Beware of the Pro Rata Rule for Roth Conversions

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

What is the Pro Rata rule for Roth conversions?

The Pro Rata rule for Roth conversions states that if you have any other deductible IRAs (i.e. a previous 401k that you’ve rolled over), the conversion of any contributions becomes a taxable event that you’ll need to pay taxes on upfront.

The Pro Rata rule for Roth conversions determines whether or not your conversion will be taxable! For taxation purposes, the IRS will look at your entire IRA holdings (even if they are in different accounts), not just the traditional IRA you are converting to a Roth IRA, and will determine what your tax bill will be based upon a ratio of IRA assets that have already been taxed to those IRA assets in total.

The IRS determines the tax on this conversion based on the value of all of your IRA assets. For example Jane, a high income earner, already has $94,500 in an IRA account, all of which has never been taxed.  She decides on January 2nd to put $5,500 into a new traditional IRA. The next day she converts the new traditional non-deductible IRA to a Roth IRA.  Jane’s income is too high for her to make a direct contribution into a Roth IRA, but there’s no income limit on conversions.  Unlike Bill she has $94,500 in other IRAs (previously non-taxed), so her total IRA assets are now $100,000. When she converts $5,500 to a Roth IRA, the IRS pro-rates her tax basis on the previous taxation of her total IRA assets, therefore making this conversion 94.5% taxable ($94,500/100,000 = 94.5%).

So if you plan on using this backdoor IRA strategy, you want to be clear as to whether or not you have any other IRAs. As you can see, this can be a confusing area and this is where we can help.  If you are a high income earner we would be happy to review your situation to determine if this strategy is in your best interest.

Also, please remember that your spouse’s IRA is separate from yours.

Stay tuned for my next blog post, Benefits of a Roth IRA!

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

– James Lange

Example of a Backdoor Roth IRA

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

As promised from our last blog post, here is an example of a Backdoor Roth IRA

Bill, a high income earner decides on January 2nd to put $5,500 into a traditional IRA for himself and another $5,500 into a traditional IRA for his wife Mary.  Bill’s income is too high to be able to deduct these contributions from his taxes.

So the next day, he converts the traditional IRAs to Roth IRAs completely tax-free.  His income is too high for him to make a direct contribution into a Roth IRA, but there’s no income limit on conversions!

Since Bill and Mary couldn’t deduct the contribution anyway, they might as well get the advantage of never paying taxes on that money again available through the Roth IRA.

Stay tuned for my next blog post, Beware of the Pro Rata Rule for Roth Conversions!

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

– James Lange

 

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

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Take the 10-second test!

Posted on by in Estate Tax, Income Tax, IRAs, Roth IRA, Roth IRA Conversions.

Please take the next 10 seconds to complete this survey about your financial future. . . you might rediscover some opportunities for financial growth.

Are you concerned about outliving your income?

Would you like to reduce (possibly eliminate) your quarterly estimated tax payments?

Would you like to see your grandchildren go to college?

Are you concerned about going into a nursing home?

Would you like to earn more competitive interest and preserve the safety of your nest egg?

Are you concerned about the stock market going down?

Would you like to find out how to take money out of your IRA tax free?

Is your house still titled as joint tenancy? (If yes, you are probably making a serious mistake!)

Are you concerned about which option to make regarding your minimum distribution requirements from your IRA at age 70 1/2?

Do you want to get more information on the Inherited IRA that can possibly continue your IRA for 30, 40, 50 years or longer even after you pass away?

Are you concerned about the likelihood that the government will get over 50% of your retirement accounts after you pass away?

If you have answered, Yes, to 3 or more of these questions, you should come in for a complimentary review!  Call 412.521.2732 and ask for Alice.

Remember, what you don’t know can hurt you!

 

Never a Better Time for a Roth IRA Conversion

Posted on by in Income Tax, Roth IRA, Roth IRA Conversions.

According to the September/October edition of Private Wealth Magazine there has never been a better time to make a Roth IRA conversion.

“”Roth IRA conversions never looked so good as they do now,” says Jones. Not only will 2012 conversions be taxed at rates no higher than 35%, today’s slow economy may lead to a legitimately low valuation of illiquid IRA assets – and a relatively low tax bill. “IRAs must be valued each year, “says Slott. “If a client is reporting a low value because of the week economy, less tax will be due on a Roth IRA conversion. ”

Paying the tax from non- IRA investment assets can trim a client’s taxable holdings, reduce future taxable investment income, and therefore reduce exposure to schedule tax hikes as well as to the coming 3.8% Medicare surtax. after five years and after age 59 1/2,all Roth IRA withdrawals will be tax-free. in essence, a Roth IRA conversion this year can move mega – IRA money from surtax straits into tax-free territory.”

Taken from : (Korn, Donald. Private Wealth Magazine, Sept./Oct. 2012. p. 54)

(The quotes in this selection are from Ed Slott, “America’s IRA Expert” and Michael J. Jones of Thomson Jones LLP, a tax consulting firm in Monterey,California)

The Affordable Health Care Act and It’s Impact on Your Retirement…

Posted on by in IRAs, Medicare, Roth IRA, Roth IRA Conversions.

Now that the Affordable Health Care Act is deemed constitutional, the Medicare surtax that is scheduled to take effect on January 1, 2013 is likely.  Tax rates on certain passive income will rise to 43.4% from the current rate of 35%, and there is scheduled increases in the capital gains rates for both lower and upper income tax bracket taxpayers.  With taxes almost inevitably increasing, the appropriate response to buy your partner, Uncle Sam, out of your IRA at today’s lower tax rates.

