CCH Says The Bear Market May Be Good Time To Convert To A ROTH IRA
(RIVERWOODS, ILL., February 26, 2003) – Continued declines in
the stock market have left many investors with significantly
diminished retirement portfolios. While some individuals may not
even want to look at their statements, given the state of their
holdings, there are tax benefits that can be reaped by making
adjustments to even the most tattered retirement portfolios,
according to CCH INCORPORATED (CCH), a leading provider of tax,
pension and business law information.
In addition to the need to diversify and rebalance, which became
apparent during the past few years, individuals may want to consider
other changes as well, including converting from a traditional IRA
to a Roth IRA and rolling over IRAs into an employer-sponsored plan
or vice-versa. Those already taking distributions from their
retirement accounts also may benefit from recent changes to IRS
regulations that provide more flexibility in minimum and early
Converting to a Roth IRA
Procrastination may have paid off for those who sat on the fence
the last few years trying to decide whether or not to convert their
traditional IRAs to Roth IRAs.
"For all the reasons that, in retrospect, a conversion from
a traditional to a Roth IRA three years ago turned out to be a bad
decision for many, doing a conversion in today’s climate could end
up being advantageous," said CCH senior pension law analyst
Nicholas Kaster, JD, author of Saving for the Future: Roth and
Someone who converted at the height of the stock market boom and
has an IRA that was heavily invested in equities, particularly tech
stocks, ended up paying conversion taxes based on the high values of
those investments. Fast-forward to January 2003, and the value of
that individual’s account today may have declined by 50 percent or
more. So, the decision to convert at that time was costly from a tax
On the other hand, the onset of a bear market may present
opportunities for those who haven’t done a conversion. With the
value of their retirement accounts near bottom, they could reap a
double benefit: taxation on the value of the account while it is
still low, and – assuming equities rebound – tax-free
distribution of a higher account balance in the future.
"Roth IRAs aren’t for everyone, but if the cost of
converting – essentially paying the taxes on the amount being
converted – was what was holding you back and if the value of your
portfolio has declined, the conversion costs have declined as
well," said Kaster.
To be eligible to convert a traditional IRA to a Roth IRA, your
adjusted gross income (AGI) must be less than $100,000. If you make
a conversion and it turns out your income exceeds the limit, it’s
then considered a failed conversion and the funds have to be put
back in the traditional IRA. You can recover any tax you paid on the
conversion by filing an amended return.
If you change your mind about a conversion, you can make one "recharacterization" back to
a traditional IRA in a given tax year. You then have 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 you can’t
make one move on December 31 and an opposite one on January 1. Limitations designed to prevent
individuals from making repetitive changes back and forth to whittle
down their tax bill for conversions apply.
For instance, say you decide in February to convert a traditional
deductible IRA valued at $20,000 to a Roth IRA. You’re in the
27-percent bracket, so you’d owe $5,400 on your next tax return.
But then the stock market declines further and along with it your
Roth account. By September, the $20,000 is only worth $16,000.
Had you waited to make the initial conversion until your account
was worth only $16,000, the tax on the conversion would have been
You could do a recharacterization at this point – switching the
money back to a traditional IRA and escaping the tax on conversion.
However, if you then decide you want to have the money in a Roth
after all, you’ll have to wait until the next year to make the
Rolling Over an IRA to an Employer-sponsored Plan
"Individuals who have been accumulating different retirement
accounts over the years also may want to consider taking advantage
of recent changes that allow them to roll over IRA assets into
employer plans and vice-versa," notes CCH pension law analyst
Glenn Sulzer, JD.
Under changes to the tax code that went into effect in 2002,
individuals can roll over distributions from an IRA into a 401(k),
403(b) or 457 plan, or roll over assets from a qualified plan into
an IRA. However, nondeductible contributions made to a traditional
or Roth IRA are ineligible for rollover to a qualified plan.
"This provision adds flexibility and offers potential
simplicity for savers wishing to consolidate their retirement
savings in a single location," according to Sulzer. However, he
cautions that 401(k) plan assets may not be rolled over to a Roth
IRA. Distributions from a 401(k) plan must be first rolled over to a
traditional IRA and then converted to a Roth IRA.
Additionally, most 401(k) plans also offer a loan option to
participants. Therefore, an IRA-to-401(k) rollover provides the
opportunity for individuals to access the funds in their retirement
accounts via a loan rather than taking a distribution, which may be
subject to the 10-percent early withdrawal penalty.
