2011 Roth Conversions, Naming Minors as Beneficiaries Highlight Mailbag

The holiday season is upon us. It is time for friends, family and financial security. The answers to these consumer questions can help you wrap up your year-end planning. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure.

1.

Dear Ed and Company,

I was planning to convert my IRA to a Roth IRA, because I figured the tax consequences would be less in 2010. However, I read in "Consumer Reports Money Adviser" that there is a 5-year waiting period before I can withdraw money from the Roth, reportedly as follows:

"The second five-year waiting period refers to when you convert a traditional IRA to a Roth IRA. You have to wait at least five years from the first day of the ta year that you made the conversion to take a qualified distribution. So if you made the switch on March 3, 2010, the five-year clock started on January 1, 2010."

Is this correct? I don't recall reading this in your articles in "Investment News." I am 83 years old, and have been taking RMD (required minimum distributions) from the traditional IRA, but I don't need the distributions.

Many thanks for your help, and best wishes for the holiday season.

George Nimick

Answer:
In your case, when converting to a Roth IRA you will not have to wait five years to make withdrawals penalty and income tax free. When you convert to a Roth IRA you are paying income tax on the taxable portion of the conversion. However, the earnings on the converted amount must stay in for five years, assuming this is your first Roth IRA, to be income tax free. This is generally not a problem because you have the ability to withdraw all the converted funds first before you get to the earnings in the first five years. If you decide to convert to a Roth IRA you annual required minimum distribution in that year must come out first and then you can convert any amount you would like.

2.

Ed and IRA Experts -

Is it wise to name minor grandchildren as primary beneficiaries of a Roth IRA or would it be better to name the parents.

Thanks,

Eileen

Answer:
If you want children to receive the IRA proceeds at your death you are better off naming them as primary beneficiaries. In that case, they, at your death, will be able to use their own age for life expectancy purposes. But, keep in mind that if you should die while they are still minors and there is no trust or guardian in place for the minors, then the court would appoint a guardian. Also, if they are not a minor, when they inherit directly that the stretch is not a guarantee because they have access to the money at will. To guarantee the stretch you might want to consider naming a trust for the child as beneficiary of the IRA>

3.

With the new tax law, a 2011 conversion will incur taxes over what period and when will payments be due?

Thanks,

Mike

Answer:
On a 2011 Roth IRA conversion the income is included in your income for 2011 and the tax due on the taxable portion of the conversion must be paid with your return for that year. However, you will have until April 15, 2012 to pay the income tax. The ability to spread the converted amount over 2011 and 2012 is only for 2010 conversions.

By IRA Technical Consultant Marvin Rotenberg and Jared Trexler
------------------------------------------------------------------------------
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC

Aftermath of Proposed Tax Cut Plan: What to do with Payroll Tax Cut

Part of the proposed tax cut plan outlined by the Obama White House earlier this week included a provision to cut the payroll tax two percentage points from 6.2% to 4.2% just for 2011.

The tax benefit tops out at $2,100 per year for anyone making $106,800 or more, so this tax cut serves as a small stimulus into the pockets of all Americans. The federal government would love for you to stimulate the economy with that money: spend on presents, spend on vacations, spend on dining out.

But I asked myself yesterday the same question many people are asking themselves as this proposal makes its way through the halls of Washington: What should I do with the money?

I ran across an article in the Personal Finance section of The Wall Street Journal (www.smartmoney.com for those who don't know) that answered that exact question.

The article offered several financially-beneficial, worthwhile ideas such as: juice up retirement savings (we at The Slott Report love that idea!), create a "health-care kitty" (read the article below for a full explanation), and upgrade appliances.

CLICK HERE to read the article in full and post a comment in the section below to offer your suggestions on how to spend the payroll tax cut.

Aftermath of the Proposed Tax Cut Plan: What Does it Mean For You?

Many individuals and families are clamoring for answers to the most logical question in the aftermath of a new proposed tax cut agreement between the White House and Congressional Republicans.

"What does the new policy mean for me?"

For clarity's sake, the announced agreement is not yet "policy" but rather a "framework" with which a deal could be struck before year's end. We do not have a comprehensive outline of the proposal's structure, nor are we 100% certain of the proposal's passage by Congress.

Yet, the broad parameters address a multitude of issues that have been in question for months and in some instances years. Here is what all of this could mean for YOU if the "framework" eventually becomes "law."

Tax rates for individuals: The Bush-era tax cuts would be extended until the end of 2012 for all taxpayers no matter income level. Current income tax rates would remain in place with a top rate of 35%--where it has held since 2003. To put the rate in perspective, the top federal tax rate was 70% just 29 years ago and 91% in 1963.

Payroll taxes: A fairly progressive measure, the agreement would reduce payroll taxes by two percentage points for employees. The change, to be instituted just for 2011, would lower the payroll tax from 6.2% to 4.2% on the first $106,800 of wages per worker (statistic according to the Tax Policy Center).

