Opportunities and Pitfalls:IRA, 401k, Roth IRA: Society of California Accountants

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Harry Rubins, Financial Consultant with Foothill …

Harry Rubins, Financial Consultant with Foothill
Securities and Rubins Financial Strategies spoke to the Society of California Accountants North Bay Chapter 1/11/12. "Opportunities and Pitfalls:IRA, 401k, Roth IRA" for participants and beneficiaries. Please visit http://rubins401k.com/

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  • 1. Opportunities & Pitfalls IRA, 401k & Roth-IRA for participants and their beneficiaries Society of California Accountants North Bay Chapter January 11, 2012 MemberHarry Rubins, Financial ConsultantFoothill Securities, Inc.320 10th St., Ste. 304 MemberSanta Rosa, CA 95401707-542-9449 www.rubins401k.comhrubins@foothillsecurities.netSecurities & Advisory Services offered thruFoothill Securities, Inc. FINRA/SIPCCA Ins Lic 0728447 Ed Slott IRA Advisor Group is not affiliated with Foothill Securities, Inc. For general information only. Consult current tax code and retirement plan regulations before taking action.
  • 2. Opportunities & PitfallsOpportunitiesSave for Retirement – tax deductible or tax free  IRA & Roth  401k, PS, DB  401k with 457b can double the contribution  Tax deferral and time creates income for retirementRoth-IRA tax free income & no age 70½ RMDsDelay 401k age 70½ RMDs if still working and less than 5% owner (current 401k only)IRD tax deduction where estate paid Fed Estate Tax
  • 3. Opportunities (cont’d)Special Spousal BenefitsParticipant Spouse is greater than 10 years younger Smaller RMDs at age 70½ (joint life tables)Beneficiary-Spouse  Keep as inherited IRA --Spouse younger than age 59½ - needs income, no 10% penalty --Decedent younger than Spouse --delay age 70½ RMDs until decedent would have been age 70½  Spouse can transfer inherited IRA to own IRA at any time & delay RMD to age 70Many more---
  • 4. PitfallsIRA terminated – 100% taxable Participant Exceeding the once per year R/O rule Beneficiary Non-Spouse 60 day R/ONot updating beneficiary forms --Any change in family status --401k after second marriagePenalties – 10 & 50%
  • 5. Pitfalls (cont’d) If 401k transferred to inherited IRA can’t use --Qualified Disclaimer --Roth conversion from IRA (non-spouse) --NUA 401k company stock (capital gain taxation) Failure to set up separate inherited accounts by Dec 31st Many problems with trust as beneficiary Not taking RMDs Many more ------
  • 6. Why Roth-IRA Conversion in 2012Before higher tax rates begin in 20133.8% Surtax on Investment Income 2013  IRA distributions and Roth conversions are not subject to 3.8% surtax.  These taxable distributions can raise income above threshold limits subjecting other investment income to the 3.8% tax.  The 3.8% surtax will hit certain IRA Trusts hard as it kicks in at a much lower income ($12k in 2013).
  • 7. Roth – IRAs will be more valuable in 2013 and beyond Participant - No age 70 ½ RMD - Distributions tax free Heirs - Inherited RMDs tax free – non-spouse - Distributions tax free - Avoids high trust tax rates
  • 8. Roth Conversions - 2012• Now anyone, regardless of income, can do a Roth conversion ▫ The $100,000 MAGI income limit is permanently repealed - 2010 ▫ Married individuals filing separately can now do a Roth conversion
  • 9. Roth-IRA - 2012• There is still an Income Limitation that prevents ▫ High income tax payers & ▫ Married filing separately• from making annual Roth - IRA contributions
  • 10. Roth-IRA vs IRA? Traditional IRA Roth IRAContributions Tax Deductible No Tax DeductionContributions after No YesAge 70 ½If still workingWithdrawals Taxable plus 10% Contributions EarningsBefore Age 59 ½ penalty Tax-free Taxable plus 10% No penalty penaltyWithdrawals Taxable Contributions EarningsAfter Age 59 ½ Tax-free Tax-free* No penalty No penalty *Meets 5 year ruleSubject to age 70 ½ RMD Yes No
  • 11. Annual Contributions - 2012Roth-IRA (same as IRA) Max Contribution $5,000 Age of 49 or younger $6,000 Age of 50 or older Income Limits Phase Out Range (MAGI) Single $110,000 - $125,000 Married – Joint $173,000 - $183,000 Married – Separate $0 - $10,000Roth 401(k)/403(b)/457(b)*– Max Contribution (same as 401(k) $17,000 Age 49 or younger $22,500 Age 50 or older No Income Limits *Roth 457(b) new for 2011 – with Roth 401(k) can do max in both $34k/$45k
  • 12. Two Types of Roth-IRAs1. Annual Contributions ▫ Roth-IRA ▫ Roth-401(k)/Roth-403(b)/Roth 457(b) – salary deferral2. Conversion from IRA, SEP-IRA, Simple-IRA, 401(k)/403(b) to Roth-IRA Conversion From Owner IRA Qualified Plan Original Owner YES YES Inherited by Spouse YES YES Inherited by non-spouse NO * YES *exception to everyone can do a Roth Conversion
  • 13. Roth Conversion Traps Little known facts -----that may have unintended consequences There may be more !