But rolling over assets from an IRA to an employer plan can have
drawbacks as well. Your investment choices in a qualified plan are
limited to what the employer wants to make available under the plan,
whereas IRA owners have a wide array of investment options from
which to choose. Also, funds transferred will be subject to any
restrictions contained in the transferee plan on changing investment
options. Also, tax law imposes certain rules on qualified plan
withdrawals that don’t apply to IRAs; for instance, the
requirement that plan distributions be taken as a joint and survivor
annuity if the participant is married and no waiver is filed.
Cashing Out of Your Retirement Accounts
While many individuals may be dismayed at the current state of
their retirement portfolios, cashing out and starting all 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. However, someone who established
an account recently and invested aggressively during the stock
market bubble could be holding an account that is now worth less
than his or her basis.
Say, for example, you opened a Roth IRA four years ago and
contributed $2,000 to the account each year, investing almost
entirely in technology stock. Your basis is $8,000, but the value of
the account has now shrunk to $5,000 – or $3,000 less than your
contributions. You may be able to dissolve the Roth and declare a
loss of $3,000 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 $5,000 that is
no longer working toward your retirement.
Retirees Now Taking Advantage of New Flexibility in IRS
For individuals who have already retired and are taking required
distributions or for those taking early distributions from their
traditional IRAs or employer-sponsored plans, the IRS has issued new
regulations easing the distribution requirements.
Under existing law, individuals are required to start taking
distributions from traditional IRAs at age 70½. Participants in
401(k) plans are also required to start taking distributions at that
age or once they retire, whichever comes last. While these
distributions are still required, the IRS released final regulations
in 2002 that make determining the required distribution amount
Under the new regulations, for each yearly distribution,
retirees, in most cases, simply divide the account balance at the
end of the previous year by a number from a life expectancy table.
Because the new table is based on longer life expectancies, it
produces lower required distributions.
The IRS also as adopted new rules that help individuals -- who
began taking early distributions from their retirement savings --
cope when there’s an unexpected drop in the value of their
retirement accounts, as has been the case for many early retirees in
While taxpayers are generally subject to a 10-percent additional
tax on amounts withdrawn from IRAs or employer-sponsored individual
account plans prior to attaining age 59½, the IRS allows an
exception when they take distributions as part of a series of
"substantially equal periodic payments" over their life
The IRS provides three safe-harbor methods for satisfying these
criteria. However, two of these methods – annuity and amortization
– result in a fixed amount that must be distributed and that could
cause the premature depletion of the account when there’s a
significant decline in the account’s market value.
Previously, once an individual chose the distribution method, she
was required to continue to use that method or face significant
penalties. Given the nose-dive in the stock market, the IRS is now
allowing individuals a one-time chance to change without penalty
from the annuity or amortization method to the minimum distribution
method, which calculates the amount that needs to be withdrawn each
year based on the current value of the account. This is particular
relief for individuals who took early retirement during the stock
market rally but who now see their retirement savings depleting far
quicker than they’d anticipated.
An example of this would be an individual who retired in 1999 at
age 55. He had $500,000 in his 401(k) plan and wanted to start
accessing the funds immediately. He chose the amortization method to
satisfy the substantially equal periodic payments. Based on the
value of the account at that time and its expected growth, it was
determined he should take out a fixed sum, hypothetically $28,000
annually for the next 25 years to satisfy the substantially equal
periodic payment requirements for early distribution.
Three years later, the stock market bottomed out and his
retirement account is only worth $250,000. He is still required to
take out the $28,000 annually under the amortization schedule,
depleting his retirement funds far faster than anticipated. Under
the new IRS rule, however, he now can switch to the minimum
distribution method, allowing him to take smaller payments and
preserve his account longer because it’s based on dividing the
balance in the account the previous year by the number of years he’s
expected to live based on the new, more generous, life expectancy
table the IRS also adopted last year.
The revised early distribution regulations became effective in
2002, and there’s no time limit by which individuals need to
change methods. However, it is a one-time offer. If an individual
later decides he or she wants to change methods yet again, the IRS
will consider that a modification and penalties will apply. In
addition, note that the relief does not apply to individuals age
70½ or older who must continue to take specific minimum
distributions even though the value of their assets have eroded.
About CCH INCORPORATED
CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded
in 1913 and has served four generations of business professionals
and their clients. CCH is a Wolters Kluwer company. The CCH tax and
accounting destination site can be accessed at tax.cchgroup.com.
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Editor’s Note: Members of the media who would like a
complimentary review copy of Saving for the Future: Roth and
Traditional IRAs may contact Leslie Bonacum at (847)
267-7153 or firstname.lastname@example.org.