Retirement Income Visions

Retirement Income Visions™ Celebrates 2-Year Anniversary!

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.

To IRA or Not to IRA?

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).

The 45 to 60 5-Step Roth IRA Conversion Strategy – Part 3

Part 1 of this blog post introduced a 5-step Roth IRA conversion strategy for individuals 45 to 60 years old who either own a sizeable traditional IRA or have the opportunity to roll over a sizeable 401(k) plan or other retirement plan to an IRA. Last week's post presented steps 1 and 2 of this strategy. This week's post discusses steps 3 and 4. Step 5 will be presented in Part 4 together with a hypothetical case to illustrate the use of this strategy. If you haven't done so already, I would recommend reading Part 2 to learn about steps 1 and 2.

Step 3 - Convert An Equal Amount Each Year Beginning in the Year After the Year(s) in Which You Recognize Your 2010 Conversion Income

If you deferred the taxation of your 2010 Roth IRA conversion income, you should plan on converting an equal amount of your traditional IRA to a Roth IRA each year from 2013 until you complete your Roth IRA conversion strategy in order to keep things simple and increase the likelihood of sticking with your plan. Alternatively, if you recognized your 2010 Roth IRA conversion income on your 2010 income tax returns, you should begin your "equalization" phase in 2011.

Recharacterization – Your Roth IRA Conversion Insurance Policy

One of my clients who was 80 years old converted a portion of her traditional IRA to a Roth IRA early in March, 2009 when the Dow Jones Industrial Average (DJIA) had just climbed over the 7,000 mark after declining to an intraday low of 6,440 on March 9^th. With the DJIA increasing by 4,000 points, or 57%, to 11,000 recently, and assuming it stays at this level, at least 57% of the value of my client's IRA at the time of conversion that would have eventually been taxed had my client not done her conversion will permanently escape income taxation provided the market remains above 11,000 and she takes no distributions from her Roth IRA for five years from the date of her conversion.

With the market up almost 60% in a little over a year, many people are wondering if this is a good time to do a Roth IRA conversion. What happens if you do a conversion, you're not as fortunate as my client, and the market does an about-face, descending below 10,000 again? This may not make much difference if the assets that you converted are not directly market-sensitive such as fixed income instruments. But what if your Roth IRA conversion assets instead consist of a diversified portfolio of small-, mid-, and large-cap individual stocks, mutual funds, and exchange-traded funds? That's a different story.

Roth IRA Conversion – A Multi-Year Strategy

With all of the buzz about Roth IRA conversions this year as a result of the elimination of the $100,000 modified adjusted gross income threshold for converting traditional IRA's to Roth IRA's, clients and non-clients alike have been asking me the million-dollar question, "Should I do a Roth IRA conversion?" The underlying implied question usually is, "Should I convert 100% of my traditional IRA to a Roth IRA this year?"

Despite the media frenzy and the associated rush to do Roth IRA conversions in 2010 to obtain the alleged benefit of recognition of 50% of the income from the conversion in 2011 and 50% in 2012, a Roth IRA conversion, if it makes sense, doesn't have to be, and in most cases shouldn't be, a one-time event. Unless you meet the criteria of one or more of the four ideal candidates presented in The Ideal Roth IRA Conversion Candidate – Parts 1 and 2, you should be using a multi-year strategy for your Roth IRA conversions. Even if you're an "ideal candidate," it still may make sense to defer a portion of your conversion to 2011 and later years.

The 5-Year Freeze

A lot of people don't realize it, however, multi-year cash flow planning is critical to a successful Roth IRA conversion. Assuming you will incur tax liability in connection with your conversion, it begins with determining what funds you have available to pay the tax. Per Three Roth IRA Conversion "Show Stoppers," if you don't have sufficient funds in checking, savings, money market, and other nonretirement investment accounts outside of your IRA to pay the tax attributable to a Roth IRA conversion, you aren't a good candidate for a Roth IRA conversion.

