Roth IRA Conversions Under New Tax Law

Roth IRAs have two big tax advantages

The two most-important Roth IRA tax advantages are:

Tax-Free withdrawals

Unlike traditional IRA withdrawals, qualified Roth IRA withdrawals are federal-income-tax-free and usually state-income-tax-free too. What is a qualified withdrawal? It’s one that is taken after you, as the Roth account owner, have met both of the following requirements:

1. You’ve had at least one Roth IRA open for over five years.

2. You’ve reached age 59½ or become disabled or dead.

For purposes of meeting the five-year requirement, the clock starts ticking on the first day of the tax year for which you make your initial contribution to your first Roth account. That initial contribution can be a regular annual contribution, or it can be a conversion contribution. For example, say your initial Roth pay-in was an annual contribution made on 4/1/14 for your 2013 tax year. The five-year clock started ticking on 1/1/13 (the beginning of the tax year for which the contribution was made), and you met the five-year requirement on 1/1/18.

Exempt from required minimum distribution rules

Unlike with a traditional IRA, you don’t have to start taking annual required minimum distributions (RMDs) from Roth accounts after reaching age 70½. Instead, you can leave your Roth account(s) untouched for as long as you live if you wish. This important privilege makes your Roth IRA a great asset to leave to your heirs (to the extent you don’t need the Roth money to help finance your own retirement).

Making annual Roth IRA contributions

Annual Roth contributions make the most sense for those who believe they will pay the same or higher tax rates during retirement. Higher future taxes can be avoided on Roth account earnings, because qualified Roth withdrawals are federal-income-tax-free (and usually state-income-tax-free too).

The downside is you get no deductions for making Roth contributions.

So if you expect to pay lower tax rates during retirement (good luck with that), you might be better off making deductible traditional IRA contributions (assuming your income permits), because the current deductions may be worth more to you than tax-free withdrawals later on.

The other best-case scenario for annual Roth contributions is when you have maxed out on deductible retirement plan contributions. For example, you’ve contributed the maximum possible amount to your 401(k) plan at work. In that case, making Roth contributions is basically a no-brainer.

Annual contributions are limited and earned income is required

The absolute maximum amount you can contribute to a Roth account for any tax year is the lesser of: (1) your earned income for the year or (2) the annual contribution limit for the year. Basically, earned income means wage and salary income (including bonuses), self-employment income, and alimony received that is included in your gross income (believe it or not). If you are married, you can add your spouse’s earned income to the total.

For 2018, the annual Roth contribution limit is $5,500 or $6,500 if you will be age 50 or older as of year-end.

Annual contribution privilege is phased out at higher incomes

For 2018, eligibility to make annual Roth contributions is phased out between modified adjusted gross income (MAGI) of $120,000 and $135,000 for unmarried individuals.

For married joint filers, the 2018 phase-out range is between MAGI of $189,000 and $199,000.

Annual contribution deadline

The deadline for making annual Roth contributions is the same as the deadline for annual traditional IRA contributions, i.e., the original due date of your return. For example, the contribution deadline for the 2018 tax year is 4/15/19. However, you can make a 2018 contribution anytime between now and then. The sooner you contribute, the sooner you can start earning tax-free income.

Well-seasoned individuals can still make annual Roth contributions

After reaching age 70½, you can still make annual Roth IRA contributions — assuming there are no problems with the earned income limitation or the income-based phase-out rule. In contrast, you cannot make any more contributions to traditional IRAs after you reach age 70½.

Roth conversions

The quickest way to get a significant sum into a Roth IRA is by converting a traditional IRA to Roth status. The conversion is treated as a taxable distribution from your traditional IRA, because you’re deemed to receive a payout from the traditional account with the money then going into the new Roth account. So doing a conversion before year-end will trigger a bigger federal income tax bill for this year (and maybe a bigger state income tax bill too).

However, today’s federal income tax rates might be the lowest you’ll see for the rest of your life. Thanks to the TCJA, the rates shown below apply for 2018. These brackets will be adjusted for inflation for 2019-2025. In 2026, the pre-TCJA rates and brackets are scheduled to come back into force.

Single Joint HOH*

10% tax bracket $ 0-9,525 0-19,050 0-13,600

Beginning of 12% bracket 9,526 19,051 13,601

Beginning of 22 bracket 38,701 77,401 51,801

Beginning of 24% bracket 82,501 165,001 82,501

Beginning of 32% bracket 157,501 315,001 157,501

Beginning of 35% bracket 200,001 400,001 200,001

Beginning of 37% bracket 500,001 600,001 500,001

* Head of household

So if you convert in 2018, you’ll pay today’s low tax rates on the extra income triggered by the conversion and completely avoid the potential for higher future rates on all the post-conversion income that will be earned in your Roth account. That’s because Roth withdrawals taken after age 59½ are totally federal-income-tax-free, as long as you’ve had at least one Roth account open for over five years.