  • 14. New Roth-IRA accounts need New BeneficiariesBeneficiaries – VERY IMPORTANT Estate plan for each retirement account Requires account owner to complete beneficiary forms and update as needed Requires beneficiary to take action by Sept 30th & Dec 31st in the year following death (Oct 30th for trust by trustee) To maximize the “Tax Free” benefits of an inherited Roth-IRA as a designated beneficiary
  • 15. New Roth-IRA accounts need New Beneficiaries (cont’d)Not having a designated beneficiary for a Roth-IRA Even worse than not having one for an IRA Inheriting IRA without a designated beneficiary Death before age 70½ RBD* -- 5 year rule Death after age 70½ RBD --Use decedent’s remaining single life expectancy (age 72 = 15.5 yrs & substrate 1 for each yr) Inheriting Roth-IRA with no designated beneficiary Roth IRA has no age 70 ½ Required Distribution - No RBD so only 5 year rule *Required Beginning Date – April 1st year following year age 70½
  • 16. New Roth-IRA accounts need New Beneficiaries – (cont’d)Why it’s important ---Roth Conversion $100,000 (earning 8%) Inherited by 10 year old grandchild—not designated beneficiary Loss of tax free growth and income After 5 years = $146,932 Not what the parents had in mind when they converted and paid taxes When it could have been a Designated beneficiary 72.8 life expectancy = $4.8 million TAX FREE !
  • 17. Beneficiary Default Election Retirement Plans What happens when there are no beneficiaries?Custodians for: IRA, Roth-IRA, SEP-IRA, Simple IRA Mutual Funds American -- Spouse, children/grand kids, to the estate Franklin -- Spouse, to the estate Vangard -- Spouse, to the estate Brokerage Pershing -- Spouse, children per stirpes, to the estate Schwab -- To the estate TD Ameritrade -- Spouse, children, to the estateQualified Plans -- 401(k), 403(b), Profit Sharing Plan Document ? ? ?
  • 18. AGE 70 ½ RMD must be taken firstRMDs must be taken before Roth conversionConverted RMD’s are excess Roth-IRA contributions - RMD must be removed - subject to 6% annual excise penalty taxConverted RMD may qualify as Roth-IRA contributions -If Roth-IRA owner is still working -Max $6,000 (age 50)Don’t forget to take inherited 401(k) RMDs
  • 19. Age 70½ RMD’s with multiple IRAs and 401(k)s RMD’s from multiple IRAs can be taken from any combination (one or all) RMD’s from multiple 401(k)s must be taken from each one -403(b) is an exception (one or all) -Still working and less than 5% owner -- no 401(k)RMD RMD’s from inherited IRA, 401(k)/403(b) -Inherited IRA – take from each decedent’s IRA (one or all same decedent) -Inherited 401(k) – take from each decedent’s 401(k) -- inherited 403b is an exception (one or all same decedent)
  • 20. Non-Spouse Beneficiaries cannot convert Inherited IRAsThis is an exception to “Everyone” can now do aRoth ConversionNon-Spouse beneficiaries cannot convert inheritedIRAs. They can convert inherited 401(k)/403(b)Convert 401(k) before transferring to anInherited IRA -remember to take inherited 401(k) RMD first
  • 21. The 10% Penalty Trap – After Roth ConversionAfter Roth conversion 10% penalty for withdrawals Within 5 years for Roth owner under age 59½Each year’s conversion has its own5 year ruleAfter age 59½ - no penalty onamount withdrawn after conversion
  • 22. Not setting up a new Roth – IRA when you have an existing Roth-IRAMost people convert into existing Roth-IRACostly problem if you need to recharacterize Stock A converted into existing Roth-IRA Stock A $60,000 Existing Roth $100,000 = $160,000 balance Stock A lost $40,000 Stock A $20,000 Existing Roth $90,000 = $110,000 balance Recharacterize just stock A?
  • 23. Not setting up a new Roth – IRA when you have an existing Roth-IRA (cont’d) Recharacterize just Stock A ($20k) No – must include net earnings of entire Roth Account Request $60,000 recharacterization before Oct 15th* Original conversion amount Trustee to Trustee transfer – important Net Income Calculation - $41,250 Stock A $20,000 Plus $21,250 from Roth-IRA $41,250 Recharacterized back to IRA Is it worth it ???? Contact Roth-IRA custodian first before submitting request to recharacterize *October 15th of year after the conversion
  • 24. Not setting up a new Roth – IRA when you have an existing Roth-IRA (cont’d)SolutionConvert stock A into separate New Roth-IRACan recharacterize Stock A now worth $20,000 orConsolidate Roth-IRA accounts after Oct 15* deadline *October 15th of year after the conversion
  • 25. Partial Conversion of After Tax Money The Pro-Rata Rule -- Part IPartial Conversion of $10,000 $10,000 after tax contribution in $100,000 IRACan not “cherry pick” and convert only $10,000 after tax money Pro-Rata Rule -- % after tax/total IRA = 10% $10,000 Conversion $1,000 tax free (10%) $9,000 taxable $10,000 conversionTotal IRA – include ALL IRAs, SEP-IRAs & SIMPLE IRAs Total IRAs now = $400,000 % = 2.5% $10,000 Conversion $ 250 tax free (2.5%) $9,750 taxable $10,000 conversion
  • 26. Partial Conversion of After Tax Money The Pro-Rata Rule -- Part IICalculations made on all IRA balances during year March 9th conversion unknown until Dec 31st using IRS 8606 All rollovers and distributions are included in the Dec 31st calculation A $500,000 R/O from 401(k) to IRA during the year – adds to the problem? Transferring $90,000 to your current 401(k) before converting the $10,000 of after tax money – won’t work It is the December 31st calculation!
  • 27. Annuity Surprise ! Account values haven’t recovered! Good time to convert? Variable annuities with Income Benefits The guaranteed value can be substantially higher Conversion is calculated using APV* This higher amount is reported to IRS not the cash value Call Insurance Company before converting -clients don’t like surprises*Actuarial Present Value
  • 28. Don’t let the Little details“Trap” you Roth Conversion documents Failure to check box “No Federal Tax withholding” Automatic 10% Federal Tax will be withheld plus any State Taxes Taxes withheld cannot be corrected or recharacterized Always confirm converted amounts are deposited and make it into the correct account – “Follow the Money” 60 day R/O – if late all taxable and lost Roth opportunity may have 10% penalty* *Under age 59½ Trustee transfers – finding out when doing tax return may be too late to correct errors
  • 29. Age 70½ Recharacterization SurpriseWhen Age 70 ½ or older and you recharacterize the yearfollowing the year of the Roth-Conversion A Required Minimum Distribution (RMD) is due by Dec 31stHow can that be – Roth-IRAs have no RMDsAfter recharacterization the funds are treated as if they never left the IRA RMD is calculated using Dec 31, 2010 Roth-IRA balance that was recharacterized in 2011 50% penalty if RMD not paid by Dec 31, 2011 Not much time if you recharacterized Oct 15thIf recharacterization is done in same year as conversion – No problem You took RMD before the conversion
  • 30. Loss of Credits, Exemptions, Deductions and more TrapsThere are many “items” that need to be reviewed with client’s CPAFinancial aid for college student maybe reduced or lostbased on parents’ income.Call College Financial Aid office and ask if they will excludeRoth conversion income
  • 31. Loss of Credits, Exemptions, Deductions andmore Traps (cont’d)Seniors have 2 problems based on their income For low income: Social Security may currently be tax free. The conversion may cause 50 to 85% of their SS income to be taxed For higher income: Medicare Part B premiums increase in cost above Single filer $85,000 Married filer $170,000 At first glance, this may deter some seniors, but the problem may continue once age 70 ½ RMD’s begin.
  • 32. Loss of Credits, Exemptions, Deductions andmore Traps (cont’d)Other tax issues with high income tax payers AMT – loss of personal exemptions and phase out of deductions Effects tax payers differently based on preference items and very complex tax calculations Tax Rate 26%-28%
  • 33. Finding Cash to Pay TaxesCash is “king” – low interest Money MarketLoans – another source of cash - Home equity line of credit - Cash value life insurance - 401(k) loanCapital losses - $3,000 per yearAge 70½ RMDsCharitable contribution strategyDonate stocks with unknown cost basis
  • 34. Roth Recharacterization “The Do-Over”• Deadline October 15, 2012 for 2011 Roth Conversion  -even if 2011 tax return was filed  Must be trustee to trustee transfer  Transfer back to any IRA  401(k) → Roth →IRA  Treated as if funds never left IRA
  • 35. Roth Recharacterization “The Do-Over”When can Account be reconverted back to Roth? Must wait until later of the calendar year after the conversion or more than 30 days after the recharacterization. Roth Roth Conversion Do-Over Conversion 2011 2012 31 days 2011 2011 2012
  • 36. Roth IRA and Conversion BenefitsTax Free Income -- You, Spouse & GrandkidsNo required Age 70½ distribution – you are in control!Make Roth-IRA contribution after Age 70½ (if still working)Distributions won’t increase tax on Social Security, Medicare premiums, AGI that affect AMT or 3.8% surtax in 2013Huge Estate Planning Benefits Beneficiary – RMD tax free income for life (non-spouse) Best asset for trusts – avoids high trust taxes 35% Fed tax for trust income above $11,650 (2012)Remove uncertainty and worry of future higher tax rates
  • 37. Naming a Trust as Beneficiary of IRA/401k is easy Making it work is NOT!! Will custodian/Plan accept Trust? Is Trust listed as beneficiary on each account? Trust document specifically drafted for IRA/401k? Trust meets 4 requirements to qualify as “stretch IRA” 1. Valid under state law 2. All Trust beneficiaries are persons and identifiable 3. Irrevocable upon death 4. By October 30th year following death, custodian/plan received Trust documents sent by Trustee. All beneficiaries will use oldest beneficiary’s life expectancy for RMDs.
