Retirement Income Visions

Black Friday – Think Roth IRA Conversion

This Friday is Black Friday. It's the day after Thanksgiving when major retailers open early promoting significant price reductions on lots of items. It has routinely been the busiest shopping day of the year since 2005.

There's another major sale taking place as I write this post that's not being publicized. It's happening in the investment world. It's one of those perfect storm moments when a confluence of seemingly unrelated factors occurs that results in a short-lived opportunity for those who act on it.

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.

Roth IRA Conversion Insights – Part 2 of 2

Last week's post discussed the first three insights to be gained from analyzing two scenarios – one with no Roth IRA conversion and a second with a Roth IRA conversion – that were presented in the April 25, 2011 post, Roth IRA Conversions – Don't Let the Tax Tail Wag the Dog – Part 6 of 6. This week's post addresses three additional insights that can be used when confronted with a Roth IRA conversion decision.

Availability of Nonretirement Investment Assets is Essential

As we saw in the two scenarios in Part 6, the availability of nonretirement investment assets is essential (1) in meeting financial needs prior to distributions from a traditional IRA account where there will be no Roth IRA conversion and (2) in fulfilling income tax obligations related to (a) Roth IRA conversions or (b) distributions from traditional IRA accounts in the case of non-conversion.

Roth IRA Conversion Insights – Part 1 of 2

Last week's post completed a six-part series discussing the three primary benefits to be derived from a Roth IRA conversion: (1) elimination of taxation on 100% of the growth of Roth IRA conversion assets, (2) elimination of exposure to required minimum distributions on traditional IRA funds converted to a Roth IRA, and (3) potential reduction in taxation of Social Security benefits.

Part 6, the finale of the series worked through two comprehensive scenarios – one with no Roth IRA conversion and a second with a Roth IRA conversion – to determine which one was projected to result in more total investment assets throughout the life of the scenario. As emphasized in the post, the results of the two scenarios cannot be generalized and used as the basis for determining whether a Roth IRA conversion is appropriate in a particular situation. Furthermore, a detailed analysis needs to be prepared by a retirement income planner for every potential Roth IRA conversion situation.

Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog – Part 6 of 6

Parts 3, 4, and 5 of this six-part series discussed the three primary benefits to be derived from a Roth IRA conversion: (1) elimination of taxation on 100% of the growth of Roth IRA conversion assets, (2) elimination of exposure to required minimum distributions on traditional IRA funds converted to a Roth IRA, and (3) potential reduction in taxation of Social Security benefits.

This week's post compares a scenario with no Roth IRA conversion to a second scenario with a Roth IRA conversion to determine which one is projected to result in more total investment assets throughout the life of the scenario. Benefit #3, i.e., potential reduction in taxation of Social Security benefits, isn't included in the Roth IRA conversion scenario since, as stated in Part 5, this benefit is less certain than the other two and there are enough moving parts in both scenarios without including this possibility.

Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog – Part 5 of 6

Parts 3 and 4 of this series addressed the first two of three primary economic benefits associated with a Roth IRA conversion: (1) elimination of taxation on 100% of the growth of Roth IRA conversion assets and (2) elimination of exposure to required minimum distributions, with the first one being the most important and overriding reason in most cases for doing a conversion. This post discusses the third and final benefit – potential reduction in taxation of Social Security benefits.

Economic benefit #3 has intentionally been saved for last. Unlike the first two benefits which will occur provided there is an increase in the value of the Roth IRA after the conversion (benefit #1) and you live until at least age 70-1/2 and you haven't depleted your traditional IRA (benefit #2), reduction in taxation of Social Security benefits is less certain. This is why this benefit is prefaced by the word, "potential."

Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog – Part 4 of 6

Part 3 of this series discussed the first of three primary economic benefits to be derived from a Roth IRA conversion, i.e., elimination of taxation on 100% of the growth of Roth IRA conversion assets. As emphasized in the post, this is the most important and overriding reason in most cases for doing a conversion. The other two benefits are: (1) elimination of exposure to required minimum distributions on traditional IRA funds converted to a Roth IRA and (2) potential reduction in taxation of Social Security benefits. The second benefit is this week's topic with the third benefit being the subject of Part 5 of this series.

Even though most people generally don't celebrate half birthdays, Congress, in its infinite wisdom, decided for some reason, that two particular half birthdays are crucial as they pertain to income taxation of distributions from retirement plan assets – age 59-1/2 and age 70-1/2. Congress has determined that if you take distributions from a retirement plan, e.g., 401(k) plan, traditional IRA, etc., before age 59-1/2, this is too soon. If you dare to do this, subject to specified limited exceptions, in addition to paying income tax, you will be assessed a premature distribution penalty of 10% of the amount of your distributions. You may also be subject to a state-imposed penalty which is 2-1/2 percent in California where I live.

Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog - Part 3 of 6

As stated last week in Part 2 of this series, there are three primary potential economic benefits to be derived from a Roth IRA conversion, with the first one being the most important and overriding reason in most cases for doing a conversion: (1) elimination of taxation on 100% of the growth of Roth IRA conversion assets, (2) elimination of exposure to required minimum distributions on traditional IRA funds converted to a Roth IRA, and (3) potential reduction in taxation of Social Security benefits. Benefit #1 is the subject of this post with the other two benefits to be discussed in Parts 4 and 5 of this series, respectively.

There are many situations in life that require a leap of faith in order to realize the potential benefits from our decision that result in actually implementing a particular course of action. Like many people, buying my first house comes to mind as one of those such moments. It's natural for us to simply think of the immediate impact of a particular decision on our daily lives. In the case of my first house purchase, the monthly mortgage payment and all of the other expenses and responsibility associated with home ownership loomed before me as formidable obstacles. It wasn't until I was able to visualize the long-term potential benefits of my decision that I was able to feel comfortable with signing the dotted line.

Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog – Part 2 of 6

Per last week's post, the 2010 "tax tail wag the dog" provision that enabled 2010 Roth IRA converters to avoid inclusion of the income from their conversion on their 2010 income tax returns and instead defer 50% of it to 2011 and the other 50% to 2012 was the driving force behind many Roth IRA conversions in 2010. As stated in the post, this was despite the fact that, until the 2010 Tax Relief Act was enacted in the last two weeks of the year which left tax rates unchanged for 2011 and 2012, converters were facing potential higher tax rates in those two years on their deferred income.

When the dust settles, was it really such a big deal that you could defer 50% of the income from a 2010 conversion to 2011 and the other 50% to 2012? In certain cases, this did enable some people to have their conversion income taxed at a lower tax rate due to the splitting of their income over two years, however, in many situations, this wasn't the result. These individuals simply received the benefit of postponing payment of 50% of their tax liability for one year and the other 50% for two years. Yes, you can earn interest on 50% of those funds for an additional year and another 50% for an additional two years, however, with our current abysmal interest rate environment, how much additional after-tax earnings will you actually receive?

Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog – Part 1 of 6

I'm always amazed at how many people are motivated solely by tax incentives when it comes to investment decisions, paying little attention to, and in many cases, completely ignoring the potential long-term economic benefits that should be the driving force behind implementation of any investment strategy. With 2010 behind us, I can safely say that the Roth IRA conversion decision definitely falls in the "tax tail wag the dog" category.

Although the jury is still out on how many 2010 Roth IRA conversions will stick due to the ability to recharacterize, or undo, a Roth IRA conversion by the tax return due date (April 18, 2011), plus extension (October 17, 2011), of the conversion year, 2010 should turn out to be a banner year for Roth IRA conversions. The last time that Roth IRA conversions received so much attention was in their debut year in 1998 when the IRS allowed you to spread the tax from a conversion over four years.

Increase Your After-Tax Social Security Benefits – Part 1 of 4

The last two posts, Say Goodbye to Up to 30% of Your Social Security Benefits – Parts 1 and 2 discussed taxation of Social Security benefits. As explained in both posts, up to 50% or 85% of Social Security benefits can be taxable depending upon the amount of one's "combined income" (50% of Social Security benefits plus adjusted gross income increased by tax-exempt income) compared to specified thresholds that are dependent upon one's tax filing status (i.e., single, head of household, married filing separate, or married filing joint) and one's tax rates.

Although, as pointed out in last week's post, taxation of Social Security benefits has been a thorn in Congress' side ever since it came into being in 1984, it appears that it's here to stay. Income taxation of Social Security benefits can be reduced or, in some cases, eliminated, in one or more years with proper planning. While much of the planning is ongoing throughout the years that one is collecting benefits, there are several opportunities that should be analyzed and potentially implemented beginning in one's 40's, many years before the receipt of one's first Social Security check. This post focuses on pre-benefit receipt planning and Parts 2, 3, and 4 address planning strategies during the Social Security benefit receipt years.

