There Are Two Five-Year Rules

Part 7 of 10 Things You Must Know About Roth Accounts

If you make a conversion, you must wait five years or until you reach age 59 1/2, whichever comes first, before you can withdraw the converted amount free of the 10% penalty. Each conversion has its own five-year holding period. So if a young account owner does one conversion in 2013 and a second conversion in 2014, the amount from the first conversion can be withdrawn penalty-free starting in 2018 and the amount from the second starting in 2019.

Earnings on a converted amount can be withdrawn tax- and penalty-free after the owner reaches age 59 1/2, as long as he or she has had any Roth IRA opened at least five years.


Kiplinger Online

You Must Pass the Tests for Tax-Free Earnings

Part 6 of 10 Things You Must Know About Roth Accounts

Because there’s no tax deduction for Roth contributions, you can retrieve that money at any time free of taxes and penalties, regardless of age.

But for earnings to be tax- and penalty-free, you have to pass a couple of tests. First, you must be 59 1/2 or older. You will get hit with a 10% early-withdrawal penalty and taxes if you take out earnings before you hit age 59 1/2. And you must have had one Roth open for at least five years. If you are 58 and opening your first Roth IRA in 2013, you can tap earnings penalty-free at age 59 1/2, but you won’t be able to tap earnings tax-free until 2018.


Kiplinger Online

A Conversion Could Trigger Other Tax Events

Part 5 of 10 Things You Must Know About Roth Accounts

Look at the big picture if you plan a conversion. The added taxable income could boost you into a higher tax bracket. A big jump in income could trigger other taxes, too, such as the new 3.8% surtax on net investment income. For Medicare beneficiaries, a rise in adjusted gross income could result in premium surcharges for Part B and Part D.

A series of small conversions over several years could keep the tax bill in check. For instance, you may want to convert just enough to take you to the top of your current tax bracket.


Kiplinger Online

You Can Do a Roth Conversion

Part 4 of 10 Things You Must Know About Roth Accounts

Another route to tax-free earnings inside a Roth is to convert traditional IRA money to a Roth. In the year you convert, you must pay tax on the full amount shifted into the Roth. That’s the price you pay to buy tax freedom for future earnings. (If you have made nondeductible contributions to your traditional IRA, a portion of your conversion will be tax-free.)

If you expect your tax rate to be the same or higher in the future, converting could make sense; if you expect your future tax rate to be lower, it might not.

You’ll want to pay the tax owed on a conversion with money outside of the IRA. Drawing money from the IRA to pay the tax will result in an additional tax bill, and a penalty if you’re under age 59 1/2.


Kiplinger Online

Your Company May Offer a Roth Option

Part 3 of 10 Things You Must Know About Roth Accounts

Many companies have added a Roth option to their 401(k) plans. After-tax money goes into the Roth, so you won’t see the immediate tax savings you get from contributing pretax money to a traditional plan. But your money will grow tax-free. (Any employer match will go into a traditional 401(k) account.)

For 2013 and 2014, you can stash up to $17,500 a year, plus an extra $5,500 a year if you’re 50 or older, into a 401(k). Contributions must be made by December 31 to count for the current tax year, and the limit applies to the total of your traditional and Roth 401(k) contributions. A Roth 401(k) is a good option if your earnings are too high to contribute to a Roth IRA.


Kiplinger Online

There Are Limits to Contributing to a Roth IRA

Part 2 of 10 Things You Must Know About Roth Accounts

To be able to contribute to a Roth, you must have earned income. And unlike traditional IRAs, if you’re still working after age 70 1/2, you can keep contributing.

In 2013 and 2014, you can stash up to $5,500 in a Roth IRA and an extra $1,000 if you’re 50 or older.

But higher-income taxpayers are barred from contributing to a Roth IRA. For 2013, the ability to contribute to a Roth phases out if your adjusted gross income is between $178,000 and $188,000 for joint filers and between $112,000 and $127,000 for single filers. Those thresholds go up for 2014: $181,000 to $191,000 for joint filers and $114,000 to $129,000 for single filers.

You can make a 2013 Roth IRA contribution as late as April 15, 2014. You can contribute to both Roth and traditional IRAs, but the total cannot exceed the annual limit.


