume that you had federal and state income tax of $4,000 and $1,000, respectively, withheld from your RMD. What happens if you return $15,000 to your IRA account by the deadline? You will be taxed on your original distribution of $20,000 less the amount returned of $15,000, or $5,000. You can also claim your RMD income tax withholding totaling $5,000 on your 2020 income tax returns.

Not all RMDs are eligible for the 60-day rollover rule. Non-spouse beneficiary owners of inherited IRAs cannot do a 60-day rollover. Once the money is withdrawn from an inherited IRA, it cannot be returned.

Planning Opportunity

Any time that legislation is enacted that affects retirement plans, you should use this as an opportunity to revisit your retirement income plan to determine how you can use it to optimize your plan. The CARES Act waiver of RMDs for 2020 is no exception.

You should begin with the question that you should be asking yourself every year regardless of your RMD:  How much should you withdraw from your retirement plan accounts? The answer to this question, as always, depends on a number of factors that need to be considered and analyzed holistically for the current and future years. These include current and projected expenses, income sources, investment assets, taxation, and extended care plan.

As pointed out in my March 30th blog post, The Roth IRA Conversion Trifecta, there’s an unprecedented opportunity to do a sizable Roth IRA conversion this year. Assuming that you haven’t taken your 2020 RMD yet or have done so and aren’t beyond the 60-day deadline for returning it to your traditional IRA or other retirement plan account, you may want to use this amount as the starting point for doing a Roth IRA conversion this year.

Using the previous example, assuming that your 2020 RMD is $20,000, you haven’t taken it yet or are within the 60-day window for returning it, and you have other sources of income to meet your needs, why not consider a Roth IRA conversion of $20,000? Furthermore, given the three events discussed in my March 30th post, it could make sense to do a much larger conversion this year subject to availability of cash to pay the income tax liability attributable to the conversion.

Benefits of 2020 RMD Waiver

Looking back to 2009 which was the last time that RMDs were waived, the long-term benefit of one-year relief from RMDs is questionable. This is due to the fact that many retirees still needed to take distributions from their retirement plans since they didn’t have alternative income sources to meet their financial needs. This is certainly the case for many, if not the majority, of retirees today.

There’s no doubt that the 2009 RMD waiver provided psychological relief for many retirees, especially those who had recently retired and were forced to return to the workplace. Unlike 2009 when many retirees were able to find work, this won’t be the case this time around as evidenced by the 10 million unemployment claims filed in the last two weeks with coronavirus job losses projected to total 47 million.

On the positive side, individuals who don’t rely on RMDs to meet their financial needs can retain tax-deferred funds and avoid 2020 taxation on distributions they would otherwise take. Many can use the 2020 RMD waiver as a planning opportunity to optimize their retirement income plan.

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Income Tax Planning IRA Retirement Income Planning Roth IRA

The Roth IRA Conversion Trifecta

Race for the prize of the Summer in Pyatigorsk,Caucasus.

Those of you who have read my Retirement Income Visions™ posts and MarketWatch Retirementors articles over the years know that I’m a big fan of Roth IRA conversions. A Roth IRA conversion, when implemented timely, can be one of the most effective strategies for optimizing retirement income.

As a result of a series of three events, the most recent of which is unfortunately in response to the coronavirus pandemic, there’s an unprecedented opportunity to do a sizable Roth IRA conversion this year. Taking advantage of this opportunity is predicated on availability of cash to pay the income tax liability attributable to the conversion.

Event #1:  Stock Market Downturn

In less than six weeks, The Dow Jones Industrial Average (DJIA) plummeted 11,355 points, or 38.4%, from its high of 29,569 on February 12th to its recent low of 18,214 on March 23rd. While it recaptured 3,423 points this past week to close at 21,637 on Friday, the DJIA is down 26.8% from its high.

Keeping in mind that any appreciation in a Roth IRA account following a Roth IRA conversion will permanently escape taxation, this is one of those market-sensitive conversion opportunities, the likes of which we haven’t experienced in 11 years. Assuming that you’re healthy and you have a reasonably long planning timeframe, you or your financial advisors should be examining how you can take advantage of this.

Event #2:  Low Income Tax Rates Expire After 2025

The current historically low income tax rates and widening tax brackets to which they’re applied that went into effect in 2018 will end after 2025. Prior to the economic meltdown triggered by the coronavirus pandemic, there was widespread agreement that tax rates will increase in 2026, if not sooner. The signing of the $2 trillion coronavirus relief bill, or CARES Act, by President Trump on Friday piled on top of our national debt of $24 trillion makes this inevitable.

Knowing that you only have six years, including 2020, to pay income tax at a lower rate than you’re likely to pay in the future, Roth IRA conversions should be a high priority for most employees who have Traditional 401(k) plans with a Roth 401(k) option as well as Traditional IRA account owners.

Event #3:  Inherited Retirement Plan Lifetime Distributions Eliminated for Non-Minor Children

In addition to the likelihood of being subject to higher income tax rates, adult children and grandchildren will no longer be able to take distributions from inherited retirement plans over their lifetime. The “stretch IRA” has been replaced with a 10-year rule for most beneficiaries with the enactment of the SECURE Act that went into effect this year.

Most nonspouse beneficiaries, including non-minor children and grandchildren are now required to withdraw 100% of the funds from their inherited retirement plans by the end of the tenth year following the year of death for deaths occurring after 2019. This will accelerate distribution of assets and taxation at higher rates for beneficiaries of 401(k) plans and Traditional IRA accounts. Although distributions won’t be taxed, this change also applies to inherited Roth IRA accounts.

With the elimination of the “stretch IRA,” it no longer makes sense in many cases to leave sizable taxable retirement plan accounts to children and grandchildren. An aggressive Roth IRA conversion plan is one way to reduce, or potentially eliminate, this problem.

Transfer Securities When Doing a Roth IRA Conversion

I have had a number of clients and other individuals tell me that they thought that they need to sell securities in their Traditional IRA account in order to do a Roth IRA conversion. This is generally not a good idea given the fact that appreciation in a Roth IRA account following a Roth IRA conversion will permanently escape taxation.

Instead, you want to specify on your Roth IRA conversion form a number of shares of one or more securities that you would like to transfer from your Traditional IRA account to your Roth IRA account. These should ideally include equity securities, e.g., large or small cap value exchange traded funds or mutual funds, which are likely to appreciate. The total value of the securities being transferred should approximate the desired amount of your conversion, keeping in mind that the value and associated tax liability is likely to change between the time that your form is submitted and your conversion is processed, especially in the current volatile environment.

Unprecedented Opportunity

As a seasoned financial advisor, I’ve experienced, and have presented to clients, several windows of opportunity to create and optimize retirement income. The three events discussed in this post, two of which didn’t exist three months ago, are a Roth IRA conversion trifecta, or perfect storm.

The three events can be leveraged to do a sizable Roth IRA conversion this year as part of a staged, or multi-year, Roth IRA conversion plan subject to availability of cash to pay the income tax liability attributable to the conversion. This is an unprecedented opportunity that many of us probably won’t experience again in our lifetime.

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Income Tax Planning IRA

Will Congress Suspend 2020 Required Minimum Distributions?

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With the Dow Jones Industrial Average (DJIA) spiraling downwards the last month in response to the spreading Coronavirus, decreasing 28.5% from its record high of 29,568.57 on February 12th to its recent low of 21,154.46 on March 12th, President Trump declared a national emergency on March 13th. Trump’s move invoked the Stafford Act, making available up to $50 billion in federal aid to the states.

The stock market decline has conjured up memories for many investors of the last major bear market when the DJIA declined 54.4% from its high of 14,198.10 on October 11, 2007 to its low of 6,469.95 on March 6, 2009. While the circumstances, duration (29 days vs. 512 days), and the economic impact of the current stock market decline are quite different from the previous one, investors’ portfolios have taken a hit.

