Hill's Personal Finance

Small Business' Need A Plan

A retirement plan, that is. Without one, business owners
may miss out on attracting the most qualified employees.

 Do you own a small business? If so, what do you think of your staff? Do you have the best and the brightest working for you? A good rule of thumb is this … take good care of your employees, and they’ll take good care of you. If you value your employees, you should give some thought to their futures. Have you considered their retirement needs? And on the flip side, if you DON’T feel you have a superior staff, have you thought about why that might be?

 Often, it comes down to benefits. Today’s employees are more conscientious than ever about their retirements, and how today’s decisions could affect their future. Many Americans begin planning their retirement as soon as they graduate college (or even sooner!). That means if you aren’t offering a retirement plan, you may be missing out on the kind of highly motivated, self-directed employees you’ve been looking for. That’s right, your 401(k) can be used as a recruiting tool!

 What about taxes? Well, a 401(k) can provide tax benefits. You can get a tax deduction based on salary deferral and employer contributions; your employees get tax-deferred growth of their assets. Many other retirement plans also offer significant tax breaks.

 So you want to offer a 401(k). Now what? The first thing to consider is how much current interest there would be at work in having a 401(k) plan. Poll your current employees and find out two things: 1) how interested they are, and 2) what (if anything) would be a deciding factor for them that would make them enroll or not enroll. Next, you’ll want to determine the cost (both in terms of money and time) to implement your 401(k) retirement plan. And finally, with any plan you’ll want to carefully consider what investment options are available.

 How do you compare? If you’re hoping to use your 401(k) as a recruiting tool, be sure to consider the total benefits package you’re offering to your employees, and how the 401(k) will fit into that package. It may be worthwhile to try and find out what your competition is offering.

 Getting started. The first step toward offering great retirement benefits is learning all you can about what options are available. I would recommend that you speak with a qualified financial professional who can help you sort through the choices and determine which options will work best for your business.

 

Rules Change for 401K In-Service Rollovers

401(k)-to-Roth rollovers are now possible before age 59½.

A new possibility. Sometimes employees want to pull money out of a 401(k) before they retire. It isn’t always because of an emergency. Some workers want to make an in-service non-hardship withdrawal just to roll their 401(k) assets into an IRA. Why? They see lower account fees and greater investment choices ahead.

 

As a result of the Tax Increase Prevention Reconciliation Act (TIPRA), tax laws now permit in-service non-hardship withdrawals from 401(k), 403(b) and 457 plans to traditional IRAs and Roth IRAs before age 59½. Of course, the employee must be eligible to take a distribution from the plan, and the funds have to be eligible for a direct IRA rollover.¹

 

This option may be very interesting to highly compensated employees who want the tax benefits of a Roth IRA. The income limits that prevented them from having a Roth IRA have been repealed, and they may have sizable 401(k) account balances.

Does the plan allow the withdrawal? Good question. If a company’s 401(k) plan has been customized, it may allow an in-service withdrawal for an IRA rollover. If the plan is pretty boilerplate, it may not.

The five-year/two-year rule also has to be satisfied. IRS Revenue Ruling 68-24 says that for an in-service withdrawal from a qualified retirement plan to take place, an employee has to have been a plan participant for five years or the funds have to have been in the plan for two years.²

401(k) plan administrators may need to amend their documents. Does the Summary Plan Description (SPD) on your company’s 401(k) plan allow non-hardship withdrawals? If it doesn’t, it may need to be customized to do so. This year, plan administrators nationwide are fielding employee questions about rollovers to Roth IRAs.

401(k) plan participants need to make sure the plan permits this. An employee should request a copy of the SPD. If you ask and no one seems to know where it is, then call the toll-free number on your monthly 401(k) statement and ask a live person if in-service, non-hardship withdrawal distributions are an option. In some 401(k)s, an in-service non-hardship withdrawal will prevent you from further participation; be sure to check on that.

