All posts in Roth IRA

08 Apr

Protecting Your IRA From Income and Estate Taxes, Choose the Best Distribution Method and Beneficiary

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 2001
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An individual retirement account (IRA) is one of the most common tools used to assure financial independence after retirement because of its tax deduction for contributions and the tax-deferred growth. But the rules regarding distributions and beneficiaries can be confusing, and a wrong decision can result in both a loss of flexibility and Uncle Sam taking a huge bite out of your nest egg — especially after your death.

In addition, the Treasury Department this year substantially revised the 1987 proposed regulations governing the required minimum distribution rules from IRAs and qualified retirement plans, both after age 701/2 and after death. So whether you are opening a new IRA or reviewing your existing account, you need to carefully consider these two key issues.

1. Taking Distributions

You generally cannot take distributions from your IRA before age 591/2 without incurring a 10% penalty. But you also will face a penalty if you don’t take minimum distributions soon enough — 50% of the amount you should have withdrawn but didn’t. Distributions must start by your required beginning date, which is April 1 of the calendar year after you reach age 701/2.

The 2001 proposed regulations make it simpler for you and your plan administrator to understand and apply minimum distribution rules. Under the 2001 and 1987 proposed regulations, you determine the required minimum distribution by dividing your account balance by the distribution period.

For lifetime required minimum distributions, the 2001 proposed regulations provide a uniform distribution period for all participants of the same age. An exception applies if the sole beneficiary is your spouse and he or she is more than 10 years younger than you. If this is the case, you can use the longer distribution period measured by the joint life and last survivor life expectancy of you and your spouse.

Use the uniform distribution table to determine your required minimum distribution for each year based on your current age and account balance as of the end of the prior year. You no longer need to elect to recalculate or not recalculate your life expectancy.

After your death, the distribution period is generally the remaining life expectancy of your designed beneficiary. Your beneficiary’s remaining life expectancy is calculated using the beneficiary’s age in the year following the year of your death, reduced by one for each subsequent year.

2. Naming a Beneficiary

Although this appears to be a simple decision, the obvious choice — your spouse or your children — may not be the best. Remember that at your death, your IRA will be subject to federal estate tax as well as income tax to the IRA beneficiary. But with proper planning and a smart beneficiary choice, you can reduce this tax liability.

Under the 2001 proposed regulations, your designated beneficiary is determined as of the end of the year following the year of your death — rather than as of your required beginning date or the date of your death as required under the 1987 proposed regulations. Thus, any beneficiary eliminated by distribution of the benefit — or through a disclaimer during the period between your death and the end of the year following the year of your death — is disregarded in determining your designated beneficiary.

If at the end of the year following the year of your death you have more than one designated beneficiary and the account hasn’t been divided into separate accounts or shares for each beneficiary, the beneficiary with the shortest life expectancy becomes the designated beneficiary. This approach is consistent with the 1987 proposed regulations.

Let’s take a look at your choices for beneficiaries and examine how the recently proposed regulations affect them:

Spouse. Designating your spouse as your IRA beneficiary provides him or her the most access to the funds. If your spouse survives you, he or she can roll over the benefits into an IRA in his or her own name and withdraw as much or little as he or she needs. Your spouse can then name your child as beneficiary and calculate minimum distributions using the joint life expectancy of himself or herself and the child. When your spouse dies, the remaining IRA balance will be distributed to your child over the remainder of your spouse’s and child’s joint life expectancies. This method can stretch out IRA distributions and thus extend tax-deferred growth in the account.

Children. If you name your child the beneficiary of an IRA, he or she cannot take ownership of it like a spouse can. In calculating distributions to a nonspouse beneficiary, the 1987 proposed regulations distinguished between whether you died before or after your required beginning date. Under the 2001 proposed regulations, the same rules for distributions after your death apply regardless of whether you died before or after your required beginning date.

In the absence of a plan provision or election of the five-year rule, the life expectancy rule applies in all cases in which you have a designated beneficiary. If you die after your required beginning date, your designated beneficiary, whose life expectancy is used to determine the distribution period, is determined as of the end of the year following the year of your death — rather than as of the date of your death.

If you die before your required beginning date, the proposed regulations now allow a waiver of any excise tax resulting from the life expectancy rule during the first five years after the year of your death if your entire benefit is distributed by the end of the fifth year following the year of your death.

Credit shelter trust. Naming a credit shelter trust as beneficiary allows you to maximize your estate tax savings on your IRA. Your gift and estate tax exemption ($675,000 in 2001, but up to $1 million by 2006) will protect the account from estate taxes on your death, and the trust language will keep it out of your spouse’s taxable estate. Yet your spouse can still have access to the funds.

