Tennessee Estate Planning Law : Tennessee Estate Planning Lawyer & Attorney : Bryan Howard : Howard & Mobley Law Firm : Nashville, Chattanooga, Memphis

In a recent case, Cajun Industries, LLC vs. Robert Kidder, et al., the decedent designated his three children as beneficiaries of his 401(k) plan after his first wife died. He remarried a few months before he died and did not realize he needed to make any changes because he still wanted his 401(k) plan to go to his children. Unfortunately, when he died, his new wife successfully claimed the entire 401(k) account due to a federal law known as ERISA. This law required Mr. Kidder to fill out a new beneficiary form after he remarried and to obtain the consent of his new wife.  Because his wife had not consented to his designation in favor of his children, ERISA required the account to be distributed to his wife.

There were two other potential solutions that would have allowed the funds in the 401(k) account to go to Mr. Kidder’s children. Prior to getting married, Mr. Kidder could have asked his wife to sign a prenuptial agreement wherein she agreed to sign a waiver of his 401(k) plan. Alternatively, before he married, Mr. Kidder could have rolled his 401(k) account to an IRA and then designated his children as beneficiaries of his IRA. The rules requiring a spousal waiver to a beneficiary designation do not apply to IRAs.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A previous article explained that IRA account holders who did not make a charitable distribution in the last two weeks of 2010 can make a $200,000 Charitable IRA Distribution in 2011, provided that at least $100,000 of the distribution is made by January 31, 2010. One of my clients asked whether there is any way for him to convert his 2010 required minimum distribution (“RMD”) into a charitable distribution.

My client took his RMD of $82,000 on December 1st prior to going to Florida for the winter. He would now like to give the $82,000 to charity so that he does not have to pay tax on the RMD. Unfortunately, there is no way for him to avoid paying income tax on the RMD.

He can make an $82,000 distribution from his IRA to charity in January, 2011. If he had not taken the RMD in 2010, he could treat the January distribution made to charity as a non-taxable RMD for 2010. However, since he already received the $82,000 as a taxable RMD, the January gift will not help him to reduce his 2010 income taxes.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Over the past 6 trading days, the Dow Jones Industrial Average has dropped from 11,167 to 10,380, which is a drop of 7.6%. If you have not already converted your IRA to a Roth IRA, this is a golden opportunity to make the conversion.  By converting now, you might lose the opportunity to convert at the bottom if the market drops further. However, if it turns out that this is merely a temporary correction, you will be glad you made the conversion even if you slightly miss the bottom. If this turns out to be the beginning of a bear market, you can recharacterize your Roth IRA to a traditional IRA and try again next year. The recharacterization option lets you “win” if the market rebounds and “break even” if the market goes down further.

A market correction is also a good opportunity for establishing a GRAT. GRATs are similar to Roth IRAs in terms of letting you start over without a penalty if the market declines after you establish the GRAT. This may be your last chance to make a tax-free transfer of wealth to younger generations through the utilization of short-term GRATs. Congress is considering legislation that would eliminate this opportunity.  
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

For the last four years, IRA owners who are over age 70.5 have been able to make charitable gifts from their IRA of up to $100,000 per year. This law has been extended before and Congress is currently working on another extension for 2010. Congress’ willingness to continue extending this law is attributable to the popularity of this technique.

Even if Congress extends the law, there may be a better way to make a gift to charity. Here’s how it works: Step 1: Determine how much you want to give to charity from your IRA. Step 2: Make the gift to charity from your non-IRA assets. For example, you could give highly appreciated securities or real estate. Step 3: Convert the same amount of your IRA to a Roth IRA.

The income from the Roth conversion will be offset by the charitable income tax deduction so that the net effect on your income taxes is neutral. Income tax neutrality is consistent with a direct gift to charity from your IRA. However, the synthetic gift has the additional effect of converting appreciated securities from your taxable portfolio into a Roth IRA where you will never pay taxes on the appreciation or the earnings of the securities.