Assuming you have sufficient funds in nonretirement accounts to pay the tax attributable to a Roth IRA conversion, you have completed Step 1 of Roth IRA conversion cash flow planning. Step 2 requires an understanding of IRS' "5-Year Freeze" rule. If you do a Roth IRA conversion, in addition to being at least 59-1/2, you must wait at least five years from the first day of the year in which you do a conversion to take a distribution from your Roth IRA in order to avoid a potential 10% tax on early distributions.

Consequences of Not Doing Your RMD Before Your RIC

The lesson of last week's blog post is that if you're 70-1/2+, IRS deems the first distributions from your traditional IRA to satisfy your required minimum distribution("RMD") and therefore you must always take your RMD before doing a Roth IRA conversion. What are the consequences of not taking your RMD before doing your Roth IRA conversion? This post will answer this question and will discuss how to correct this situation.

At first blush, there would appear to be two potentially serious repercussions:

1. 50% penalty on the amount that should have been withdrawn but was not, and
2. 6% excise penalty for every year the money remains in your Roth IRA

Do Your RMD Before Your RIC

I'm not a big fan of acronyms because there's way too many of them and it's easy to get confused by them, however, my original title for this post, "Don't Forget to Take Your Required Minimum Distribution ("RMD") Before You Do Your Roth IRA Conversion ("RIC")" was way too long. So, for my fellow non-acronym fans (otherwise known as "NAF's"), please bear with me on this one.

With the one-year suspension of required minimum distributions ("RMD's") in 2009, it's easy to forget that if you're at least 70-1/2 years old, you must start, or resume, taking mandatory minimum withdrawals from your traditional IRA accounts in 2010 based on their account value on December 31, 2009 and an IRS life expectancy factor. The RMD rules are even further off the radar screen for those individuals age 70-1/2+ with modified adjusted gross incomes in excess of $100,000 who were previously ineligible for a Roth IRA conversion who were anxiously waiting for 2010 to roll around so that they could finally do a conversion.

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 31^st 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.

Reduce or Eliminate Your Required Minimum Distributions With a Roth IRA Conversion

A lot of people I talk to get upset when they discover that they must begin taking required minimum distributions ("RMD's") from their traditional IRA's beginning at age 70-1/2. They forget about all of the income tax savings that they've realized over the years from either making deductible IRA contributions or from making pre-tax contributions into 401(k) plans that they rolled over into their IRA accounts. This is especially true when they haven't reinvested the tax savings from their deductible contributions which is fairly typical.

Moreover, many people don't realize that IRS has authorized a deduction for their contributions in exchange for the right to tax distributions from their traditional IRA's, whether voluntarily or via RMD's. Whether or not you've taken any distributions from your IRA, beginning at age 70-1/2, you are required to take a minimum distribution each year from your traditional IRA accounts based on their value on December 31^st of the preceding year and an IRS table life expectancy factor. The taxable portion of each distribution includes deductible contributions as well as earnings.

Two Steps to a Nontaxable IRA for High Income Individuals

If your goal is to contribute on a regular basis to a nontaxable investment account without investing in low-yielding tax-free municipal bonds from which you can take nontaxable distributions beginning at age 59-1/2 and assuming you can live with the annual contribution limits, IRS has provided you with this opportunity. Depending on the amount of your income each year, you will be able to achieve your goal in either one or two steps.

In 2010, if your modified adjusted gross income ("MAGI") is less than $105,000 if you're single or $167,000 if you're married filing a joint return, you can contribute up to $5,000, or $6,000 if you're 50 and over, to a Roth IRA assuming that you receive taxable compensation of at least these amounts. Your Roth IRA distributions will be nontaxable provided that you (a) don't take any distributions for at least five years after you make your first Roth IRA contribution and (b) wait until you reach age 59-1/2 to take your distributions.

Two Great Roth IRA Conversion Candidates

In the two previous blog posts, I examined four scenarios where it's possible to convert a portion, and possibly all, of a traditional IRA to a Roth IRA while incurring minimal or no income tax liability attributable to the conversion, and, as such, qualify as ideal Roth IRA conversion candidates.

