by Chris Conroy Vice President of Advanced Marketing

With the New Year fast approaching, what's a great way to generate business while helping your clients? Present year-end tax planning strategies before it's too late. With many clients' families in town for the holidays, December is often a great month to get in front of your clients and address tax matters. Don't overlook these opportunities to conduct IRA check-ups, touch on additional tax planning solutions, and educate clients on reasons why Roth IRAs and conversions are an excellent discussion point.

 

Roth IRAs

Roth IRAs continue to be an area worth exploring. A Roth IRA offers tax-free accumulation and withdrawals if certain conditions are met. Unlike traditional deductible IRAs, taxpayers cannot deduct contributions made to Roth IRAs, but qualified distributions from Roth IRAs aren't included in a taxpayer's gross income or subject to the additional 10% federal income tax penalty for early withdrawals. This means that qualified withdrawals from a Roth IRA will be free of federal income tax. During the client's lifetime, money is available on a tax-favored or tax-free basis, and RMDs are not required. After the client's death, wealth can typically be transferred to family members income tax-free.

Owners of Roth IRAs may make withdrawals, but keep in mind they'll still pay applicable annuity surrender charges. Since contributions are taxed prior to being placed into a Roth, monies withdrawn will incur no penalties or taxes. Qualifying withdrawals may also be tax free if taken following a five-year period starting the year the first contribution was made in the client's name and certain conditions are met upon distribution, such as after age 59 1/2. Roth IRA earnings distributed prior to age 59 1/2 are subject to a 10% penalty unless withdrawals are made in connection with specific exceptions. Refer to IRA Publication 590, Individual Retirement Arrangements (IRAs), for details on taxability of withdrawals.

2011 Roth Contribution Limits

The 2011 IRA contribution limits remain unchanged from 2010. Since 2008, the most an individual may contribute to a regular IRA each year is $5,000. However, clients turning age 50 or older by the end of the year may contribute an extra $1,000. These limits apply to both Roth and traditional IRAs. Unlike traditional IRA contributions, some upper earners are not eligible to contribute to Roth IRAs. Married individuals filing jointly can contribute the maximum to a Roth only if their modified adjusted gross income (MAGI) is below $169,000. If their MAGI is between $169,000 and $179,000, then their contribution amount is phased out. For clients filing individually, the 2011 Roth phase-out limit is $107,000 to $122,000 of MAGI.

Spousal Roth IRAs

If you're married and you file a joint return, you can make regular contributions to a Roth IRA even if you have little or no qualifying income. Solely for the purpose of determining how much you can contribute to an IRA, you'll be treated as if you had taxable income equal to:

Your qualifying income (if any) + Your spouse's qualifying income (if any) - Your spouse's regular contributions to traditional IRAs and Roth IRAs.

For most people, this rule works out very simply. If either spouse works for a living and earns at least double the IRA contribution limit, both spouses can contribute the maximum amount to an IRA. Remember that the MAGI contribution limits still apply.

Roth Conversions

Even if clients make too much money for a direct Roth IRA contribution, they may have access to a Roth IRA through the backdoor. Beginning January 1, 2010, clients were given the opportunity to convert a regular IRA into a Roth IRA regardless of income. This is the result of The Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005. A Roth conversion is a way to change an existing qualified retirement plan, such as a 401(k) or a traditional IRA, to a Roth IRA. By converting, clients can take money that is currently tax-deferred and convert it into an account which grows tax-free. However, to convert, they are required to pay taxes on the amount converted. If the conversion occurred in 2010, clients had the option to split taxes into two payments in 2011 and 2012.

Upon conversion, the taxpayer will pay income taxes on the amount of converted pre-tax IRA money and any additional interest earnings. A taxpayer who opts for a Roth conversion will not incur the 10% penalty for withdrawals prior to age 59 1/2 at the time of conversion. For clients not comfortable paying the tax on the conversion, a partial conversion option is available. As long as your clients are eligible to convert, they can continue to do a partial conversion year after year, never having to make the larger tax payment, yet gradually converting their retirement accounts to tax-free status.

Converting to a Roth IRA might make sense if:

• Clients believe that the benefit from their money growing tax-free will be greater than the cost of having to pay the taxes due at the time of conversion
• Clients expect to live a long time after conversion, and do not want to be forced to take unneeded distributions at age 70 1/2
• Clients have the money available to pay the taxes due at the time of conversion
• Clients want "tax diversification" – providing different tax status IRAs to mitigate future unknown tax bracket risk and manage taxable income in retirement
• Clients want to leave money for future generations

Remember, each client's financial situation is different. There are many Roth IRA conversion calculators available online to assist you. Also, keep in mind the following when helping clients make decisions about converting to a Roth:

• If you expect their tax rate to be higher in retirement than it is right now, a conversion is more likely to be the right move.
• The greater the expected rate of return of their investments, the more likely a Roth conversion is a good idea.
• The longer the client has until retirement, the better the Roth conversion will appear.

Case Study: Should Paul convert to a Roth IRA?

Assume Paul is age 55 and has pre-tax assets of $100,000 in a 401(k) plan from a previous employer that he rolled into a traditional IRA. He's in the 28% combined tax bracket, and Paul is concerned his tax rate is going to be 35% when he retires at age 65. Paul thinks he can earn a 7% rate of return and would pay 15% tax rate on the non-IRA account. Paul is concerned about doing a full Roth conversion due to the tax bill that would be due ($28,000), but feels comfortable with a partial conversion of 25% of the IRA. This will result in a lighter tax impact ($7,000), and Paul can elect additional Roth conversions in future years. The above chart illustrates the impact of Paul's election to convert one-fourth of his IRA to a Roth.

By converting a portion of his traditional IRA into a Roth IRA, Paul increased the value of the converted funds by nearly 11%. Here, he can spread the tax bill burden over future years and tax plan as income levels and other circumstances may change.

Conclusion

For clients looking for a retirement savings vehicle with some distinct tax advantages, a Roth IRA might be the right fit. Roth conversions also provide a great alternative for some higher income clients. Make December your client tax planning month, and call your Sales Consultant for help increasing year-end sales.

FOR AGENT USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC. 12020 - 2011/10/24

Agents may not give tax, legal, accounting or investment advice. Individuals should consult with a professional specializing in these areas regarding the applicability of this information to his/her situation.