If this is permissible and you want to make the move, you better make an IRA rollover with the assets withdrawn. If you don’t, that distribution out of your qualified retirement plan will be slapped with a 20% federal withholding tax and federal and state income taxes. Oh yes, you will also incur the 10% early withdrawal penalty if you are younger than age 59½. Additionally, if you have taken a loan from your 401(k), any in-service withdrawal might cause it to be characterized as a taxable distribution in the eyes of the IRS.³

Obviously, this IRA rollover possibility is not a big hit with the national and regional retirement plan providers, who would like to see you keep participating in their 401(k) programs rather than partly or fully bail out. But many employees would like a broader and more diverse range of investment options - and some would like the chance to direct their money into vehicles designed to produce future income streams.

Don’t forget to talk to the professionals. Retirement plan administrators and participants should talk to the financial consultant that has helped them with their 401(k) program before making a move. This article is simply an overview, and there will be different details to attend to with each employee. So be sure to touch base with the financial professional you trust.

 

Citations.

¹ articles.sun-sentinel.com/2009-08-16/business/0908140293_1_roth-ira-roth-conversions-simple-ira [8/16/09]

² smbhr.benefitnews.com/news/rolling-the-dice-with-a-roth-ira-rollover-2682826-1.html [1/22/10]

³ macpa.org/Content/22372.aspx [2/1/10]

 

Should Something Replace the 401(K)?

Do Americans need a new way to save for retirement?

 

In fall 2009, TIME Magazine raised eyebrows with a cover article called “Why It’s Time to Retire the 401(k)”. Author Stephen Gandel, the magazine’s senior economic writer, argued that 401(k)s, 403(b)s and IRAs had proven themselves “a lousy idea, a financial flop.”

Citing data from the Society of Professional Asset-Managers and Record Keepers, Gandel noted that in 2009, the average 401(k) had a balance of $45,519. Moreover, 46% of all 401(k) accounts had balances of under $10,000. However, he failed to mention that the average 401(k) account has been held for less than a decade.^1,2

A 401(k) plan simply takes too long to succeed, Gandel argued, and is too susceptible to market forces; in a market downturn, he said, it is unfair that the most hurt are the most invested.

What might the alternative be? A New York Times editorial called for a radical move, contending that “the only way to avoid wide variations in [401(k)] outcomes would be to develop a savings plan in which the government shared the risk - say, by providing a guarantee that returns would not fall below a certain level.” The editorial called for shifting the retirement savings “risk that is currently borne by individuals onto corporations and the government.”³

Obviously, not everyone is going to agree with that. But arguments for something similar are gaining momentum. A group of retirement plan administrators calling themselves the ERISA Industry Committee is pitching an idea called the New Benefit Platform for Life Security, which sounds like kind of a super-IRA with some characteristics of an annuity.

In this concept, your employer would have nothing to do with your retirement plan (unless it wanted to match your contribution to it as a perk). Instead, you would set up your own portable retirement plan with a retirement plan administrator of your choice in the free market. Your “NBP” wouldn’t have contribution limits, and you could set it up like a traditional pension to produce a lifelong retirement stream upon retirement. It certainly sounds great – except for one drawback. Who knows if the company acting as your retirement plan administrator would be around 20, 30 or 50 years from now?⁴

Other voices are proposing retirement insurance, possibly even from the federal government. Prof. Teresa Ghilarducci, an economist at The New School in New York City, has offered the idea of directing 5% of the wages of all working Americans into a mass retirement fund, which would pay out 26% of your end salary annually for the remainder of your life. (A little social security to complement Social Security, so to speak.) A Harvard professor would like to set up Social Security so that we would get 20% more than our final pay in SSI.¹ At this juncture and with this federal deficit, who knows if these are anything other than pipe dreams.

