Monday, October 24, 2011

e-YWM Alert #19- Year End Retirement Planning Moves

Over the next few weeks we will be sending a series of emails regarding different tax planning strategies that can be implemented before year end. These emails are overviews of often complicated strategies. If you feel one of these may be of use to you or you have questions about any of them please contact us.
Below please find a number of strategies related to the use of Retirement Plan's as a tax strategy. Additional information on Roth to IRA conversions can be found at our e-alert archives at  in E-Alert #5 sent in November of 2010.

Roth Conversion:

Taxpayers may convert funds in traditional IRAs to Roth IRAs regardless of their income level.
Individuals considering whether to roll over or convert for 2011 should keep in mind that unlike the usual IRA rollover, a switch from traditional IRA or qualified plan to a Roth IRA is not income tax free. Instead, it is subject to tax as if it were distributed from the traditional IRA or qualified plan and not recontributed to another IRA.  However this rollover to a Roth IRA is not subject to the 10% premature distribution tax.
Why make a traditional IRA-to-Roth IRA conversion? Roth IRAs have two major advantages over traditional IRAs:
(1) Distributions from traditional IRAs are taxed as ordinary income (except to the extent they represent nondeductible contributions). By contrast, Roth IRA distributions are tax-free if they are "qualified distributions".
(2) Traditional IRAs are subject to the lifetime required minimum distribution (RMD) rules that generally require minimum annual distributions to be made commencing in the year following the year in which the IRA owner attains age 70 ½. By contrast, Roth IRAs aren't subject to the lifetime RMD rules that apply to traditional IRAs (as well as individual account qualified plans).
There are other tax advantages: Because distributions from Roth IRAs are tax-free such distributions:
  • may keep a taxpayer from being taxed in a higher tax bracket that would otherwise apply if they were withdrawing taxable distributions,
  • don't enter into the calculation of tax owed on Social Security payments, and have no effect on AGI-based deductions.  
  • Allow the benefits of a Roth IRA to flow through to beneficiaries of Roth IRA accounts, who also can make tax-free withdrawals from such accounts (they are, however, subject to the same annual post-death minimum distribution rules that apply to beneficiaries of traditional IRAs).
Who should make traditional IRA-to-Roth IRA conversions? The consensus view is that the conversion route should be considered by taxpayers who:
1. Have a number of years to go before retirement (and are therefore able to recoup the dollars that are lost to taxes on account of the conversion);
2. Anticipate being taxed in a higher bracket in the future than they are now; and
3. Can pay the tax on the conversion from non-retirement-account assets (otherwise, there will be a smaller buildup of tax-free earnings in the depleted retirement account).
Timing of rollover/conversion. A conversion from a traditional IRA to a Roth IRA is taxed in 2011 if it takes place before the end of the year. As far as rollovers are concerned, even though a distribution in 2011 from a traditional IRA is taxed in that year, the distributee has 60 days to roll over the distribution to a Roth IRA even if the rollover isn't completed until 2012
Backing out. A taxpayer who rolled over or converted from a traditional IRA to a Roth IRA earlier in 2011 may find that the move wasn't wise after all because the Roth IRA account has declined in value. The taxpayer can back out of the transaction by recharacterizing the rollover or conversion, i.e., transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. This must be done by the due date of the return (including extensions) for the year of conversion.  So for 2011, you have until October 15, 2012 if you extend your return to redo the conversion.

Losses on Investments held by Roth IRAs.
Losses on investments held within a Roth IRA aren't recognized when the losses are incurred. However, if the taxpayer liquidates all of his Roth IRAs, a loss is recognized if the amounts distributed are less than his unrecovered basis, namely his regular and conversion contributions, all of which are nondeductible contributions. The loss is an ordinary loss but it can only be claimed as a miscellaneous itemized deduction subject to the 2%-of-AGI floor.

Example: Early in 2011, Anne, a single taxpayer who is age 60, converted her traditional IRA with a $50,000 balance into a Roth IRA and invested the money in an aggressive growth fund. The traditional IRA was funded entirely with deductible contributions. Now the Roth IRA is worth only $25,000. A rough estimate for the year shows that Anne will have $100,000 of AGI and taxable income of $80,000 without factoring in the loss, putting her in the 25% tax bracket for 2011. Anne sees little hope for a recovery of the investment in the near future. She has no other Roth IRAs.
If Anne liquidates her Roth IRA (and has no other miscellaneous itemized deductions), she can claim $23,000 of the loss as a miscellaneous itemized deduction on Schedule A, Form 1040 ($25,000 less $2,000, which is 2% of her $100,000 AGI). The deduction will mean $5,750 in tax savings for Anne (25% of $23,000). In essence, that cuts her economic loss to $19,250 ($25,000 loss less $5,750 tax savings).

Caution: The tax savings may diminish (or even disappear) if the taxpayer is subject to the alternative minimum tax (AMT). That's because miscellaneous itemized deductions can't be claimed for purposes of calculating the AMT. Additionally Taxpayers who are thinking of liquidating their Roth IRAs should keep in mind that they will be giving up the opportunity to eventually withdraw any future gains tax-free.
Unexpected tax trap for Roth IRA owners. For IRA owners that made a traditional-IRA-to-Roth-IRA a 10% premature withdrawal penalty tax applies if the owner withdraws converted amounts within the five-tax-year-period beginning with the tax year in which the conversion took place. Because the penalty tax applies to a distribution to the extent that the converted amount was taxable when the conversion took place, a taxpayer could wind up paying a penalty tax even though none of the distribution is includable in income.

Self-employeds should establish a retirement plan before year-end.
A self-employed person who wants to contribute to a Keogh plan for 2011 must establish that plan before the end of 2011. If that is done, deductible contributions for 2011 can be made as late as the taxpayer's extended tax return due date for 2011. However, a self-employed person who misses the year-end deadline to establish a Keogh plan has until his extended 2011 return due date both to establish and to make deductible contributions to a Simplified Employee Pension (SEP) for 2011. Keogh plans, however, can be designed to provide more flexibility for a self-employed business owner than a SEP can provide. 

All information presented above is generic, if you would like to know how this may be applied to your specific situation please give us a call at 303-792-3020 or reply directly to this email.  Additional resources are always available at our website,

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