  • 38. Naming a Trust as Beneficiary (cont’d) Decedent’s IRA/401k successfully transferred to a properly titled inherited IRA – not to the Trust RMD’s are paid out of the inherited IRA to the Trust for distribution Avoid having IRA Trust pay estate debts and expenses as trust may be ineligible for “stretch IRA” Is the right type of Trust named? -Conduit (pass through) Trust -Discretionary (accumulation) Trust Who are the trust beneficiaries? -Conduit trust only includes primary beneficiary -Discretionary trust includes both primary & remainder beneficiaries
  • 39. Naming a Trust as Beneficiary (cont’d) Definition of trust income is important to avoid Uniform Principal & Income Act that defines RMDs (90% principal & 10% income) as only 10% of RMD is distributed. Is trustee a family member or bank and understands their fiduciary obligations and who to call for guidance for all the many complex trust issues? If Special Needs Trust or control for many years is not needed consider a custodial beneficiary. Sally Jones custodian FBO Mark Smith UTMA/CA to age 25.
  • 40. Qualified Disclaimers Section 2518 Allows for post death flexibility to change estate plan Disclaimer is written document prepared by attorney and received by custodian/plan within 9 months of date of death Primary beneficiary can disclaim any or all of inherited IRA/401(k) to named contingent beneficiaries Individuals making disclaimer must not have accepted or transferred any of the inherited IRA/401(k) (Exception decedent’s RMD)
  • 41. Road Map for Beneficiaries Inheriting 401(k), IRA & Roth-IRADon’t Touch Inherited Accounts Until You Get Help!
  • 42. What Beneficiaries Need to DoAsk – Procedures to inherit account & if Roth IRA meets 5 Year RuleName – New Beneficiaries - Very Important!Take – Decedent’s remaining RMD if age 70½ or olderAsk if 401k has Company Stock, Roth 401k or after tax contributions; what is procedure for Non-Spouse Beneficiary transfers & conversions to Roth-IRA?Ask if Federal Estate Taxes were paidTransfer to properly titled inherited account (no 60 day R/O)  Mary Smith deceased (DOD 11/4/10) FBO Jane Smith Beneficiary
  • 43. Important Deadlines December 31st year of death – Decedent’s RMD if age 70½ or older 9 Months after death – Qualified Disclaimer & Fed Estate Taxes deadlines Year Following Death --September 30th – Qualify for stretch IRA & cash out charitable bequests --October 30th – Trust documents received by IRA custodian/Plan --December 31st – Separate accounts for multiple beneficiaries Complete company stock transfer within calendar year Transfer out of 401k and complete Roth conversion Start Inherited RMD (non-spouse)Note: Spouse Beneficiary has special benefits – don’t lose them!
  • 44. Road Map for Spouse Beneficiary Inheriting 401(k), IRA & Roth-IRASpouse Beneficiary has special benefits – don’t lost them!
  • 45. Spouse Beneficiary Special BenefitsSpouse can transfer to own IRA – “Fresh Start” --After qualified disclaimers and 401k company stock transfers --Can transfer at anytime so can keep as inherited IRA when income is needed (no 10% penalty)until spouse is age 59 ½.Delay RMD Distributions --For own IRA until spouse is age 70½ --For inherited IRAs*, until decedent would have been age 70½ *Only if spouse was sole beneficiaryRecalculate Life Expectancy–For account registered as inherited IRA * --Spouse can recalculate life expectancy after 1st year so age 70 ½ RMDs are smaller and last longer than for a non-spouse * only if spouse was sole beneficiary If all this seems complicated – it is! This is not the time to “do it yourself”
  • 46. IRA, 401(k) Roth IRAfor participants & their beneficiaries Take advantage of the Opportunities and avoid the pitfalls