This week's blog presents two additional Roth IRA conversion candidates that I would classify as "great," but not "ideal," candidates. Both scenarios have the potential for the IRA owner or beneficiaries to end up with more assets than they would if they don't do a conversion, however, there could be a sizeable amount of income tax liability attributable to the conversion, depending upon the situation. The two scenarios are as follows:

The Ideal Roth IRA Conversion Candidate – Part 2

Last week's blog post, The Ideal Roth IRA Conversion Candidate – Part 1, discussed two situations where it's possible to convert a portion, and possibly all, of a traditional IRA to a Roth IRA while incurring minimal or no income tax liability attributable to the conversion. This week's post presents two additional Roth IRA conversion "ideal candidates." 

As mentioned in last week's post, all four situations, in addition to assuming availability of a traditional IRA, require preparation of an income tax projection, including calculation of potential exposure to alternative minimum tax, or "AMT," to determine the amount of the traditional IRA that should be converted to a Roth IRA to achieve this result. The two situations that are the subject of this week's post are as follows:

The Ideal Roth IRA Conversion Candidate - Part 1

The last two blog posts, Three Roth IRA Conversion "Show Stoppers" and Clearing the Roth IRA Conversion Hurdles presented three scenarios in each post where the answer to the question, "Should you convert your traditional IRA's to Roth IRA's?" was a definitive "no" and "probably not a good idea," respectively. Assuming that you weren't eliminated from the Roth IRA conversion game by any of the three "show stoppers" and you cleared all three "high hurdles," are you a candidate for a Roth IRA conversion?

Whenever you are evaluating candidates, whether it be for political office, employment, or some other situation, you always want to compare the individual against an established ideal candidate profile. In the case of a Roth IRA conversion, the ideal candidate is someone who will incur minimal or no income tax liability as a result of the conversion.

Clearing the Roth IRA Conversion Hurdles

Should you convert your traditional IRA's to Roth IRA's? This question is a hot topic this year with the repeal of the $100,000 modified adjusted gross income barrier for converting traditional IRA's to Roth IRA's. Last week's blog post, Three Roth IRA Conversion "Show Stoppers" discussed three scenarios where the answer is a definitive "no."

Assuming that none of the three "show stoppers" are applicable to your situation, you're ready to lace up your running shoes and step onto the track. I liken the Roth IRA conversion decision-making process to the 100 meter (women) and 110 meter (men) high hurdles events in track and field.

Three Roth IRA Conversion "Show Stoppers"

Effective January 1^st this year, the $100,000 modified adjusted gross income barrier for converting traditional IRA accounts to Roth IRA accounts was eliminated. Now that the floodgates are open and everyone can convert their traditional IRA's to Roth IRA's, if you haven't done so already, should you jump on the bandwagon? While the potential benefits of tax-free withdrawals and not being subject to required minimum distributions ("RMD's") (See Year of the Conversion) are extremely attractive, there are several obstacles one must overcome before switching horses.

Before discussing these obstacles, which will be continued in next week's blog post, it's important to keep in mind that when contemplating a Roth IRA conversion, it doesn't have to be an all-or-nothing event. You can, and it's often preferable, to do partial conversions of traditional to Roth IRA's over one or more years.

Year of the Conversion

 If you grew up in my generation, you probably remember Al Stewart's 1976 hit, "Year of the Cat" from his platinum album with the same name. Well, 34 years later (boy, am I getting old!), 2010 is being dubbed by the financial community as the "Year of the Conversion" in reference to the removal of the income threshold in connection with Roth IRA conversions.  

Although the Roth IRA and the Roth IRA conversion technique were both established by the Taxpayer Relief Act of 1997 for taxable years beginning in 1998, like a lot of tax legislation that provides for potentially favorable benefits, the ability to  take advantage of the latter until now has been dependent on one's income level. From 1998 through 2009, only taxpayers with modified adjusted gross income of less than $100,000 were eligible to convert a traditional IRA to a Roth IRA.