Tag: Roth IRA

Posted on Mar 19, 2018

The Roth IRA remains an attractive retirement planning vehicle for many individuals after the changes made by the Tax Cuts and Jobs Act (TCJA). Here’s what you need to know about Roth IRAs and Roth IRA conversions under the new law.

Tax Advantages

Roth IRAs offer several important tax advantages over traditional IRAs. First and foremost, unlike traditional IRA withdrawals, qualified Roth IRA withdrawals are federal-income-tax-free — and they’re usually state-income-tax-free, too. In general, a qualified withdrawal is one that’s taken after the Roth account owner has met both of the following requirements:

    • The owner has had at least one Roth IRA open for over five years, and
  • The owner has reached age 59½, become disabled or died.

For purposes of meeting the five-year requirement, the clock starts ticking on the first day of the tax year for which you make your initial contribution to your first Roth account. That initial contribution can be a regular annual contribution, or it can be a conversion contribution.

The second reason Roth IRAs are beneficial is that they’re exempt from the required minimum distribution (RMD) rules. So, unlike with traditional IRAs, you don’t have to start taking RMDs from Roth IRAs after reaching age 70½. Roth IRAs can be left untouched for as long as you live. This important privilege makes your Roth IRA a great asset to leave to your heirs (unless you need the money to help finance your own retirement).

New Tax Law Eliminates Reversal Privilege for Roth IRA Conversions

Did you know that the Tax Cuts and Jobs Act (TCJA) contains a provision that negatively affects Roth IRA conversions?

Under prior law, you had until October 15 of the year after an ill-advised conversion to reverse it to avoid the conversion tax hit. Thanks to the TCJA, for 2018 and beyond, you can no longer reverse the conversion of a traditional IRA into a Roth account. This elimination of the conversion reversal privilege is permanent.

However, the IRS recently clarified, in Frequently Asked Questions (FAQs) posted on its website, that, if you converted a traditional IRA into a Roth account in 2017, you can reverse the conversion as long as it’s done by October 15, 2018. (That deadline applies regardless of whether you extend the deadline for filing your 2017 federal income tax return to October 15.)

In IRS jargon, a Roth conversion reversal “recharacterizes” the Roth account back to traditional IRA status. Your Roth IRA trustee or custodian (or tax advisor) can help you fill out the requisite paperwork.

When do reversals make sense? Suppose you converted two traditional IRAs (Accounts A and B) into two Roth IRAs in 2017. The value of Account A has increased since the conversion date. Unfortunately, Account B has plummeted in value, and it’s now worth significantly less than it was on the conversion date. In this situation, you’d be required to pay income tax on Account B’s value on the conversion date — and some of that value is now gone.

Fortunately, through October 15, 2018, you have the option of recharacterizing Account B back to traditional IRA status. After the reversal, it’s as if the ill-fated conversion never happened, so you won’t owe any 2017 income tax on the conversion of Account B. And you can still leave Account A in Roth IRA status.

Annual Roth IRA Contributions

The idea of making annual Roth IRA contributions makes the most sense for those who believe they’ll pay the same or higher tax rates during retirement. Higher future taxes can be avoided on Roth account earnings, because qualified Roth withdrawals are tax-free. The downside is that you get no deductions for making Roth contributions.

If you expect to pay lower tax rates during retirement, current tax deductions may be worth more to you than tax-free withdrawals later. So, you might be better off making deductible traditional IRA contributions, assuming your income is below the phaseout threshold (below).

Roth contributions also make sense when you’ve maxed out on deductible retirement contribution possibilities but you want to sock away additional money for retirement.

There are limits to annual Roth IRA contributions, however. The maximum amount you can contribute for any tax year is the lesser of:

    • Your earned income for the year (including wages, salaries, bonuses, alimony and self-employment income), or
  • The annual contribution limit for that year.

