Hedging higher tax rates with Roth conversions

With the Bush-era tax cuts set to expire at the end of 2012, many investors are seeking ways to hedge against a potential increase in tax rates for 2013 and beyond. One option that should not be overlooked is the use of Roth conversions.

A Roth conversion allows you to pay tax on the converted IRA assets now, with those assets then growing tax-free for the rest of your life. It is generally preferable to defer taxes for as long as possible, but in a situation where tax rates may increase in the future, it may be worth locking in the taxes at today’s rates. For example, the top tax rate in 2012 is 35%; In 2013, the top tax rate may be as high as 43.4% (39.6% top marginal rate plus the 3.8% “Medicare surtax”). If tax rates don’t increase, you can always undo the conversion by recharacterizing the Roth back to a traditional IRA. As long as a recharacterization is done by the extended due date of the tax return (October 15th), you’ll just be back to where you started.

It is also important to recognize that a Roth conversion may bump you up into a higher tax bracket in the year of the conversion, depending on the amount converted. In that case, you should consider a partial conversion, where you only convert enough to stay within your current tax bracket. This is where the assistance of a tax professional can be invaluable.

Everyone’s situation is different, and whether a Roth conversion makes sense for you will depend on your particular circumstances and desires. Your financial advisor and CPA can help you weigh the costs and benefits of such a strategy to determine if it is right for you.


Year-end tax planning

Our friends at Thomson Reuters have provided another wonderful checklist of year-end tax planning opportunities. As we enter the final week of the year, it’s worth considering if any of these options can save you money. (more…)


Solution for a lack of choices in company sponsored retirement plans

I use your investment strategy for my Roth IRA and Rollover IRA.  My current employer uses Prudential for my company’s 457 plan.  Looking at the options, I cannot seem to use your allocation strategy due to a lack of choices.  Do you have any suggestions?

A recurring theme in most plans is a limited number of investment options.  This restricts your ability to properly allocate and diversify your account.

If you find yourself in this situation the allocation tactic described below is a simple and practical way to get your portfolio on track.



Can you benefit from a “Backdoor” Roth?

Since their introduction in 1998, Roth IRAs have become an important part of the financial planning landscape. They offer the unique ability for investors to grow their money tax-free, not simply tax-deferred like traditional IRAs. They also avoid required minimum distributions so they can grow undiminished for many years. In fact, Roth IRAs are wonderful assets to pass along to the next generation, where they can continue to grow tax-free even longer.

Until recently, this unique retirement vehicle was available only to individuals with incomes below certain thresholds. “High-income” individuals could not contribute to Roth IRAs or convert traditional IRAs into Roth IRAs. Some of this changed in 2010, when the Roth conversion income limitations were permanently repealed. Now, anyone (regardless of income) can make a Roth conversion.  However, the Roth contribution limitation was not repealed. This means that if your income exceeds the levels in the table below, you cannot contribute directly to a Roth IRA—but you can achieve the same result by first contributing to a non-deductible traditional IRA and then converting it to a Roth IRA.

This presents an interesting opportunity for high income individuals, who perhaps yearn to save beyond their 401(k) or 403(b) retirement plans or who simply desire the account diversification that comes with adding a Roth vehicle to their retirement mix. (more…)


How can I invest for my grandchildren on a few hundred dollars a year?

A couple recently asked my advice about how to put aside money for their new grandson, money he could use in his retirement. They didn’t have much money, but they wanted to get an early start.

I suggested a variation of an old formula that calls for setting aside $1 a day starting when you’re born. Babies can’t do this for themselves, but grandparents can. I told them that if they put aside $1 a day until their grandson’s 18th birthday, in theory, that money could grow to $1.5 million by the time he reached 65.

They could save $365 during their grandson’s first year, then add the same amount on every birthday until he reached 18.  Their total investment: $6,935.

It’s not easy to invest $365 efficiently, but exchange-traded funds (ETFs) don’t have minimums. If they could earn 10 percent, they could turn this money into more than $16,000 by their grandson’s 18th birthday. (more…)


It’s not too late to consider a Roth conversion

The end of the year is a busy time for most of us. Don’t forget to consider whether the Roth conversion might be worth your while. This year’s deadline, December 31st, is quickly approaching.

The income limitations to convert to a Roth have been repealed for this year and beyond, so anyone with an IRA is now eligible. Also, don’t forget that for 2010 conversions only, you have the option of recognizing the conversion income in the subsequent two years (2011 and 2012). This allows you to receive the benefits of a Roth IRA immediately while delaying the tax hit for a few years.

If you convert now and later change your mind, you can “undo” the conversion with a recharacterization—so you are not necessarily locked into the conversion if you do it this year. You have until the extended due date of your tax return (i.e. October 17, 2011) to recharacterize the conversion if you change your mind.

You may consider doing partial conversions—converting just enough each year to use up the rest of a particular tax bracket, like the 15% or 25% tier. Although this requires more work and planning each year, it’s a great way to gradually gain Roth exposure while sensibly controlling the tax impact.

Your financial advisor or CPA can help you decide if a Roth conversion is right for you. You can also find more information on the pros and cons of a Roth conversion in my article “Roth IRAs: To convert or not to convert.”


Roth IRAs: To convert or not to convert

As a financial advisor and CPA, I often receive tax questions from my clients.  One that has been coming up a lot in the past year is: “Should I convert my non-Roth retirement plan (401(k), traditional IRA, 403(b) or 457(b)) to a Roth IRA?”  The question isn’t surprising, given the new rules that took effect January 1 for Roth IRA conversions.

The short answer, which should not surprise you, is: “It depends.”

The issue is complex, and the answer for one person can be radically different from the answer for someone else. Converting might be a boon, a mixed bag or a mistake, all depending on your circumstances.

It’s worse than that, because the only way to make sure you’re making the right choice is to know some variables of the future which simply cannot be known.

My bottom-line advice is to seek professional advice from your tax advisor, your financial advisor or your tax attorney before you take the plunge.

A word of caution

The difficulty with Roth conversions, like the difficulty for many tax strategies, is that the right answers cannot be known in advance. You usually cannot know your future income for sure. You cannot know what Congress will do to the tax code. And you cannot know future tax rates. In each case, the best you can do is guess. (more…)

1 Comment

The Roth 401(k): Is it right for you?

Tax season has started in earnest, and some clients are asking whether or not they should switch their 401(k) accounts at work to the new Roth 401(k). They are hoping, I’m sure, for a simple answer. However, “It’s simple” is one thing you’ll almost never hear me say about a tax issue.

The Roth 401(k) is new for 2006 and reportedly is being offered or seriously considered by about 30 percent of the employers who have traditional 401(k) plans. If you are given the choice, should you stick with the traditional plan or switch to a Roth?

Sometimes – and this seems to be one of those times – I conclude that “fence sitting” is the best strategy.

The new Roth 401(k) offers a new flavor of retirement savings. With it, employees can save for retirement with no tax deduction at the time of savings, no tax on the growth in the account and no tax due at the time of withdrawal.

In the standard 401(k), you get a deduction at the time of savings, and there’s no pay-as-you-go tax on the growth (as there is if you own mutual funds in non-sheltered accounts). But you’ll pay tax on the contributions and the growth when you withdraw the money. (more…)