Kiplinger Online

10 Things You Must Know About Roth Accounts – blog series

Tax-free income is a dream of every taxpayer. And if you save in a Roth account, it’s a reality. Roths are the youngsters of the retirement savings world. The Roth IRA, named after the late Delaware Sen. William Roth, became a savings option in 1998, followed by the Roth 401(k) in 2006. Creating a tax-free stream of income is a powerful retirement tool. These accounts offer big benefits, but the rules for Roths can be complex.  Over the next two weeks, stay tuned for 10 things you must know about the Roth!  To get you started, here is #1:
You Pay Uncle Sam Now, Instead of Later

Roths turn traditional IRA and 401(k) rules on their head. Rather than getting a tax break for money when it goes into the account and paying tax on all distributions, with a Roth, you save after-tax dollars and tax-free withdrawals in retirement. 

By accepting the tax breaks for traditional accounts, you accept the government as your partner. If you’re in the 25% tax bracket, for example, 25% of all earnings will effectively belong to the IRS to be collected when you withdraw the money. With a Roth, 100% of all future earnings are yours.

The Roth strategy of paying taxes sooner rather than later will pay off particularly well if you’re in a higher tax bracket when you withdraw the money than when you passed up the tax break offered by the traditional account. If you’re in a lower tax bracket, though, the Roth advantage will be undermined.


Kiplinger Online

Evan Wolfson to Appear on Lange Money Hour

Be sure to tune in to KQV 1410AM tomorrow, Wednesday December 4th, at 7:05pm EST to listen to one of the greatest civil rights leaders in our country speak about the marriage equality movement in our country and the situation for same-sex couples in our state.

Evan Wolfson, a Pittsburgh native, is a former Director of Lambda Legal, author, and founder of  He was also named one of Time magazine’s 100 Most Influential People Alive in 2004.  His contributions as a lawyer and a leader to the LGBT civil rights movement in our country is undeniable and inspiring.

If you can’t tune in, will be streaming the show live on Wednesday night and re-airing it the following Sunday morning at 9:05.  Don’t miss this historic and important show!

Also, if you are a resident of Western PA and in a same-sex relationship, or you know someone who is, consider joining us for our free workshops starting at 9:30am on December 7th at the Wyndham Pittsburgh University Center.

You can read the full invitation here:  PA Same-Sex Couples Can Now Take Advantage of the Defeat of DOMA to Cut Taxes and Increase Wealth.

Using a Roth IRA as a wealth planning tool

Rebecca Katz: Our first question is from Nicholas in Florence, Alabama. Thanks for the question. “If we are in upper income brackets and never plan to use all of our IRA money, is it prudent to convert to a Roth, to then be passed on as an inheritance?” So, Joel, we were going to come to you first. I owe you anyway, since I butchered your name.

Joel Dickson: Usually when we talk about the potential value of a Roth IRA conversion, first and foremost, the biggest consideration is often “what is your tax rate today versus what will the tax rate be when the proceeds are withdrawn in the future.” If you think it’s going to be higher in the future than where you are currently today, you might think about having more Roth IRA assets, because you’re basically trading the lower tax rate today for avoidance of a higher tax rate in the future. That’s kind of the basic discussion that we would have.

But if we take that a step further and think about more sophisticated or more complex interactions that can occur with Roth IRAs, the answer ultimately comes to a certain standpoint of “it depends in this case.” Because if you’re in a high income bracket, and you’re going to stay there, and your heirs might have a lower tax rate, normally you would think, “Well, maybe a Roth IRA conversion isn’t for me.” However, there are some other things that might come into play in that decision.

One being, for example: at age 70½, you end up having to take required minimum distributions from a traditional IRA, in essence taking money out of the tax-preferenced vehicle. Whereas with a Roth, you don’t have to take those required minimum distributions while you’re alive.

A second one would be that, if you can use taxable assets to pay the conversion tax, you are in effect sheltering more assets in a tax-deferred or a tax-preferenced vehicle, which might make some sense, even if your tax rate isn’t going to change.

And then finally, as we’ll talk about more later, if you were to do a Roth IRA conversion and you use money from your—say—a taxable account, to pay the conversion tax, it removes that money from your total estate. And for those that might be thinking about estate planning, or might be facing estate taxes, given the size of their estate, that can be one tool among many that can help reduce the size of the overall estate.

