Roth IRA Recharacterizations and the Death of the Stretch IRA

Are Roth IRA Conversions legal? How can you change your mind after making a Roth IRA conversion?

Roth IRA Recharacterizations and The Death of the Stretch IRA James Lange

This is one in a series of posts about Roth IRA conversions and the Death of the Stretch IRA.  If you have not visited my blog before, it might be helpful to back up and read a few of the preceding posts.

Roth IRA Conversions – a Legal Way to Beat the Death of the Stretch IRA?

As you might know, I do a lot of presentations for legal and financial professionals, as well as plain old normal people, about Roth IRA conversions and the Death of the Stretch IRA.  One question that comes up a lot in my presentations involves the legality of Roth IRA conversions.  People look at the numbers I show them and say, “It doesn’t seem right that you can do this because your family is so much better off.  It seems too good to be true.  Is it legal to do this?”

In order to answer that question, I’d like to refer you to this quote from Judge Learned Hand said “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury.  There is not even a patriotic duty to increase one’s taxes.  Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible.  Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

I definitely do not advocate doing anything illegal – in fact, I applaud you if you were one of the people who asked the question – but, like Judge Learned Hand, I certainly believe that you should take advantage of every tax break that you’re allowed to.  Would you worry about taking a tax deduction for a Traditional IRA contribution that you made, or for a donation to a charity?  Of course not!  Roth IRA conversions are no different.  They’re definitely legal – they’re permitted by the US Tax Code, and the IRS even has a specific form that your CPA has to use when you do one.  The problem is that they’re very complicated, and most people don’t like the idea of having to deal with even the most basic tax maneuvers – much less the complicated ones.   So yes, Roth IRA conversions are definitely legal, and you don’t have to worry about bringing the IRS down on your head if you do one.  But I still want to talk to you about how you can possibly get hurt when you go through the process.

Roth IRA Recharacterizations – Your Safety Net

Suppose you’ve read my books and my blog, and you’re rightly concerned about the Death of the Stretch IRA.  You convert $100,000 of your Traditional IRA, and, because you’re in the 25% tax bracket, you paid $25,000 from your after-tax money.  You now have a Roth IRA worth $100,000 and your savings account is $25,000 lighter.  Then the market crashes, and suddenly your Roth IRA is worth only $60,000.  You paid all those taxes for nothing!  Or did you?

At the risk of making a complicated topic even more complicated, you need to know about Roth IRA recharacterizations.  If you make a Roth IRA conversion, the IRS gives you until October 15th of the year following the year that you made the conversion, to change your mind.  So if you make a Roth IRA conversion in 2017, and the value of your account goes immediately down, you have a fairly long time where you can wait it out and see if the market recovers.  But suppose it doesn’t recover?  Well, as long as you act by October 15th of 2018, you can recharacterize, or “undo”, your conversion.  I like to give my clients as much time as possible to decide whether or not the Roth conversion was a good idea, so I generally suggest that they ask for an extension on their tax return so that they don’t file it before that October 15th date.  In most cases, a drop in the stock market that happens right after a Roth conversion and causes so much chagrin will work itself out within a year, and my client is happy that they made the change after all.  But if there is a long-term drop in the stock market, like there was in 2008, it is good to know that you can change your mind.  There is one thing I do want to point out, though.  If you recharacterize your Roth conversion, you’ll get back the money you paid in taxes.  You won’t get back the money you lost in the market – at least not because of the recharacterization.  You might get your money back eventually, but you’ll have to wait until the market comes back up.

Like Judge Learned Hand said, you are not obligated to pay more tax than the law requires.  Roth IRA conversions can provide you with a hedge against the Death of the Stretch IRA, and save your family an enormous amount of money in taxes over the long term.  And the ability to recharacterize, or “undo” your conversion should give you the peace of mind in knowing that you do not pay a nickel more in tax than you have to.

