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Ed Slott's Free IRA Update

June 2008

Volume 1, Number 6

 

In This Issue

  • Focus on Funding Roth IRAs
  • Question of the 
    Month
  • News, Rulings and Other Updates
  • Retirement 
    Planning Tip
  • Ed Slott's IRA 
    Advisor - June Issue

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June Focus – Funding Roth IRAs

There is no doubt that Benjamin Franklin was right when he said “In this world nothing is certain but death and taxes”. However, what is uncertain about taxes today is not if, but by how much, they will increase in the future. Economists and financial experts project that the tax rates will go up in the future, and as such, taxpayers should look for ways to shelter their money from those projected increased tax rates. One way of doing so is to fund the increasingly popular Roth IRA.

Roth IRAs are funded with after-tax (already taxed) money, which means you do not get a deduction for any contributions you make. However, the tradeoff is that future distributions are tax and penalty-free if they meet certain requirements.These requirements are explained during Ed Slott’s Ed Slott's Exclusive 2-Day IRA Workshop, Instant IRA Success.

Funding Roth IRAs

Roth IRAs can be funded from the following sources:
Rollovers from Designated Roth Accounts (DRA): Balances in Roth 401(k) and Roth 403(b) accounts, referred to as DRAs, can be rolled over to Roth IRAs, providing the individual meets requirements to make withdrawals from the DRA.

  • Regular Roth IRA contributions of up to $5,000 or $6,000 for individuals who are at least age 50 by the end of the year. For a married couple, aggregate contributions for the year can be $10,000 or $12,000 if they are both age 50 or older by the end of the year.
  • Roth IRA Conversions: An individual can move his balances from his Traditional IRA, SEP IRA and SIMPLE IRAs to his Roth IRA, providing his modified adjusted gross income (MAGI) does not exceed $100,000 and his tax-filing status is not married-filing-separately. This is referred to as a Roth IRA conversion. The $100,000 MAGI and married-filing-separately limitations are repealed beginning in 2010, which means everyone can convert to Roth

While any taxable portion of Roth conversion amounts are taxable for the year in which the conversion occurs, the potential for tax-free growth can outweigh the impact of paying income taxes on the amount at the time of conversion. However, the following should be noted:

  • A partial conversion is an option. Therefore, an individual can choose to convert only a fraction of his non-Roth retirement account balance to his Roth IRA instead of converting the entire balance in one year.
  • Spread the conversion over several years. Individuals who cannot afford to pay the taxes on a conversion of a large amount can choose to convert the balance in smaller amounts each year. For instance, someone who wants to convert $200,000 in total can choose to convert $50,000 each year instead of the entire $200,000 in one year.
  • The income tax break. For conversions done in 2010, the income from the conversion can be spread ratably over 2011 and 2012.
  • Assess the impact on the tax return. Individuals must understand the impact of including the conversion on their tax return. The additional income can impact deductions, phase-outs, exemptions, credits, taxability of Social Security payments and AMT.

Roth Conversion Don’ts

  • Don’t Convert RMD Amounts: Only amounts that are rollover eligible can be converted to a Roth IRA. Therefore, required minimum distribution (RMD) amounts must be taken from the retirement account before the conversion occurs. Otherwise, the conversion will include the RMD amount and create an excess contribution (of the RMD amount) in the Roth IRA.
  • Don’t Convert SIMPLE IRA assets in the first 2 years: SIMPLE IRA assets can be converted to a Roth IRA only if it has been at least two years since the first contribution was deposited to the SIMPLE IRA. If the conversion occurs before the 2-year period, it will be considered an ineligible conversion by the IRS and subject to a 25% penalty if the conversion occurs when the owner is under age 59 ½ .
  • Don’t pay your withholding taxes from your IRA: If you request to have taxes withheld from your Roth conversion, the amount withheld for taxes is not considered part of the conversion. Instead, it is treated as a regular distribution and is subject to the 10% early distribution penalty unless an exception applies. If you cannot afford to pay the taxes out of pocket, consult with your tax or financial professional to determine whether it makes sense for you to do a conversion that year.

Individuals who are considering converting their non-Roth retirement accounts to Roth IRAs should consult with a tax professional about the possible tax impact of the conversion and determine steps that can be taken to reduce or eliminate any negative impact. For instance, consideration should be given to how the conversion could affect an individual’s Medicare Part B premium.

Explanations of the rules that govern IRAs are usually provided in Ed Slott's IRA Advisor Newsletter. If you are not already a subscriber and want to get an idea of what the newsletter includes, you can preview past issues before subscribing.

Set yourself apart from the competition, and bring in millions in new IRA rollover business by subscribing to Ed Slott's IRA Advisor Newsletter and attending Ed Slott's IRA Workshops. Click here to see a schedule of upcoming workshops.

Question of the Month

Question: An individual converted his Traditional IRA balance to his Roth IRA and failed to take his RMD amount before the conversion. What should he do?

Answer: He should first determine the RMD amount that should have been taken from his traditional IRA. That amount is required to be removed from his Roth IRA as a return-of-excess contribution. The amount must include any net income attributable (NIA) and must be removed by his tax filing deadline. If he filed his tax return by the due date, he receives an automatic 6-month extension to remove the amount, generally to October 15. Failure to remove the amount by the deadline will result in him owing the IRS a 6% excise tax on the amount of the RMD for each year it remains an excess contribution in his Roth IRA.

The NIA on the excess amount can be earnings or losses, and is computed by using a formula provided by the IRS. This formula can be found in IRS Publication 590, available at www.irs.gov.


News, Rulings and Other Updates

  • Additional Guidance on qualified HSA funding distributions: The IRS issued Notice 2008-51, in which they provide additional guidance on qualified HSA funding distributions (QHFD) from IRAs. Among other things, Notice 2008-51 provides that a QHFD is not subject to income tax or the 10-percent early distribution penalty. In order to qualify for this provision, the IRA owner must remain an eligible individual during the entire testing period. According to the IRS, the testing period begins with the month in which the qualified HSA funding distribution is contributed to the HSA and ends on the last day of the 12th month following that month.
  • Relief for Withdrawals of Stimulus Payments: The IRS issued Announcement 2008-44, which provides for tax-free and penalty-free withdrawals of stimulus payments credited to IRAs, HSAs, MSAs and Section 529 plans, if the amount was credited to the account via direct deposit. In order to qualify for the exception, the amount must be withdrawn from the account by the deadline for filing the account owner’s 2008 tax-return, plus extensions.

June’s Retirement Planning Tip

There is a misconception among some financial professionals that purchasing life-insurance is a waste of money. But as any member of Ed Slott’s Elite IRA Advisor Group will tell you, life-insurance can be one of the defining tools for creating an effective estate plan. Individuals who inherit retirement accounts may need to pay estate taxes and income taxes, and may find that the only source of money to cover the expenses is the retirement account. If they inherited life-insurance proceeds in addition to the retirement account, these amounts can be used to pay estate taxes, negating the need to make withdrawals from the IRA (to pay estate taxes). This strategy is explained in detail in The Retirement Savings Time Bomb... And How to Defuse It, by Ed Slott.


Highlights from Ed Slott’s IRA Advisor Newsletter - June 2008 Issue

The June 2008 issue of Ed Slott's IRA Advisor is now available online. The areas covered include the following:

  • Only one IRA to IRA rollover per year is permitted and there is no relief on mistakes in this            area. In this month's issue we highlight recent rulings where costly errors could not be corrected.
  • Some of the tax rebate checks are getting trapped in IRAs. IRS has ruled on how to remove those funds without tax or penalties.
  • IRAs and Wash Sales: This month's Guest IRA Expert is Mike Jones. He recaps the IRS ruling stating that the wash sale rules apply to IRAs and Roth IRAs.
Feature Article

Avoiding Once-per-Year IRA Rollover Disasters
  • No Relief on Additional Rollover
    60-Day Rollover vs. Trustee-to-Trustee (Direct) Transfer
  • Once-per-Year IRA Rollover Rules
  • Exceptions to the Once-per-Year Rule
  • Possible Fixes
  • Advisor Action Plan

Getting a Tax Stimulus Payment Out of an IRA

  • IRS Announcement 2008-44
  • Direct Deposit Background
  • Withdrawing the Stimulus Payment (The Tax Rebate) from an IRS

Be sure to review the June issue and post your questions on our message board at http://www.irahelp.com/phpBB/index.php?area=, where some of the best experts in the retirement field gather to discuss technical issues.

To view current and past issues of the IRA Advisor, click the link below to access our "Subscribers Only" section of our website:
http://www.irahelp.com/newsletter.php?area=a
http://irahelp.com/newsletter.php?area=a (for America Online users)

If you do not already subscribe to Ed Slott's IRA Advisor Newsletter, you may do so by clicking here and providing the required information, or by calling 800-663-1340. Each issue is 8 full pages of must-have tax information. Individuals who subscribe to the online version of the Ed Slott's IRA Advisor Newsletter, receive access to back issues at no additional cost.


Ed Slott and Company-100 Merrick Road, 200 East, Rockville Centre, NY 11570
Send comments about this newsletter to Ryan@irahelp.com

 

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