Unlike the 2007 – 2009 event, we’re still in the early stages since the Coronavirus was declared a pandemic by the World Health Organization on March 11th.  Although the DJIA increased 1,985 points, or 9.4%, on March 13th from its previous close, 1,176 points, or 72%, of the increase occurred in the last half-hour of trading after President Trump announced his financial response to the Coronavirus. The global economic impact, which is already widespread, is just beginning to unfold.

Precedent for Required Minimum Distribution Relief

Flashback to 2008. 439 days and 41% into the stock market decline from its October 11, 2007 high, Congress unanimously enacted, and President Bush signed, the Worker, Retiree, and Employer Recovery Act of 2008 on December 23, 2008. The Act contained various provisions designed to help pension plans and plan participants weather the economic downturn that existed at that time.

One of the key provisions of the Act was the waiver of the rule for individuals to take required minimum distributions, or RMDs, from their qualified retirement plans and IRAs in 2009 only. This was in response to many individuals, especially older ones, being upset that they would be forced to sell deflated assets to satisfy their RMD and avoid a 50% penalty.

While the long-term benefit of one-year relief from RMDs is questionable, especially since many retirees still needed to take distributions from their retirement plans in 2009 due to lack of alternative income sources to meet their financial needs, it did serve a purpose. Most important, it provided psychological relief for many retirees, especially those who had recently retired and were forced to return to the workforce.

Potential for 2020 RMD and Other Retirement Plan Relief

Will Congress suspend 2020 RMDs as part of an ongoing economic response to the Coronavirus situation? Will they enact other legislation to provide other types of retirement plan relief? I believe that both are possibilities, especially if the stock market continues its downward trend. Unlike the 2009 RMD suspension, there are five key differences that need to be considered before this becomes reality:

1.  We’re still early in the game.

As previously stated, the 2008 legislation to provide RMD relief was enacted after the stock market dropped 41% in fourteen months. The current stock market decline, while significant, has lasted only about a month. As such, it doesn’t qualify as a bear market, which is generally a decline of 20% or more over a sustained period of time, typically at least two months.

Given the possibility that the stock market could reverse its course in the next three to six months, if not sooner, many would argue that it’s premature to enact any legislation to provide RMD and other retirement plan relief in 2020.

2.  We were overdue for a sizable stock market correction.

Many financial advisors, including myself, have been warning clients about the likelihood of a major stock market correction for the last several years. The DJIA experienced unsustainable growth of 225% from 2009 through 2019. The average annual return of 20.5% over that 11-year period dwarfed the DJIA’s 99-year average return of 7.75% from 1921 to 2019, unadjusted for dividends and inflation.

Seasoned investors as well as younger ones who are familiar with the 54% drop between October, 2007 and March, 2009, are psychologically better prepared for the current market correction. Having said this, we’re living in different economic times and once again, we’re early in the game with the Coronavirus.

To the extent that the stock market continues to experience sharp daily declines and individual investors’ portfolios underperform for an extended period of time, many will experience buyer’s remorse. This will be more prevalent among those approaching, and who are already in, retirement that don’t have adequate sustainable income and extended care protection plans.

3.  There’s more awareness of the importance of sustainable income when planning for retirement.

An interesting development that makes it less likely for Congress to implement an RMD suspension plan and other types of retirement plan relief is that more individuals have assumed personal responsibility for their retirement planning. This began with the replacement of the vast majority of private industry defined benefit pension plans that our parents and grandparents depended on for a significant portion of their retirement income with 401(k) plans.

Following the 2007 – 2009 stock market decline, people became more aware of the importance of sustainable income when planning for retirement. I personally expanded my business model in 2009 from one that focused on traditional investment management, or accumulation, to a retirement income planning, or distribution, model.

The inclusion of appropriate sources and adequate amounts of sustainable income, taking into consideration timing of income distributions to meet projected changing expense needs throughout retirement, is essential to preparing for a financially successful retirement. Individuals who recognize this and have developed a retirement income plan are less vulnerable to stock market downturns and less dependent on the government for financial relief.

4. The SECURE Act recently provided retirement relief.

Congress, when considering any retirement relief in 2020, including suspension of RMDs, may be reluctant to pass new legislation at this time because of favorable changes in the SECURE Act which became law on December 20, 2019 and went into effect this year. One of the key provisions was the increase in the RMD age from 70-1/2 to 72. Another favorable change was the elimination of the 70-1/2 age limit for making traditional IRA contributions.

The foregoing changes were enacted in exchange for elimination of the “stretch IRA” which was replaced with a 10-year rule for most beneficiaries. This change will result in most non-spouse retirement plan beneficiaries no longer being allowed to take retirement plan distributions over their lifetime. These individuals are now required to withdraw 100% of the funds from their inherited plans by the end of the tenth year following the year of death for deaths occurring after 2019.

Given the Coronavirus pandemic and associated negative economic impact that has occurred since the SECURE Act went in effect, Congress may be willing to consider a delay of the commencement of the 10-year rule until 2021 or 2022 or changing to a 12-year rule.

5. 2020 RMD suspension would need to be retroactive.

The fifth and final consideration relates to timing. When the Worker, Retiree, and Employer Recovery Act of 2008 was enacted, it occurred at the end of 2008 effective for 2009. Given the fact that we’re already two and a half months into 2020 and many individuals have already taken their 2020 RMDs, any legislation providing RMD relief for 2020 would need to be retroactive to January 1st.

The legislation would need to give individuals who have already taken their 2020 RMDs the option to return the full amount to the retirement plan accounts from which they were withdrawn. Retirement plan sponsors and IRA custodians would have additional responsibilities, including tracking the returns, not issuing 2020 Form 1099-R’s to report the withdrawals, and confirming that the returned amounts don’t exceed the distributions that were taken.

Retirement Plan Relief More Likely in 2021

Suspension of 2020 RMDs and other types of financial relief for retirement plan participants, while possible, aren’t likely to be enacted and made effective this year. Although such legislation would increase the longevity of retirees’ assets and provide psychological relief, there are various considerations discussed in this blog post that need to be addressed.

If the economy and stock market continue its downward trend for the next six months or so, it’s more likely that legislation suspending RMDs and delaying the commencement of the nonspouse beneficiary10-year rule, or potentially changing to a 12-year rule, would be enacted at the end of 2020 effective in 2021.

 

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401(k) Plans Estate Planning IRA Life Insurance Retirement Asset Planning

Avoid Unintended Consequences for You and Your Family

Novyy Urengoy, Russia - June 20, 2019: Crashed cars Ford Focus and Mitsubishi ASX in the city street.

As defined by Wikipedia, “in the social sciences, unintended consequences (sometimes unanticipated consequences or unforeseen consequences) are outcomes that are not the ones foreseen and intended by a purposeful action.” I don’t know if Robert Merton, founder of the sociology of science, had it in mind when he developed and popularized the term in the twentieth century, however, it’s clearly applicable to estate planning.

A monumental moment in many individuals’ lives occurs when they finally meet with, and engage the services of, an estate planning attorney. This isn’t an easy thing to do as evidenced by the fact that more than half of U.S. adults don’t have a will.

For those who take the plunge, it’s important that this is followed up with periodic reviews with an estate planning attorney and financial professionals to discuss potential changes to an estate plan whenever there are any major life-changing events. These include birth, death, marriage, divorce, career changes, and major health events.

Wills and Living Trusts are Part of an Estate Plan

Without discussing the purpose of wills, living trusts, and other estate planning documents, suffice it to say that while the beneficiaries named in these documents generally control the disposition of assets at the time of death, there are several situations where they don’t apply. These include participants in retirement plans and owners of life insurance and annuities.