The 401(k) is still a vital retirement savings vehicle. In fact, many financial advisors feel it is the most useful retirement savings vehicle available to most Americans. The problem is that many 401(k), 403(b)s and IRAs are underutilized – people invest too little, or too infrequently, or withdraw what they’ve saved and invested too often.

Reaction to market whiplash, or a prelude to real revision? Of course, had the stock market not suffered so badly in late 2008 and early 2009, people might not be talking about this at all. Whether history proves the 401(k) a great idea or not, the thing for pre-retirees (and journalists) to remember is that there is no one retirement savings or retirement planning “answer”. A 401(k) is simply one of the “clubs in the bag” that you can carry as you stay “on course” for retirement – ideally, a component of a diversified retirement savings strategy.

 

Citations.

¹ time.com/time/business/article/0,8599,1929119-1,00.html [10/9/09]

² investmentnews.com/apps/pbcs.dll/article?AID=/20091025/REG/310259979/1031/RETIREMENT [10/25/09]

³ nytimes.com/2009/08/24/opinion/24mon1.html?_r=1 [8/24/09]

⁴ moneywatch.bnet.com/retirement-planning/blog/financial-independence/retire-the-401k-replace-it-with-this/558/ [10/15/09]

 

ARE YOU PREPARED TO PAY FOR LONG TERM CARE?

In the coming years, many Americans will face the challenge.

70% of people currently over age 65 will require some long term care someday. That is the estimate of the U.S. Administration on Aging, a division of the U.S. Department of Health & Human Services.¹ Will Medicare or private health insurance pay for it? The short answer is “no”.

In the decades ahead, baby boomers will reach their seventies, eighties and nineties. With aging parents of their own, some are learning how much long term care really costs. Some are still unaware.

How many of us are financially prepared for the possibility? Here are a couple of “averages” to consider from MetLife’s 2009 survey of LTC costs. The average annual cost of nursing home care is now $79,935 or $219 per day. That’s up 3.3% from 2008. The average nursing home stay is about 2.5 years, which means you would need roughly $200,000 to pay those bills.²

Can you imagine paying it out of pocket? Taking out a reverse mortgage to do it? Using Medicaid because you have nothing left? No one wants these financial circumstances. The clear answer is long term care insurance coverage.

How expensive is LTC coverage? Annually, it typically costs about as much as a cheap used car. MarketWatch cited an example from the MetLife survey: in 2009, a 52-year-old federal employee could pay $1,524 annually for an LTC policy with a $200-per-day benefit for three years and a maximum lifetime benefit of about $200,000.²

Does $1,500 or $1,800 or $2,100 annually (just to throw out a few numbers) sound expensive? These premiums are certainly inexpensive compared to the staggering bills you may face if the need for LTC enters your life. Yes, there is a chance that you may never need LTC coverage. However, with advances in medicine and healthcare, we may live much longer than we anticipate before we leave this world. Factor in diseases such as Alzheimer’s and Parkinson’s and other gradually disabling disorders, consider the population wave of baby boomers maturing, and you see why this coverage makes so much sense for so many.  

Partnerships to make paying for it easier. Many states have created partnership programs to encourage people to buy LTC coverage. Essentially, these plans provide dollar-for-dollar asset protection when you buy an LTC policy. So for every dollar the policy pays out in benefits, you get an equal dollar amount in asset protection under a state’s Medicaid spend-down regulations.

 

For example, let’s look at Ohio. Let’s presume a couple have a $100,000 LTC policy. If they use up the whole $100,000 to pay for LTC, they would have to spend down their assets to $2,250 to qualify for state Medicaid benefits. But … if they exhaust a $100,000 partnership policy, they can potentially qualify for Medicaid coverage and still retain $101,500 of their assets.³ State governments are increasingly offering to partner with LTC policyholders with inflation-adjusted policies.