Stop back soon for more Roth IRA Conversion talk!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

Will New Rules for Inherited IRAs Mean the Death of the Stretch IRA?
Are There Any Exceptions to the Death of the Stretch IRA Legislation?
How will your Required Minimum Distributions Work After the Death of the Stretch IRA Legislation?
Can a Charitable Remainder Unitrust (CRUT) Protect your Heirs from the Death of the Stretch IRA?
What Should You Be Doing Now to Protect your Heirs from the Death of the Stretch IRA?
How Does The New DOL Fiduciary Rule Affect You?
Why is the Death of the Stretch IRA legislation likely to pass?
The Exclusions for the Death of the Stretch IRA
Using Gifting and Life Insurance as a Solution to the Death of the Stretch IRA
Using Roth Conversions as a Possible Solution for Death of the Stretch IRA
How Lange’s Cascading Beneficiary Plan can help protect your family against the Death of the Stretch IRA
How Flexible Estate Planning Can be a Solution for Death of the Stretch IRA
President Trump’s Tax Reform Proposal and How it Might Affect You
Getting Social Security Benefits Right with the Death of the Stretch IRA
The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Part II: The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Social Security Options After Divorce: Don’t Overlook the Possibilities Just Because You Hate Your Ex
Is Your Health the Best Reason to Wait to Apply for Social Security?
Roth IRA Conversions and the Death of the Stretch IRA
How Roth IRA Conversions can help Minimize the Effects of the Death of the Stretch IRA
How Roth IRA Conversions Can Benefit You Even if The Death of Stretch IRA Doesn’t Pass
The Death of the Stretch IRA: Will the Rich Get Richer?
The Best Time for Roth IRA conversions: Before or After the Death of the Stretch IRA?
Roth IRA Conversions and the Death of the Stretch IRA
Part II: How Roth IRA Conversions Can Help Protect You Against the Death of the Stretch IRA

Roth IRA Conversions and the Death of the Stretch IRA

How Roth IRA Conversions Can Help Protect You Against the Death of the Stretch IRA

Roth IRA Conversions and the Death of the Stretch IRA James Lange Pgh

Those of you who follow my blog know that I’ve spent a lot of time talking about the Death of Stretch IRA, and some ideas that you can take advantage of that could provide some defense for your own family.  The next few posts will continue my discussion about Roth IRA conversions, and how they might benefit your heirs after the Stretch IRA is eliminated.

When Will the Stretch IRA Be Eliminated?

Some of my critics have said that I’m making a lot of noise about something that might never happen.  They say that the Stretch IRA won’t be eliminated, and all of this discussion is for naught.  I have two responses to that.  First, I think it’s completely unrealistic to expect that our legislators will maintain the status quo.  We have reached the point where our spending is no longer sustainable.  Our national debt is estimated at about $20 trillion, but an even scarier statistic is how it relates to our gross domestic product (GDP).  That number is about 106 percent – meaning that we owe more than what the entire country produces.   At one point, President Trump suggested that we follow the lead of other countries and simply default on our debt.  I would be surprised if he could get that proposal through Congress, but if he plans to return the country to solvency as he promised, he’ll need a lot of revenue to do it.  With more than $25 trillion being held in tax-deferred retirement accounts, eliminating the Stretch IRA is a quick and relatively painless way to pump a lot of tax money into the government’s coffers.  And that, my friends, is why I believe that the Death of the Stretch IRA will happen soon – possibly before the end of 2017.  More than likely, the Death of the Stretch IRA will be included as part of a major tax reform – which, as you might recall, was part of President Trump’s campaign platform.  Remember, he promised a simplification of the tax code – and there’s nothing simpler than grabbing all your money by eliminating the Stretch IRA!

Roth IRA conversions – A Great Defense Against the Death of the Stretch IRA

Let’s suppose you die before the Stretch IRA is eliminated.   Your family will be in a better financial position because they can withdraw your IRAs using the old rules – and stretch it over their lifetimes.  But even if they are able to use the old rules, you could still be better off by doing a series of Roth IRA conversions.  In my previous posts, I talked about the concept of purchasing power, and how you and your spouse can be better off during your lifetimes if you convert.  We’ve proven this to hundreds of our clients by running the numbers for them, and collectively they’re better off by millions of dollars because they took our advice.