Year of the Extension

"Year of the Conversion," the initial post on January 11^th of this year kicked off a weekly series of informative posts regarding a tax/financial planning technique that was authorized by Congress beginning in 1998. As explained in "Year of the Conversion," 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. Beginning in 2010, the $100,000 income threshold has been eliminated and, as a result, anyone who has a traditional IRA can convert part or all of his/her accounts to one or more Roth IRA accounts.

I felt it would be fitting to conclude the Roth IRA conversion series with "Year of the Extension" to remind anyone who has done a conversion in 2010 or is still planning on doing one in 2010 or in future years of a very important, and often overlooked, step in the Roth IRA conversion process. Unlike most tax planning techniques whereby once you've implemented the technique, it's a done deal and you simply need to report the historical transaction on your income tax return, Roth IRA conversions need to be monitored for up to 22 months following the conversion date depending upon when the conversion occurs.

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

Per Part 1 of this blog post last week, there are dozens of questions that need to be answered when deciding whether a Roth IRA conversion makes sense in your situation. Just looking at, let alone trying to answer, all of the questions is overwhelming and discourages many people from proceeding with one or more Roth IRA conversions.

This is without doubt an area that requires professional analysis and guidance. Even professional financial advisors, however, are often guilty of "analysis paralysis" when dealing with Roth IRA conversions. This term is defined by Wikipedia as:

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:

Not Converting 100% of Your Traditional IRA’s? – Don’t Use All of Your Basis – Part 2

If you haven't yet read last week's post, I recommend that you do so before reading this one. Last week's post listed three types of partial Roth IRA conversion scenarios and stated that the calculation of taxable gain in scenarios #2 and 3 can be problematic when basis exists if you're not careful. This week's posts illustrates each of the three scenarios.

Scenario #1 – Conversion of a Portion of a Single Traditional IRA Account

Suppose you own one traditional IRA account with a value of $120,000 and basis of $100,000. If you convert 50% of the account value, or $60,000 to a Roth IRA, you would use 50% of your basis, or $50,000 to calculate your taxable gain as follows: $60,000 - $50,000 = $10,000. Your remaining unused basis would be $50,000 (total basis of $100,000 less basis used of $50,000).

Not Converting 100% of Your Traditional IRA’s? – Don’t Use All of Your Basis – Part 1

In the August 2, 2010 post, Remember Your IRA Basis Scorecard When Planning Roth IRA Conversions, the concept of basis, including the importance of tracking it and using it to offset otherwise taxable gains in connection with Roth IRA conversions, was discussed. This post and next week's post are follow-ups to that post since they expand upon the discussion of how taxable gains are calculated in connection with a partial Roth IRA conversion when basis is available.

We learned in Remember Your IRA Basis Scorecard When Planning Roth IRA Conversions that you're taxed on the difference between the value of your distribution and your basis in the distribution. This is a relatively simple calculation when you convert 100% of all of your traditional IRA accounts, however, it's a different story when you do a partial Roth IRA conversion.

Retirement Income Visions™ Celebrates 1-Year Anniversary!

It's hard to believe that a whole year has gone by since Retirement Income Visions™ initial blog post, but it has! This marks Retirement Income Visions™ 52^nd post since it debuted on August 16, 2009 as a weekly blog, with new posts published each Monday morning.

As stated in the initial post, Retirement Income Visions™ Makes Its Debut, the blog, and the associated importance of retirement income planning as a separate and distinct niche, was inspired and motivated by my clients' experience during the October, 2007 – March, 2009 stock market decline.

Remember Your IRA Basis Scorecard When Planning Roth IRA Conversions

Most people who sell assets are familiar with the income tax concept of "basis." Basis, in its simplest form, is essentially what you pay for something. When you sell an asset, you're not taxed on the sales proceeds. Instead, you pay tax on the difference between your net sales proceeds and your cost basis. Net sales proceeds is equal to gross sales proceeds reduced by any selling expenses. Cost basis is equal to purchase price plus increases to the purchase price less accumulated depreciation or amortization. Basis, therefore, reduces the amount of otherwise taxable gain.

The concept of "basis" also applies to traditional IRA's. When you make a contribution to a traditional IRA, your contribution is either deductible, partially deductible, or nondeductible depending upon (1) whether you're an active participant in a qualified retirement plan, (2) the amount of your modified adjusted gross income, and (3) your tax filing status. To the extent that any portion of your IRA contributions are deductible, they aren't credited with any basis. Nondeductible IRA contributions, on the other hand, are counted as, and increase, traditional IRA basis.

