Roth IRA

Roth IRA Conversion – Analysis Paralysis? – Part 1 of 2

As is evident by the sheer number of blog posts to date about Roth IRA conversions – 33 – there’s a lot of things to consider when deciding whether a Roth IRA conversion makes sense for you. These include, but are not limited to, the following questions:

  • Should you do a Roth IRA conversion?
  • How much traditional IRA should be converted?
  • In which year(s) should a conversion be made?
  • Should you employ a multi-year conversion strategy, and, if so, what’s the best plan for you?
  • At which point during a particular year should a conversion be done?
  • Does it make sense to do multiple conversions in a single year?
  • Even though the income from a conversion in 2010 can be deferred to 2011 and 2012, should you do a conversion in 2010?
  • If you do a Roth IRA conversion in 2010, should you go with the default of reporting 50% of the conversion income on your 2011 tax returns and 50% on your 2012 returns or should you instead make an election to report 100% of your conversion income on your 2010 income tax returns?
  • Will your income tax rate be higher or lower than what it is now when you take distributions from your IRA accounts?
  • Which assets should be converted?
  • Should you set up multiple Roth IRA conversion investment accounts?
  • Is the current primary beneficiary of your traditional IRA a charity?
  • Are there retirement plans available for conversion other than active 401(k) plans?
  • What is the amount of projected income tax liability attributable to a potential conversion?
  • When will the tax liability attributable to the conversion need to be paid?
  • What sources of funds are available for payment of the tax liability?
  • Will withdrawals need to be made from the converted Roth IRA within five years of the conversion?
  • Do you have a life expectancy of five years or less with no living beneficiaries?
  • Do your itemized deductions and personal exemptions exceed your gross income such that you can convert a portion, or perhaps all, of your traditional IRA to a Roth IRA without incurring any income tax liability?
  • Do you own a rental property with a large passive activity loss carry forward that you can sell and do a Roth IRA conversion while incurring minimal or no income tax liability?
  • Is there a net operating loss that you can use to offset Roth IRA conversion income?
  • Is there a large charitable contribution available from the establishment of a charitable remainder trust that can be used to offset income from a Roth IRA conversion?
  • What is the basis of your traditional IRA, i.e., how much of your IRA has come from nondeductible IRA contributions or qualified retirement plan after-tax contributions?
  • Are you a surviving spouse in a low tax bracket who isn’t dependent on your IRA and one or more of your children are in a high income tax bracket?
  • What are the years and amounts of your projected required minimum distributions with and without a Roth IRA conversion?
  • What is the amount of projected taxable Social Security benefits that can be reduced by doing a Roth IRA conversion?
  • Do you have a SEP-IRA that can be converted to a Roth IRA?
  • Do you have a dormant 401(k) plan that can be converted?
  • How will a Roth IRA conversion affect financial aid qualification?
  • Will your Medicare Part B premium increase if you do a Roth IRA conversion?
  • If you do a Roth IRA conversion in 2010, will your Medicare Part B premium increase in more than one year?
  • What are the income tax consequences of a partial 72(t) Roth IRA conversion?
  • Should you not do a full Roth IRA conversion and instead leave funds in your traditional IRA for future nondeductible IRA contributions?

Feeling overwhelmed? Read Part 2 next week.

IRA Roth IRA Social Security

Want to Reduce Taxable Social Security Benefits? Consider a Roth IRA Conversion

Last week’s post, Reduce or Eliminate Your Required Minimum Distributions With a Roth IRA Conversion was a precursor to this week’s topic. It explained how a Roth IRA conversion can be used to reduce, or potentially eliminate, required minimum distributions (“RMD’s”). It also illustrated the growth potential of a distribution-free IRA vs. one that is subject to RMD’s.

In addition to achieving greater growth through a reduced distribution or distribution-free IRA, a Roth IRA conversion can also reduce your taxable Social Security benefits. To the extent that a Roth IRA conversion reduces the amount remaining in your traditional IRA, your RMD’s will be reduced since they are based on the value of your traditional IRA as of December 31st of the preceding year. When you reduce RMD’s, you reduce income that is used in the calculation of taxable Social Security benefits, assuming that you don’t replace your previous RMD income with other taxable income.