A new option (and a nice tax break). There are now whole life insurance policies and annuities structured to provide either a long-term care benefit or a death benefit – and thanks to the Pension Protection Act, starting on 1/1/10 the interest deducted to pay premiums and benefits from tax-qualified LTC coverage will no longer be taxed. (This applies to combination whole life/LTC policy plans and combination annuity/LTC policy plans; premiums for traditional LTC insurance policies will still be paid with after-tax dollars. So with these new combination whole life/LTC and annuity/LTC policies, you will now have tax-free premiums and tax-free benefits.)⁴

59% of Americans are wrong when it comes to long term care. AARP conducted a survey in 2006 and found that 59% of respondents believed Medicare would pay for extended nursing home care. Another 52% incorrectly thought that Medicare would cover assisted living costs. In 2009, AARP found that 44% of Americans were “not very prepared” or “not at all prepared” to bear sudden long term care expenses.

 

I urge you to join the ranks of the prepared. November is Long Term Care Awareness Month – a good time to look at ways to plan for long term care needs. Now is the time to confer with an insurance advisor or financial advisor to learn more about your options.

 

Citations.

¹ naifa.org/newsevents/releases/200810212_LTCMonth.cfm [10/21/09]

² blogs.marketwatch.com/retirement/2009/10/27/long-term-care-insurance-is-it-worth-the-bet/ [10/21/09]

³ ltc4me.ohio.gov/faq.aspx [8/08]

⁴ seniormarketadvisor.com/r/smaMag/d/contentFocus/?adcID=c52394c846a85ab7538a370dfea5a92f [10/16/08]

⁵ aarp.org/research/ppi/ltc/Other/articles/the_costs_of_long-term_care__public_perceptions_versus_reality_in_2006_--_aarp_fact_sheet.html [12/13/06]

⁶ assets.aarp.org/rgcenter/il/bulletin_ltc_09.pdf [4/09]

NO SSI INCREASE FOR 2010

The Social Security Administration (and the IRS) leave benefits and retirement plan contribution limits unchanged.

 

SSI will remain flat for the first year since 1975. Social Security benefits are keyed to inflation. So what happens when year-over-year inflation becomes negative? No cost-of-living adjustment (COLA) occurs to increase your Social Security income. On October 15, the Social Security Administration announced that there would be no COLA for 2010. (The 2009 SSI COLA was 5.8%, the largest boost since 1992.)¹

“What do you mean, negative inflation?” That’s the question some SSI recipients are asking. Aren’t prices seemingly going up at the grocery store every day – and going up everywhere else?

Unfortunately, the federal government doesn’t measure consumer inflation with a price check on aisle six. It uses the Consumer Price Index (CPI), which is really an estimation of the average prices of consumer products we buy. There is also core CPI, which excludes food and energy costs.

From September 2008 to September 2009, overall CPI fell by 1.3%. Across that span, overall food prices actually fell 0.2% and prices on dairy products and fruits and vegetables respectively dropped 9.5% and 6.4%. Food prices only account for about a seventh of CPI, and rents actually constitute about 40% of the “prices” measured by core CPI. In September, rents fell in the United States for the first time since 1992. (We also have a decline in retail gasoline prices from last fall to this fall.)^2,3

With year-over-year inflation negative, the SSA has no logical reason for a COLA. Yet roughly two-thirds of America’s seniors live on less than $20,000 a year, some entirely on SSI.¹

Another stimulus check? President Obama is urging Congress to authorize one-time $250 stimulus payments to Social Security and Supplemental Security income recipients, veterans, railroad retirees and government retirees. That $250 would equal about 2% of the average annual SSI benefit for a retiree. These checks would be mailed sometime in 2010 to about 57 million people. Recipients could not qualify for multiple checks.⁴

Retirement plan contribution limits will stay the same. These are also inflation-indexed. On October 15, the Internal Revenue Service chimed in with a statement that 401(k) contribution limits will remain at $16,500 for 2010. The maximum contribution limits for other types of defined-contribution and defined-benefit retirement plans will also remain the same for 2010.^5,6