Alisa Shin: I think I would just add one thing, from an estate planner’s perspective. I think the other factor to consider is what your goals are with respect to your wealth. So, if a client is charitably inclined, it might make sense to not convert all of it but just convert a portion of it so that you can leave your traditional IRA assets to that charity. And because it’s a public charity and a tax-exempt entity, when they receive the IRA at your death, they won’t have to pay income tax on it.

Rebecca Katz: Lots of thinking that you have to do.

Alisa Shin: Exactly.

Rebecca Katz: Well, we have a very specific question around that from Craig, and he asks if you could “explain how Roth IRAs fit into estate planning, along with traditional IRAs and taxable investments. What are the pros and cons when it comes to thinking about your estate?”

Alisa Shin: Right. Well, Joel kind of hit on it in an earlier question, but just to reiterate and add a couple points. You know, I really think it’s probably in three areas. One is, again, what your goals are with respect to your estate plan. Who do you want your assets to go to? Do you have a charitable intention? If you do, a Roth IRA might not be appropriate in your plan, or maybe even just a partial conversion may be appropriate. It’s not a one-and-done deal. You don’t have to do a 100% conversion. You can do partials and you can do it over time if your goals start to change.

The second one is if you have a taxable estate. If you’re going to be subject either to federal estate or even state estate tax, converting it and paying the taxes from non-IRA assets effectively reduces your family’s overall estate tax exposure. And that’s just by way of mathematics—the nature of the estate tax, because it’s a cumulative tax, and how that’s calculated. Your family will almost always be better off if you convert and pay the income tax up-front.

Now you have to take other considerations into effect. You know, tax rate, your income tax rate today, your kids’ potential income tax rate, or if you’re going to give it to your grandchildren, what their tax rate’s going to be. So there’s a lot of different factors. There’s no—unfortunately there’s no one answer for all of our clients. You could have two clients who have the exact same net worth, same family structure, same ages, and I bet you they’re going to come to different answers to that question.

Rebecca Katz: Does it change? I mean there were recent changes in estate tax, and I guess you have to keep your eye on that in case that changes too?

Alisa Shin: Exactly, exactly. And we did. We got a new law in January that gave us what I’ll loosely call permanency, in the estate tax world, probably the first time in almost 12 years: we don’t have a sunset provision. And right now, each individual can give up to $5.25 million free of the federal estate tax. But there still are a number of states—I want to say 13 to 14 states—that have their own state estate tax. So even though your net worth might be below that [$]5.25 [million], it’s almost guaranteed that if you live in a state that has a state estate tax, you’ll be subject. Because those thresholds tend to be much lower than [$]5.25 [million].

Rebecca Katz: Did you want to add something, Maria?

Maria Bruno: If I could add to it, because I think you need to think about it in terms of estate taxes as well as income taxes. We talk a lot around tax diversification on the planning side, when you’re saving for retirement—tax diversification by having traditional, Roth, taxable accounts, gives you a lot of flexibility when you’re withdrawing assets. Similarly with estate planning, so if you have different types of accounts, you can perhaps strategically think about beneficiary planning, wealth transfer. It just adds more to it, I think.

Alisa Shin: Absolutely.

Rebecca Katz: We have a follow-up question. Joe from West Bloomfield, Michigan, says,”Is there any drawback to designating my grandchildren as opposed to my children as Roth beneficiaries?” It sounds like we’ve talked about some of the advantages, if you’re talking about a much longer time horizon; are there any drawbacks?

Alisa Shin: I think one factor is whether or not your children need the money. Are you disinheriting them because there’s a reason that you’re doing so, or you’re giving other assets? Some people assume that because they might give it to the grandchildren, the grandchildren will take care of the parent if the parent really needs the money. I always think that’s a little risky. One would hope, but you never know.

I would want to make sure that the grandchildren truly are the intended beneficiaries of it. And just going on the softer side of the planning, is really thinking through—depending on how old the grandkids are now—what kind of sense you have, what kind of people they are, how they manage money, how their decision making skills are. If something happens to you prematurely and they receive a Roth IRA that’s a large amount, it could have negative consequences that are not intended.

So if you are considering that, I would really encourage you, if you’re comfortable, to make sure that you’re talking with your kids, so that you can coordinate your planning with your children’s planning to ensure that everyone is on the same page and there’s no surprises at the end of the day.

Rebecca Katz: Conversation—it sounds like a lot of this comes down to having conversations and being thoughtful about what your intentions really mean.

Joel Dickson: I think we can generalize that discussion even a little bit more. Which is to say, beneficiary designations generally are extremely important and can affect plans. For example, there’s a lifetime unlimited spousal estate tax benefit. So if you start then going to different beneficiary designations, you might trigger estate tax if it’s not a well-crafted plan. So there are lots of things to think about with beneficiary designations.

Important information

All investing is subject to risk, including the possible loss of the money you invest.

Withdrawals from a Roth IRA are tax free if you are over age 59½ and have held the account for at least five years; withdrawals taken prior to age 59½ or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2013 The Vanguard Group, Inc. All rights reserved.

Roth Recharacterizations

Disclaimer: Please note that the Tax Cuts and Jobs Act of 2017 removed the ability for taxpayers to do any “recharacterizations” of Roth IRA conversions after 12/31/2017. The material below was created and published prior the passage of the Tax Cuts and Jobs Act of 2017. 

Rebecca Katz: We just got this great question in that I was going to ask you myself if nobody else did. This is from George in North Carolina, so thank you, George. “Please explain Roth re-characterization.” Is this the “oopsie, I converted and I shouldn’t have done that”?

Maria Bruno: Yes, but it’s not always an oopsie. It could be a very viable strategy that someone is employing. Actually we’re having these conversations right now because at the end of last year there was a lot of uncertainty around what would happen with 2013 tax rates. So some investors actually decided they would convert, and then maybe decide to re-characterize later. So what a re-characterization is is it’s really almost a mulligan; the IRS lets us do a do-over. So if you convert to a Roth IRA or even if you contribute to a Roth IRA and then decide that you want to reverse that, the IRS allows you to do that.

Now there are some stipulations; there’s holding period requirements. So if you converted last year, for instance, and you want to re-characterize this year, you have until essentially October 15 to do that. So it’s a tax filing deadline or a tax extension.

So you can convert them. Basically what it does is it takes whatever—whether it’s a partial re-characterization or a full re-characterization—brings that back into a traditional IRA. So any earnings or losses would be carried back over into that traditional IRA. The end result is as if the conversion never happened or the Roth contribution never happened.

Joel Dickson: Where this can be valuable is, for example, although this is not as likely this year—given that we’ve had pretty robust financial market returns—but let’s take that $100,000 that we had been talking about earlier and you converted that from a traditional to a Roth IRA. Let’s assume that it was fully taxable, so it was all $100,000 of pre-tax dollars.

If the investment that you put it into in the Roth IRA were to have gone from $100,000 to $80,000, that is, declined 20%, sort of go “Well, why should I pay taxes on $100,000 when right now the account is worth $80,000?” So re-characterizing back to the traditional IRA where now you have $80,000—and then once you get over the certain requirements to then do a reconversion, which basically is either 30 days following the re-characterization or the next tax year—it sort of depends on where you are in the tax cycle. You would now just reconvert $80,000 and pay tax on $80,000, instead of paying tax on $100,000 if you wouldn’t have re-characterized.

Rebecca Katz: Assuming the markets didn’t go back up.

Maria Bruno: There’s holding periods. So you’re kind of at the mercy of the markets, almost, depending on how you’re invested. You can actually put the monies back into the traditional IRA and keep it there or you can actually reconvert after the holding period expires.

Joel Dickson: One of the things that I do think we have to be careful about in 2013—because as Maria mentioned there was a lot of uncertainty about tax rates, we have the fiscal cliff, all that kind of stuff—for some people tax rates increased in 2013 from where they were in 2012, either through all of the deductions changing, or through the Medicare, or through ordinary income tax rates. So even if the account went down in terms of the value of the conversion from a traditional to a Roth, it might not make sense to re-characterize, because now you would be reconverting in 2013 or 2014 at potentially higher tax rates. So what matters is the total tax bill, not so much the amount in the account.

Important information

All investing is subject to risk, including the possible loss of the money you invest.

Withdrawals from a Roth IRA are tax free if you are over age 59½ and have held the account for at least five years; withdrawals taken prior to age 59½ or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2013 The Vanguard Group, Inc. All rights reserved.