Whether you’re a participant in a retirement plan or own a life insurance policy or annuity contract, a beneficiary form is used to name primary and contingent beneficiaries. While they may be identical, the beneficiaries and percentages specified on beneficiary forms supersede those in wills, living trusts, and other estate planning documents. Copies of current beneficiary forms should be retained in an estate planning file that includes your other estate planning documents.

Trust and other non-standard beneficiary designations are often appropriate for estate planning documents and beneficiary forms where there are children who are young, have special needs, struggle with substance abuse problems, or are otherwise not good candidates for inheriting assets outright. Coordination of designations between wills, living trusts, and retirement plan, life insurance, and annuity beneficiary forms in light of the various assets and values to which they apply is essential.

Enter Unintended Consequences

As you can imagine, a fair amount of time and expense is devoted to litigating beneficiary issues in probate court. This is often associated with unintended consequences related to erroneous or outdated beneficiary designations that surface after death.

Unintended consequences are possible when contingent beneficiaries aren’t named, are improperly named, or when a primary or contingent beneficiary has passed and a beneficiary form hasn’t been updated with a replacement beneficiary. Sometimes the mistakes can be corrected after death; however, this generally isn’t the case. This post discusses two types of situations that present opportunities for unintended consequences related to beneficiary form designations.

Former Spouse Beneficiary of 401(k) Plan and Life Insurance Policy

One type of unintended consequences scenario can occur when a divorcee dies and never changed the beneficiary designation of a retirement plan, life insurance policy, or annuity contract from his/her former spouse to another beneficiary. There have been two Supreme Court cases in the last eleven years that have addressed this situation.

The first case, Kennedy vs. DuPont, which was decided in January, 2009, ruled that the beneficiary, who was a former spouse, was entitled to the 401(k) plan since it is an ERISA-covered plan that’s governed by federal law. Under ERISA, a spouse always receives half the assets of a qualified retirement plan unless he/she has completed a spousal waiver and another person or entity is listed as a beneficiary.

The second case, Sveen v. Melin, which was decided in June, 2018, upheld Minnesota’s revocation upon divorce law which has been adopted in twenty-six states. Under this law, there’s an assumption that a decedent intends to terminate all connections with his/her ex-spouse. In this case, it was decided that the former spouse, who was the primary beneficiary of a life insurance policy, wasn’t entitled to the proceeds and they were instead payable to the contingent beneficiaries.

Although Case #2 didn’t result in unintended consequences since it was determined that the former spouse wasn’t entitled to the life insurance proceeds, expensive and prolonged litigation was required in order to obtain this result. Furthermore, litigation was necessary despite the fact that Minnesota has a revocation upon divorce statute.

Estate as Beneficiary of a Retirement Plan

A second type of event related to beneficiary form unintended consequences can arise when it’s determined that an estate is the beneficiary of a retirement plan. This can occur when (a) there’s no beneficiary designation and no surviving spouse or (b) the individual who is named as the primary beneficiary is deceased and there are no named contingent beneficiaries.

Whenever a retirement plan participant dies without an effective beneficiary designation, the terms of the retirement plan or IRA agreement need to be reviewed. Qualified retirement plans such as 401(k) plans are subject to ERISA. The default beneficiary for these types of plans is generally the employee’s surviving spouse if applicable or the employee’s estate. Most IRA’s also provide that benefits are payable to one’s estate whenever there’s no surviving spouse and no effective beneficiary designation.

If an individual is the beneficiary of a retirement plan, he/she is considered to be a “designated beneficiary.” A designated beneficiary is entitled to defer distribution of inherited retirement benefits by withdrawing them gradually over his/her life expectancy under IRS’ minimum distribution rules.

An estate cannot be a designated beneficiary since it isn’t an individual. As such, it cannot take advantage of the life expectancy minimum distribution rules. Instead, there are two rules that apply in this situation, both of which are less favorable. This often results in unintended consequences when there are non-spouse beneficiaries and sizable retirement plan assets. The two rules are as follows:

  • If the decedent died before his/her required minimum distribution date, all benefits must be distributed by the end of the year that contains the fifth anniversary of the date of death (the five-year rule), or
  • If the decedent died on or after his required minimum distribution date, all benefits must be distributed in annual installments over his/her life expectancy had he/she not died.

The five-year rule is typically reduced to an immediate lump-sum payment in the case of 401(k) plans since installment payouts generally aren’t offered by these types of plans. As such, 100% of the value of the plan is subject to taxation in the year that it’s distributed.

In addition to being able to take advantage of the five-year rule, an executor of an estate can potentially set up inherited IRAs in the names of children as successor beneficiaries of a decedent if the IRA provider permits this type of transfer. Each child can then take distributions from the beneficiary IRA over his/her expected life expectancy.

Periodically Review Beneficiary Forms

An estate plan needs to be reviewed periodically during an individual’s lifetime to ensure that distributions will be made to intended beneficiaries upon death. A crucial part of the review is current retirement plan, life insurance, and annuity beneficiary forms since distribution of these types of assets isn’t controlled by the terms of wills, living trusts, and other estate planning documents.

As discussed, erroneous, incomplete, or outdated beneficiary designations can result in distribution of retirement plan assets, life insurance policies, and annuity contracts to unintended beneficiaries, unfavorable income tax consequences, and expensive and protracted litigation in some cases.

Categories
Income Tax Planning IRA Retirement Income Planning Roth IRA

7 Reasons to Start a Staged Roth IRA Conversion Plan Today

- ‘A goal without a plan is just a wish’ written on a blackboard. Blurred styled background.

If you want to succeed at chess, you need a plan for evaluating positions and setting short- and long-term goals. This includes being willing to strategically sacrifice pawns, knights, bishops, and even rooks in order to achieve the object of the game, i.e., checkmating your opponent’s king.

Just like chess, when planning for retirement you need to keep the ultimate goal in mind if you want to win — optimizing the longevity of your assets. With retirement, your opponent is the IRS as well as your state tax agency if you’re subject to state income tax. Similar to chess, you need to be willing to sacrifice pieces to achieve success. The pieces in the game of retirement planning come in the form of strategic income tax prepayments.

If you’re in your 50’s or 60’s and you have traditional 401(k) plans, SEP-IRAs, and traditional IRAs to which you’re contributing, why wait until 70-1/2 when the value of your plans have potentially doubled and tax rates are potentially higher to pay income tax on your distributions? Wouldn’t you rather use prudent retirement income planning strategies today to pay less tax for the rest of your life and have more funds available when you need them the most – during your retirement years?

One underutilized strategy for accomplishing this is with a staged, or multi-year, Roth IRA conversion plan. The length of the plan needs to be flexible with the number of years dependent upon many variables, a discussion of which is beyond the scope of this post. The following are seven reasons to start this type of plan today.

1. Eliminate taxation on the future growth of converted assets.

Assuming that you will be subject to taxation during your retirement years, eliminating taxation on the future growth of converted assets is the most important reason for implementing a staged Roth IRA conversion plan before you retire. 100% of the value of Roth IRA assets, including appreciation, will be permanently exempt from taxation.

Appreciation is typically responsible for the majority of the value of retirement plan assets over time. Suppose that you did a $60,000 partial Roth IRA conversion using a moderately aggressive equity portfolio in the beginning of March, 2009 when the Dow Jones Industrial Average was 7,000. Let’s further assume that you paid income tax at a rate of 25%, or $15,000, attributable to your conversion. Assuming that you retained your portfolio, it could potentially be worth $240,000 today.

To keep the example simple, let’s further assume no additional growth and a current tax rate of 25%. If you didn’t do the Roth IRA conversion in 2009, you would have net assets of $240,000 less income tax of $60,000, or $180,000. As a result of doing the Roth IRA conversion, you have $225,000 ($240,000 less income tax liability of $15,000 paid in 2009) or an additional $45,000 available for your retirement needs.