There are 3 other benefits of the synthetic gift technique. You are not limited to a charitable gift of $100,000 per year. You can make a gift to your private foundation or donor advised fund. This is not possible with a direct gift from the IRA.  Finally, if you have not yet attained age 70.5, you are not eligible to make a direct gift from your IRA.  The synthetic gift technique has no age limit.

There is a potential pitfall with this technique. There are complicated income tax rules that affect the timing and amount of your charitable income tax deductions. Make sure your CPA examines the consequences before you make a synthetic charitable IRA gift™.
 

A synthetic charitable IRA gift™ may be a better choice for you than a charitable IRA rollover because it provides money to charity and allows you to convert a portion of your taxable portfolio to a Roth IRA. 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A prior article pointed out that higher tax rates in the future would increase the chance that converting your IRA to a Roth IRA would provide a benefit to you and your family. We now know that income tax rates for high-income individuals will increase beginning in 2013, due to the 2010 Healthcare Act.

High-income taxpayers, defined as single people earning more than $200,000 and married couples earning more than $250,000, will be hit with a a tax increase on wages and a new levy on investments. Under the provisions of the new law, which take effect in 2013, high-income taxpayers will be taxed at an additional 0.9% on wages exceeding $200,000 for single people or $250,000 for married couples.

Beginning in 2013, a new 3.8% tax will be imposed on net investment income of high-income taxpayers. Net investment income includes interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Net investment income is reduced by properly allocable deductions to such income. However, the new tax will not apply to income in tax-deferred retirement accounts such as IRAs and 401(k) plans. Also, the new tax will apply only to income in excess of the $200,000/$250,000 thresholds.

These new taxes enhance the benefits of a Roth IRA conversion in two respects. First, if you do not make the conversion, the required distribution from your regular IRA will increase the chance that you are a high-income individual. Even though the new investment tax will not apply to the amount distributed from a regular IRA, the income from the IRA may force more of your other income to bear a 3.8% tax. If you had converted to a Roth IRA, you would not be required to take a required minimum distribution. Even if you take a distribution, it would not be considered income.

If you make a Roth IRA conversion, it is advisable to pay the income taxes from separate assets. If you do not make a conversion, the income from those separate assets would be hit with this 3.8% investment tax. Stately differently, the after-tax income that you would have received from the money used to pay the conversion tax will be decreased due to the new 3.8% investment tax.

The increased taxes for high-income taxpayers may only be getting started. The new taxes in the Healthcare Act help to pay for the benefits provided by the Act. Many have predicted that the cost of the new Act will substantially exceed the government’s estimates. If this is true, someone will have to pay for the additional costs.

Regardless of whether the new taxes fully pay for the Healthcare Act, someone needs to pay for the burgeoning federal deficit. High-income taxpayers will be a likely target. Any additional taxes imposed in the future will further enhance the benefit of having made a Roth IRA conversion in 2010.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the eighth and final article of a series dealing with the topic of converting your traditional IRA to a Roth IRA. For prior articles, see:

Part 1 – Reasons to Consider the Roth Conversion
Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 4 – How Long Can You Stretch?
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving

Roth IRAs  are tremendous assets to own because they grow tax-free, allow tax-free withdrawals, and do not require you or your spouse to make withdrawals.

Determining whether the cost of a Roth IRA is a good investment depends on numerous factors, including income tax rates that will apply to you and your family now and in the future, whether you and your family can pay the conversion tax and meet your spending needs from other sources, whether you will be subject to estate taxes, and how much you plan to give to charity during your lifetime and at death.

Wealthy families are the most likely candidates to benefit from a Roth IRA conversion because they are likely to be in a high income tax bracket in the future, they can pay the conversion tax and meet spending needs from other sources, they will be subject to estate taxes, and they are able to make additional charitable gifts to offset the income tax generated by the conversion. 
 

The recharacterization option is a valuable tool which allows you to make a conversion and then change your mind as long as 21 months later. During this 21-month period, you will see tax law changes that have occurred and how your investments have performed. When you make a conversion, you should create several Roth IRA accounts, with each account holding different asset classes, in order to maximize the flexibility afforded by the recharacterization option.
 