Considering a Partial 72(t) Roth IRA Conversion? – Tread Lightly

The topic of this week's blog post is one which, quite frankly, doesn't pertain to very many people. You may be wondering why I'm writing about it if this is the case. Besides bringing the topic to the attention of those who may be affected by it, the main reason I'm writing this post is to provide interested readers with an example of a tax planning strategy that, while it doesn't run afoul of any IRS rules, hasn't been officially blessed by IRS.

As with many of my blog posts, this one was inspired by one of my clients. Mr. and Mrs. R., who are retired, aren't yet receiving Social Security benefits, and derive the majority of their income from Mrs. R.'s 72(t) IRA and two nonqualified term certain annuities, a sizeable portion of which is nontaxable.

Will Your Medicare Premium Increase If You Do a Roth IRA Conversion? – Part 3

We learned three important things in Parts 1 and 2 of this blog post regarding the potential impact of a Roth IRA conversion on one's Medicare Part B premium:

1. 1. The amount of income from the conversion can increase one's Medicare Part B annual premium by more than $3,000 if single or more than $6,000 if married and both individuals are eligible for Medicare.
2. The premium increase, if there is one, will occur two years after the year in which the income from the conversion is included on one's income tax return.
3. Assuming a 2010 conversion, the premium increase, if there is one, will occur in 2013 and 2014 if the "Default" method is used to report the conversion or in 2012 if the "Election" method is used.

Will Your Medicare Premium Increase If You Do a Roth IRA Conversion? – Part 2

Last week's blog post, Will Your Medicare Premium Increase If You Do a Roth IRA Conversion? began a discussion of how Medicare Part B (medical insurance) premiums are calculated. As discussed last week, of importance is that Social Security Administration ("SSA") will use the income reported on your federal income tax return from two years prior to the current year to determine the amount of your Part B Medicare premium. Also of importance is the distinction between IRS' and Social Security Administration's definition of "modified adjusted gross income," or "MAGI."

IRS uses MAGI for various purposes, including calculation of allowable real estate rental losses, deductibility of IRA contributions, and qualification for certain tax credits, to name a few. Prior to 2010, it was also used to determine eligibility for Roth IRA conversions. From 1998 through 2009, only taxpayers with MAGI of less than $100,000 were eligible to convert a traditional IRA to a Roth IRA. For purposes of Roth IRA conversion eligibility determination, income attributable to the conversion was excluded from the calculation of MAGI. There are several adjustments, both negative and positive, made to "adjusted gross income," or "AGI" to arrive at IRS' definition of MAGI.

Will Your Medicare Premium Increase If You Do a Roth IRA Conversion? – Part 1

It's always amazing to me how one thing in life leads to another. This phenomenon is so true when it comes to the Roth IRA conversion series of blog posts that I've been writing and publishing since the beginning of the year, with the first post, Year of the Conversion, published six months ago on January 11^th. As an example of the "one thing leads to another" phenomenon, the idea for last week's post, Got Dormant 401(k)? Consider Converting to a Roth IRA came about as a result of writing the previous week's post, Don't Forget About Your SEP-IRA for Roth IRA Conversions.

This week's post is yet another example of the "one thing leads to another" phenomenon. The second to last paragraph of Got Dormant 401(k)? Consider Converting to a Roth IRA discussed various factors to consider when contemplating the Roth IRA conversion decision. Included in the list of factors was the affect of the conversion on Medicare premiums. Since this is an important consideration for anyone 65 years of age or older who is evaluating a Roth IRA conversion, I am devoting this week and the next two week's posts to this topic.

Got Dormant 401(k)? Consider Converting to a Roth IRA

Last week's blog post, Don't Forget About Your SEP-IRA for Roth IRA Conversions, made the point that most people who are considering doing a Roth IRA conversion think about using a traditional IRA account into which deductible and/or nondeductible contributions have been made. Many people don't realize that other types of retirement plans are also eligible for a Roth IRA conversion. One such plan is the popular 401(k).

Many employers allow former employees to keep their 401(k) plans intact, however, there's an often-overlooked catch which I'll get to shortly. As a result, 401(k) plans often lie dormant for years after an individual parts ways with his/her employer. In addition to limitation of investment choices, this can also result in an unpleasant surprise for a plan participant's beneficiaries upon the plan participant's death. This is due to the fact that employers that permit former employees to retain their 401(k) plans generally don't allow them to do so indefinitely. Most plans require immediate distribution of plan assets at death, resulting in immediate taxation and the abrupt end of tax-deferred growth of the plan.