2. Take advantage of low federal tax rates scheduled to expire after 2025.

While there have been numerous changes in the federal tax law over the last 35 years making for a difficult comparison, the income tax rates that took effect in 2018 are historically on the low side. This is especially true when you also consider the widening of the various tax brackets. A bonus for business owners was the reduction of the Subchapter “C” corporate tax rate to 21% and addition of  a qualified business income (QBI) deduction of up to 20% for other business entities. The latter change reduced the effective tax rate for affected individuals.

With federal tax rates scheduled to expire after 2025 and higher rates likely thereafter, there’s a window of opportunity for Roth IRA conversions. You can potentially benefit from paying taxes on conversions at a low rate for up to seven years if you implement a multi-year staged Roth IRA conversion plan in 2019.

3. Reduce required minimum distributions beginning at age 70-1/2.

Minimum distributions, or RMDs, are required to be taken from non-Roth retirement plans beginning at age 70-1/2 based on the value of your accounts using an IRS table life expectancy factor. The income tax liability attributable to RMDs can be significant, reducing spendable income in retirement.

Why let your opponent, i.e., IRS, control your retirement income plan? A staged Roth IRA conversion plan can go a long way toward minimizing the value of taxable retirement plan accounts subject to RMDs while growing your nontaxable Roth IRA accounts.

4. Potentially reduce Medicare Part B premiums.

Reducing RMDs has a domino effect. One example is Medicare Part B premiums which are determined using modified adjusted gross income (MAGI) from two years prior to the current year. Medicare Part B annual premiums currently range from $1,626 to $5,526 depending upon income. Couples pay double this amount, or $3,252 to $11,052.

To the extent that you successfully execute a staged Roth IRA conversion plan and reduce your taxable retirement plans and RMDs, you can also reduce your MAGI. This can result in significant Medicare Part B premium savings over the course of one’s retirement.

Income tax planning, which is always recommended when considering Roth IRA conversions, is especially important beginning at age 63 since the amount of your conversions in a particular year can potentially increase your Medicare Part B premiums that you would otherwise pay beginning at age 65.

5. Reduce widow or widower’s income tax liability.

A second example of the domino effect of reducing RMDs is the ability to reduce the negative effects of the widow or widower’s income tax penalties. Surviving spouses who don’t remarry are subject to higher income taxes. An example of this was illustrated in Is Your Widow(er) Included in Your Income Tax Plan?.

A staged Roth IRA conversion plan executed while both spouses are alive can reduce the survivor’s ongoing income tax liability. If you’re married, own non-Roth retirement accounts, and you recognize that there’s a realistic possibility that one of you may outlive the other for several years, a staged Roth IRA conversion plan makes sense.

6. Reduce dependency on taxable assets in retirement.

In addition to reducing or potentially eliminating RMDs, a Roth IRA conversion plan reduces your dependency on taxable assets in retirement. The easiest way to illustrate this is with an example.

Let’s suppose that you’re retired and you want to do some major home improvements that you’ve been putting off, the cost is $100,000, you have $600,000 in traditional IRA accounts, and you’re in a combined 35% federal and state income tax bracket. You would need to withdraw $154,000 from your traditional IRA accounts in order to net $100,000 after tax.

If you instead had Roth IRA accounts, you could withdraw $100,000, or $54,000 less, since income tax liability wouldn’t be an issue. To the extent that you can reduce your dependency on taxable assets in retirement, you will optimize the longevity of all of your retirement assets.

7. Stay focused on retirement income planning.

The seventh reason for starting a staged Roth IRA conversion plan today, while not obvious, is very important. Given the multi-year nature of this type of plan, you’re forced to get in the habit of focusing on retirement income tax planning as long as you continue to own non-Roth retirement assets.

Whenever you visit your staged Roth IRA conversion plan, it’s an opportunity to examine and implement other retirement income planning and protection strategies that can also optimize the longevity of your assets. Given the fact that it’s difficult at best to do this yourself and a single mistake can be costly, an investment in a qualified team of income tax, investment, insurance, and legal professionals who specialize in retirement income planning is prudent.

Retirement income planning, much like chess, requires a great deal of patience and focus to be successful. If executed well, you can optimize the longevity of your assets while accomplishing another goal — stalemate IRS!

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Income Tax Planning IRA

Are Nondeductible IRA Contributions Worth It?

Frustrated and overworked businessman burying his head uner a laptop computer asking for help

For various reasons discussed in my MarketWatch article, The Tax Rules That Limit the Deductibility of Your IRA Contributions, traditional IRA contributions may be nondeductible or partially deductible. To the extent that you make nondeductible IRA contributions, they will require a separate tracking system and will complicate the taxation of your traditional, SEP, and SIMPLE IRA distributions.

Next to Roth 401(k)’s and Roth IRAs, nondeductible IRAs can be a great retirement savings vehicle if funded consistently. Like Roth 401(k)’s and Roth IRAs, 100% of contributions are nontaxable. Unlike Roth accounts, earnings on nondeductible IRAs will eventually be taxed as distributions are taken.

Nondeductible IRA Contributions Must be Tracked

Each year that you make a nondeductible IRA contribution, you’re required to report it on IRS Form 8606 – Nondeductible IRAs as part of your tax filing. A separate form is used for each spouse if married.

Once you make your first nondeductible IRA contribution, although it isn’t required, Form 8606 should be included in your federal income tax return every year thereafter, even in years that you don’t make nondeductible IRA contributions. The reason for doing this is because you need to keep a running total of “basis” in your traditional IRAs.

When you take distributions from your non-Roth IRAs, you’re entitled to apply a portion of your basis against the amount of your distributions to reduce the taxable amount. If you haven’t accounted for your traditional IRA basis on Form 8606 every year since you began making nondeductible IRA contributions, this will be problematic come distribution time.

Basis – The Key to Reducing Taxation of IRA Distributions

What is basis and why do you need to keep a running total? Basis is the cumulative total of nondeductible IRA contributions reduced by the cumulative amount that’s been used to reduce the taxable portion of distributions from traditional, SEP, and SIMPLE (i.e., non-Roth) IRAs.

If you haven’t included Form 8606 as part of your tax returns each year since you began making nondeductible IRA contributions, it will be difficult, if not impossible, for you to reconstruct your traditional IRA basis. You may have made your first nondeductible IRA contribution when you were 25 and are now taking your first distribution from your traditional IRA at age 70-1/2.

Unless you’ve saved all of your income tax returns for the last 45 years or have maintained a traditional IRA basis spreadsheet, you won’t know the amount of your traditional IRA basis. Consequently, 100% of the distributions from your traditional, SEP, and SIMPLE IRAs will be taxable.

Don’t Forget the Total Value of All of Your Non-Roth IRAs When Taking Distributions

In addition to tracking basis, Form 8606 is used to calculate the taxable portion of non-Roth IRA distributions whenever you have made nondeductible IRA contributions in the current year or a previous year.

The total value of all of your traditional, SEP, and SIMPLE IRAs as of December 31 in the year of distribution must be reported on Form 8606 whenever you take a distribution from one of those types of accounts. Inherited and Roth IRAs are excluded. You cannot simply use the value of the account from which you took your distribution assuming you have other non-Roth IRA accounts.

The basis in your traditional IRAs relative to the adjusted value of your non-Roth IRA accounts is used to calculate a percentage that’s used to determine the amount of basis that can be used to reduce otherwise taxable IRA distributions. The higher the percentage, the greater the reduction.

Are Nondeductible IRA Contributions Worth the Effort?

Calculating and keeping track of traditional IRA basis is a lifetime project. It begins the first year that you make a nondeductible IRA contribution and continues until you have no basis remaining in your traditional IRAs. This could be for the rest of your life assuming that you continue to own any traditional, SEP, or SIMPLE IRA accounts.

Given the fact that allowable nondeductible IRA contributions are limited to a maximum of $5,500 or $6,500 a year if 50 or over, are they worth the effort? The answer depends upon the frequency and amount of your nondeductible IRA contributions, other potential sources of retirement income, and level of tax expertise.