While we’re referencing the IRS, some other important figures aren’t changing next year. The standard deduction will remain at $11,400 and $5,700 for joint and single filers; it will go up $50 to $8,400 next year for heads of household. The yearly gift tax exclusion will stay at $13,000 for 2010, and the value of a personal exemption will remain at $3,650.⁷

No COLA … but more purchasing power? A former deputy Social Security commissioner who now works for the conservative American Enterprise Institute contends that the average retiree will actually have $725 more in purchasing power in 2010 thanks to falling prices and the freeze in Medicare Part B premiums (which will not increase in 2010 for most Social Security recipients). A senior policy analyst for the non-partisan Center on Budget and Policy Priorities told the Christian Science Monitor that if Social Security income was wholly determined by consumer prices, SSI recipients would have their checks cut by 2.1% next year.⁸  

What can you do in response here? Even if you are really wealthy, your SSI is a big chunk of money. If you were hoping for a COLA and want and need to have more money on hand for 2010, this is the time of year to meet with a financial advisor or tax advisor who may work with you and help you plan to find it.

Citations.

¹ baltimoresun.com/business/bal-bz.cola16oct16,0,2468505.story [10/15/09]

² bloomberg.com/apps/news?pid=20601103&sid=awvcLZFBUdhk [10/15/09]

³ bls.gov/news.release/cpi.t01.htm [10/15/09]

⁴ latimes.com/business/la-na-obama-seniors15-2009oct15,0,6276604.story [11/15/09]

⁵ irs.gov/newsroom/article/0,,id=214321,00.html [10/15/09]

⁶ irs.gov/newsroom/article/0,,id=214321,00.html [10/15/09]

⁷ google.com/hostednews/ap/article/ALeqM5jva4VYYkvx3LKvGF-2CY81N9q1dwD9BBPJGG0 [10/15/09]

⁸ features.csmonitor.com/politics/2009/10/16/do-seniors-on-social-security-deserve-that-raise-next-year/ [10/16/09]

The Creative way to Maximize Your Pension

Here’s a move that might prove useful for you and your spouse.

 

Are you wondering how to make the most of your pension? If you’re thinking about which income option to take, maybe it’s time to think outside the box. Here’s why.

When most retiring public service employees meet with a pension administrator and look over their income options, they face an either/or question. Do they sign up for the survivor’s benefit or not?

You want to do the right thing. At first glance, it seems like a no-brainer. If you have a spouse, of course you want the survivor’s benefit – right? After all, this is the option that guarantees the continuance of pension income for your spouse after you pass away. In most cases, it is structured so that the pension income lasts for the longer of two lives.

But do you really want to reduce your retirement income? You may not realize that this choice carries an opportunity cost.

If you choose to distribute your pension income under a “joint and survivor” arrangement, the monthly income you get will likely be hundreds of dollars less than if you had chosen a “single life” distribution. The pension fund knows that a joint life pension will almost certainly have to pay out over more years than a single life pension, so the monthly income will have to be set lower.

Selecting the joint life option means reducing your retirement income. If you take that option and die early, your spouse is looking at a lifetime of reduced pensions. If you and your spouse die a year or two apart, there is little benefit derived from the choice you’ve made. (In most cases, you can’t reverse a pension payout option you selected years ago.)

If you choose the survivor’s benefit, you are making an insurance decision. Seriously, you are. When you check that box, you are arranging for a cash benefit to be paid out to a surviving spouse. A life insurance policy has the same function – and it might be better to go get one.  

The outside-the-box choice that is too often overlooked. Here’s the real choice: Should you insure your spouse’s future level of income, or should you insure yourself?

Let’s put it another way. Let’s say your spouse outlives you. After you die, do you want your spouse to receive some taxable retirement income, or a significant cash benefit that will not be taxed? (Life insurance proceeds aren’t taxed, except in a few limited cases, but survivor pension benefits are.)^1,2

Before you retire, you could purchase a whole life insurance policy in an amount that would give your spouse or your children the equivalent of a similar monthly benefit. That whole life policy could even build cash value over time.

