Roth Conversion and IRA Contribution Questions Highlight Mailbag

This week's Slott Report Mailbag includes questions about converting an employer-based 401(k) to a Roth IRA, the use of trusteed IRAs and what to do if you want to make an IRA contribution from money you earned at the end of 2011, but didn't receive until 2012. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Ed and Company,

Send questions to mailbag@irahelp.com

I stumbled onto you through a Morningstar newsletter which indicated you saying that I could turn my old 401(k) account into a Roth IRA. I checked your website and found the following in the FAQs.

Can I convert my IRA or employer plan to a Roth IRA?


All funds in traditional IRAs, SEP IRAs, and employer plans such as 401(k)s are eligible to be converted to a Roth IRA. Funds in a SIMPLE IRA can also be converted AFTER the SIMPLE account has been open for two years. A conversion before that date will be subject to a 25% penalty tax on the amount withdrawn AND the funds are not eligible for transfer to any other type of plan except another SIMPLE. To do a conversion of employer plan funds, you must be eligible to take a distribution from the plan.

Does this mean that I could roll over the funds in my 401(k) account (which is still with my former employer) directly into a Roth IRA instead of a regular rollover IRA without paying any taxes or penalties at the time of the rollover?

Thank you very much in advance for clarifying this for me.

Answer:
If you are eligible to withdraw the funds from your 401(k) plan, then you can convert those funds directly into a Roth IRA. You no longer have to first establish a traditional IRA (under the old rules) with those funds and then convert to a Roth IRA. You can now go directly to a Roth IRA. You will, however, have to pay income tax on the taxable amount being converted.

2.

Ed and Company,

What are the advantages and disadvantages of Trusteed IRAs? Are Trusteed IRAs protected from creditors?


Answer:
There are two possible ways to answer your question. If you are asking about the difference between a self-directed IRA and a managed or trusteed IRA, then both are treated identically for creditor protection purposes. You have whatever protection is available under state law. Then there are trusteed IRAs that are offered by a handful of IRA custodians. They are sort of a poor man’s trust. You may have a series of check boxes where you select the provisions that you want to apply in your case. Again, any creditor protection will be what is available under state law.

3.

I have an issue.

I generated earned income (salary) for the pay period Dec 18 -31. Disbursement of pay for the period didn’t occur until January 2012, consequently, I did not receive a W-2 for 2011.

Can I make an IRA contribution for 2011 in an amount not to exceed the Gross Pay earned during the period Dec 18-31? I was intending to make the contribution and in lieu of a W-2, I would attach the corresponding pay stub received in January which indicates it covers a pay period ending Dec 31, 2011.

Thanks for your help!
TC


Answer:
Interesting question that could perhaps best be answered by your tax preparer. The answer may depend on the date of the check that you received rather than on the actual dates you worked. Nonetheless, we picked this question because many individuals could be in you exact predicament, and the answer is never to guess yourself, but rather to ask your tax preparer.

-By Marvin Rotenberg and Jared Trexler

Read More

5 Things to Accomplish Before April's Tax Deadline

Thanks to April 15th falling on a Sunday and a Washington D.C. holiday (Emancipation Day) on the following day, the April 15th filing deadline is pushed back to April 17, 2012 for 2011 federal income tax returns. Below are five things you should address between now and then.

#1 - Make your 2011 IRA or Roth IRA contribution
If you haven't yet made a full 2011 IRA and/or Roth IRA contribution, you can still do so up to the April 17th filing deadline. The 2011 IRA/Roth IRA contribution limit was $5,000 ($6,000 if you were 50 or older by the end of the year). If you’re making your 2011 IRA contribution in 2012, make sure you notify your custodian and that they correctly code it as a 2011 contribution so that if you decide to make a 2012 contribution at a later time, you won’t run into any problems. Getting a contribution in so late isn’t preferable, but it’s definitely better than not making one at all.

#2 - File your 2011 tax return or an extension
No surprise here – you must file by April 17th or face failure to file penalties (find out in this article if you have to file a tax return). What you file though, is up to you and depends on your situation. If you have all your 2011 tax information, you’re probably best off filing your actual 2011 tax return. If you don’t have all your information – say, for instance a K-1 has yet to arrive or if you plan on recharacterizing a 2011 Roth conversion - you may want to file an extension. The extension is automatic as long as you file Form 4868 by the April 17th deadline. If you file an extension, you generally have until October 15th to file your return.

#3 - Pay your 2011 tax liability
Whether you file a return or an extension by April 17th, you must pay your 2011 tax liability by April 17th. An extension only gives you a longer time to file, not to pay your taxes. How do you know how much to pay if you haven’t completed your actual return yet? Simple… estimate. You may want to add a little cushion to your estimate, just in case you’re wrong. It will help you avoid underpayment penalties and you’ll get a refund of any overpaid amounts when you file your return, plus interest.