If your nondeductible IRA contributions will be hit or miss and/or minimal in amount, e.g., $2,000 or less per year, it probably doesn’t make sense. This is especially true if you have other significant sources of retirement income, such as 401(k) plans, fixed income annuities, pensions, or Social Security.

If, on the other hand, you and/or your spouse are consistently making maximum nondeductible IRA contributions of $5,500 or $6,500 over ten or more years, the required accounting is probably worth the effort. This is especially true if you wouldn’t otherwise set aside the funds in a savings plan dedicated to retirement and/or your other potential sources of retirement income are limited.

Finally, assuming that you decide to make nondeductible IRA contributions, I recommend that you engage the services of an income tax professional to prepare your tax returns if you aren’t doing so already. Given the complexity of calculating the amount of allowable nondeductible contributions, tracking basis, and calculating the taxable portion of distributions, the potential tax savings from doing it correctly can easily justify the fees.

Categories
401(k) Plans Income Tax Planning IRA Roth IRA

RMDs: Recapture My Deductions – A Questionable Strategy

Pebbles in the form of a arch on the coast

Although most non-tax professionals don’t appreciate it, there’s a fair amount of symmetry throughout the tax law. This is especially true when it comes to retirement plan contributions.

Deductible, Nondeductible, or Partially Deductible Contributions

Employers, employees, and self-employed individuals can make deductible, nondeductible, or partially deductible contributions to retirement plans. Deductibility depends upon the type of plan.

Contributions to traditional 401(k), 403(b), and SEP-IRA plans are deductible with the exception of after-tax employee 401(k) contributions. Contributions to Roth 401(k) plans and Roth IRAs are nondeductible. Traditional IRA contributions are deductible, nondeductible, or partially deductible depending upon filing status, income level, and participation in other retirement plans. All contributions are subject to specified limits.

Age 70-1/2 – The Party’s Over

Once you turn 70-1/2, you’re no longer allowed to contribute to a traditional IRA. In addition, account owners generally must begin taking annual withdrawals from their retirement plans. Exceptions to this requirement include non-inherited Roth IRAs and 5% owners of businesses sponsoring a retirement plan. The first payment can be delayed to April 1 of the year following the year in which you turn 70-1/2.

Required minimum distributions (RMDs), is the technical term for the annual minimum amounts that must be withdrawn from retirement plans beginning at age 70-1/2. While the title of this post euphemistically refers to RMDs as “Recapture My Deductions,” the required distribution rules make no distinction between previously deductible vs. nondeductible contributions.

RMD Calculation and Taxation

RMDs are calculated by dividing the prior December 31 balance of the retirement plan or IRA account by a life expectancy factor published by the IRS in tables in Publication 590-B – Distributions from Individual Retirement Arrangements.

The life expectancy factor for RMDs for noninherited retirement plans for most people is generous, beginning at 27.4 at age 70 and decreasing gradually to 1.9 at age 115 or older. This allows individuals who only take RMDs to retain balances in their retirement plan accounts at death to transfer to their heirs.

Distributions from non-Roth accounts are fully taxable with the exception of those arising from nondeductible IRA and after-tax employee 401(k) plan contributions. A special calculation must be performed to determine the taxable portion in the latter situation.

Plan for Distributions When Making Retirement Plan Contributions

There’s symmetry between the fact that contributions to retirement plans, with the exception of non-inherited Roth IRAs, are subject to the required minimum distribution rules. What goes in, plus earnings, must eventually be withdrawn.

What most people, overlook, however, when deciding whether to make deductible vs. nondeductible contributions to retirement plans, especially 401(k)s, is the fact that cumulative distributions from retirement plans often exceed cumulative contributions. Furthermore, the difference can be significant.

When deciding between making contributions to a traditional vs. Roth 401(k) plan, most people assume that the current tax savings from making a deductible traditional 401(k) contribution will exceed any long-term benefit to be derived from nontaxable distributions from a Roth 401(k) plan. This is often untrue, even in situations where your marginal tax rate when making contributions exceeds your rate at the time of withdrawals. This is illustrated in my How to Put Some Muscle Into Your Roth 401(k) September 2, 2016 MarketWatch article.

Reduce RMDs with Roth IRA Conversions

RMDs are taxed at ordinary income tax rates. This can be as high as 37% for federal purposes plus applicable state income taxes which can be as much as 13.3% in California under current tax law.

To the extent that you do strategic or market-sensitive Roth IRA conversions, you will reduce your RMDs and eliminate taxation on the growth of your conversions. Furthermore, you can also potentially reduce taxation of your Social Security benefits and Medicare premiums.

Optimize Your After-Tax Retirement Plan Distributions

When you retire, you should optimize after-tax retirement plan distributions for you and your heirs. While you can play the game of making deductible retirement plan contributions and “recapture my deductions” beginning when you turn 70-1/2, this may not be the best strategy for accomplishing this goal.

Categories
Income Tax Planning IRA

It’s Time for IRA – 401(k) Contribution Parity

When the election hoopla is finally behind us and Congress begins working with a new president, a recurring theme, i.e., tax simplification, will be on the agenda. Simplification of the rules and regulations pertaining to IRAs to put them on par with 401(k) plans is much needed and long overdue.

Retirement Plan Discrimination

The retirement system in the United States discriminates in favor of those who have access to 401(k) plans. Based on recent statistics that less than 50% of businesses with fewer than 100 employees offer 401(k) plans, ironic as it is, there are millions of individuals who are unable to accumulate meaningful savings for retirement in a retirement plan.

Unless you participate in a 401(k) plan, IRS rules limit your ability to make deductible contributions to traditional IRAs and nondeductible contributions to Roth IRAs. Even when contributions are permitted, the maximum allowable amounts are a fraction of 401(k) plan limits.

Two changes are needed to enable all individuals who aren’t participants in 401(k) plans to (a) contribute to the IRA of their choice and (b) accumulate a nest egg in a retirement plan comparable to what’s possible with a 401(k):

  • Eliminate income testing for traditional and Roth IRAs
  • Create a universal 401(k)/IRA contribution limit

Eliminate Income Testing for Traditional and Roth IRAs

Unlike a 401(k) plan, the ability to make deductible contributions to a traditional IRA and nondeductible contributions to a Roth IRA is subject to income testing based on modified adjusted gross income (MAGI). The income thresholds for making partial or fully deductible traditional IRA contributions and for calculating allowable Roth IRA contribution amounts vary depending upon tax filing status.

The rules are more complicated for making deductible contributions to traditional IRAs since participation in a retirement plan at work also comes into play. Furthermore, even if you aren’t covered by a retirement plan at work, you’re prohibited from making a deductible IRA contribution if you’re married and file jointly and your MAGI is $194,000 or more.

Income testing needs to be eliminated so that fully deductible contributions to a traditional IRA and nondeductible contributions to a Roth IRA can be made.  Whether you’re single or married, you would be able to make contributions to both types of plans.

Create a Universal 401(k)/IRA Contribution Limit

As previously stated, IRA contribution limits are a fraction of 401(k) contribution limits. Per the 2002 – 2016 IRA and 401(k) Contribution Limits table, the disparity, which was $8,000 in 2002 for individuals under age 50, has increased to $12,500 if you’re under 50 and $17,500 if 50 or older.

Historical IRA contribution limits, as well as increases in those limits, have paled in comparison to 401(k)s. The maximum allowable contribution for IRAs, which was $3,000 (under age 50) or $3,500 (50+) in 2002, has increased by $2,500 and $3,000, respectively, to $5,500 and $6,500, respectively, as of 2016. 401(k) plan contribution limits, on the other hand, have increased from $11,000 to $18,000 and from $12,000 to $24,000 for under age 50 and age 50+ participants, respectively, during the same timeframe.