Most wealthy individuals should make a conversion and follow the steps outlined in the following timeline.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the seventh article in a series of eight articles dealing with the topic of converting your traditional IRA to a Roth IRA. For other articles, see:

Part 1 – Reasons to Consider the Roth Conversion
Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 4 – How Long Can You Stretch?
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 8 - Putting It All Together

Individuals who make significant charitable gifts have additional considerations when evaluating whether to convert a traditional IRA to a Roth IRA. A lot of my clients plan to give at least a portion of their traditional IRA to charity upon their death. In addition to wanting to make charitable gifts, these clients realize that the bequest to charity will avoid income taxes and estate taxes. Individual beneficiaries would have to pay income taxes if they received the IRA. Furthermore, if the IRA owner’s estate is larger than the allowable estate tax exemptions, there will also be estate taxes imposed upon the portion of the IRA that is paid to children.

Individuals who plan to give their IRA to charity have less to gain by making a conversion. If you are planning to leave a portion of your IRA to charity, a conversion will cause you to pay income taxes now that you might not otherwise be paying later. In certain circumstances, you can still justify making the Roth IRA conversion. Nevertheless, I have discouraged my clients who plan to leave their entire IRA to charity from making the Roth conversion.

Some IRA owners intend to leave only a portion of their IRA to charity. Assume that Mrs. Brown has a $500,000 IRA and the beneficiaries are designated as follows: $100,000 to XYZ Church, $100,000 to XYZ University, and the balance to children.

Mrs. Brown can convert a portion of the IRA to a Roth IRA. Ideally, she will not convert beyond the amount which will allow there to be at least $200,000 in her traditional IRA upon her death. Some guesswork will be required to determine how much to leave in the traditional IRA so that there is at least $200,000 at the time of her death because there will be earnings and required minimum distributions during her remaining lifetime.

Assume that Mrs. Brown expects to live to age 90 and her investment advisors recommend that she leave at least $300,000 in her traditional IRA so that there will be at least $200,000 left when she dies. She should convert the entire $500,000 and place $100,000 in five separate accounts. No later than October 15 of the year following the conversion, she will recharacterize three of the accounts, or perhaps more if investments have performed poorly. This technique allows her to make the conversion with the best performing accounts while leaving sufficient funds in the traditional IRA to make the charitable bequests at the time of her death.

Your lifetime charitable giving is also relevant to the Roth conversion analysis. You will recognize income in the year of the conversion. For conversions in the year 2010, you can elect to recognize 50% of the income in the year 2011 and 50% in the year 2012. If you know that you will be making large charitable gifts in the future, you may choose to accelerate those gifts into the year of the conversion (or into 2011 and 2012 for conversions in the year 2010).

If you need a charitable deduction now, but do not want the charities to receive the funds until later, your charitable donation can be “escrowed” in a donor advised fund or a private foundation. Both of these structures allow you to identify the charitable recipients and make the actual charitable gifts in a later year.

In summary, you should consider accelerating charitable gifts to reduce income taxes attributable to a conversion of your traditional IRA to a Roth IRA. You should not convert the portion of your traditional IRA that you intend to leave to charity upon your death.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the sixth article in a series dealing with the topic of converting your traditional IRA to a Roth IRA. For other articles, see:

Part 1 – Reasons to Consider the Roth Conversion
Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 4 – How Long Can You Stretch?
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 7 – Ramifications of Charitable Giving
Part 8 - Putting It All Together

Wealthy individuals who expect to leave a significant portion of their IRA to their children or grandchildren have an additional reason to consider a Roth IRA conversion. The income taxes payable on the conversion will reduce the amount that is subject to estate taxes upon the death of the IRA owner.

The benefit can be illustrated by examining a “deathbed” conversion to a Roth IRA. Assume that a widow has a $5.5 million estate, including a $1 million traditional IRA, that she plans to leave to her children during a year when the federal estate tax exemption is $3.5 million. If a Roth conversion is made immediately prior to death and the widow is in the highest current marginal income tax bracket, herr estate would have to pay $350,000 of income taxes. However, the combined Tennessee and federal death taxes will decrease by approximately $176,000 because the income tax liability becomes an estate tax deduction.