But what if the Death of the Stretch IRA happens during your lifetime?  Do you believe, as I do, that the Stretch IRA will be eliminated so that the Congress can put one finger in to the country’s fiscal dyke that is already bursting at the seams?  Well, when I give talks about possible solutions to the Death of the Stretch IRA, I tell people that Roth IRA conversions are a tool that can be beneficial in either situation.  So it doesn’t matter if you die before or after the Stretch IRA is eliminated – Roth IRA conversions can still be beneficial to your family.

Waiting for the Death of the Stretch IRA

It was less than a year ago that the Senate Finance Committee voted 26-0 to eliminate the Stretch IRA.  Congress never got a chance to vote on their proposal because they were consumed by one of the most bitter and contentious election processes in recent history.  Well, we’ve been watching Congress’s actions all summer long, and have had ongoing discussions with some individuals who are in the know about the status of the Death of the Stretch IRA.  If you subscribe to this blog, you’ll be among the first to know when it finally happens.

Stop back later for the latest updates on the Death of the Stretch IRA!

Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

Will New Rules for Inherited IRAs Mean the Death of the Stretch IRA?
Are There Any Exceptions to the Death of the Stretch IRA Legislation?
How will your Required Minimum Distributions Work After the Death of the Stretch IRA Legislation?
Can a Charitable Remainder Unitrust (CRUT) Protect your Heirs from the Death of the Stretch IRA?
What Should You Be Doing Now to Protect your Heirs from the Death of the Stretch IRA?
How Does The New DOL Fiduciary Rule Affect You?
Why is the Death of the Stretch IRA legislation likely to pass?
The Exclusions for the Death of the Stretch IRA
Using Gifting and Life Insurance as a Solution to the Death of the Stretch IRA
Using Roth Conversions as a Possible Solution for Death of the Stretch IRA
How Lange’s Cascading Beneficiary Plan can help protect your family against the Death of the Stretch IRA
How Flexible Estate Planning Can be a Solution for Death of the Stretch IRA
President Trump’s Tax Reform Proposal and How it Might Affect You
Getting Social Security Benefits Right with the Death of the Stretch IRA
The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Part II: The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Social Security Options After Divorce: Don’t Overlook the Possibilities Just Because You Hate Your Ex
Is Your Health the Best Reason to Wait to Apply for Social Security?
Roth IRA Conversions and the Death of the Stretch IRA
How Roth IRA Conversions can help Minimize the Effects of the Death of the Stretch IRA
How Roth IRA Conversions Can Benefit You Even if The Death of Stretch IRA Doesn’t Pass
The Death of the Stretch IRA: Will the Rich Get Richer?
The Best Time for Roth IRA conversions: Before or After the Death of the Stretch IRA?

The Best Time for Roth IRA conversions: Before or After the Death of the Stretch IRA?

For many individuals, a series of well-timed Roth IRA conversions can be the best defense against the Death of the Stretch IRA.

The Best Time for Roth IRA conversions: Before or After the Death of the Stretch IRA?

A lot of clients ask me if I manage my own finances the way I recommend they manage theirs, and the answer is definitely “yes”.   I realized though, that I have not told you my own Roth IRA conversion story, and how my decision will affect my own family after the Death of the Stretch IRA.

Roth IRA Conversions – The Best Time is in Years of Low Income

Think back to 1998.  It was long before we ever had to worry about the Death of the Stretch IRA, and it was the first year you were permitted to make Roth IRA conversions.  Back then, if your Modified Adjusted Gross Income was more than $100,000 you were restricted from making Roth IRA conversions.  Our family’s income was over $100,000, so I thought my income restricted me and never imagined I’d be eligible to do Roth IRA conversions myself.  Then on February 16, 1998, our office was wiped out by a devastating fire that started in a pizza shop located directly below us.  Can you imagine this happening to a CPA firm in the middle of tax season?

I learned some valuable lessons from this experience.  First, never put your office above a pizza shop.  Second, I learned more about the insurance process than I ever cared to know.  We had extremely high expenses because everything needed fixed and, even though I was well insured, I didn’t get the check for the damage until 1999. That meant that 1998 was a very tough year for the business financially.   I couldn’t take a salary, and for the first time our family’s income was far less than $100,000.  Did I get upset?  No.  I said to my wonderful wife, “Cindy, I think we have an opportunity here”.