The amount of one’s income and filing status determine the amount of taxable Social Security benefits. For this purpose, income includes tax-exempt interest income and 50% of Social Security benefits in addition to all other items of income normally included in the calculation of adjusted gross income. If the resulting total exceeds specified base amounts ($25,000 for single and head of household and $32,000 for married filing jointly), then at least 50%, and up to 85%, of Social Security benefits are taxable.

The easiest way to illustrate the impact of RMD’s vs. no RMD’s on the taxation of Social Security benefits is with an example. Per the attached Taxable Social Security Benefits Example, all facts are identical with the difference being that Case A includes taxable IRA’s, or RMD’s, in the amount of $18,000 vs. $0 in Case B. Case A provisional income of $50,000 exceeds the base amount of $32,000, resulting in taxation of Social Security benefits. $11,100, or 55.5% of Social Security benefits, are taxable. Case B provisional income of $32,000 is identical to the base amount, resulting in no taxation of Social Security benefits.

While the amount of your income excluding RMD’s may be in excess of the Social Security base amount, resulting in taxation of your Social Security benefits, you may be able to reduce the percentage of your taxable Social Security benefits below 85%, and possibly as low as 50%, by reducing your RMD’s via one or more Roth IRA conversions. This can result in significant income tax savings for many years.

When deciding whether or not to do a Roth IRA conversion, as well as the amount of same, whether you’re 40 years old or 70 years old, always keep in mind the impact of your decision on the potential taxation of your current and/or future Social Security benefits.

Annuities Deferred Income Annuities Retirement Income Planning

Designing Your Income Annuity Plan

While one of the benefits of income annuities as stated in Immediate Income Annuities: The Cornerstone of a Successful Retirement Income Plan is reduced dependence on ongoing investment management, anyone considering the purchase of an annuity should first engage the services of a professional retirement income planner.

A professional retirement income planner, after discussing your retirement income needs with you and analyzing your financial situation, will prepare an income annuity plan that includes a comprehensive analysis and recommendations. The analysis should include multi-year cash flow, income tax, and portfolio projections that illustrate the following:

  • Use of income annuities vs. other types of annuities
  • Use of income annuities vs. other types of investments
  • Amount of taxable vs. nontaxable annuity payments in the case of nonqualified annuities
  • Taxation of projected Social Security benefits with and without single premium immediate annuities (“SPIAs”) and deferred income annuities (“DIAs”)
  • Affect of the use of income annuities on projected required minimum distributions (“RMDs”)
  • How income annuities are being used to close one’s income gap
  • Advantages and disadvantages of implementing an income annuity plan now vs. later
  • Projected portfolio assets in the event of a long-term care situation
  • Projected portfolio assets upon death
  • Projected ongoing cash flow following death to surviving spouse and other beneficiaries
  • Implementation of other planning techniques that can be used in conjunction with income annuities

If it is determined that fixed income annuities should be part of the recommended solution, the recommendations should discuss specific design parameters, including the following:

  1. Contract type: nonqualified or qualified
  2. Whether SPIAs and/or DIAs should be used
  3. Number of SPIA and DIA contracts to be purchased
  4. Initial purchase amounts
  5. Ongoing purchase amounts and timing of same
  6. Source of funds to be used for initial and ongoing purchases of each contract
  7. Whether the annuity contract is replacing another annuity contract or life insurance policy
  8. Plan type: period certain, life, joint life
  9. Payment commencement dates for DIAs
  10. Payment amount
  11. Payment frequency: monthly, quarterly, semi-annual, or annual
  12. Inflation percentage increase
  13. Number of payments in the case of a period certain
  14. Owners
  15. Annuitants
  16. Beneficiaries
  17. Life insurance companies

As you can see, the analysis and parameters associated with the design of an income annuity plan is complex, to say the least. Annuities should never be purchased as stand-alone products when used as part of a retirement income planning solution. A professional retirement income planner should always be engaged to perform the requisite analysis and make recommendations that will result in the best solution for determining, and closing, your projected income gap before purchasing any annuities.