Another way of analyzing the conversion is that the income tax rate on the conversion is 17.4% rather than 35%. Because the income tax rate is lower, the conversion is more likely to be a good idea.

Even though the effective tax rate on the conversion is only 17.4%, this does not guarantee that the conversion will be beneficial. The answer depends on the tax rates that would apply to future distributions to the beneficiaries of the IRA if you had not converted it to a Roth IRA.

Your beneficiaries will get future income tax deductions attributable to the federal (but not Tennessee) death taxes paid with respect to the IRA. This deduction will reduce income taxes on future distributions from the IRA to the beneficiaries. The value of this deduction will never be as good as the $176,000 reduction in estate taxes. Furthermore, federal tax law already imposes hurdles to getting the full benefit of this deduction. I predict that future tax laws will impose additional hurdles.

When calculating the income tax rate that will apply to your beneficiaries, keep in mind that they will also be receiving income from other assets that they inherit from you. The beneficiaries may also live in states that impose state income taxes on distributions from a traditional IRA (unlike Tennessee).

What if you die at a time when there is no federal estate tax? Assume that you convert in January of 2010, then die in December of 2010, and that the current federal estate tax laws are not revised. Your estate will not be subject to federal estate taxes. If you were counting on a reduction in federal estate taxes to make the conversion a good idea, your executor will be able to recharacterize the Roth IRA as a traditional IRA until October 15, 2011. I recommend discussing this matter with your executor and/or adding a codicil to your will.

IRA owners whose estates will pay federal estate taxes when they die can leave their children and grandchildren a more useful inheritance by converting at least a portion of their IRA to a Roth IRA. In most cases, the beneficiaries will receive more spendable after-tax income from their inheritance.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the fifth article in a series dealing with the topic of converting your traditional IRA to a Roth IRA. For other articles, see:

Part 1 – Reasons to Consider the Roth Conversion
Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 4 – How Long Can You Stretch?
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving
Part 8 - Putting It All Together

Investment performance has extra significance during the first 21 months after a conversion to a Roth IRA. Your investment performance may determine whether you undo the conversion. The recharacterization option allows you to change your mind about a conversion as late as October 15 of the year following the conversion. This means that if you convert in January, you can make the Roth decision after seeing your investment returns over the prior 21 months.

The ability to make your decision after seeing your investment returns allows you to choose the maximum income tax rate that you are willing to pay. Assume that you are in a 35% income tax bracket and are only willing to make the conversion if the maximum tax rate on the conversion is 25%. This means that you will recharacterize the Roth IRA to a regular IRA unless the value of the IRA has grown by 40% during the first 21 months.

Unless you are a fantastic investor, there is a small likelihood of achieving a 40% rate of return on your entire portfolio over a 21 month period. However, you only need to obtain this return on a portion of your portfolio.

For example, assume that you convert an IRA with a value of $600,000 into six separate Roth IRAs with values of $100,000. You choose the overall investments for the Roth IRAs as if they were one account, yet place different asset classes in different Roth IRAs. Splitting your various asset classes into separate Roth IRAs increases the volatility of returns for each Roth IRA without increasing the risk of the overall portfolio. By increasing volatility, you significantly improve the chances of achieving a higher return on portions of your portfolio during the first 21 months.

Assume that the values of the six Roth IRAs after 21 months are $150,000, $130,000, $110,000, $100,000, $80,000, and $60,000. You will keep the two largest Roth IRAs and recharacterize the four with the lowest values. You will pay $70,000 of tax (35% times $200,000) on the two largest Roth IRA accounts with a combined value of $280,000. This represents an effective tax rate of 25%. The overall return on the portfolio was $30,000, which represents an aggregate return of 5%. However, by splitting the portfolio into its separate asset classes, you were able to achieve a much higher return on the portion of the portfolio that you converted.

Derivatives can be used to further increase the volatility among segments of your overall portfolio, without necessarily increasing the volatility of your combined portfolio. Though derivatives are frequently used by hedge fund managers, they are not utilized by many investors because they are less well understood and because they generally receive unfavorable income tax treatment when they are used in taxable accounts. The tax disadvantage is not a concern for Roth IRAs because Roth IRAs do not pay income taxes.