To clarify the 1997 amendment to the 1987 proposed regulations, the 2001 proposed regulations provide examples in which a testamentary trust is named as your beneficiary. In addition, the look-through trust rules still apply.

Charity. Naming a charity as beneficiary may offer the best tax results. Designating a charity will result in a charitable deduction for estate tax purposes for the full value of the IRA. Because the charity is tax exempt, income tax will also be avoided when the IRA is distributed. Of course, this is only a viable option if your spouse and children will not need the IRA assets.

No designated beneficiary. If you elect to recalculate your life expectancy and die without a designated beneficiary, the 2001 proposed regulations provide that your remaining account balance must be distributed within your remaining life expectancy recalculated immediately before your death. Previously, the 1987 proposed amendments required that your remaining account balance be distributed in the year after your death. Yet the five-year rule automatically applies if you don’t have a designated beneficiary as of the end of the year following the year of your death.

Protect Your Nest Egg

If your IRA is subject to both estate tax (with rates as high as 55%) and income tax (with rates as high as 39.6%), it will be severely depleted after your death. That’s why it’s critical to defer and minimize these taxes. The 2001 proposed regulations simplify how you apply the minimum distribution rules.

To learn more about planning with your IRA, turn to page 6 and request a complimentary copy of our Estate MiniPlanner “Are Your Retirement Benefits Safe From Creditors?” And please don’t hesitate to call us for assistance. We’d be glad to help you navigate this complex area.

08 Apr

Are Your Retirement Benefits Safe From Creditors?

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 2001
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Maintaining a qualified retirement plan, such as a 401(k), offers long-term security. But how safe are these assets if you are subject to claims before retirement? The Internal Revenue Code specifically bars qualified plan benefits from being assigned or alienated except under certain circumstances. The U.S. Supreme Court has taken this further, conclusively holding that ERISA qualified plan benefits are absolutely protected from creditors (including in bankruptcy) other than the IRS, spouses and ex-spouses under qualified domestic relations orders. Nonetheless, several questions come to mind.

Are IRAs Protected? 

Upon retirement, retirees commonly roll over 401(k) and other qualified plan assets into individual retirement accounts (IRAs). But the protection for assets held in such nonqualified plans is unclear. Federal law does not expressly protect them, though many states have enacted statutes that do.

Are Distributions Protected? 

Whether a plan distribution is protected from creditors primarily depends on state law, and, as with IRAs, the protection afforded varies widely. Many states give some level
of protection to segregated funds that consist only of the amount necessary to support the debtor.

Other states rely on federal law. Federal bankruptcy exemptions apply to distributions reasonably needed to support a plan beneficiary. But it is unclear whether the debtor must already be receiving payments to take advantage of the exemption. Clearly unprotected are amounts in excess of what is reasonably necessary for support.
Unfortunately, federal law mandates when distributions must begin and how much must be taken. If creditors are an issue, hold off taking distributions as long as possible.

Are Funds Contributed Shortly Before Filing Bankruptcy Protected? 

The fraudulent conveyance rules bar giving assets away to avoid paying a creditor. Conversion of assets that are not protected into assets that are, such as contributing funds to a 401(k) shortly before filing bankruptcy, should not, strictly speaking, be a fraudulent conveyance.

But a prefiling contribution doesn’t look good, particularly if the timing of the contribution is unusual for the debtor. A bankruptcy trustee can refuse a discharge order for a debtor who has engaged in transactions that appear to impede a creditor’s rights.

Smart and Effective

Maximizing contributions to plans continues to be one of the most effective retirement savings and asset protection devices available. Despite uncertainties, the potential benefit appears to outweigh the risk. If you have any questions about the security of your plan please call us. We would be glad to help you assess your accounts and advise you on ways to scrutinize the risk of loss
to creditors.

08 Apr

Should Your Younger Spouse Roll Over Your IRA After You’re Gone?

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 2001
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If your individual retirement account (IRA) balances are substantial, what’s the best way to plan your estate? Generally, you should name your spouse as the primary IRA beneficiary to provide greater flexibility. After your death, your spouse will have three options. But choosing the best can be complicated, especially if your spouse is younger.

Option 1

Your surviving spouse can keep your IRA in your name and continue to take distributions the same way you took them. Your spouse takes minimum distributions either over his or her life, or over a period not exceeding his or her life expectancy. Even if your spouse is under age 591/2, distributions from the IRS are subject only to income tax, not the 10% penalty for early withdrawals.

