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Roth IRAs and Conversion Opportunities Wayne D. Eski, CPA, CVA AEPC 1/28/08.

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Presentation on theme: "Roth IRAs and Conversion Opportunities Wayne D. Eski, CPA, CVA AEPC 1/28/08."— Presentation transcript:

1 Roth IRAs and Conversion Opportunities Wayne D. Eski, CPA, CVA AEPC 1/28/08

2 Won’t cover Roth 401k or Roth 403b Complicated RMD rules Inherited (stretch) IRAs Investing in real estate via self-directed IRAs Investments appropriate for IRAs

3 10 yrs ago Roth IRAs born under Taxpayer Relief Act of 1997. Named after the late Senator William V. Roth Jr. Special rule in 1998 allowed 4-yr spread to report the conversion income. IRS Publication 590 and Form 8606. Beginning in 2007 can file Form 8888 to request all or part of federal tax refund be paid directly into an IRA account.

4 Eligibility Must have earned income. Earnings limitation: Can not contribute to Roth IRA if Modified AGI in… 2007: >$114K if Single or >$166K if MFJ 2008: >$116K if Single or >$169K if MFJ Maximum contribution: 2007: $4K + $1K catch up if age 50 2008: $5K + $1K catch up if age 50 (same as Traditional IRAs, but do not apply to Roth 401k/Roth 403b)

5 Ways to Fund (but not Roth 401k or Roth 403b) Contribute after-tax dollars directly into account. Convert existing traditional IRA (rollover distribution) –Starting in 2008, can directly convert a traditional 401(k) into a Roth IRA without having to roll it into a Rollover IRA first; Roth IRA eligibility requirements still apply and triggers conversion income.

6 Advantages of Roth IRA over Traditional IRA Both have same annual maximum contributions. Both allow tax-deferred compounding of earnings & growth. Roth IRA contributions allowed regardless of age, whereas contributions to traditional IRA not permitted after age 70½. Roth IRAs not subject to RMD rules during life - but beneficiaries are (different rules for spouse and nonspouse.) Roth IRA contributions are made with after-tax dollars, thus Qualified distributions are tax-free (and not subject to withholding.)


8 What is a tax-free Qualified distribution? 5-yr holding period, and must be Age 59½, or Death, disability or Qualified special purpose under IRC 72(t) 3 most common: –Higher education costs –Medical > 7.5% AGI –$10K for first time home buyer (can be used for child/grandchild) If a Nonqualified distribution there are specific ordering rules, but basically if it all comes out the earnings are taxed at ordinary rates (and if <59½ subject to 10% penalty.)

9 Nonqualified distributions Specific Ordering rules: 1.Regular Roth contributions 2.Converted dollars (FIFO - deductible before non-deductible) 3.Earnings

10 Conversions Conversions trigger income tax today in exchange for future tax savings. Cost-benefit analysis should consider: –current and future tax rates (key) –time horizon –method of paying tax –expected rate of return Nonspouses cannot convert inherited IRAs. MAGI must be under $100K in 2008-09. Beginning in 2010 no income limitation…

11 Conversions in 2010 and after TIPRA eliminates the $100K conversion threshold. Effectively everyone will be able to have a Roth IRA. Income from 2010 conversions is reported in 2011/12. If conversion in 2011 or beyond, taxes are due in the conversion year. Money in the IRA converted should not be used to pay the taxes or penalties could be applicable. Example…

12 Conversion Example 1 Joe maxes out his 401(k) at work, but makes too much to contribute to a Roth IRA and was never persuaded to make nondeductible traditional IRA contributions. His advisor convinces him to open a regular IRA and he funds the max in 2007-10 ($4+5+5+5=$19K basis) In 2010 the account value (FMV) is $25K when he converts. Tax result: Joe only pays tax on taxes on the $6K earnings. If Joe is in 25% bracket, he pays $1,500 in taxes: $750 in 2011 and 2012.

13 Conversion Example 2 (other IRAs exist) Same facts as Example 1, but Joe has other IRAs including a SIMPLE IRA, SEP IRA, or rollover IRA resulting from a prior job. The FMV of his other IRAs combined is $165K. Joe’s tax basis in his other IRAs is zero. Joe only wants to convert his Traditional IRA valued at $25K. Basis calculation (pro-rata): $19K basis combined / $190K account value combined = 10%, thus, only 10% of the conversion is considered basis recovery. Tax result: Joe must pay tax on $22,500 conversion income ($25,000 FMV less $2,500 basis). If he’s in 25% bracket he’ll pay $5,625 (spread over 2 yrs.)

14 Good conversion candidates Someone with small or no IRA accounts. Nonworking spouse of a retirement plan participant. Someone who’s made nondeductible IRA contributions all along and has significant basis. Someone who can roll their non-Roth, zero-basis IRAs into their employer’s qualified plan. Nonspouses can NOT convert an inherited IRA.

15 Recharacterizations/Reconversions (Regular  Roth  Regular  Roth) ( convert / recharacterize / reconvert ) Why recharacterize? –Post-conversion account value drops. –Ineligible to convert due to high income. Can recharacterize up to October 15 of following year if return is on 6-month extension. Not permitted to reconvert back to a Roth IRA before the later of Jan 1 of year after conversion or 30-days after the recharacterization. Conversions done early in the year offer the flexibility to recharacterize and reconvert early in the next year.

16 Losses on investments held in Roth IRA Current guidance treats same as rules for traditional IRAs and are deductible to the extent of unrecovered basis (regular and conversion contributions.) Watch for unexpected tax trap: if withdrawal occurs within 5 yrs of conversion, a 10% penalty could apply on an otherwise tax-free distribution. Example: in 1999 Jeff converted his sole zero-basis IRA worth $60K to a Roth IRA and invested in tech stock. In 2001 the Roth IRA is worth $25K and Jeff throws in the towel and withdraws the entire account at age 49. Tax result: Jeff will be hit with $2,500 penalty tax on the withdrawal. He should also qualify for $35K misc itemized deduction subj to 2%.

17 Opportunities If kids or grandkids have earned income from summer job, they can benefit from decades of compounding. No RMD requirement makes Roth IRA a tax-efficient way to pass on assets to beneficiaries outside of probate. –taxes paid on conversion on behalf of future beneficiaries is not a taxable gift and reduces gross estate. –but Roth IRA is still included in gross estate for 706. In most scenarios, a total or partial conversion will result in more wealth accumulation in the long run – especially if long time horizon and conversion tax is paid out of other assets. Be certain of your client’s whole IRA picture and be aware of the tax consequences of a conversion when other IRAs exist.

18 Opportunities cont’d Under current law, starting in 2010, high earners not eligible to contribute to Roth IRAs could make non- deductible contribs to a regular IRA and then convert to a Roth IRA the next day with no tax consequences. This could be repeated every year, circumventing Roth income limits on contributions. Don’t be surprised if Congress writes some anti-abuse provision into law before 2010. Wacky as these rules may sound, a Roth IRA can be an effective way to achieve generally tax-free income in retirement and is a tool in your estate planning toolkit.

19 Q & A Thanks

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