A universal 401(k)/IRA contribution limit is needed in order to equalize the playing field.  Using the current 401(k) plan limits, subject to earned income, everyone would be able to make pretax contributions to traditional 401(k) plans and traditional IRA accounts and/or after-tax contributions to Roth 401(k) plans and Roth IRA accounts up to $18,000 if under age 50 or $24,000 if 50 or older in any calendar year with provision for inflation increases.

For those inclined to do so, the ability to make after-tax contributions of up to $35,000 a year that applies to 401(k) plans, should also be extended to traditional IRA accounts in order to achieve true contribution parity.

Consequences of Proposed Changes

The proposed changes, like all tax changes, would have various consequences. Six of the more significant ones are as follows:

1.  Nondeductible IRA contributions and accounting would be eliminated in most cases.

With the demise of income testing, all contributions to a traditional IRA up to $18,000 or $24,000, as applicable, would be deductible in full. This would phase out and eventually eliminate the current onerous requirement of keeping records of nondeductible IRA contributions that are required to calculate taxable amounts of IRA distributions, with the exception of after-tax contributions in excess of the $18,000 and $24,000 limits.

2.  More 401(k) plans will offer a Roth option.

Employers that currently have a 401(k) plan without a Roth option will be more inclined to add this alternative so that employees won’t need to contribute to private Roth IRAs.

3.  More 401(k) plans will offer after-tax contributions.

Similar to #2, employers that currently have a 401(k) plan with no after-tax contribution provision will be more likely to add this option to compete with traditional IRAs.

4.  SEP-IRA accounts wouldn’t be as prevalent.

If you’re self-employed and have a SEP-IRA, you can make deductible contributions up to the lesser of 25% of compensation or $53,000. Unless your net self-employment income exceeds $96,000 if you’re less than 50 or $129,000 if 50 or older and you have the funds to make larger contributions, the universal 401(k)/IRA contribution limits of $18,000 (less than 50) and $24,000 (50+) would be sufficient to meet your needs.

5.  Solo 401(k) plans would generally be unnecessary.

As an alternative to a SEP-IRA, self-employed individuals are allowed to set up solo 401(k) plans that essentially duplicate the features and benefits available with 401(k) plans that are used by companies with hundreds of employees. With the exception of potential creditor protection under state law, solo 401(k) plans and their associated administration requirements would be unnecessary with the proposed rule changes.

6.  401(k) plan participants may choose to contribute to traditional and Roth IRAs.

401(k) plan participants may choose in some cases to allocate a portion or all of their contributions to a traditional and/or Roth IRA in order to achieve greater investment diversification, including access to fixed income annuities. While most 401(k) plans have a large number of investment choices, they’re typically limited compared to IRAs.

Tax Simplification and Level Retirement Playing Field

The two proposed changes, which are much needed and long overdue, would achieve IRA-401(k) contribution parity. If enacted, they would be a significant step toward simplifying tax law pertaining to retirement plans while providing non-401(k) plan participants with an opportunity to accumulate sizable nest eggs in a retirement plan which isn’t possible today with traditional and Roth IRA contributions.

Categories
Annuities Deferred Income Annuities IRA Retirement Income Planning

The 401(k) Unlevel Playing Field

With the Summer Olympics in Rio de Janeiro underway, sports are on my mind. There’s an unlevel playing field in the retirement planning world. Forgetting about defined benefit plans which are in a league of their own, 401(k) plans are the clear favorite for employees who want to save for retirement.

401(k) participants enjoy a decided advantage over those who don’t have access to these retirement plans when it comes to making contributions. This includes higher limits, greater ability to deduct contributions, ease of contributing to a Roth account, and potential employer matching contributions.

Higher Contribution Limits

The ability to accumulate a meaningful nest egg using traditional IRA and Roth IRA accounts is limited by several roadblocks that aren’t an issue with 401(k) plans. The most significant advantage of 401(k) plans over traditional and Roth IRAs is their contribution limit.

You can contribute up to the lesser of compensation or $18,000 to a 401(k) plan if you’re less than 50 years old. This is $12,500 greater than the maximum allowable IRA contribution of $5,500. The spread increases to $17,500 if you’re 50 or older, with limits of $24,000 and $6,500 for 401(k) and IRA contributions, respectively.

Greater Ability to Deduct Contributions

Pre-tax contributions to a traditional 401(k) are fully deductible. With traditional IRA plans, deductibility is potentially affected by participation in another retirement plan at work and marital status. If you or your spouse is covered by an employer retirement plan, then you must apply an income test based on your modified adjusted gross income, or “MAGI,” and tax filing status to calculate the amount of your deductible contribution.

Assuming that you’re covered by a retirement plan at work and you’re single, full deductions to traditional IRAs are allowed for MAGI of $61,000 or less, no deduction if MAGI is $71,000 or more, and a partial deduction is allowed for MAGI in between. The floor and ceiling for married filing jointly is $98,000 and $118,000, respectively.

If you aren’t covered by a retirement plan at work and you’re married and you file jointly, full deductions to traditional IRAs are allowed for MAGI of $184,000 or less, no deduction if MAGI is $194,000 or more, and a partial deduction is allowed for MAGI in between.

Ease of Contributing to a Roth Account

Employees may elect to make nondeductible contributions to a Roth account assuming it’s offered as part of their 401(k) plan. Furthermore, they may allocate contributions between traditional and Roth accounts as they see fit so long as their total contributions don’t exceed the IRS annual limits of $18,000 and $24,000 for those younger than 50 and 50 or older, respectively.

The ability to make Roth IRA contributions, like traditional IRA contributions, is limited by MAGI. If you’re single, Roth IRA contributions are allowed for MAGI of $117,000 or less, no contribution if MAGI is $132,000 or more, and a partial contribution for MAGI in between. The floor and ceiling for married filing jointly is $184,000 and $194,000, respectively.

Potential Employer Matching Contributions

Some 401(k) plans provide for employer matching contributions. A typical arrangement is the employer matches 50% of employee contributions up to the first 6% of salary.

As an example, suppose that your salary is $100,000, you contribute 10% to your 401(k) plan, and your employer matches your contributions using the typical arrangement. In addition to your contributions of $10,000 (10% x $100,000), your employer will contribute $3,000 (50% x 6% x $100,000) to your 401(k) account, resulting in total contributions of $13,000.

Importance of Retirement Income Planning

Whether you’re considering making contributions to a traditional 401(k), Roth 401(k), traditional IRA, or Roth IRA, you should do so within the context of a retirement income plan. A plan can be used to project the amount of after-tax income that you will receive from various sources beginning in a specified year for the duration of retirement.

You can prepare what-if scenarios to determine which types of retirement accounts, e.g., traditional vs. Roth 401(k), and annual contribution amounts are likely to optimize projected after-tax retirement income.  Your plan can, and should be, used to calculate gaps between projected retirement expenses and income. This in turn can be used to determine other types of non-retirement account investments and contribution amounts you should make to enable you to reduce the projected gaps and achieve your retirement income planning goals.

Deferred fixed income annuities should be included as part of your analysis since they’re designed for retirement income planning. Fixed income annuities, which generally aren’t offered in 401(k) plans, are the only investment that provides sustainable lifetime income. They also offer significant potential income tax savings and aren’t subject to IRS’ required minimum distribution rules when owned individually outside of a retirement plan.

While 401(k) plans enjoy many advantages on the front end, account values cannot be easily translated into projected retirement income streams. Whenever you invest in fixed income annuities, you know how much income you will receive each year beginning at a specified date with a given investment amount at the time of investment. This enables you to close projected income gaps with greater precision than is possible with 401(k) plans.