Why insure your life instead of your spouse’s future income level? This choice makes sense on many levels. First, you increase your retirement income by not choosing the joint life expectancy payout option. (If your spouse should pass away before you do, this will prove an even wiser financial decision.)

 

Second, you have a life insurance policy that will give your spouse financial protection in the form of a sizable death benefit if you pass away first. Your spouse could even use the life insurance proceeds to purchase an immediate annuity, which could then provide a lifelong income stream.

 

Third, if your spouse dies before you, you still have the maximum pension while the eventual life insurance proceeds may be directed to other beneficiaries you name on your policy – such as your children. (Will your children inherit your pension income? No, they will not.)

 

Fourth, there’s a lot of uncertainty today about the health of state and local pension funds. The less you have to worry about that subject, the better.

 

How would you pay for this new insurance policy? Well, it may be easier than you think. If you select a single life pension, the money you receive may result in income enough to live on and fund the policy.

 

Factors to consider. This “pension maximization” strategy makes the most sense if you and your spouse are in good health and if you are within 10 years of retirement. You also want to scrutinize the terms of your pension and medical plan, and take a look at the other income and tax consequences of making this move.

 

By the way, this strategy is common in corporate America. It’s about time more public service employees used it as well. I urge you to look into it, and to discuss it with a licensed insurance professional or financial advisor.

 

Citations.

¹360financialliteracy.org/Life+Stages/Retirement/FAQs/Life+insurance+and+estate+planning/Are+life+insurance+proceeds+income+taxable.htm [2008]

² advisortoday.com/200704/clientpension.html [4/2007]

 

 

Is America Prepared to Retire?

Two-thirds of us have no financial plan.

 

64% of Americans have no financial strategy at all. That’s right – no plan whatsoever to build wealth or keep it. That finding comes from the 2009 National Consumer Survey on Personal Finance conducted by the Certified Financial Planner Board of Standards, Inc. (The survey collected data from 1,700+ U.S. residents.)¹

Only 17% of us have a written financial plan that is updated regularly. So congratulate yourself if you are in that group. The CFP Board found that just 17% of the 36% polled who did have a written financial plan had reviewed it in light of changing times. Notably, 48% said they had benefited from having a written plan.^1,2

Just 38% of the 36% having written financial plans retain a financial advisor. The really troubling part: 37% of those with written plans are doing their financial planning on their own. Another 12% of respondents with written plans have consulted a friend or family member who isn’t a financial services professional for advice.¹

Why don’t more people have a financial plan? After all, Americans of all incomes and savings levels certainly are free to set financial goals. In the survey, the reasons varied. Some cited the expense of engaging a financial advisor; some said they get along just fine without a financial plan, and others felt their finances weren’t complicated enough to warrant one. Others were hazy about financial services industry qualifications - 40% of respondents had no idea that there were professional credentials or designations for financial advisors.

Syndicated financial columnist Humberto Cruz recently noted that when he told some fellow vacationers in Orlando that he wrote about financial planning, they all asked him if he gave stock tips. He had to explain that he was simply a journalist, not a financial planner.^3,4

Defined goals lead to definite plans. If you set financial objectives and plan for them, you vault ahead of most Americans – at least according to the CFP Board’s findings. A written financial plan does not imply or guarantee wealth, of course; nor does it ensure that you will reach your goals. Yet that financial plan does give you an understanding of the distance between your current financial situation (where you are) and where you want to be. Too many Americans, it seems, have little comprehension of their financial situation or their financial potential.

How much planning have you done? Retiring without a financial plan is an enormous risk; retiring with a financial plan that hasn’t been reviewed in several years is also chancy. A relationship with a financial advisor can help to bring you up to date about what you need to do, and provide you with more clarity and confidence when it comes to the financial future.

 

Citations.