#4 - Make your 2012 first quarter estimated tax payment
For those of you who are required to make quarterly estimated tax payments, April 17th is a double-whammy. Not only do you have to pay up for any balance owed on your 2011 tax liability, but your first quarter payment for 2012 must be made at the same time. This year, some of you might be first time estimated tax payers thanks to 2010 Roth conversions that were spread over two years. The first part of that income is included in your 2011 income, which serves as the basis for determining 2012 “protective” estimated tax payments.

#5 - Start planning for next year
As many of you may be aware, if Congress takes no action before the end of the year, federal income tax rates are scheduled to revert to their pre-Bush tax-cut levels. There are a number of strategies that could help take advantage of this situation, should it come to pass, so be sure to discuss planning strategies with your tax and/or financial advisor.

-By Jeff Levine and Jared Trexler

Read More

Leaving Your Current Job? You Have Retirement Plan Options - Part 2

This is the final part of a two-part article examining six options individuals have for their retirement plan benefits when they leave an employer or become their own boss. In the first part, we covered three options (rolling over to a Traditional IRA, taking a lump sum distribution, leaving it in the plan). We finish our guide with the last three options and provide some closing words of wisdom when considering which choice is best for you.

CLICK HERE TO READ PART 1 OF THE SERIES

Roll To a New Company Plan
 If you are changing employers you may have an opportunity to participate in your new company’s retirement plan. Many permit you to rollover assets from a former employer’s plan, which would allow you to keep all of your company-sponsored retirement funds in one place. Also, you would retain the benefits afforded qualified plan participants, such as enhanced protection against creditors, potential to purchase life insurance in the plan, or retain the insurance policies you had purchased previously in your former employer’s plan. However, the first step is to check the new company’s plan document to determine if you will be allowed to rollover assets from another company’s plan.
Of course, keeping your money inside a company plan subjects you to the rules established by the employer for investing as well as naming beneficiaries. Also, distribution options may be limited for both you and your beneficiaries, but most plans typically have liberal withdrawal rules when it comes to this type of money.

Convert to a Roth IRA
Under the old rules, in order to convert from a corporate plan to a Roth IRA you would have had to first put the funds into a Traditional IRA and then convert to a Roth IRA. Now, you can go directly from a qualified plan into a Roth IRA without an intermediate step.

We have discussed the virtues of Roth IRAs on many previous occasions. If you are considering converting to a Roth IRA make sure you have outside liquidity to pay the income tax. If you have to use some of the company plan money to pay the tax it generally does not make good financial sense and could subject you to an early distribution penalty if you don’t otherwise qualify for an exception (e.g. separation from your employer in or after the year you attain age 55.)

Converting to a Roth Account Offered by the Employer
If your employer plan has adopted a Roth option within their 401(k), 403(b), or governmental 457(b) plan and if the plan allows, you may be able to transfer funds that you would otherwise be able to withdraw into the Roth account in the plan. If you are transferring taxable amounts to the Roth 401(k), you will have to pay income tax on the taxable amount. The conversion to a Roth account inside the employer plan is an irrevocable transaction. There is no recharacterization allowed. You must be sure you have the funds to pay the income tax due on the conversion.

We didn’t discuss 403(b) plans in particular, but we should mention a special provision that allows 403(b) participants who have account balances prior to 1987 to defer RMDs (required minimum distributions) on those amounts until age 75, provided records are available to identify such balances. The remaining 403(b) account balance (post 1986 money) must still follow the regular age 70 ½ distribution rules. If, however, the 403(b) money is transferred to an IRA this provision does not apply.

Finally, whether you leave a company for a new job or retire to a life of leisure, you have an important decision to make regarding your company retirement savings. The options are many and the rules are complex, so you should consult with an advisor who is very knowledgeable in this area. It will be money and time well spent for both you and your heirs.

-By Marvin Rotenberg and Jared Trexler

Read More

Ed Slott's Webcast: 5 Biggest Stretch IRA Mistakes

Ed Slott's FREE Webcast, The 5 Biggest Stretch IRA Mistakes, is now streaming at www.IRAhelp.com through March 23. You can register and listen immediately to the 5 missteps that trigger huge taxes and destroy inherited IRAs. The STRETCH IRA is one of biggest (if not the biggest) benefit in the tax code, so make sure you learn the steps necessary to preserve a financial legacy with this 20-minute webcast.

Click Here to register or go to www.IRAhelp.com for more information.

- By Jared Trexler

Read More