Categories
Income Tax Planning IRA

Deductibility of Your IRA Contribution Endangered by Your Spouse’s Retirement Plan

Just like the bald eagle is an endangered species, so is the deductibility of your IRA contribution if you're married, your spouse is covered by a retirement plan, and your contribution exceeds a certain limit.
Portrait of a bald eagle, lat. haliaeetus leucocephalus

It’s no wonder that Americans are clamoring for tax simplification. You need to look no further than the rules pertaining to deductibility of IRA contributions to appreciate this.

I wrote a RetireMentors article, The Tax Rules That Limit the Deductibility of Your IRA Contributions, which was published December 9 in MarketWatch. The article discussed three sets of rules that determine whether your IRA contribution is deductible.

The common theme of all of the rules is whether you or your spouse is covered by a retirement plan at work. While none of the rules make sense due to the low maximum IRA contribution limit, i.e., $5,500 or $6,500 if you’re 50 or older, one of them defies logic and is furthermore discriminatory in my opinion.

IRA Marriage Penalty

Let’s suppose that you don’t have a retirement plan at work. You should be allowed to make a maximum deductible IRA contribution of up to $5,500 or $6,500, depending on your age, without any further restrictions, right?

Unfortunately the answer to this question is, “not necessarily.” You can make a deductible IRA contribution if you don’t have a retirement plan at work and you’re single. If you’re married and your spouse is covered by a retirement plan, your ability to deduct a portion or all of your contribution is subject to an income test.

To begin with, you need to be familiar with, and calculate, “modified adjusted gross income,” or “MAGI.” MAGI is “adjusted gross income,” or “AGI,” increased by certain sources of nontaxable income and various otherwise allowable deductions. While MAGI is often the same as AGI, this isn’t always the case.

Even if you’re not covered by a retirement plan at work and your spouse is, your ability to deduct your IRA contribution is threatened once your MAGI exceeds $183,000. There’s a narrow $10,000 band between $183,000 and $193,000 where a portion of your contribution is deductible. None of your contribution is deductible, however, once your MAGI exceeds $193,000.

Discriminatory Rule

Why should the deductibility of your IRA contribution when you’re not covered by any retirement plan at work be endangered if (a) you’re married, (b) your spouse has a retirement plan at work, and (c) your income exceeds a certain level? Why shouldn’t you be entitled to an income tax deduction for your contribution just like your spouse assuming he/she is contributing to a traditional 401(k) plan?

To add insult to injury, the amount of your maximum contribution and potential deduction is 30% of what your spouse can contribute to his/her retirement plan — $5,500 vs. $18,000. Furthermore, the limit decreases to 27% if you’re both over 50 – $6,500 vs. $24,000.

The fact of the matter is that we’re motivated by income tax deductions and many individuals won’t make an IRA contribution unless it’s deductible. Often times, if they don’t make an IRA contribution, they also won’t invest the funds elsewhere.

Ignoring potential increases in contribution limits, the 401(k) plan spouse can save and deduct up to $360,000 to $480,000, depending on age, over 20 years. The spouse who doesn’t have any retirement plan is limited to making contributions to an IRA totaling $110,000 to $130,000, depending on age, over the same period. Once again, the annual IRA contributions may or may not be deductible depending upon income.

When you get together with family this holiday season and the topic of income tax simplification comes up, which it will since tax time is just around the corner, please keep this blog post in mind. It’s as good a place as any to start a discussion about this popular topic.

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Annuities Celebration Income Tax Planning IRA Retirement Income Planning Roth IRA Social Security

Retirement Income Visions™ Celebrates 2-Year Anniversary!

Retirement Income Center

Thanks to all of my subscribers and other readers, Retirement Income Visions™ is celebrating its two-year anniversary. Since its debut on August 16, 2009, Retirement Income Visions™ has published a weekly post each Monday morning, the theme of which is Innovative Strategies for Creating and Optimizing Retirement Income™.

As stated in the initial post two years ago, Retirement Income Visions™ Makes Its Debut, the importance of retirement income planning as a separate and distinct discipline from traditional retirement planning was magnified during the October, 2007 – March, 2009 stock market decline. Although the stock market experienced three positive and encouraging days this past week, the market volatility the last three weeks has only served to emphasize the need for a comprehensive retirement income plan.

Add to the mix the increasing instability of the Social Security and Medicare programs and the rapid decline of traditional pensions as a source of retirement income. Not to mention increasing life expectancies, soaring health care costs, and an economic situation ripe for inflation. Retirement income planning is no longer an option – it has quickly become a downright necessity.

Since inception, Retirement Income Visions™ has used a themed approach, with several weeks of posts focusing on a relevant retirement income planning strategy. This past year was no exception. The weekly posts, together with the customized Glossary of Terms, which currently includes definitions of 99 terms to assist in the understanding of technical subject matter, has contributed to a growing body of knowledge in the relatively new retirement income planning profession.

Going back a year, the six August 16 through September 20, 2010 posts completed a 36-part series on Roth IRA conversions. This was a very timely topic with the January 1, 2010 availability of this strategy to all taxpayers regardless of income level, combined with the ability to defer 50% of the reporting of income from a 2010 Roth IRA conversion to 2011 and the other 50% to 2012.

The September 27, 2010 post, Plan for the Frays in Your Social Security Blanket, began a 25-part educational series about Social Security. The first two parts discussed some of the historical events in connection with changes to the Social Security system affecting benefit amounts and delay in the commencement of receipt of benefits. The October 11, 2010 post, Do Your Homework Before Flipping the Social Security Switch, began a five-part series regarding various considerations in connection with electing to begin receiving Social Security benefits before full retirement age (“FRA”).

The November 15, 2010 post, Wait Until 70 to Collect Social Security? examined the opposite end of the spectrum, i.e., delaying the start date of receipt of Social Security benefits. The follow-up three-part series, Pay-to-Play Social Security, presented the “do-over” strategy, a little-publicized strategy for increasing monthly benefits in exchange for repayment of cumulative retirement benefits received.

The “file and suspend” and “double dipping” strategies for potential maximization of Social Security benefits were addressed in the next two two-part posts from December 13, 2010 through January 3, 2011, Breadwinner Approaching Social Security Retirement Age? – File and Suspend and Working? Remember Your Social Security Spousal Benefit When Your Spouse Retires.

Income taxation and associated planning strategies was the subject of the subsequent respective two- and four-part January 10 through February 14, 2011 series, Say Goodbye to Up to 30% of Your Social Security Benefits and Increase Your After-Tax Social Security Benefits. The February 21, 2011 post, Remember Your Future Widow(er) in Your Social Security Plan made the point that the decision regarding the start date of Social Security Benefits, in addition to fixing the amount of your retirement benefit, may also establish the amount of your spouse’s monthly benefit.

Retirement Income Visions™ Social Security series culminated with the three-part February 28 through March 24, 2011 series, Your Social Security Retirement Asset. These three posts discussed the importance of Social Security as an asset, perhaps one’s most important asset, in addition to its inherent role as a monthly retirement income stream.

With the media’s emphasis in 2010 on the two-year deferral of inclusion of income from a 2010 Roth IRA conversion as the motivating factor for pursuing this planning technique, I felt that there wasn’t enough attention given to the potential long-term economic benefits available through use of this investment strategy. Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog began a six-part series on this important topic on March 21, 2011 that ran through April 25, 2011. The May 2 and May 9, 2011 Roth IRA Conversion Insights two-part series followed up the Roth IRA conversion economic benefit discussion.

The importance of nonretirement assets in connection with retirement income planning was discussed in the May 9, 2011 Roth IRA Conversions Insights post as well as the May 23 and May 30, 2011 respective posts, Nonretirement Investments – The Key to a Successful Retirement Income Plan and Nonretirement vs. Retirement Plan Investments – What is the Right Mix? This was followed up with two posts on June 6 and 13, 2011 regarding traditional retirement funding strategies, Sizeable Capital Loss Carryover? Rethink Your Retirement Plan Contributions and To IRA or Not to IRA?