As many of you know, for a long time I have advocated that making conversion of at least a portion of your IRA to a Roth IRA is a good idea for most taxpayers. Now, with the recent Supreme Court decision that the tax and locations of the Affordable Health Care Act, the benefits of the conversion become even more advantageous and more certain, particularly for upper income taxpayers. The benefits are making Roth IRA conversions can be measured in hundreds of thousands of dollars, even millions if you can stretch the life of the Roth IRA over multiple generations.

If you are interested in a detailed technical analysis of the Medicare surtax or the benefits of Roth IRA conversion, please call and ask our Client Service Coordinator Alice for more information.   We would be happy to provide you with an explanation or set up a meeting with  one of our professionals.

Last Minute Tax Strategies for IRAs & Other Retirement Accounts

Posted on by in Estate Tax, Income Tax, IRAs, Roth IRA, Roth IRA Conversions.

Make your 2010 IRA contribution as late as April 18, 2011: 

You can contribute up to $5,000 (or $6,000 if you are 50 or older) until the time you file your income tax return, but no later than April 18, 2011.  If you participate in a retirement plan at work, the IRA deduction phases out if you are married and your joint AGI is $89,000 or more, or if you are single and your adjusted gross income is $56,000 or more.  Filing an extension will not buy you additional time.  Non-deductible pay-ins to IRAs and Roth IRAs are also due by April 18, 2011.

Make a deductible contribution to a spousal IRA:

If you do not participate in a workplace-based retirement plan but your spouse does, you can deduct some or all of your IRA contributions on your 2010 income tax return as long as your adjusted gross income does not exceed $177,000.

Make a contribution to a Roth IRA: 

Contributions to Roth IRAs are not tax deductible, but the earnings on them may be withdrawn totally income tax-free in the future as long as the distributions are qualified.  A Roth IRA distribution is qualified if you’ve had the account for at least five years, the distribution is made after you’ve reached age 59½, you become totally and permanently disabled, in the event of your death, or for first-time homebuyer expenses.  Contribution limits are the same as traditional IRAs, except the maximum contribution for both Roth and traditional IRAs is still limited to $5,000 or $6,000 for persons age 50 or older.

To make a full Roth IRA contribution for 2010, your AGI cannot  exceed $177,000 if you are married or $120,000 if you are single.  You are subject to the same limitations for a non-working spouse.  Subject to some exceptions, I usually prefer Roth IRAs to traditional IRAs or even traditional 401(k)s.

Look into Roth IRA conversions:

The rules for contributions to Roth IRAs are different from the rules for Roth IRA conversions.  Prior to January 1, 2010, you could only convert a traditional IRA to a Roth IRA if your AGI was $100,000 or less (before the conversion).  However, this dollar cap is now removed starting January 1, 2010 and there is no limit to your earnings in order to qualify for a Roth IRA conversion.  Please remember that a conversion to a Roth IRA may place you in a higher tax bracket than you are in now and have other adverse consequences, such as subjecting more of your Social Security to be taxable due to the increase in your AGI.  Please also note that a Roth IRA conversion does not have to be all or nothing. You can elect to do a partial Roth IRA conversion and you can convert any dollar amount you decide is best for your situation.  Our most common set of recommendations after “running the numbers” is usually a series of Roth IRA conversions over a number of years.  Please remember that a Roth IRA conversion may not be appropriate for all investors.

Deadline is Nearing for the First-Time Homebuyer Tax Credit

Posted on by in Home Buyer, Roth IRA Conversions and tagged .

Even though the First-Time Homebuyer Tax Credit deadline is November 30th, the real deadline is upon us. That’s because the November 30th deadline refers to the closing date. Since most home purchases take between 45 to 60 days between contract signing and the closing date, you need to start house hunting in earnest in order to take advantage of this tax credit.

Qualifying taxpayers who buy a home by November 30th can get up to $8,000, or $4,000 if married filing separately.  Even better news — this credit does not have to be repaid as long as the home remains the main residence for 36 months after the purchase date.

Taxpayers can claim 10 percent of the purchase price up to $8,000, but the credit amount starts to phase out for taxpayers whose modified adjusted gross income (MAGI) is more than $75,000 ($150,000 filing jointly).  If you do qualify for this tax credit, think about how you want to use it.  You can use it towards a nice tax refund – or – use the benefit of the tax credit to make a Roth IRA conversion if eligible.

Technically, you don’t have to actually be a first-time homebuyer to qualify for this credit.  If you did not own any other main home during the three-year period ending on the date of purchase, you will be considered a first-time homebuyer.

One side note for those who purchased homes between April 8, 2008 and December 31, 2008 – you do not qualify for this tax credit, but you may qualify for a different tax credit which amounts to 10 percent of the purchase price up to $7,500 ($3,750 for married individuals filing separately).  The big difference is that this tax credit must be repaid in 15 equal installments over 15 years beginning with the 2010 tax year.

With the success of the First-Time Homebuyer Tax Credit program – over 1.4 million homebuyers have used this credit so far – there is talk of extending the November 30th deadline.  However, Congress has yet to make a decision on an extension.  In the meantime, good luck house hunting!  If you would like more details on this tax credit and to see if you qualify, visit www.irs.gov.