My wife and I had about $250,000 in Traditional IRAs between us.  I told her that our normal income level would restrict us from making Roth IRA conversions, but our income in 1998 was far below normal – making that year the best time for us to do Roth IRA conversions.  I told her that I thought we should convert the entire amount to Roth IRAs and voluntarily pay the tax due the $250,000 conversion amount.  After she got over her initial shock, she looked at the mathematical calculations I had done and, being an extremely intelligent woman, she immediately understood that our family would be better off by hundreds of thousands of dollars in the long run.  And so we did it – we converted every last dime of our IRAs to Roths.  And those Roth IRAs are now worth quite a lot more than they were in 1998.

The law has since changed, and there are no longer any income restrictions on Roth IRA conversions.  This means that you can do smaller Roth IRA conversions over a series of years rather than all at once like I did, and by doing so you can convert them at a lower tax rate than I was able to.  The best time for many retired individuals is the period after you’ve stopped working, but before you are required to take minimum distributions from your IRAs and retirement plans.  And with the Death of the Stretch IRA looming, there are probably even more reasons now for you to consider Roth IRA conversions than I had when my office caught fire in 1998.

Transferring my Roth IRA to My Child

Twenty years later, it is likely that Cindy and I will never spend those Roth IRAs.  Some people will argue that, if that’s the case, there was no benefit to us converting our IRAs to Roths.  Why pay tax when you didn’t have to, they ask?  Well, I guess it’s because, in the long run, I was thinking of what would happen when I die and my Roth IRA is transferred to my child.  My daughter Erica was only three years old when we did those Roth IRA conversions.  If I die tomorrow and my Roth IRA is transferred to her, she’ll be hundreds of thousands of dollars better off because I did that conversion.  And if I live for another twenty years, it’s not unreasonable to think that she’ll be more than a million dollars better off when I die.

When my Roth IRA is transferred to her after my death, Erica will still be required to take minimum distributions from the account every year.  If I die before the Death of the Stretch IRA legislation is passed, those minimum distributions can be stretched over her lifetime and the bulk of the IRA can continue to grow in a tax-free environment.  If I die after the Death of the Stretch IRA legislation is passed, she’ll be required to withdraw the entire IRA within five years.  Although the money will be forced from the tax shelter more quickly, at least the withdrawals will be tax-free to her.  And I can’t think of a better present for my little girl.

Stop back soon for more Roth IRA talk!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

Will New Rules for Inherited IRAs Mean the Death of the Stretch IRA?
Are There Any Exceptions to the Death of the Stretch IRA Legislation?
How will your Required Minimum Distributions Work After the Death of the Stretch IRA Legislation?
Can a Charitable Remainder Unitrust (CRUT) Protect your Heirs from the Death of the Stretch IRA?
What Should You Be Doing Now to Protect your Heirs from the Death of the Stretch IRA?
How Does The New DOL Fiduciary Rule Affect You?
Why is the Death of the Stretch IRA legislation likely to pass?
The Exclusions for the Death of the Stretch IRA
Using Gifting and Life Insurance as a Solution to the Death of the Stretch IRA
Using Roth Conversions as a Possible Solution for Death of the Stretch IRA
How Lange’s Cascading Beneficiary Plan can help protect your family against the Death of the Stretch IRA
How Flexible Estate Planning Can be a Solution for Death of the Stretch IRA
President Trump’s Tax Reform Proposal and How it Might Affect You
Getting Social Security Benefits Right with the Death of the Stretch IRA
The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Part II: The Best Age to Apply for Social Security Benefits after the Death of the Stretch IRA
Social Security Options After Divorce: Don’t Overlook the Possibilities Just Because You Hate Your Ex
Is Your Health the Best Reason to Wait to Apply for Social Security?
Roth IRA Conversions and the Death of the Stretch IRA
How Roth IRA Conversions can help Minimize the Effects of the Death of the Stretch IRA
How Roth IRA Conversions Can Benefit You Even if The Death of Stretch IRA Doesn’t Pass
The Death of the Stretch IRA: Will the Rich Get Richer?