For 2018, the annual Roth contribution limit is $5,500 (or $6,500 if you will be age 50 or older as of year end). In addition, for 2018, eligibility to make annual Roth contributions is phased out between modified adjusted gross income (MAGI) of $120,000 and $135,000 for unmarried individuals. For married joint filers, the 2018 phaseout range is between MAGI of $189,000 and $199,000.

The deadline for making annual Roth contributions is the same as the deadline for annual traditional IRA contributions, which is the original due date of your return. For example, the contribution deadline for the 2018 tax year is April 15, 2019. However, you can make a 2018 contribution anytime between now and then. The sooner you contribute, the sooner you can start earning tax-free income.

Important: Making contributions to traditional IRAs is off limits for the year you reach age 70½ and beyond. In contrast, people age 70½ or older can still make annual Roth IRA contributions (assuming the eligibility requirements explained above are met). So, Roth IRAs can be a smart savings tool for older individuals as well as for younger ones.

In addition, if you’re an employee, research whether your employer offers a Roth 401(k) option. This retirement savings tool is similar to a Roth IRA: It allows you to make after-tax contributions. Qualified withdrawals from a Roth 401(k) are generally federal and state tax-free. But these accounts are not exempt from the RMD rules. And, unlike Roth IRAs, there are no income level phaseouts for contributing to Roth 401(k) accounts, so they can be a tax-wise move for higher income individuals who are above the income thresholds for contributing to a Roth IRA.

Roth Conversions

The quickest way to get a significant sum into a Roth IRA is by converting a traditional IRA to Roth status. The conversion is treated as a taxable distribution from your traditional IRA, because you’re deemed to receive a payout from the traditional account for the money that will go into the new Roth account. So converting your IRA before year end will trigger a bigger federal income tax bill for this year — and possibly a bigger state income tax bill, too. The good news: There are no income limits on Roth conversions, and the amount you convert isn’t hit with the 10% early IRA withdrawal penalty tax even if you are under age 59½.

More good news for conversions: Today’s federal income tax rates might be the lowest you’ll see for the rest of your life. For most individuals, the tax rates for 2018 through 2025 will be lower than what you paid in prior years. In 2026, the pre-TCJA rates and brackets are scheduled to come back into force, but many people doubt that will happen.

So, if you convert your traditional IRA into a Roth IRA in 2018, you’ll pay today’s low tax rates on the extra income triggered by the conversion and completely avoid the potential for higher future rates on all the postconversion income that will be earned in your new Roth account. That’s because qualified Roth withdrawals taken after age 59½ are totally federal-income-tax-free after you’ve had at least one Roth account open for over five years.

To be clear, the best candidates for the Roth conversion strategy are people who believe that their tax rates during retirement will be the same or higher than their current tax rates.

A word of caution: Converting a traditional IRA with a significant balance could push you into a higher tax bracket. For example, if you’re single and expect your 2018 taxable income to be about $100,000, your marginal federal income tax bracket is 24%. Converting a $100,000 traditional IRA into a Roth account in 2018 would cause a big chunk of the extra income from the conversion to be taxed at 32%. (For 2018, the 32% tax bracket starts at $157,501 for single  people.) But if you spread the $100,000 conversion equally between 2018 and 2019, the extra income from converting would be taxed at 24% (assuming Congress leaves the current tax rates in place through at least 2019).

To Roth or Not to Roth?

Should you incorporate a Roth IRA into your retirement savings program? Roth IRAs offer significant tax advantages, if you’re eligible to make annual contributions or if you convert a traditional IRA into a Roth account. Today’s comparatively low federal income tax rates under the TCJA provide an extra incentive to consider the Roth conversion strategy right now. Contact your tax advisor to help understand the pros and cons of Roth IRAs and Roth conversions under the new tax law.

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Posted on Sep 13, 2016

Fall is a good time to pause and review your financial planning strategy. A lot can happen in a year. If your personal life, market conditions or tax laws have changed, you may need to revise your long-term financial plans. Here are some retirement and estate planning considerations that may be worthwhile.

IRS Proposal Threatens Discounts on Transfers of Family-Owned Business

For years, proactive taxpayers have used family limited partnerships (FLPs) and other family-owned business entities in estate planning. If properly structured and administered, these estate-planning tools allow high net worth individuals to transfer their wealth to family members and charities at a substantial discount from the value of entities’ underlying assets. Examples of assets that may be contributed to an FLP include marketable securities, real estate and private business interests.

Important Note. The FLP must be set up for a legitimate purpose (such as protecting assets from creditors and professional-grade asset management) to preserve valuation discounts.

Valuation discounts on FLPs relate to the lack of control and marketability associated with owning a limited partner interest. These interests are typically subject to various restrictions under the partnership agreement and state law.

The IRS has targeted FLPs and other family-owned businesses in various Tax Court cases. To strengthen its position in court, the IRS issued a proposal in August that could significantly reduce (or possibly eliminate) valuation discounts for certain family-owned business entities. Among other changes, the proposal would add a new category of restrictions that would be disregarded in valuing transfers of family-owned business interests.

If finalized, the proposed changes won’t go into effect until 2017 (at the earliest). So there still may be time to use these estate-planning tools and be grandfathered in under the existing tax rules. If you’ve been considering setting up an FLP or transferring additional interests in an existing one, it may be prudent to act before year end.

Contact your estate planning advisor for more details on this proposal — or to utilize this strategy before any new restrictions go into effect.

Roth IRAs

Do you understand the key differences between traditional and Roth IRAs? Roth IRAs can be an effective retirement-saving tool for people who expect to be in a higher income tax bracket when they retire. Here’s how it typically works.

You open up a Roth IRA and make after-tax contributions. The tax savings come during retirement: You don’t owe income taxes on qualified Roth withdrawals.

As an added bonus, unlike with traditional IRAs, there’s no requirement to start taking annual required minimum distributions (RMDs) from a Roth account after reaching age 70 1/2. So you’re free to leave as much money in your Roth account as you wish for as long as you wish. This important privilege allows you to maximize tax-free Roth IRA earnings, and it makes the Roth IRA a great asset to leave to your heirs (to the extent you don’t need the Roth IRA money to help finance your own retirement).

The maximum amount you can contribute for any tax year to any IRA, including a Roth account, is the lesser of:

  1. Your earned income for that year, or
  2. The annual IRA contribution limit for that year. For 2016, the annual IRA contribution limit is $5,500, or $6,500 if you’ll be age 50 or older as of year end.

If you’re married, both you and your spouse can make annual contributions to separate IRAs as long as you have sufficient earned income. For this purpose, you can add your earned income and your spouse’s earned income together, assuming you file jointly. As long as your combined earned income equals or exceeds your combined IRA contributions, you’re both good to go.

Unfortunately, your ability to make annual Roth contributions may be reduced or eliminated by a phaseout rule that affects high-income individuals. But you may be able to circumvent this rule by making an annual nondeductible contribution to a traditional IRA and then converting the account into a Roth IRA. In this indirect fashion, high net worth individuals can make Roth contributions of up to $5,500 if they’re under age 50 or up to $6,500 if they’re at least 50 and younger than 70 1/2 as of the end of the year. (Once you hit 70 1/2, you become ineligible to make traditional IRA contributions, and that shuts down this strategy.)

If you’re married, you can double the fun by together contributing up to $11,000 or up to $13,000 if you’re both at least 50 (but under age 70 1/2). There are various rules and restrictions to using this strategy, and it may be less advantageous if you have one or more existing traditional IRAs. So, consult with your tax advisor before attempting it.

Self-Directed IRAs

Self-directed IRAs expand the menu of investment options available in a typical IRA. For instance, with a self-directed IRA you may be able to include such alternatives as hedge funds, real estate and even equity interests in private companies. These types of investments often offer higher returns than traditional IRA investment options.

But self-directed IRAs aren’t a free-for-all. The tax law prohibits self-dealing between an IRA and “disqualified” individuals. For example, you can’t lend money to your IRA or invest in a business that you, your family or an IRA beneficiary controls. The consequences for self-dealing can be severe, so consult with your financial advisor before making the switch.

Deductible Losses on Underperforming Stocks

Do you own stocks and other marketable securities (outside of your retirement accounts) that have lost money? If so, consider selling losing investments held in taxable brokerage firm accounts to lower your 2016 tax bill. This strategy allows you to deduct the resulting capital losses against this year’s capital gains. If your losses exceed your gains, you will have a net capital loss.

You can deduct up to $3,000 of net capital loss (or $1,500 if you are married and file separately) against ordinary income, including your salary, self-employment income, alimony and interest income. Any excess net capital loss is carried forward to future years and puts you in position for tax savings in 2017 and beyond.

Gifts of Appreciated Assets

Suppose you are lucky enough to have the reverse situation: You own stocks and other marketable securities (outside of your retirement accounts) that have skyrocketed in value since they were acquired. Taxpayers in the 10% or 15% income tax brackets can sell the appreciated shares and take advantage of the 0% federal income tax bracket available on long-term capital gains. Keep in mind, however, that depending on how much gain you have, you might use up the 0% bracket and be subject to tax at a higher rate of up to 20%, or 23.8% when considering the Medicare surcharge that may apply.

While your tax bracket may be too high to take advantage of the 0% rate, you probably have loved ones who are in the lower tax brackets. If so, consider gifting them assets to sell.

Important Note. Gains will be considered long-term if your ownership period plus the gift recipient’s ownership period equals at least a year and a day.

Giving qualified-dividend-paying stocks to family members eligible for the 0% rate is another tax-smart idea. But before making a gift, consider the gift tax consequences.

The annual gift tax exclusion is $14,000 in 2016 (the same as 2015). If you give assets valued at more than $14,000 (or $28,000 for married couples) to an individual during 2016, it will reduce your $5.45 million gift and estate tax exemption — or be subject to gift tax if you’ve already used up your lifetime exemption. Also keep in mind that if your gift recipient is under age 24, the “kiddie tax” rules could potentially cause some of his or her capital gains and dividends to be taxed at the parents’ higher rates.

Charitable Donations

Charitable donations can be one of the most powerful tax-savings tools because you’re in complete control of when and how much you give. No floor applies, and annual deduction limits are high (20%, 30% or 50% of your adjusted gross income, depending on what you’re giving and whether a public charity or a private foundation is the recipient).

If you have appreciated stock or mutual fund shares that you’ve owned for more than a year, consider donating them instead of cash. You can generally claim a charitable deduction for the full market value at the time of the donation and avoid any capital gains tax hit.

If you own stocks that are worth less than you paid for them, don’t donate them to a charity. Instead, sell the stock and give the cash proceeds to a charity. That way, you can generally deduct the full amount of the cash donation while keeping the tax-saving capital loss for yourself.

Life Changes

Have there been any major changes in your personal life, such as a recent marriage or divorce, the birth or adoption of a new child, or a death in the family? If so, you may need to revise the beneficiaries on your retirement accounts and life insurance policies. You also may need to update your will and power of attorney documents.

Life changes can be stressful, and it’s very common for these administrative chores to be overlooked. But failure to update financial plans and legal documents can lead to unintended consequences later on, either when you die or if you become legally incapacitated and need someone else to make certain decisions on your behalf.

Got Questions?

These are just a handful of financial issues to consider at year end. Your financial and legal advisors can run through a more comprehensive checklist of planning options based on your personal circumstances. Call Cornwell Jackson to schedule a meeting as soon as possible, before the hustle and bustle of the holiday season starts.

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