Estate and gift tax: A bone of contention with some, the tentative framework includes an estate-tax provision for 2011 and 2012 with a top rate of 35% and an exemption of $5 million per individual. The White House released no language on this as of this printing, so the actual parameters make a difference.

Extenders: The most important for IRA holders is the transfers of IRA assets to charities by those over age 70 1/2.

Unemployment Benefits: This was the major sticking point for the Obama White House. The agreement would extend federal benefits at their current level (up to 99 weeks) for 13 months through the end of 2011.

Other Tax Credits: These include a $1,000 child tax credit; an expansion of the Earned Income Tax Credit for larger families and married couples; a continuation of the higher-education tax credit.

Those are just the basics. We at The Slott Report will be monitoring this situation closely and posting articles and explanations on how the final passed bill affects retirement planning and IRAs in particular.


By Jared Trexler
------------------------------------------------------------------------------
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC

Over 70 1/2 and Still Working

Your client is over 70 ½ and is still working. Does he have to take an RMD?

The answer is, it depends. The law allows an employee who is still working to defer distributions in the plan of the company for which he is working until after retirement. This is optional for the plan; it must allow this provision. There is no definition of “still working.” Presumably you could work for one hour a year and qualify.

There is an exception to that rule. If the employee is a 5% or more owner of the company for any part of the year, then he must take an RMD if he is 70 ½ or older.

The answer is different for IRA-based plans such as SEP or SIMPLE plans. There is always a distribution from an IRA at age 70 ½ (except for Roth IRAs) whether you are still working or not.

The employee can continue to make contributions to an employer plan after age 70 ½ even if there is a required distribution, as long as the plan allows. Contributions cannot be made to a traditional (regular) IRA once the account owner reaches the year he turns 70 ½. If there is earned income, contributions can continue to be made to Roth IRAs.

The RMD for a company plan such as a 401(k) plan cannot be satisfied with a distribution from an IRA. Each plan must calculate and distribute its own RMD. Again there is an exception. 403(b) account RMDs can be aggregated and taken from one or more 403(b) accounts, but not from an IRA.

By IRA Technical Consultant Beverly DeVeny and Jared Trexler
------------------------------------------------------------------------------
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC

Retirement Fears: Older Wills Can Be a Problem

Older wills and the estate tax issue. Talk about broaching a hot-button issue in Washington and around the nation these days. The action is furious, thought not particularly fast, and we could have a resolution shortly.

Yet, we never count taxes before they are hatched. This installment of Retirement Fears broaches the issue of older wills and raises the estate tax dilemma sitting before a lame duck session of Congress.

CLICK HERE to read Retirement Fears.

------------------------------------------------------------------------------
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC

Are You an IRA Expert?

Welcome to this month’s installment of Are You an IRA Expert? Always thought you knew more than the next guy about IRAs and retirement accounts? Well now is your chance to prove it. Below are three questions, ranging from beginner to expert. Test your IRA skills by trying to get all three right!

Questions:

Use the following information to answer the questions below:

John, age 57, died March 4, 2009. He left his sole IRA to his wife (50%) and his two sons, Bradley (25%) and Mark (25%).

Beginner: In order to be eligible for separate account treatment, John's beneficiaries must split the inherited account by what date?

Intermediate: Since John died with designated beneficiaries, but before his required beginning date, under the Tax Code his beneficiaries will have two options (an IRA custodial document can be more restrictive). What are they?

Expert: If John's wife transfers her share of the account by the deadline to receive separate account treatment (see question #1) and chooses to remain a beneficiary, when must she begin taking required minimum distributions?

Answers:

Beginner: December 31, 2010. In order to receive separate account treatment, accounts must be split by December 31st of the year following the year of an IRA owner's death. Accounts may be split afterwards, but all beneficiaries will be “stuck” using the oldest beneficiary’s life expectancy and a spouse will not be able to take advantage of any special spousal distribution rules.

Intermediate: Distributions may be made over beneficiaries' life expectancies or the entire account may be emptied by December 31st of the fifth year following the year of death.

Expert: December 31st of the year John would have turned 70 ½. One of the special spousal distribution rules is that a spouse who remains a beneficiary does not need to begin taking RMDs until December 31st of the year the deceased spouse IRA owner would have been 70 ½. This is only available when a spouse is the sole IRA beneficiary or if they split the account before the deadline for separate account treatment.

So how did you do? Are you an IRA Expert? Unless the answer is a resounding yes, you may want to consider consulting with an advisor who has specialized knowledge and training in this area when you have these, or other IRA questions.

By IRA Technical Consultant Jeffrey Levine and Jared Trexler
------------------------------------------------------------------------------
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC

IRA Holders Still Undecided About Switching to Roths

Financial Planning posted an article on its website today titled, "IRA Holders Still Undecided About Switching to Roths". In the article, author Temma Ehrenfeld discussed a statistic that 23 percent of the middle class remained undecided in October about converting to an IRA.