¹ cfp.net/downloads/CFP_Board_2009_National_Consumer_Survey.pdf [7/24/09]

² reuters.com/article/pressRelease/idUS132983+24-Sep-2009+BW20090924 [9/24/09]

³ sltrib.com/business/ci_13467337 [10/2/09]

⁴ chicagotribune.com/topic/hc-cl-cruz-bio,0,84843.story [10/9/09]

Pro VA article in WSJ?

Yes its true, the Wall Street Journal did a positive story on variable annuities.

In Service 401(k) Withdrawls & Income Planning

An option you can use to develop your retirement income plan while you work.

Can you withdraw money from your 401(k) while you are still employed? Not everyone should; not everyone can. However, if you can, it may mean that you can effectively implement part of your retirement income plan before you retire.

If your 401(k) plan permits it, you can take an in-service withdrawal and redirect some of your 401(k) funds into another investment vehicle that offers you income guarantees.

The reasons why. A non-hardship withdrawal can provide you with early access to a portion of your retirement assets, freeing you to manage them as you wish. If the mix of funds in your 401(k) have taken a big hit lately, you might be wondering how some of those assets would do in other kinds of investments, especially those with less risk exposure.

This very question has led some people to withdraw assets from qualified retirement plans such as 401(k)s and direct them into non-qualified annuities that they own independently. A non-qualified annuity contract may be structured to provide tax-deferred growth for retirement, or immediate income. You aren’t even required to take distributions at age 70½ (though your contributions aren’t tax deductible.) The annuity may be fixed or variable. Another nice feature: non-qualified annuities do not have annual contribution limits. (There are annual contribution limits on qualified annuities held within IRAs and employer-sponsored retirement plans.)¹

Today, you can find popular non-qualified annuity investments that will allow you to take advantage of stock market gains while protecting your principal against stock market losses. Many of them offer the option of guaranteed lifelong income payments. Some of these annuities may let you allocate assets across a mix of stocks, bonds and funds through subaccounts.²

With features like these, you may be interested in these kinds of investments if you are approaching retirement age.

The 72(t) strategy to avoid the early withdrawal penalty. If you are still working and pull money out of your 401(k) before age 59½, you will almost certainly pay a 10% early withdrawal penalty plus income taxes on the money you take out.³ But you might be able to make early withdrawals with the help of IRS Rule 72(t).

Rule 72(t), based on life expectancy, lets you schedule fixed income withdrawals for five years or until you reach 59-1/2, whichever is longer.⁴ It lets you receive fixed, equal payments according to IRS calculations.

First things first: make sure you can do this. Talk with your employee benefits officer at work, and see that the Summary Plan Description (SPD) permits non-hardship withdrawals. Talk with your financial or tax advisor to make sure it is an appropriate move for you given your overall financial plan. If you know you’ll need more retirement income, there can be real merit to reinvesting early withdrawals from a 401(k) in vehicles that generate it.

Citations.

¹ thestreet.com/glossary/index.html?term=1267             [7/6/09]

² investopedia.com/articles/04/111704.asp     [11/10/08]

³ money.cnn.com/magazines/moneymag/money101/lesson23/index.htm [11/10/08]

⁴ money.cnn.com/2001/06/08/strategies/q_askexperts_disabled/             [6/8/01]

Roth IRA Conversions for 2010

A unique opportunity for IRA owners.

 

In 2010, anyone may convert a traditional IRA to a Roth IRA. No income limits will stand in the way of the conversion.¹ Should you do it? Here’s why it may (or may not) make sense for you to go Roth next year.