You will need to closely monitor your investments during the 21 month period following the conversion. On December 2 of the year of the conversion, you should consider recharacterizing accounts that have gone down in value. You can then reconvert on January 2 of the following year. On the other hand, if your investments do very well during the first months after the conversion, you might choose to shift the investment mix of the successful Roth accounts to decrease the risk of going backwards during the remainder of the 21 month period.  Similarly, you might shift investments to increase the volatility of accounts that are positive, yet not positive enough to keep the Roth IRA conversion. Ideally, any investment changes made during the 21 month period will maintain your overall desired portfolio allocation.

After the 21 month period, you can combine all of the Roth IRAs that you did not recharacterize and invest the combined Roth IRA account according to your long-term objectives. You will also need to coordinate the investments in your Roth IRA, your traditional IRA, and your taxable investment accounts.

The ability to decide about keeping a Roth conversion after seeing your investment returns will encourage a lot of investors to take a “free look.”  Careful planning with the assistance of your investment advisors is required to take maximum advantage of this tremendous opportunity.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the fourth article in a series dealing with the topic of converting your traditional IRA to a Roth IRA. For other articles, see:

Part 1 – Reasons to Consider the Roth Conversion
Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving
Part 8 - Putting It All Together

If you convert to a Roth IRA, you are betting that the present value of incremental withdrawals by you and your family in the future are greater than the taxes you will pay at the time of the conversion. Future withdrawals will be maximized when you and your heirs keep the Roth IRA intact for a long time.

The first and most important hurdle for keeping the Roth IRA intact is whether you can pay the tax on the conversion from other assets. If you must use funds from the IRA to pay the tax, my advice is to not make the conversion.

The next hurdle is whether you and your spouse will need to take withdrawals from the Roth IRA. One benefit of Roth IRAs is that you do not have to take required minimum distributions during your lifetime. If you designate your spouse as the beneficiary following your death, your spouse can rollover the Roth IRA to his or her own Roth IRA. Your spouse will not have to take any distributions during his or her lifetime. Thus, if you and your spouse can meet your living expenses from other sources, you will never have to take a distribution during your remaining lifetimes.

The final hurdle is the time period over which your children (and/or grandchildren) will take withdrawals from the Roth IRA after you and your spouse die. They will be required to take distributions over their remaining life expectancy, determined under IRS tables at the death of the survivor of you and your spouse. For example, if the beneficiary is age 45, his or her life expectancy is 38 years.

Your beneficiaries will be eligible to leave the Roth IRA intact for a long time. However, imagine the temptation for the beneficiaries to make tax-free withdrawals to buy new cars or to take vacations. If you are concerned that your beneficiaries might take distributions for wants rather than needs, you can use a trust as the beneficiary of the Roth IRA. The Trustee would be required to withdraw the required minimum distribution and could withdraw more if the beneficiary needs more. In addition to slowing down withdrawals, the Trustee might add investment expertise that the beneficiaries lack.

Families that can meet spending needs from sources other than the Roth IRA have more to gain from converting a traditional IRA to a Roth IRA. If the Roth IRA will be liquidated relatively quickly, paying tax now is less likely to provide a benefit to your family.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the third article in a series dealing with the topic of converting your traditional IRA to a Roth IRA. This article will examine the impact of income tax rates. For other articles, see:

Part 1 – Reasons to Consider the Roth Conversion
Part 2 – The Recharacterization Option
Part 4 – How Long Can You Stretch?
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving
Part 8 - Putting It All Together

A comparison of the income tax rate that will apply at the time of the conversion and the income tax rates that would apply to future withdrawals from your traditional IRA is the most important factor in helping you decide whether or not to make the conversion. The general rule is easy to state. If you anticipate your future income tax rates to be lower, converting to a Roth IRA is likely to be a poor choice. If rates will be the same or higher, converting is likely to be a good idea.

Judging by historical standards, the current top marginal income tax rate in the U.S. is extremely low. Since 1932, there have only been five years (1988-1992) where the top rate was lower than it has been for the period of 2003 through 2009.