CLICK HERE to read the entire article.

The Slott Report's Take:

A key point to remember is the opportunity to spread the tax bill out over two years (2011 and 2012). This advantage expires on December 31st of this year. The survey by First Command shows that people do understand the benefits of a conversion, but many are leery because:

1)They believe they will be in a lower tax bracket in retirement
2)They do not have the money to pay the conversion taxes up front

Consumers should realize that tax rates will likely rise so you may be underestimating your tax bracket in retirement. And if not, you can always undo a Roth conversion up to October 15th of the year after the conversion. That is called a Roth recharacterization.

Roth conversions are NOT for everyone, but it is a subject you should talk about with your financial advisor before year-end. Also, make sure you know where you are going to get the money to pay the tax.

As Ed said at the end of the article: "If a client does not have enough non-IRA funds to pay the tax on a Roth conversion, the conversion generally won't be worth it."

IRAs (SEP, Inherited, Stretch) Highlight Mailbag

IRAs, IRAs, IRAs. We have a full plate (leftovers from Thanksgiving) of IRA questions in this week's Mailbag. These questions touch on topics such as SEP IRAs, inherited IRAs and naming the trust as the beneficiary of IRAs. We answer all of those questions below!  As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure.

1.

The Slott Report,

The retitling of an inherited IRA account has been covered.

1. When the beneficiary of an inherited IRA dies (the original IRA owner and the beneficiary have both died) how is the IRA then retitled?

2. If an IRA beneficiary disclaims, does the person that then inherits the IRA simply retitle it without regard to it having been disclaimed?

3. When a beneficiary inherits an IRA, can the beneficiary immediately provide the custodian with a new beneficiary list for the inherited IRA, before the IRA is retitled?

Kind regards,

George Bumiller

Answer:
We will take this in the three designated parts.

1. Assuming the beneficiary of the inherited IRA named their own beneficiary when they inherited the IRA, then at the death of the beneficiary, the account would be retitled with the name of the original owner for the benefit of the new beneficiary. The life expectancy factor being used will not be extended for the new beneficiary, it will continue with the term in use by the original beneficiary.

2. When doing a disclaimer, within nine months after the date of death, it is as if the person disclaiming never existed. Therefore, if a primary beneficiary disclaims, the contingent, next in line, will be the new owner. The title of the account would be the inherited IRA, name of deceased owner, for the benefit of the new owner.

3. The general answer is YES, but you always want to check the custodian first to see what they will or will not allow.


2.

We have an A-B trust with no provisions for our IRAs. My wife's traditional IRA is worth about $600,000 with beneficiaries being our 3 children. My IRA is smaller with my wife as the beneficiary. Do we need an IRA trust to ensure that the children as beneficiaries stretch their portion of their IRAs rather than cash and owe lots of income taxes or does the trust need to be the beneficiary of the IRA or neither of the two?

What needs to be done to insure that the children will stretch their portion of this traditional IRA?

Thanks!

Answer:
You bring up a good question about insuring the stretch IRA. To absolutely insure that the beneficiaries, in this case the children, will use the stretch payouts, you should consider naming a trust as beneficiary of the IRA. You will need to work with an attorney who knows the IRA rules, especially the IRA trust rules.


3.

My wife is a self-employed consultant. She started a SEP IRA and maxed that out and then started an individual 401(k) plan. How much can she contribute to the combined plans? Our joint taxable income is over $250,000. She is 56 years old.

Thanks,

Cary

Answer:
Most SEP IRA documents state that SEP IRA must be the only plan for the business. A self-employed individual cannot have a SEP IRA and individual 401(k) plan. You can only have one or the other.

By IRA Technical Consultant Marvin Rotenberg and Jared Trexler
------------------------------------------------------------------------------
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC

In-Plan Roth Rollover Guidance Released

IRS has released guidance on the conversion of 401(k) and 403(b) plan assets to Roth 401(k) or Roth 403(b) accounts in Notice 2010-84. This guidance also applies to governmental 457(b) plans beginning January 1, 2011. Here are the highlights:

• Plan participants, spouses, and alternate payees who are current or former spouses can do the in-plan Roth conversion.

• The funds converted must be eligible for rollover from the plan.

• The conversion is not treated as a distribution in the case of a plan loan being converted and spousal consent is not needed.

• In-plan rollovers are not subject to the 10% early distribution penalty and direct rollovers are not subject to 20% mandatory withholding.

• If the conversion is done in 2010 the participant can spread the income over 2011 and 2012 or elect to include all the income on their 2010 tax return.

• All in-plan Roth conversions must make the same tax election - either the two-year spread or to include the income on the 2010 tax return. The election is made on Form 8606.

• There is NO option to recharacterize an in-plan Roth conversion.

By IRA Technical Consultant Beverly DeVeny and Jared Trexler
------------------------------------------------------------------------------
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC