Backdoor Roth IRAs: How Does the Backdoor Roth IRA Conversion Work?

Posted on by in 401(k), 403(b), Educational Resources, IRAs, Roth 401(k), Roth IRA, Roth IRA Conversions, Traditional IRA and tagged , , , , , .

The backdoor Roth conversion consists of two simple steps:

1)      You make a nondeductible contribution to your traditional IRA.

2)      Within a couple of days you convert this IRA into a Roth IRA (potentially paying little to no taxes on the conversion).

There’s one big caveat: This strategy works best tax-wise for people who don’t already have money in traditional IRAs. That’s because in conversions, earnings and previously untaxed contributions in traditional IRAs are taxed—and that tax is figured based on all your traditional IRAs, even ones you aren’t converting.

For an investor who doesn’t already hold any traditional IRAs, creating one and then quickly converting it into a Roth IRA will incur little or no tax, because after a short holding period there’s likely to be little or no appreciation or interest earned in the account.  However, if you already have money in traditional deductible IRAs, you could face a far higher tax bill on the conversion.

If you choose to, you can contribute to a non-deductible IRA for 2014 (the maximum is $5,500 or $6,500 for those age 50 or older). Remember, you must contribute to your IRAs prior to the April 15 2015 tax deadline. This non-deductible IRA can then be used for your backdoor Roth IRA conversion (please call us prior to doing so because the rules for Roth conversions can be complicated).

Want to learn more? Give us a call at 412-521-2732.

Examples of a Backdoor Roth IRA coming soon.

– James Lange

Backdoor Roth IRAs: A Potential Way for High Income Earners to Participate

Posted on by in 401(k), 403(b), Educational Resources, IRAs, Roth 401(k), Roth IRA, Roth IRA Conversions, Traditional IRA and tagged , , , , .

The traditional contribution (“front door”) for Roth IRAs is currently not available for higher income earners. Married couples earning $191,000 or more and singles earning $129,000 or more in 2014 are still barred from contributing directly to Roth IRAs.

In 2010, Congress changed the rules and since then anyone can convert a traditional IRA to a Roth IRA. However, higher income earners are still ineligible to contribute to a Roth IRA.

A Backdoor Roth IRA is a strategy for some higher income earners to participate in Roth IRAs.  It is a way for higher income earners to put money into a traditional IRA and then roll that into a Roth IRA, getting all the benefits.  While this strategy sounds simple, there are several rules that you must know and follow to make sure you do not incur unintended tax consequences.  This is where working with a knowledgeable financial or tax professional can provide some great guidance and value.

One of the primary benefits of a Roth IRA is that any money contributed grows tax-free and is withdrawn without any further income taxation. In addition, unlike a traditional IRA, Roth IRAs have no required lifetime minimum distributions. Another benefit of a Roth IRA is it can be passed on to your heirs income tax free. This allows your funds to grow and compound tax free over many years.

Want to learn more? Give us a call at 412-521-2732.

More on this subject in the coming weeks.

– James Lange

Some things to consider about your Retirement Plan

Posted on by in 401(k), 403(b), IRAs, IRS, Medicare, Roth 401(k), Roth IRA, Roth IRA Conversions.

In 2013, the maximum 401(k) contribution is $17,500 (plus a $5,500 catch-up contribution for those 50 or older by the end of the year). If you are self-employed, you have other retirement savings options. We will review these alternatives with you when you come in for your appointment. One of my favorites for many one person self- employed businesses is the one person 401(k) plan.

In light of the new increased tax rates effective in 2013, plus the addition of the new Medicare surtax on Net Investment Income, higher income taxpayers may want to consider switching from Roth 403(b) and Roth 401(k) elective deferral contributions back to tax deductible contributions. The current savings may outweigh the benefits of tax-free growth on the Roth accounts. As mentioned earlier, the focus moving forward for higher income taxpayers is toward reducing adjusted gross income.

You can also contribute to an IRA for 2013 up through April 15, 2014. The maximum is $5,500 with a catch-up (for taxpayers 50 or older) provision of $1,000.

– Excerpt from Jim Lange’s 2013 Year-End Tax Report

retirement-james-lange-financial-group-ira-asset-management-savings

The Hazards of Naming Different Beneficiaries for Different Accounts

Posted on by in 401(k), 403(b), Beneficiary Designations, Educational Resources, Lange’s Cascading Beneficiary Plan and tagged , , .

It is quite common in my practice for clients to say they want one particular account to go to one beneficiary and a different account to another beneficiary. The accounts might reflect the relative proportionate value that the client wants each of the different beneficiaries to receive, but I think this can turn into a nightmare.

• You will have a terrible time trying to keep track of the different
distribution schedules.

• As the different investments go up or down, the amount going to the different heirs would also go up and down, which is probably not the intent.

• A beneficiary designation may say, “ I leave my Vanguard account to beneficiary B and my Schwab account to beneficiary A. ” If during your lifetime you switch or transfer money from Vanguard to Schwab, you have, in effect, changed who is going to get what, and that may not be your intention.

In general, I prefer one master beneficiary designation for all IRAs, retirement plans, 403(b)s, 401(k)s, and the like. In it I describe distributions as I would in a will or irrevocable or revocable trust. That way, we can avoid mistakes and simplify estate administration after the retirement plan owner dies.

I recognize that, for investment purposes, people use different accounts for different beneficiaries. For example, you might treat the investments of a grandchild beneficiary differently from those of a child or spouse. Under those circumstances I would be willing to bend and accept different beneficiaries for different accounts.

The one area where it might make sense to direct certain money to particular beneficiaries is FDIC insured deposits. At press time, the amount that the FDIC would insure rose from $ 100,000 to $ 250,000 through 2009. Assuming the money is outside the IRA (there are different protections for IRAs) one way to get more FDIC insurance is to have different beneficiaries with different paid on death designations. If you are a parent with four kids and you have four $ 250,000 CDs, you can do a pod account for each child and have the entire amount federally guaranteed. If the money was in an IRA, you are also insured up to $ 250,000 but you can ’ t get additional coverage by naming additional beneficiaries.

Retire Secure! Pay Taxes Later – The Key to Making Your Money Last, 2nd Edition, James Lange, page. 271-272 https://www.paytaxeslater.com/

The Clear Advantage of IRA and Retirement Plan Savings during the Accumulation Stage

Posted on by in 401(k), Estate Tax, Income Tax, IRAs, Lange’s Cascading Beneficiary Plan, Roth 401(k), Roth IRA.

If you are working or self-employed, to the extent you can afford to, please contribute the maximum to your retirement plans.

Mr. Pay Taxes Later and Mr. Pay Taxes Now had identical salaries, investment choices, and spending patterns, but there was one big difference. Mr. Pay Taxes Later invested as much as he could afford in his tax-deferred retirement plans—even though his employer did not match his contributions. Mr. Pay Taxes Now contributed nothing to his retirement account at work but invested his “savings” in an account outside of his retirement plan.

Please look at Figure 1. Mr. Pay Taxes Later’s investment is represented by the black curve, and Mr. Pay Taxes Now’s, by the gray curve. Look at the dramatic difference in the accumulations over time—nearly $2 million.

There you have it. Two people in the same tax bracket who earn and spend an identical amount of money and have identical investment rates of return. But, based on the simple application of the “Pay Taxes Later” rule, the difference is poverty in old age versus affluence and a $2 million estate.

Can't see this image - go to https://www.paytaxeslater.com/ and download the book!

Retirement Assests, IRAs vs. After-Tax Accumulations

Retire Secure! Pay Taxes Later – The Key to Making Your Money Last, 2nd Edition, James Lange, page. xxxi  https://www.paytaxeslater.com/

Answers to The 70 1/2 Quiz!

Posted on by in 401(k), Income Tax, IRAs.

Yesterday we tested your knowledge of the tax laws surrounding Required Minimum Distributions…  Let’s see how you did! 

  • 1 D: April 1, after the year that you turn 70 1/2. For example, if you turn 70 1/2. in the year 2005, the required beginning date would be April 1, 2006.
  • 2 Usually not.Let me explain. The year that you turn age 70 ? is often referred to as your required beginning year. You must take out a distribution for this year, but the government says that you have until April 1 of the following year before you need to actually take the money out.. Taking your beginning year distribution in the following year does not relieve you of the obligation to take a required distribution in that year, however. Thus, by waiting you will have to take two distributions in the following year-a delayed distribution from the beginning year and another for the current year!Why is this bad? Let us assume that your minimum distribution for the year 2005 was $15,000 and that you wait until March 31, 2006 to actually take out this amount. The $15,000 is treated as a distribution for the 2006 tax year.However, you also must take a minimum distribution for the year 2006, for which the deadline is December 31, 2006. If we assume that your minimum distribution for the year 2006 is $18,000, then your total distribution would be $33,000 in one calendar year! This might push you up into a higher tax bracket for 2006. Thus, in most cases it is best to take your minimum distribution during the year that you turn age 70 ?, rather than waiting until April 1 of the following year. It is best to prepare a tax projection in order to determine which way is best for you, depending on your circumstances.
  • 3 C: A 50% penalty. For example, if your minimum distribution was $20,000 and you only took out $8,000, then the difference would be $12,000. The penalty would be 50% of $12,000, which equals $6,000! Talk about a penalty!
  • 4 E: You can name almost anything or anyone. For example, you can name your spouse, children, grandchildren, a trust, a charity, your estate, or even your dog!
  • 5 A: YES! Under prior law, if you designated a charity as a partial beneficiary, this would prohibit your spouse from rolling over the rest of the proceeds or any of the other beneficiaries from electing to take IRA distributions over their lifetime. However, under the new laws, the spouse would have the right to roll it over into her IRA even though the charity was one of the primary beneficiaries, as long as the charity took out its distributions.
  • 6 No.?The final regulations no longer take the beneficiary into consideration.! It makes no difference even if there is no beneficiary because the individual would still take out a minimum distribution based upon the new table. There is an exception, of course, if a spouse is the primary beneficiary and he or she is more than 10 years younger than the IRA owner. In such a case you can use a different table that has longer life expectancies. However, in this example, this is not an issue.
  • 7 Yes!?If the spouse is the primary beneficiary of the living trust and the trust is the primary beneficiary of the IRA, and the other conditions listed below are also satisfied, then the IRS allows you to “look through” the trust and treat the spouse as being the primary beneficiary of the IRA. The spouse then has the right to roll it over into his or her own IRA.The required conditions are as follows:?
    1. The beneficiary designation must be valid under applicable state law.
    2. It must be irrevocable or become irrevocable at your death. Revocable trusts become irrevocable when you pass away and therefore a revocable trust can now be the beneficiary.
    3. All beneficiaries of the trust must be individuals.
    4. The beneficiaries must be identifiable from the trust document.
    5. A copy of the trust or trust certification that identifies the beneficiaries in any subsequent revisions must be given to the plan administrator no later than December 31st of the year after the?person passes away.
  • 8 D:The child would have the right to use any of these options; however, the best choice in most cases would be to take the distributions over his or her lifetime. The election must be made no later than December 31 of the year following the year of death. This is usually by far the best option for most non-spouse beneficiaries because it permits the maximum deferral for taxpayers who do not really need the money, while providing an option to receive the full amount in one year or over a five-year period if desired…Unfortunately, many IRA custodians default to taking out the distribution over a shorter period of time unless an election is made to extend it. Many beneficiaries (and their advisors!) are not aware of this rule and forget to make any election, and therefore are subject to the default provisions that the IRA custodian has. It is extremely important to review your custodian’s language in order to determine what options that they allow after you die.
  • 9 E: It doesn’t matter anymore! There used to be a number of factors to take into consideration before making your choice on calculating your Required Minimum Distribution such as selecting life expectancy, the recalculation method, single vs. joint, hybrid, term certain, etc. There is now one uniform table that most people will use. This table generally assumes that the beneficiary is 10 years younger than the IRA owner. The only exception is a situation in which the beneficiary is a surviving spouse who is more than 10 years younger than the IRA owner. Under the facts of this question, the spouse is 67 years old. Although this is only three years younger than the IRA owner, you can still calculate your minimum distribution assuming he or she is 10 years younger.
  • 10 C:?You might be depleting your IRA principal, but the IRS does not require this. The IRS merely requires that you take out a minimum distribution based on the new table and whether IRA principal decreases in a given year depends on whether the required distribution exceeds the growth in asset value for that year.For example, let us assume that your spouse is your primary beneficiary and both of you are 70 years old. According to the IRS tables, you have a life expectancy of 26.2 years. Therefore, if you have $100,000 in your IRA at the end of the prior year, you would have to take a minimum distribution of $3,817, which is about 4% of the IRA balance. If your investments inside of your IRA earn more than 4% , then your IRA will actually grow! The following chart illustrates what happens to your IRA balance if IRA investments earned a 10% return.

    IRA beginning balance:?$100,000

    Earnings during year:?10,000

    Less required minimum distribution -3,817

    Ending IRA Balance?$106,183

    Obviously, if your minimum distribution is greater than the earnings on your IRA, however, then you will start depleting your principal.

3 Myths About Social Security

Posted on by in 401(k), 403(b), Social Security and tagged .

Myth #1: By the time I retire, Social Security will be broke.

If you believe this, you are not alone. More and more Americans have become convinced that the Social Security system won’t be there when they need it. In an AARP survey released last year, only 35 percent of adults said they were very or somewhat confident about Social Security’s future.

It’s true that Social Security’s finances need work, because over the long term there will not be enough money to fully cover promised benefits. But radical changes aren’t needed. In 2010 a number of different proposals were put forward that, taken in combination, would put the program back on firm financial ground for the future, including changes such as raising the amount of wages subject to the payroll tax (now capped at $106,800) and benefit changes based on longer life expectancy.

Myth #2: The Social Security Trust Fund Assets are Worthless.

Any surplus payroll taxes not used for current benefits are used to purchase special-issue, interest-paying Treasury bonds. In other words, the surplus in the Social Security trust fund has been loaned to the federal government for its general use — the reserve of $2.6 trillion is not a heap of cash sitting in a vault. These bonds are backed by the full faith and credit of the federal government, just as they are for other Treasury bondholders. However, Treasury will soon need to pay back these bonds. This will put pressure on the federal budget, according to Social Security’s board of trustees. Even without any changes, Social Security can continue paying full benefits through 2037. After that, the revenue from payroll taxes will still cover about 75 percent of promised benefits.

Myth #3: I Could Invest Better on My Own.

Maybe you could, and maybe you couldn’t. But the point of Social Security isn’t to maximize the return on the payroll taxes you’ve contributed. Social Security is designed to be the one guaranteed part of your retirement income that can’t be outlived or lost in the stock market. It’s a secure base of income throughout your working life and retirement. And for many, it’s a lifeline. Social Security provides the majority of income for at least half of Americans over age 65; it is 90 percent or more of income for 43 percent of singles and 22 percent of married couples. You can, and should, invest in a retirement fund like a 401(k) or an individual retirement account. Maybe you’ll enjoy strong returns and avoid the market turmoil we have seen during the past decade. If not, you’ll still have Social Security to fall back on.

Five Financial Tips for Women

Posted on by in 401(k), IRAs, Life Insurance.

Five Financial Tips for Women

  1. Make it a Priority to Understand What You Already Have – For working woman, make sure you fully understand your employee benefits and your company’s retirement plan.  Make it a point to see what your short and long term disability and life insurance can offer you and then fill in the gaps with individual policies. You may be surprised what your benefits do and do not cover.  It’s better to know now then at the time you may need to use them.
  2. Fund Your Retirement Plan:  Most employers offer employees a retirement plan and you must take advantage of it. Make sure though that you consult with a qualified financial advisor when choosing your fund choices.  Leave the selection up to the professionals and review it once a year to make sure your maximizing your returns. Beyond your company’s retirement plan, look into getting your own IRA or Roth IRA, which allows you grow wealth tax-free through the course of your lifetime – it’s worth looking in to.
  3. Recognizing the Challenges is Half the Battle: There’s no doubt about it – women face obstacles that men do not.  Women still earn less than their male counterparts, live longer and are typically out of the workforce for 12 years, on average, taking care of children and now more than ever, aging parents. Recognize these challenges, set goals and build a plan to action to overcome your specific hurdles.  Things such as making a career move or initiating salary negotiations, refinancing your mortgage, opening up an IRA or Roth IRA and adjusting your risk tolerance on your investments can all make a powerful impact on your financial picture.
  4. Don’t be Afraid to Fire a Bad Advisor:  Let’s face it, there are thousands of financial advisors out there…some of which may suit you better than others.  Choosing a financial advisor is like choosing a doctor.  Choose a person who focuses on your needs and not there’s, someone who listens to your goals, keeps you on track and meets with you at least once a year to review your situation.  If you’re not satisfied with the relationship you have, move on!
  5. It’s Never Too Late:  Regardless of your age, there are ideas and options that can help your financial picture – we see it everyday.  There is no better time to start investing than right now. Make it a priority to meet with an advisor in 2011.  Ask people you trust to refer you to someone that listens and achieves results and get started as soon as possible.

5 Things Taxpayers Can Proactively Do To Best Take Advantage of the New Income and Estate Tax Law

Posted on by in 401(k), 403(b), Estate Tax, IRAs.

There are some BIG changes for taxpayers in the creation of the new 2010 Tax Relief/Job Creation Act.  How can you best respond to this law?  Take a look at these 5 things all taxpayers can proactively do to best take advantage of the changes:

1.  With the money you save on the reduction of your social security tax, you should contribute at least that much additional money to your retirement plan.

2.  Contribute to your retirement plan in the following order:

  • Contribute whatever an employer is willing to match or even partially match
  • Contribute to your Roth IRA and if married to your spouses Roth IRA, even if your spouse isn’t working
  • Maximize your contribution to your Roth 401(k) or Roth 403(b) if available
  • If not available, maximize your contribution to your traditional 401(k) or 403(b)
  • If your income is too high to qualify for a Roth IRA, contribute to a nondeductible 401(k).

3.  Since we have two more years of low tax rates, make Roth IRA conversions.  Consider multiple conversions since you can “recharacterize” or undo them.  If you do multiple conversions, you can keep the ones that do well and undo the ones that don’t.

4.  Review your wills and trusts.  Many, if not most of the wills done for taxpayers with estates of $1 million are now outdated.  Not only will you not get optimal results, but your existing wills and trusts might be a huge restriction on the surviving spouse.

5.  Now that you can either leave or gift $5,000,000 or $10,000,000 if you are married, you should rethink potential gifts to children and grandchildren without tax laws that would otherwise restrict gifts you would like to make.

New Tax Law Creates Enormous Opportunities for Millions of Employees

Posted on by in 401(k), 403(b), Educational Resources and tagged .

FOR IMMEDIATE RELEASE
CONTACT: JAMES LANGE, CPA
OFFICE: 412.521.2732

September 27, 2010 – The President signed a new law, effective immediately, that has an enormous impact on millions of retirement plan owners.

The new law will allow employees to convert all, or a portion, of their traditional 401(k) or 403(b) retirement plan to a Roth 401(k) or Roth 403(b). The law is actually part of the Small Business Jobs and Credit Act which has implications for small businesses, but this little known provision also has a profound impact on employees with these retirement plans who will want to make a Roth conversion.

This bill would allow 401(k), 403(b), and governmental 457(b) employees to convert their pre-tax account balances into Roth designated accounts, which is the official title for a Roth 401(k) or Roth 403(b). A Roth 401(k) or Roth 403(b) will enjoy income tax-free growth for the lives of the plan owner, spouse, children and grandchildren. The amount of the conversion, however, would be considered taxable income. If an employer has an existing 401(k) or 403(b) plan, employees could immediately make the conversion to either a Roth 401(k) or Roth 403(b).

This new legislation will be extremely important to people who are still working and have substantial wealth in their employer retirement plan as it will essentially allow them to convert their traditional 401(k) or 403(b) to a Roth designated account that would still be part of their employer retirement plan. Previously, if an employee’s retirement plan was tied up in a 401(k), they would not have been eligible to make a Roth conversion while they were still working. Now, if employers have Roth designated accounts, employees can make a Roth conversion of whatever amount they wish.

Since tax rates are expected to go up in 2011, at least for upper income taxpayers, it will definitely be to their advantage to make a conversion to a Roth 401(k) or Roth 403(b) in 2010 while they can still pay a lower tax on the conversion.

One strategy that would be highly beneficial for middle income taxpayers who are still employed and have limited access to their retirement plan is that they will be able to make a partial conversion of their 401(k) to a Roth 401(k), since it might be too aggressive for them to convert their entire 401(k) and pay income taxes on that conversion. An even better long-term strategy for this middle income group is a series of multiple, partial conversions over a period of years of the pre-tax dollars in a 401(k) to the Roth designated account in the 401(k). Conversely, if a person is a high income employee or will likely always be in the top tax bracket, they should consider a much more substantial Roth conversion.

Another huge benefit of this law is that these new Roth designated accounts will enjoy excellent creditor protection since, for the most part, 401(k) and other retirement plans are controlled by a federal law called ERISA which offers better creditor protection than ordinary IRAs or even Roth IRAs. A good example of this is OJ Simpson, who is collecting substantial income while he is in jail because the judgments against him could not penetrate the ERISA creditor protection on his retirement plan.

Obviously, the law only covers employees who have access to Roth designated accounts at work, but it would be to an employer’s advantage