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Bear Market Strategies for Roth IRAs Offer Tax Savings to Tattered PortfoliosSome Gain Advantage Today, More to Benefit Come 2010 with Elimination of Income Restrictions on Roth Conversions(RIVERWOODS, ILL., January 2009) – Finding optimism in the stock market’s performance may be impossible for anyone saving for retirement. However, Roth IRAs can offer tax benefits as people await the eventual market comeback, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and pension information, software and services (CCHGroup.com). “Roth IRAs can provide needed flexibility in a down market, whether it’s converting to a Roth to avoid future taxes, undoing a conversion through recharacterizing to a traditional IRA or cashing out of a Roth to cover current expenses if needed,” said CCH Senior IRA and Pension Analyst Nicholas Kaster, JD. For eligible individuals, contributions to traditional IRAs are deductible in the tax year that the contribution is made and distributions are taxed as ordinary income. With Roth IRAs, contributions are made after-tax, but qualified distributions are taken tax-free. Roth IRAs have the same contribution limits as traditional IRAs – $5,000 for 2009, plus an additional $1,000 catch-up contribution for individuals 50 or older. The ability to make deductible IRA contributions is limited for active participants in employer-provided plans – with adjustable gross income (AGI) for contributing phasing out between $55,000 and $65,000 for single filers and $89,000 to $109,000 for married couples filing jointly. Roth IRAs, however, are available to more taxpayers than deductible IRAs because the allowable AGI for contributing to a Roth IRA is higher: phasing out between $105,000 and $120,000 for single taxpayers and between $166,000 and $176,000 for married couples filing jointly. Below CCH outlines three Roth IRA strategies for a bear market. Converting to a Roth IRAWith the value of their traditional IRAs near bottom, many people may benefit from paying taxes on the diminished value and converting their account to a Roth IRA. This would confer a double benefit – assuming equities rebound – as their portfolios will grow and they will further benefit from taking tax-free distributions during retirement. To be eligible to convert a traditional IRA to a Roth IRA, a taxpayer’s AGI must be $100,000 or less. If a taxpayer makes a conversion and it turns out that her income exceeds the limit, it’s then considered a failed conversion and the funds have to be put back in the traditional IRA. The taxpayer can recover any tax paid on the conversion by filing an amended return. Starting in 2010, the $100,000 AGI restriction will be lifted. This will allow anyone to convert a traditional IRA to a Roth IRA regardless of income, as long as they pay the taxes at the time of conversion. Taxpayers making a conversion in 2010 will have the added bonus of being able to pay the taxes on a pro-rata basis over 2011 and 2012, helping to soften the tax consequences. “Lifting the restriction may seem like only a benefit to the wealthy, but it also will be a near-term benefit to the federal government,” Kaster said. “Rather than waiting 10, 20 years or longer before they can tax a lot of this money when it’s distributed during retirement, the IRS will be collecting taxes as people are making the conversions.” Recharacterizing an IRAEveryone is entitled to change their mind – at least once when it comes to IRAs. Specifically, if a taxpayer changes his mind about a conversion, he can undo the conversion by “recharacterizing” the contribution back to a traditional IRA in a given tax year. He then has to wait until the next tax year before making a “re-conversion” back to a Roth IRA. In addition, at year-end, a 31-day period must pass between recharacterization and re-conversion, meaning he can’t make one move on December 31 and an opposite one on January 1. These limitations are designed to prevent individuals from making repetitive changes back and forth to whittle down their tax bill for conversions. For anyone who converted to a Roth IRA in 2008, a recharacterization could have been a good tax strategy depending upon timing. For example, in February 2008 a taxpayer converted a traditional deductible IRA valued at $25,000 to a Roth IRA. She is in the 25-percent bracket, so she would owe $6,250 on her next tax return. But then the stock market nose-dived and along with it, her Roth account. By October, the $25,000 portfolio is worth just $15,000. Had she waited to make the initial conversion until her account was worth only $15,000, the tax on the conversion would have been only $3,750. If she decided to do a recharacterization at that point, she could switch the money back to a traditional IRA and escape the tax on conversion. However, if she then decides she wants to have the money in a Roth after all, she’d have to wait until the next year to make the switch again. “Recharacterization is probably a strategy that would have worked best in the 2008 market. People that recharacterized to a traditional IRA in 2008 need to now consider in 2009 if they want to move back into a Roth IRA or if circumstances are now such that staying with the traditional IRA is better,” Kaster said. Cashing OutWhile many individuals may be dismayed at the current state of their retirement portfolios, cashing out and starting over is generally not the best approach. You may be able to achieve a loss on your current return, but the long-term downside is that the remaining money, no matter how much it has shrunk, is no longer in a retirement account and it no longer enjoys tax-deferred status. In most instances, an IRA that has been funded over several years is still likely to be worth more than the basis – or what the individual actually contributed to the account – despite the stock market’s recent poor performance. Someone who established an account more recently and invested aggressively, however, could be holding an account that is now worth less than his or her basis. Say, for example, you opened a Roth IRA five years ago and contributed $3,000 to the account each year, investing almost entirely in growth stocks. Your basis is $15,000, but the value of the account has now shrunk to $8,000 – or $7,000 less than your contributions. You may be able to dissolve the Roth and declare a loss of $7,000 on your current income tax return. The loss would appear as a miscellaneous itemized deduction on Schedule A, and it could only be taken if the total of your miscellaneous itemized deductions exceeded 2 percent of your AGI. However, if you decided to claim a loss on this Roth IRA account, IRS guidelines require that you liquidate all Roth IRA accounts you hold. Likewise, if the account you want to close out is a traditional IRA, then you’re required to liquidate all your traditional IRA accounts. You’re also now holding $8,000 that is no longer working toward your retirement. “There are not a whole lot of ways to accumulate tax-favored savings, so taxpayers should typically avoid tapping these resources unless there’s simply no other option,” Kaster said. Look Before You Leap into Roth IRAsAlthough Roth IRAs are a useful retirement vehicle for some, they are not for everyone. Before investing in a Roth IRA, Kaster suggests considering the following:
About CCH, a Wolters Kluwer businessCCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Among its market-leading products are The ProSystem fx® Office, CorpSystem®, CCH® TeamMate, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. The company provides products and services globally for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has annual revenues (2007) of €3.4 billion ($4.8 billion), maintains operations in over 33 countries across Europe, North America and Asia Pacific and employs approximately 19,500 people worldwide. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. For more information, visit www.wolterskluwer.com. -- ### -- nb-09-13 |
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