Don’t Forget About Your SEP-IRA for Roth IRA Conversions

On a recent occasion, I was discussing the Roth IRA conversion strategy with a long-time friend who told me that he converted his IRA to a Roth IRA years ago, and furthermore, he spread the income from the conversion over four years to reduce his tax bite. My friend was referring to the one-time opportunity to do a Roth IRA conversion in 1998 and spread the income from the conversion over four years starting with 1998 provided that your modified adjusted gross income was less than $100,000.

I knew that, in addition to his Roth IRA, my friend, who is an employee of his closely-held corporation, had another type of retirement plan. When I questioned him about this, he told me that he also has a SEP-IRA account into which he makes contributions every year. I asked him if he was aware that he could convert a portion, or all, of his SEP-IRA to a Roth IRA and he told me he didn't know he could do this.

The 45 to 60 5-Step Roth IRA Conversion Strategy – Part 4

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. Steps 1 and 2 of this strategy was presented two weeks ago in Part 2 and steps 3 and 4 were discussed last week in Part 3.

This week's post presents the fifth and final step together with a hypothetical case to illustrate the use of this strategy. If you haven't done so already, I would recommend reading Parts 2 and 3 to learn about steps 1, 2, 3, and 4.

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.

The 45 to 60 5-Step Roth IRA Conversion Strategy – Part 2

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. This post presents steps 1 and 2 of this strategy, with steps 3 and 4 to be discussed in Part 3, and step 5 to be presented in Part 4 together with a hypothetical case to illustrate the use of this strategy.

Step 1 - Begin Your Plan in 2010 Using a Larger Conversion Amount Than in Subsequent Years

I'm recommending that you begin your Roth IRA conversion strategy in 2010 to take advantage of the one-time opportunity to defer 50% of the income from your 2010 conversion to 2011 and 50% to 2012 or, alternatively, take advantage of lower income tax rates in 2010 if you elect to include the income from your 2010 conversion on your 2010 federal income tax return if this makes more sense for you (see In Which Tax Year(s) Should You include Your 2010 Roth IRA Conversion Income – Parts 1, 2, and 3).

The 45 to 60 5-Step Roth IRA Conversion Strategy – Part 1

Are you 45 to 60 years old and either have a sizeable traditional IRA or have the opportunity to roll over a sizeable 401(k) plan or other retirement plan to an IRA? If so and you would like to enhance the likelihood of maximizing your retirement benefits, you should consider implementing a multi-year systematic plan to convert the vast majority, if not all, of your traditional IRA to a Roth IRA.

Ideally, you want to begin converting your traditional IRA to a Roth IRA beginning in 2010 and complete your conversion plan by the year that you will begin receiving Social Security benefits or no later than the year before you will turn 70-1/2. Your age, the value of your IRA, future contributions to your IRA, recharacterizations (See Recharacterization - Your Roth IRA Conversion Insurance Policy), income tax rates, income tax planning opportunities, and source of funds to pay the income tax liability attributable to your conversions will directly affect your actual annual conversion amounts as well as when you will complete your plan.

In Which Tax Year(s) Should You Include Your 2010 Roth IRA Conversion Income? – Part 3

If you haven't done so already, I would recommend that you read parts 1 and 2 of this blog post to understand the choice that you face regarding the year(s) for recognizing income if you do a Roth IRA conversion in 2010. This post will use the information presented in parts 1 and 2 to illustrate an example of the two options available.

As an example, let's keep it simple and assume that your projected 2010, 2011, and 2012 pre-Roth IRA conversion taxable income is $175,000, your tentative 2010 Roth IRA conversion income is $150,000, and you prepare your tax returns using married filing joint status. Your projected 2010, 2011, and 2012 taxable income using the two potential income recognition scenarios would be as follows:

Be on the Lookout for Roth IRA Conversion Opportunities

Was last week's 5.7% decline in the Dow Jones Industrial Average (DJIA), from 11,009 on April 30^th to 10,380 on May 7^th, a temporary pullback from the recent highs this year or the beginning of a prolonged market decline? Unless your crystal ball works better than mine, we won't know the answer to this question until several months or more from now when we're looking in the rearview mirror.

While I don't practice market timing for my clients, I believe that it's prudent to look for opportunities to implement investment strategies to take advantage of various market conditions. Although a Roth IRA conversion will result in elimination of income tax liability on Roth IRA distributions provided no withdrawals are taken within five years of the conversion and the Roth IRA owner is at least 59-1/2 when taking distributions (see Year of the Conversion), this benefit can be negated by income tax liability associated with the conversion, itself.