This option has great appeal if your spouse is considerably younger than age 591/2 and will most likely withdraw all or substantially all the IRA funds before reaching age 591/2. For example, assume that your estate consists of a house, some small investment accounts and a large IRA and your surviving spouse wants to remain in the house and will need to tap IRA funds to live on. Then income tax deferral will probably not be a concern and this is likely the best option.

Option 2

Your spouse can roll over your IRA into his or her own IRA and name his or her own beneficiaries, such as your children. No matter your spouse’s age at the time, he or she may take distributions over his or her and a beneficiary’s joint life expectancy. The IRA minimum distribution rules require starting distributions by April 1 of the year after he or she turns 701/2. Naming a younger beneficiary allows your spouse to take smaller distributions from the IRA, thus increasing the amount that can continue to grow tax deferred.

A rollover is often the preferred option, but it has one disadvantage if your spouse is younger than age 591/2 when you die: He or she will owe a 10% penalty tax in addition to regular income tax on early withdrawals. (The 10% penalty is not assessed on early withdrawals used for qualified higher education expenses incurred during the same year as the withdrawals.)

Option 3

If your IRA is large enough, the best option may be for your surviving spouse to divide your IRA into separate IRAs maintained under your name. Your spouse then can elect to treat one of the separate accounts as his or her own and roll it over into his or her own IRA, so that it grows tax deferred until he or she reaches age 591/2. Your spouse can take withdrawals from the portion left in your name without incurring the 10% penalty.

For example, Gary, age 52, dies with $1 million in his IRA when his designated beneficiary, his wife, is 40. She rolls $600,000 into a new IRA in her name and designates one child as the beneficiary. Starting when she is age 591/2, she can take distributions from her own account over her and the child’s joint life expectancies. She leaves $400,000 in Gary’s IRA and takes distributions from it — regardless of her age — as needed without incurring a penalty.

Understand the Tax Implications

If your estate consists of a large IRA and your spouse is younger than age 591/2, tax consequences could complicate your and your spouse’s estate plans. Understanding these implications now can help your spouse avoid tax after you’re gone. And for help on how to inform your spouse about your estate plan, please fax back page 6 for a complimentary copy of our Estate MiniPlanner “How To Provide Both Financial Security and Peace of Mind.”

08 Apr

How Valuable Could the New Roth IRA Be to You?

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 1998
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The Taxpayer Relief Act of 1997 provides several inducements for retirement savings. The Act creates education individual retirement accounts (IRAs). It offers the ability to withdraw funds from IRAs without penalty for higher education expenses, as well as the limited ability to withdraw funds for a first-time home purchase. It expands eligibility for the deductible IRA. It eliminates the excise tax on excess IRA and qualified retirement plan distributions and accumulations. But perhaps the greatest benefit the Act offers is the new savings vehicle called the Roth IRA.

How the Roth IRA Works

Starting in 1998, a husband and wife with an adjusted gross income (AGI) of up to $150,000 (and singles with AGI up to $95,000) can each make annual contributions of $2,000 to a Roth IRA. Unlike those made to traditional IRAs, the contributions are not deductible, but they do still grow tax-deferred. And, qualified distributions from both contributions and their earnings are tax-free. By contrast, deductible contributions and their earnings are both taxed on withdrawal from a traditional IRA.

Another way to establish a Roth IRA is through a rollover from an existing IRA. At the time of the rollover, you will owe income tax on all previously untaxed contributions and earnings, but you won’t be subject to the 10% early withdrawal penalty. And, if you roll over IRA assets before Jan. 1, 1999, the resulting tax bill will be spread over four years. If your AGI for the year (not including the amount rolled over) exceeds $100,000, you cannot roll over the IRA during that year.

Should You Pay Tax Now? 

The Roth IRA promises greater long-term benefits than the deductible IRA. Why? As a general rule, as long as your income tax rate stays the same or increases at the time you withdraw funds, you will end up with more money in a Roth IRA than in a deductible IRA because the growth is never taxed. If, however, you expect your rate to be lower at retirement, you are probably better off with the deductible IRA.

Look at the example above. Assume you contribute $2,000 per year for 5, 10, 15 or 20 years, you earn a compound annual return of 8%, and you then withdraw the proceeds without penalty. For the deductible IRA, assume you were in the 28% income tax bracket when the contributions were made. As you can see, as long as your income tax rate doesn’t drop, you will have more funds available for your use with a Roth IRA.

Should You Roll Over?