To be clear, the best candidates for the Roth conversion strategy are people who believe that their tax rates during retirement will be the same or higher than their current tax rates. If you fit into that category, please keep reading.

Consider multi-year conversion strategy

Converting a traditional IRA with a relatively big balance could push you into a higher tax bracket. For example, if you’re single and expect your 2018 taxable income to be about $110,000, your marginal federal income tax rate is 24%. Converting a $100,000 traditional IRA into a Roth account in 2018 would cause about half of the extra income from the conversion to be taxed at 32%. But if you spread the $100,000 conversion 50/50 over 2018 and 2019 (which you are allowed to do), almost all of the extra income from converting would be taxed at 24%.

Ill-advised conversions in 2018 and beyond cannot be reversed

For 2018 and beyond, you cannot reverse the conversion of a traditional IRA into a Roth account. Under prior law, you had until October 15 of the year after an ill-advised conversion to reverse it and thereby avoid the conversion tax hit.

2017 Conversions can still be reversed as late as Oct. 15, 2018

The IRS has clarified that if you converted a traditional IRA into a Roth account in 2017, you can reverse the conversion as long as you get it done by 10/15/18. That 10/15/18 deadline applies whether or not you extend your 2017 Form 1040.

You accomplish a Roth conversion reversal by “re-characterizing” (weird word chosen by the IRS) the Roth account back to traditional IRA status. That is done by turning in the proper form to your Roth IRA trustee or custodian.

Conclusion on conversions

Low current tax cost for converting + avoidance of possibly higher tax rates in future years on income that will accumulate in your Roth account = continuing perfect storm for the Roth conversion strategy. However, talk to your tax adviser before pulling the trigger on a conversion — just to make sure you’ve considered all the relevant factors.

The Bottom Line

Even with the new law’s dis-allowance of the Roth conversion reversal privilege, Roth IRAs are still a tax-smart retirement savings alternative for many folks. Maybe now more than ever.

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Advantages Of A Revocable Living Trust

Many people believe a Last Will and Testament is sufficient to meet their estate planning goals.

If their goal is making the fulfillment of their wishes as easy as possible for their family and friends, with the least amount of expense, they might consider a Revocable Living Trust.

A Revocable Living Trust is a legal document that acts similarly to a Will, but does much more.

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High Earners Should Consider A ‘Back Door’ Roth IRA

Ed. Note: This article first appeared in CNBC

The April 18 tax-filing deadline is looming, and many corporate executives, attorneys and other professionals earning high salaries are seeking to save more money and cut their taxes.

There is a great strategy that they could be overlooking that may save significant taxes in retirement: setting up a Roth Individual Retirement Account.

Roth IRAs are attractive for several reasons.

While funded with after-tax dollars, any earnings are tax-deferred and withdrawals in retirement are tax-free.

Additionally, Roth IRAs are not subject to the minimum annual withdrawals required from traditional IRAs during retirement, so they can also be an excellent tax-planning tool.

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What to do if you inherit a spouse’s IRA

So you’ve inherited your spouse’s IRA. What you do now could have far-reaching tax implications. The one thing you cannot do is sit on your hands. Why? Because if you fail to withdraw at least the required minimum amount from your inherited IRA, you will be charged a penalty equal to 50% of the shortfall. This is one of the toughest penalties in our beloved Internal Revenue Code. So please pay attention and read on to learn how to calculate required minimum withdrawals from an IRA you inherited from your spouse.

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Is The 4% Rule Of Retirement Still Good Advice?

By , Contributor

Making sure the income you will count on from your retirement savings is sustainable is one of the most important steps people should take. And one common method that people have used for the past 25 years or so is the “4% rule.” However, some question whether the 4% rule is still useful.

We reached out to three of our experts on retirement planning and asked for their latest thoughts on the 4% rule and whether it’s still worthy advice. Here’s what they had to say.

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IRS Grants Sweeping Relief To Retirement Savers Who Miss Rollover Deadline

By , Contributor

In a surprise move, the Internal Revenue Service today made it dramatically easier and cheaper for taxpayers who miss the 60 day deadline for rolling over retirement account money to fix their errors. “It’s a great move by IRS. It’s a taxpayer friendly move,” exalted  IRA expert Ed Slott, after learning of the change from Forbes. “There will be people, that this ruling today, will save their retirement savings.’’

By law, money received by a taxpayer from an IRA, 401(k), or other workplace retirement plan, must be contributed (i.e. rolled over) to another retirement account within 60 days to escape immediate taxation. Otherwise, it is considered a distribution subject to regular taxes and (if you’re under 59 ½), apossible 10% early withdrawal penalty. That 60 day rule tripped up so many taxpayers, that in 2001 Congress gave the IRS the ability to waive it, if the delay wasn’t a taxpayer’s fault —for example,  his house was destroyed, or a financial advisor gave him bum advice about the time he had to do the rollover.