Why you might want to consider it. A Roth IRA permits tax-free growth and tax-free income distributions in retirement (assuming you are age 59½ or older and have held your Roth account for 5 years or longer). You can contribute to a Roth IRA after age 70½, without having to take mandatory withdrawals. While contributions to a Roth IRA aren’t tax-deductible, the younger you are, the more attractive a Roth IRA may seem.²

However, older investors have reason to go Roth as well – especially if they don’t really need to withdraw IRA assets. Under present tax law, converting an untapped traditional IRA to a Roth will shrink the size of your taxable estate, and careful estate planning could foster decades of tax-free growth for those IRA assets.³

Currently, if you name your spouse as the beneficiary of your Roth IRA, your spouse can treat the inherited IRA as his or her own after you die and forego withdrawals. So those Roth IRA assets can keep compounding untaxed across the rest of your spouse’s life.

If your spouse then names a son or daughter as a beneficiary, that heir has the choice to make minimum withdrawals according to his or her life expectancy, all while the assets continue to compound tax-free. Currently, withdrawals from an inherited Roth IRA are not subject to income tax.³

Why you may want to think twice about it. The IRS regards a traditional IRA-to-Roth IRA conversion as a distribution from a traditional IRA – a taxable event.⁴ You’ll need to pay taxes on the entire amount of the conversion. Do you have the money to do that?

Keep in mind, however: with the market down, many IRA values are lower than they have been for years. That translates to paying less tax on gains. It is also worth remembering that tax rates could increase in the years ahead – another reason why now may be a good time to convert. (You could simply do a partial Roth IRA conversion if converting the full amount would send you into a higher tax bracket.)⁴

You may be tempted to use the current IRA assets to pay the conversion tax, but should you? If you’re younger than 59½, you’re looking at a 10% penalty on the amount you withdraw, and you’ll lose the chance for tax-free compounding of those assets within the Roth IRA.⁵

Why you might want to fund a Roth IRA this year. In 2009, any withdrawals from a traditional IRA can be used to fund a Roth IRA.⁶ Interesting. Why is this so?

In years past, mandatory withdrawals from a traditional IRA typically couldn’t be deposited into a Roth IRA. But the federal government has suspended mandatory IRA withdrawals for 2009.⁷ Any IRA withdrawals made in 2009 are thereby elective withdrawals. So, if your adjusted gross income (AGI) is $100,000 or less, you have an option to fund a Roth IRA with a withdrawal from a traditional IRA – at least through the end of 2009.⁶

In 2009, you can fund a Roth IRA with after-tax contributions to a 401(k), 403(b) or 457 retirement savings plan. This year, you can take those contributions and convert them to a Roth IRA tax-free, provided your AGI is $100,000 or less. More good news: there is no limit to the conversion amount.¹

A potential tax break for those who convert in 2010. If you do a Roth conversion during 2010, you can choose to divide the taxes on the conversion between your 2011 and 2012 federal returns.⁸

Be sure to consult your tax advisor before you convert. This is a very good idea before you arrange any rollover, trustee-to-trustee transfer, or same-trustee transfer of your IRA assets. In any year, you should fully understand the potential tax impact of a Roth conversion on your finances and your estate. Also, remember that while the income limit on Roth IRA conversions will go away in 2010, the income limits on Roth IRA contributions still apply next year and for the foreseeable future.⁸

 

Citations.

¹ kiplinger.com/magazine/archives/2009/01/sweet-deal-on-roth-ira-conversion.html          [1/09]

² thestreet.com/print/story/10505164.html    [5/26/09]

³ smartmoney.com/personal-finance/retirement/estate-planning-with-a-roth-ira-7966/      [1/22/09]

⁴ smartmoney.com/personal-finance/retirement/roth-iras-you-wanted-to-know-7967/       [1/9/08]

⁵ smartmoney.com/personal-finance/retirement/roth-iras-to-convert-or-not-7965/              [1/10/08]

⁶ online.wsj.com/article/SB123033785000236433.html            [12/26/08]

⁷ usnews.com/blogs/planning-to-retire/2008/12/23/president-bush-signs-pension-relief-bill.html       [12/23/08]

⁸ kiplinger.com/columns/ask/archive/2009/q0601.htm              [6/1/09]