To decide if a rollover makes sense, determine whether the benefit of not paying tax when you take distributions will likely outweigh the cost of the immediate income tax on the amount rolled over (which will leave less in the account to grow tax-free). In other words, when you take distributions will you have more available for your use in a Roth IRA than you would have in a deductible IRA?

Let’s look at an example. Laura has an IRA that holds deductible contributions and their earnings. In January 1998, she considers withdrawing $10,000 from her IRA and rolling it into a Roth IRA. She has $2,800 in a taxable account which she can use to pay the tax that will result from the rollover, and she expects her AGI for 1998 to be $55,000.
Assuming that the IRA will grow at 10% annually, that Laura will remain in the 28% bracket and that the taxable account will grow at a 7.2% after-tax basis, should she make the rollover? Let’s compare the possible outcomes of her two options:

1. If Laura leaves $10,000 in her deductible IRA, in 20 years she will have $67,275 in her IRA, but only $48,438 available for her use because of the 28% income tax on her withdrawal. She will have $11,247 left in her taxable account ($2,800 plus growth), for total funds of $59,685.

2. If Laura rolls $10,000 into a Roth IRA, in 20 years she will have $67,275 in her IRA which will all be available for her use because the withdrawal will be tax-free. She will have only $1,083 in her taxable account, because of the taxes of $700 per year for four years that she paid on the rollover. Her total funds available will be $68,358.
This example indicates that the Roth IRA will provide a better result for Laura. It does assume, however, that she will live for 20 more years, and, perhaps more important, that the law will not change again!

4 Key Questions

Your answers to the following four key questions will help you determine whether a Roth IRA is a better option for your situation than a deductible IRA:

1. When will you take distributions? If you still have a long time until you will retire or take other qualified distributions, a Roth IRA may be beneficial because you will accumulate a large amount of earnings that you won’t have to pay taxes on. If you have a shorter time until retirement but don’t expect to take distributions then, a Roth IRA will probably still be good for you because you can continue to let the amounts in the IRA build up tax-free indefinitely and can continue to make contributions, even after age 70 1/2.

2. Will you be in the same, a higher or a lower tax bracket when you take distributions? If you will be in at least as high a tax bracket when you need to take distributions from the IRA as you are in now, a Roth IRA may be beneficial because you likely will not pay any more in taxes by paying them up front.
If you are considering rolling over funds from a traditional IRA, also consider the following questions:

3. How long has your traditional IRA been open? If it has been open for a relatively short period of time and your answers to the previous questions also incline you toward the Roth IRA, a rollover will likely be beneficial because you won’t have much earnings to pay taxes on at the rollover and the potential for tax savings on future earnings is great.

4. Does your traditional IRA consist primarily of deductible or nondeductible contributions? If it consists primarily of nondeductible contributions and your answers to the previous questions indicate that a Roth IRA will likely be beneficial, a rollover is the best option because you will have to pay tax only on the limited deductible contributions and any earnings, and the potential for tax savings on future earnings is great.

Each situation is different and must be analyzed based on your set of circumstances. We would be pleased to assist you in determining if the Roth IRA is right for you.

What Is a Qualified Distribution?

Qualified distributions from Roth IRAs are not subject to income tax or the 10% early withdrawal penalty. Distributions are qualified if:

  • The account has been open for more than five years, and
  • Distributions are made after age 59 1/2 or as a result of long-term unemployment, disability or death, or are used to buy a first home.

Roth IRA: Total available on tax-free withdrawal

Years in IRA
5
10
15
20
Paid out tax-free $12,672 $31,292 $58,648 $98,845

Deductible IRA: Total available after taxes on withdrawal

Years in IRA
5
10
15
20
If tax rate drops to 15% $13,849 $35,162 $63,242 $105,182
If tax rate stays at 28% 12,446 30,249 55,763 92,401
If tax rate rises to 31% 12,122 30,391 54,036 89,451
If tax rate rises to 36% 11,581 27,910 51,157 84,533
If tax rate rises to 39.6% 11,191 26,795 49,084 80,992

Other Roth IRA Benefits

  • Although nonqualified distributions coming from earnings in the IRA are taxed, distributions are treated as coming first from contributions, which are not taxable.
  • No minimum distribution rules.
  • Post-age-70 1/2 contributions allowed.
08 Apr

Should you convert to a Roth IRA?

In Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner May-June 2007
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Roth IRAs can offer significant estate planning advantages over traditional IRAs. But until recently, these advantages have been unavailable to higher-income taxpayers who often stand to benefit the most. Under tax legislation passed last year, anyone – regardless of income level – can convert a traditional IRA to a Roth IRA starting in 2010.