Until today, however, to get 60 day relief, you had to apply to the IRS for what’s known as a private letter ruling. That meant paying the IRS a stiff fee (which rose on January 1, 2016 to a stunning $10,000), plus shelling out another $5,000 to $10,000 for a tax pro to prepare the private letter ruling request. The ruling took six to nine months, and you couldn’t roll the money into a new account until the IRS  gave the green light. Even worse, Slott says, a lot of people didn’t even know the letter ruling was an option, and ended up paying a whopping tax bill on their retirement savings and losing potentially decades of tax deferral, because of an innocent mistake.

But in Revenue Procedure 2016-47, both  issued and effective today, the IRS has created a new “self-certification” procedure that allows someone who misses the 60 day deadline to avoid the expense and delay of obtaining a private letter ruling. Instead, a taxpayer submits a model IRS letter to the  new retirement account custodian, checking in that letter one of 11 acceptable excuses for missing the deadline. This isn’t an unconditional pass—the IRA custodian will report the letter to the IRS and should the taxpayer be audited, the IRS can still determine he didn’t quality for 60 day relief.

But the 11 excuses are pretty inclusive and cover most of the reasons that the IRS has granted private letter relief for in the past.   They include an error by a financial institution; a taxpayer misplacing (and never cashing) the retirement account distribution check; and a taxpayer mistakenly putting the check in a taxable account he thought was an eligible retirement account.  There’s also lots of dispensation for personal problems, including a death or serious illness in the family;  a home being severely damaged; and even a taxpayer being unable to  complete the rollover because he was incarcerated.

One catch is that the taxpayer must usually complete the late rollover within 30 days after the circumstance which kept him from making a more timely rollover is discovered or ends. “One of these reasons is because a family member dies. Who’s to say when the 30 days starts? When do you finish grieving?’’ Slott asked. “It’s a little ambiguous. I would get it done as soon as possible,” he added.

While the reasons are broad, they only apply if you were eligible to do a 60 day rollover to begin with.  That’s a crucial point, because, as a result of a 2014 U.S. Tax Court decision,  taxpayers may only do one 60 day IRA rollover every 12 months, no matter how many IRAs they have.  (Before that, you could do one rollover a year for each IRA.)

The safest way to move money from one retirement account to another is to have one trustee (that would be the bank, broker, mutual fund or other financial firm that holds your account)  transfer it directly to another trustee.  You can do that as many times a year as you want and run no risk of missing the 60 day deadline. In announcing the new self-certification procedure, the IRS urged taxpayers to consider such direct trustee-to-trustee transfers.

Note that IRAs inherited from anyone other than a spouse never qualify for 60 day rollovers; they can be moved only from trustee to trustee and must be carefully retitled as an “inherited IRA” —e.g.  “John X. Smith II,  deceased, inherited IRA for the benefit of John X Smith III.”

In addition, 401(k) money is almost always best transferred directly from custodian to custodian. That’s because if you take a distribution from your 401(k), your employer must withhold 20% for taxes, meaning you won’t have the full amount to put into the new account unless you can come up with it from your other savings.

Warning: one excuse the IRS won’t allow is that you were using your retirement money as a short term loan for some non-retirement purpose—say, a down payment on a house—and missed the 60 day deadline because of a snag. In its private letter rulings, the IRS has shown little mercy to taxpayers in such situations.

Source: Forbes

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Tax-Smart Ways to Save When You’re Too Old for a Traditional IRA

Some workers may be too old to contribute to a traditional IRA.

By Kimberly Lankford, August 19, 2016

I’m 72 years old and earn some money as a self-employed consultant. Can I contribute to an IRA and, if so, how much?

You can’t contribute to a traditional IRA starting in the year you turn 70½. But you can contribute to a Roth IRA at any age, and the money can grow tax-free in the account indefinitely (you don’t have to take required minimum distributions). To qualify for a Roth, your income in 2016 must be less than $132,000 if you’re single or $194,000 if you’re married and file taxes jointly.

You can contribute up to the amount you earned for the year (your net income from self-employment), with a maximum of $6,500 ($5,500 plus $1,000 for people age 50 and older). If your earnings are well over the $6,500 max, you can simply contribute that amount, but if they are close to or under the maximum, you’ll need to know what is considered compensation and how to calculate your allowed contribution. For that information, see IRS Publication 590, Individual Retirement Arrangements.

Or, because you are self-employed, you can contribute to a solo 401(k), says Rande Spiegelman, vice president of financial planning with the Schwab Center for Financial Research. You can deduct your contribution now and defer taxes on the money until it’s withdrawn. But because you’re over age 70½, you must take required minimum distributions from the solo 401(k). Employees usually don’t have to take RMDs from their current employer’s 401(k) if they’re still working at age 70½, but that rule doesn’t apply if you own 5% or more of the company. Because you’re self-employed and own the whole company, you’re stuck taking the RMDs.

 

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