 In light of the huge deficits that this country is facing, it seems inevitable that the highest marginal income tax rate will increase significantly. The top marginal income tax rate is currently scheduled to increase from 35% to 39.6% in 2011. The health care legislation that is currently being considered by Congress may include a surtax on the highest income taxpayers. We cannot tell for sure where rates are headed. However, there is a good chance that the highest rates will be increasing.

Not all wealthy individuals pay tax at the highest income tax rate. They may receive a lot of their income as tax-free interest on municipal bonds and tax-advantaged capital gains. Even if you are currently in the highest marginal income bracket, your income might decline in future years, especially if you are still working.

You need to keep in mind who will be paying the tax. It is reasonable for wealthy individuals to conclude that they and their spouses will always be in the highest marginal income tax bracket. However, if they only withdraw the required minimums, there will be a lot left in the IRA for their children. The children may not be in the top income tax bracket.

State income taxes should be considered. Tennessee does not impose an income tax on withdrawals from a traditional IRA. You might move to a state that imposes tax on distributions from a traditional IRA. It is more likely that your children will live in a state that imposes a tax on distributions from a traditional IRA.

You should also consider the possibility of leaving at least a portion of your traditional IRA to charity. If you are planning to make a bequest to charity upon your death, you should satisfy the bequest with a portion of your IRA. The income tax rate on distributions to charity from your IRA will be zero.

Even if income tax rates are highest in future years, this does not necessarily mean that you will benefit by converting. The conversion will likely force you into the highest bracket in 2010 because you will have the include the entire amount in your income for that year (or half in 2011 and half in 2012 if you make a deferral election).

The danger of higher income tax rates in the future will motivate a lot of people to convert at least a portion of their traditional IRA to a Roth IRA in 2010. Before you convert, you should consult with your CPA and other advisors to make sure that you are taking into account the myriad of factors that will determine the tax rates for you and your family if you do not make the conversion.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the second article in a multi-part series dealing with the topic of converting a traditional IRA to a Roth IRA. For other articles, see:

Part 1 – Reasons to Consider the Roth Conversion
Part 3 – The Impact of Income Tax Rates
Part 4 – How Long Can You Stretch?
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving
Part 8 - Putting It All Together

This article will focus on recharacterizations. A recharacterization allows you to change your mind and undue a Roth conversion. This is such a valuable option, that it will significantly influence how many people choose to make a conversion.

A recharacterization can be made any time before October 16 of the calendar year following the conversion. This means that if you make the Roth conversion in January of 2010, you can recharacterize as late as October 15, 2011. You have nothing to lose by making the conversion in 2010. You can make the conversion, evaluate the consequences for up to 21 months, and then recharacterize if you decide that the conversion was a bad idea.

A decline in the value of the Roth IRA after the conversion will be a common reason for making a recharacterization. Alternatively, you might decide that you cannot afford to pay the tax from separate assets or that you or your children will be in a lower tax bracket in the future.

If you recharacterize, you must recharacterize the entire Roth IRA account. However, you do not have to recharacterize all Roth IRA accounts. If you segregate your IRA into multiple Roth IRAs at the time of the conversion, you will be able to pick and choose which accounts you recharacterize. If one or more of the accounts goes down in value, you may be well advised to recharacterize the accounts that have declined in value. You should work with your investment advisors to fund the various accounts with different assets whose historical returns have not been highly correlated.

If you only plan to convert a portion of your IRA, you might as well convert the entire account and create several Roth IRAs. You can then recharacterize the accounts that have the lowest investment return.

After you recharacterize, you can reconvert to a Roth IRA again. The reconversion can be made on the later of (a) 30 days after the recharacterization; or (b) the taxable year following the taxable year of the original conversion. For example, if you convert in January of 2010 and recharacterize on November 1, 2010, you will have to wait until January 1, 2011 before you can reconvert. If you recharacterize a January 2010 conversion on October 15, 2011, you will be able to reconvert on November 15, 2011.