Know the difference

Traditional IRAs can offer current tax deductions and tax-deferred growth, but withdrawals are subject to ordinary income taxes at rates as high as 35%. A Roth IRA takes the opposite approach: Contributions aren’t deductible, but qualified withdrawals of contributions and – best of all – earnings are income-tax free.

From an estate planning perspective, the Roth IRA is the clear winner. With a traditional IRA, you have to take required minimum distributions starting at age 70 1/2, whether you need the money or not. But a Roth IRA can continue growing income-tax free indefinitely, allowing you to build a larger nest egg for your family.

Also, when you leave a traditional IRA to your children or other heirs, income taxes may take a big bite out of their inheritance because they’ll have to pay income tax on all distributions. Roth IRAs provide a dual estate planning benefit: Not only are distributions to your heirs income-tax free, but the amounts you pay in taxes on the income you contribute to the Roth IRA are removed from your estate. In other words, by paying the taxes associated with a Roth IRA, you essentially make a tax-free gift to your heirs.

Know your limits

There’s no income limit for making contributions to a traditional IRA. So long as you receive enough compensation from a job to cover your contribution, you can set aside up to $4,000 in 2007 ($5,000 if you’re 50 or older). If you’re married and your spouse has little or no income, you may also be able to contribute similar amounts to a spousal IRA.

The tax deductibility of your contributions, however, depends on your participation status in employer-provided retirement plans and your income. If, for example, one or both of you participate in a plan at work, your IRA contributions become nondeductible above specified income limits, which are quite low.

Roth IRAs are subject to the same contribution limits as traditional IRAs, but higher-income taxpayers are ineligible. If you’re a joint filer, for example, your ability to contribute to a Roth IRA in 2007 is phased out beginning at $156,000 of modified adjusted gross income (MAGI) and eliminated once your MAGI reaches $166,000. If you’re single, the phaseout range is $99,000 to $114,000 of MAGI.

It’s also possible to convert an existing traditional IRA into a Roth IRA. Previously, this option was reserved for taxpayers with MAGI of $100,000 or less. But the income limit for conversions will be eliminated – beginning in 2010 – under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), which was signed into law in May 2006. This is good news if you’ve built up large balances in traditional IRAs, either through annual contributions or by rolling over funds from a 401(k) or other employer-sponsored retirement plans.

Know your options

TIPRA opens the door for higher-income taxpayers to take advantage of the Roth IRA’s estate planning benefits. By converting a traditional IRA into a Roth, you can avoid required minimum distributions and allow your savings to continue growing income-tax free.

You’ll have to pay income tax on the amount you convert, but in many cases the benefits of tax-free growth outweigh the tax hit. Plus, if you make the conversion in 2010, TIPRA allows you to defer the tax and include half of the conversion income on your 2011 return and half on your 2012 return.

Be sure to analyze the tax consequences before you convert. Depending on the size of your IRA and your income level, a Roth IRA conversion can bump you into a higher tax bracket. If that’s the case, you may want to convert your IRA gradually over several years to minimize the tax impact.

TIPRA doesn’t lift the income restrictions on contributions to a Roth IRA. But it creates a “back door” option for high-income earners.

For example, Nancy, age 50, doesn’t have an IRA. With MAGI in excess of $200,000, she’s ineligible to contribute to a Roth IRA but can make nondeductible contributions to a traditional IRA. Nancy sets up a traditional IRA in 2007 and contributes $5,000 per year. Assuming an 8% rate of return, the IRA’s balance in 2010 is $22,531. Nancy converts the entire amount into a Roth IRA. Because her contributions (totaling $20,000) weren’t deductible, Nancy pays taxes only on $2,531 in earnings. She can include the entire amount on her 2010 return, or report half that amount on her 2011 and 2012 returns.

After 2010, Nancy continues contributing $5,000 per year to her traditional IRA, avoiding taxes on the earnings by immediately converting the funds to her Roth IRA. When she retires at age 65 (again, assuming an 8% rate of return), her Roth IRA has grown to more than $150,000, all of which can be distributed income-tax free.

Assuming that the law isn’t changed, the new conversion rule effectively allows Nancy to enjoy the benefits of a Roth IRA even though she’s ineligible to make Roth IRA contributions.

Making the switch

Under the right circumstances, the new conversion rules create valuable estate planning opportunities for high-income earners. Be sure to check with your tax advisor before opening a Roth IRA account.