Tax Planning....It's Never Too Early to Start

Does it make sense to convert a Traditional IRA account to a Roth IRA?

   

Now that the "fiscal cliff" is (supposedly) well behind us...at least for a few months... 

...before you know it, tax time will be here. 

And one milestone that the President signed a couple of weeks ago to avoid it, was permanent tax legislation that allows us to more properly plan for the years to come...or at least in 2013 until the next tax bill is passed ! 

Much of my working life (and Allen Weintraub's) were spent talking to individuals about the importance of planning for retirement, and then one day... 

We both got there just like so many of them ! 

I believe I also speak for Allen in that assisting those many individuals in their "earning years", allowed us a great deal of satisfaction in watching so many of them proceed through life as we did; and now, an even greater satisfaction, knowing that in some way, their retirement years are a bit more comfortable as a result of our guidance and assistance. 

But planning is not something that STOPS when you retire; it's a continuous journey through life. 

And...that's the purpose of this article.

2012 is over; and it's time to start thinking about 2013.

Over the years IRA accounts have been quite popular amongst those still in the working world because they allowed an individual the opportunity to reduce their annual federal tax liability by making annual contributions for their eventual retirement. 

The IRA continued to gather additional support as 401(k) plans became established as well. 

As the years progressed, the IRA took on an even more important aspect of retirement planning as people left the workplace either at termination or at retirement, as distributions from these plans were made. 

Congress addressed the potential tax problem that the average individual would incur at that time, and as a result, the Rollover IRA became an integral aspect of planning for those individuals because that too allowed deferral of federal income taxation until the funds would be removed for personal use. 

Federal income tax rules; however, required that a minimum distribution take place no later than age 70½. 

As the years progressed and federal deficits mounted, in order to generate additional tax revenue, the IRA account took on another change, the Roth IRA. 

Here, dependent on other income restrictions, an individual could contribute funds to this vehicle on a NON-tax deferral basis; however, earnings on the account would be FREE of federal income taxation. 

As we are now seniors, and in many cases, our working years are behind us, the initial promises of "being in a lower tax bracket at retirement," may not be the case due to funds accumulated over our lifetimes, inheritances, and most importantly, constant changes in the IRS code. 

The result....possibly...being in a higher tax bracket. 

As a result of that possibility, if you have Traditional IRA accounts, it might be time to ask your tax advisor if any or all of these accounts be converted to a Roth IRA as the years proceed.

The BAD NEWS about embarking on this path is that the amount converted would be FULLY INCLUDED in your annual income in the year the funds were converted for federal income tax purposes, and the respective taxes would have to be paid by the April 15th deadline (often including quarterly estimates of income tax payments). 

...and those who would seem to benefit the most from this conversion would be those who have other funds accumulating on a TAXABLE basis.

The object would be to REDUCE taxable assets, and convert them to NON-TAXABLE ones. 

As a result of changes in our federal income tax laws over the past few years, many people have (or will shortly) realize that your Social Security Benefits may be TAXABLE, the result of which, REDUCES YOUR SPENDABLE INCOME.

...and it no longer takes a great deal of income FOR THAT TO TAKE PLACE.

Here's what most people don't know ! 

Up to 85% of Social Security benefits are taxable depending upon the taxpayers Modified Adjusted Gross Income (MAGI). 

When calculating MAGI for Social Security purposes, taxpayers MUST INCLUDE all taxable AND tax exempt income, plus 50% of their Social Security benefits. 

Though many retirees do not have to pay federal income taxes on their Social Security benefits,  for those who receive substantial income in addition to Social Security, up to 85% of the benefits may be taxable.

  

According to the Social Security Administration, about one third of benefit recipients pay federal taxes on their Social Security benefits. 

To be more specific,  Security Security Benefits... 

...may become taxable when retirees’ “provisional income" exceeds certain limits. 

"Provisional income" is defined by the IRS as the sum of wages, taxable and nontaxable interest, dividends, pensions, self-employment, and other taxable income plus 50% of your annual Social Security benefits. 

The amounts of the limits depend on a retiree’s filing status. 

For single taxpayers, 50% of Social Security benefits may become taxable
when their provisional income exceeds $25,000.

For single retirees with provisional income over $34,000, up to 85% of Social Security benefits may be taxable. 

If you are a married taxpayer filing jointly and your total combined income is greater than $32,000, then up to 50% of your Social Security benefit may be taxable. 

If your total combined income is greater than $44,000, then up to 85%  of your benefits may be taxable. 

And something most people seem to forget.... 

If you are a WIDOW or WIDOWER, you're SINGLE for federal income tax purposes.

Now here's the GOOD NEWS ! 

ROTH distributions are not included in the calculation. Therefore, having a ROTH IRA to supplement retirement income may be very important in managing taxability of Social Security benefits. 

And here are additional benefits of a Roth IRA. 

Beneficiaries of an IRA can stretch the account tax-free over their lifetime. Both traditional and ROTH IRA beneficiaries enjoy this stretch benefit, but the Roth IRA will continue to build tax free, while the traditional IRA’s tax burden will increase with its future growth. 

Still more...

  

Remember, under a Traditional IRA, if you reach age 70½ and still don't want to take money out of your IRA, the tax rules force you to take a distribution. 

The Roth IRA provides a way to extend the benefits of IRA investing for as long as you can afford to leave the money in the account, and that can mean more wealth for your later years — or for your heirs, because the age 70½ requirement DOES NOT APPLY to Roth IRA's. 

And yet one more...

The annual distributions you receive from a traditional IRA increase your income. 

Depending on your income level, this too could cause part of your social security benefit to be taxable, year after year throughout your retirement. 

Distributions you take from a Roth IRA are not considered as "tax-exempt income" in the calculation of how much your social security benefits are taxed.

So....does it make sense to convert a Traditional IRA to a Roth IRA?

It's something to consider and most importantly, discuss with your tax advisor as you gather your records to determine your income tax liability for 2012.

But....if conversion to a Roth IRA is your choice, consider it NOW...as early in the year as possible.

Why now?

...because you will have all of 2013 to generate tax-free accumulations, rather than little, if any, by completing the transaction at the end or the year...when your account will be higher, and as a result, incur a higher income tax liability.

Dick Arendt