Because the deadline for recharacterizing is October 15 of the year following the year of the conversion, there is an advantage to making a conversion in the early portion of the year. If you convert in December, you will have 10 months to decide whether or not to recharacterize. If you convert in January, you will have as much as 21 months to evaluate the decision.

In summary, the ability to recharacterize a Roth IRA conversion will cause numerous individuals to “test the waters” even if they are not convinced that the conversion is a good idea for them. When you convert your traditional IRA to a Roth IRA, you should consider splitting the IRA into several Roth IRAs so that you can maximize the benefits afforded by the recharacterization option.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

This is the first article in an eight part series on Roth IRA conversions. For other articles, please see:

Part 2 – The Recharacterization Option
Part 3 – The Impact of Income Tax Rates
Part 4 – How Long Can You Stretch?
Part 5 – The Impact of Investment Returns During the First 21 Months
Part 6 – The Impact of Estate Taxes
Part 7 – Ramifications of Charitable Giving
Part 8 - Putting It All Together

A lot of my clients are planning to take advantage of a new opportunity that will be available for the first time in January of 2010. They will be able to convert their traditional IRA account to a Roth IRA account. The conversion opportunity has been available for several years, but only to individuals with less than $100,000 of adjusted gross income.

Roth IRAs offer several benefits. Like Traditional IRAs, Roth IRAs do not have to pay taxes on their earnings. However, unlike traditional IRAs, qualified distributions from Roth IRAs are not subject to income taxes.

Another advantage is that Roth IRAs do not require you to take minimum annual distributions after you attain age 70½. If you designate a child or grandchild as the beneficiary after the deaths of you and your spouse, the child or grandchild will be required to take distributions over his or her remaining life expectancy. The potential for allowing funds to grow in a tax-free environment and be withdrawn over a long period of time makes a Roth IRA a fantastic asset to pass on to children and grandchildren.

If you convert to a Roth IRA, you are betting that the present value of the incremental after-tax distributions to you and your beneficiaries in the future is greater than the taxes you will have to pay at the time of the conversion. Whether paying tax now is a good bet depends on a number of factors including tax rates, and the ability of you and your heirs to keep the Roth IRA intact for a long time.

The analysis is complex. I plan to write several additional blogs regarding this topic in order to help you make this decision.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A recent decision by the Tennessee Supreme Court (PDF) ruled that the entire increase in value of a 401(k) plan that occurs after marriage is a marital asset that is subject to equal division upon divorce. It does not matter whether the increase in value is attributable to appreciation of the assets that were held in the plan prior to marriage or contributions that were added to the account during the marriage. The pre-marital balance of the plan was separate property that was not subject to division.
 

The case confirmed that IRAs are treated differently. Appreciation of a pre-marital IRA that occurs during the marriage continues to be separate property and is not a marital asset subject to division upon divorce, unless the other spouse substantially contributed to its preservation and appreciation.
 

There are two lessons to be learned from this case. First, keep good records that demonstrate the account balance of the 401(k) plan on the date of your marriage. Second, if your 401(k) plan permits in-service withdrawals, you should establish an IRA, rollover your 401(k) to the IRA prior to your marriage, and exclude your spouse from making any investment decisions for your IRA.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A 2008 law eliminated the requirement for taking a required minimum distribution from your IRA in 2009. The IRS decided to give a reprieve to IRA participants who would like to take advantage of this law by returning a distribution taken earlier this year. You can roll over the distribution to a new IRA until the later of November 30, 2009, or sixty (60) days after the date of the distribution.

Foregoing a distribution in 2009 may not be advantageous. As a general rule, you are merely postponing the tax until a later year. If you believe you will be in a higher tax bracket in later years due to tax law changes, you might pay less tax by taking a distribution in 2009.

Another factor is the ability to convert your IRA to a Roth IRA in 2010. A lot of my clients are planning to make this conversion.

If you anticipate converting your IRA to a Roth IRA in 2010, you should not take a distribution from your IRA in 2009. This will maximize the amount that you can convert to a Roth IRA in 2010.

See the attached guidance from the IRS regarding the ability to roll over a distribution taken earlier this year in order to avoid paying tax for 2009.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link