The June 20 and June 27, 2011 posts, Do You Have a Retirement Income Portfolio? and Is Your Retirement Income Portfolio Tax-Efficient? addressed the need for every retirement income plan to include a plan for transitioning a portion, or in some cases, all, of one’s traditional investment portfolio into a tax-efficient retirement income portfolio. This was followed by the July 5, 2011 timely Yet Another “Don’t Try to Time the Market” Lesson post.

The July 11, 2011 Shelter a Portion of Your Portfolio From the Next Stock Market Freefall began a new timely and relevant ongoing series about indexed annuities. This post was published just ten days before the July 21st Dow Jones Industrial Average peak of 12,724.41 that was followed by the beginning of a steady stock market decline coinciding with the final days of U.S. debt limit negotiations and Standard & Poor’s unprecedented U.S. credit rating downgrade, culminating with a closing low of 10,719.94 this past Wednesday. As implied in the titles of the July 18 and July 25, 2011 posts, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities and Limit Your Losses to Zero, this relatively new investment strategy has the potential to be a key defensive component of a successful retirement income plan.

As I did a year ago, I would like to conclude this post by thanking all of my readers for taking the time to read Retirement Income Visions™. Once again, a special thanks to my clients and non-clients, alike, who continue to give me tremendous and much-appreciated feedback regarding various blog posts. Last, but not least, thank you to my incredible wife, Nira. In addition to continuing to support my weekly blog-writing activities, she also endured my year-long family tree project that I recently completed. Well, sort of. Is a family tree ever completed?

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IRA

To IRA or Not to IRA?

Retirement Income Center

Without going into the details, IRA contributions may be deductible, non-deductible, or partially deductible. Assuming that you’re eligible to make a deductible contribution, should you do it? As with all financial decisions, it depends upon the facts.

Let’s assume that you’re married, you’re both 50 years old, neither one of you is an active participant in an employer-sponsored retirement plan, and your marginal federal income tax rate is 25%. Given this scenario, you would be eligible to make deductible IRA contributions of up to $6,000 each, for a total of $12,000. Forgetting about a potential state income tax deduction, assuming you make maximum contributions, you will reduce your income tax liability by $3,000 ($12,000 x 25%). Looking at it another way, the cost of your IRA contributions is $9,000 ($12,000 less income tax savings of $3,000).

Since your spouse and you are both 50 years old, you’re both eligible to make IRA contributions for another 20 years until age 70-1/2. Assuming that you both continue not to be active participants in an employer-sponsored retirement plan, you will be able to make deductible IRA contributions totaling at least $240,000 ($12,000 x 20), excluding potential additional contributions permitted by legislated contribution limit increases. Per Exhibit 1, after making contributions totaling $240,000, 25%, or $60,000 of which was financed by federal income tax savings, resulting in net out-of-pocket total contributions of $180,000 ($240,000 less income tax savings of $60,000), and assuming earnings of 5%, the total value of both of your IRA’s in 20 years is projected to be approximately $417,000.

That’s pretty awesome. Why wouldn’t you implement this plan? Keeping in mind that a deductible IRA plan is a tax-deferral plan, even though you may receive income tax deductions of $12,000 a year, or a total of $240,000 over 20 years, you, and potentially your heirs, will eventually pay income tax on 100% of your contributions. This must occur beginning at age 70-1/2 when you will be required to take minimum withdrawals from your plan that are calculated each year using the value of your IRA on December 31st of the previous year and your current age. Furthermore, the tax rate on your IRA withdrawals may be greater than the rates at the time when you made your contributions, resulting in greater tax liability than the tax savings you received from your contributions.

As an alternative, especially if you have other qualified retirement plans, you may want to consider taking the same $12,000 and instead make nondeductible contributions to a nonretirement investment account. Administratively, this will be easier since, unlike the IRA situation where you must deposit $6,000 into two separate accounts each year assuming you’re married, you can deposit 100% of your contributions into a single account. Furthermore, unlike an IRA which has an annual contribution limit of $5,000 or $6,000 if you are at least 50 years old, there is no cap on the amount of contributions that may be made to a nonretirement investment account.

To the extent that the investments in your nonretirement account don’t produce current taxable income, they will enjoy tax-deferred growth similar to an IRA. Unlike an IRA where withdrawals are taxable as ordinary income, withdrawals from nonretirement investment accounts are nontaxable. Instead, the sales of securities needed to produce the withdrawals are subject to capital gains. Assuming the securities that are sold have been held for at least a year, under current tax law, any gains, i.e., the excess of sale prices over purchase prices, will be taxed at favorable long-term capital gains rates which in most cases is 15%. To the extent that there is a loss on any sale, it can be offset against capital gains from other sales. Total capital losses in any year are deductible to the extent of capital gains plus an additional $3,000, with any net excess losses carried forward to future years. The availability of existing capital loss carryovers makes this alternative plan even more attractive (See last week’s post, Sizeable Capital Loss Carryover? Rethink Your Retirement Plan Contributions).

Even though a nondeductible nonretirement investment account plan may be preferable to a deductible IRA plan in certain situations, there is greater discipline associated with implementing and maintaining the former plan. Unlike a deductible IRA plan, the absence of the incentive of an annual tax deduction associated with a nonretirement plan generally requires an automatic contribution plan to be in place to ensure that regular contributions are made to the plan each year.

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IRA

Doing a Roth IRA Conversion? – Leave the Door Open

Retirement Income Center

You’re standing on the edge of the 10-meter diving platform ready to take the plunge into Roth IRA conversion waters, about to transfer 100% of your traditional IRA to a Roth IRA. Before you take that final step, there’s one more thing that you should consider if you’re still working or planning on working in the future and your income exceeds certain limits.

If you’re converting your entire traditional IRA to a Roth IRA, it doesn’t have to be, and in many cases shouldn’t be, the last Roth IRA conversion that you will do. In 2010, if you’re single and your modified adjusted gross income (“MAGI”) exceeds $120,000 or if you’re married and your MAGI exceeds $177,000, you’re prohibited from making direct contributions to a Roth IRA. It’s important to keep in mind that if your income doesn’t exceed these limits and you make a contribution to your Roth IRA, the maximum allowable amount is currently $5,000 or $6,000 if you’re 50 or older, and, furthermore, your contribution isn’t deductible.

While your income may limit your ability to make direct contributions to a Roth IRA, you may still make indirect contributions via a two-step process. In order to implement this strategy, you need to have a traditional IRA account in place. I recommend to all of my working clients who are considering full conversion of their traditional IRA’s to Roth IRA’s to keep one of their traditional IRA accounts open by leaving $1,000 in it. If you do this, even though you may be transferring 99% of your traditional IRA to a Roth IRA, you’re technically doing a partial, vs. a full, Roth IRA conversion.

Assuming that your income exceeds the specified deductible IRA contribution limits which in 2010 are $66,000 if you’re single and $109,000 if married, step one is to make a nondeductible IRA contribution to your traditional IRA account. The maximum allowable traditional IRA contribution, whether it is deductible or nondeductible, is identical to the maximum allowable Roth IRA contribution limit: $5,000 or $6,000 if you’re 50 or older.

Once you’ve made your nondeductible IRA contribution, you may immediately implement step two. Given the fact that, beginning in 2010, there are no income limitations in connection with converting traditional IRA accounts to Roth IRA accounts, step two is to complete your financial institution’s Roth IRA conversion form requesting transfer of the amount that you just contributed to your traditional IRA to your Roth IRA account. Once again, this will be a partial conversion since you generally want to leave funds in your traditional IRA account in order to keep it open for potential future contributions.

Although you have until April 15th to make an IRA contribution for the preceding year, it’s a good idea to execute this two-step process at the beginning of each year assuming that funds are available. This will get you in the habit of making sure that you implement this strategy each year, and, if done consistently over a number of years, can substantially add to the value of your Roth IRA account.