Roth IRAs Make Great Estate Planning Tools (2006-09-25)

Roth IRAs Make Great Estate Planning Tools

(2006-09-25) by David John Marotta

If the tax-free growth of a Roth IRA wasn’t enough to wet your appetite, the estate planning benefits it offers should seal the deal. Bequeathing a Roth is much the same as setting up a life-time tax-free stream of income for your heirs. Because Uncle Sam has already taken his cut of the principal when you put the money in, withdrawals from a Roth can be made tax-free, either by you or by your beneficiaries. All this happens simply by naming the appropriate beneficiaries for your Roth.

A Roth will protect your investments from its worst enemies: taxes and required distributions. Unlike their traditional counterparts, Roth’s don’t require you to begin withdrawals from the account once you reach the magic age of 70½. With time on your side and your investments sheltered from taxes, your Roth will begin to experience what Einstein called the "greatest discovery of all time" - compounding interest.

The traditional IRA is an unwieldy estate planning tool in more ways than one. Account owners must begin distributions from their account at age 70½, whether they need the cash or not. What’s more, investments in a traditional IRA grow tax-deferred, not tax-free. Uncle Sam won’t let you defer those taxes indefinitely.

By taking the required minimum distributions out of your traditional IRA each year, you put the brakes on the snowball effect of compounding interest. Plus, your required withdrawals deplete the account, making it difficult to control what you actually leave to your beneficiaries.

However, it won’t make much difference whether you leave your heirs a traditional or a Roth if they plan on draining the funds right up front. A Roth can offer a goldmine, but only if the owner keeps the funds in their tax-free environment over the long haul.

A Roth can help you keep more of your money by sheltering your investments from capital gains and from minimum distribution requirements — at least for a while. Spouses who inherit a Roth can also forgo taking distributions, preserving the account’s ability to grow unchecked year after year.

All of that changes once the Roth is passed on to the next generation. All other beneficiaries of a Roth must begin taking distributions after inheriting the funds. It is best to drawn down an inherited Roth as slowly as possible over the beneficiary’s expected lifetime. The required distribution amounts are based on the beneficiary’s age: the younger the heir, the smaller the required distribution. Taking the smallest distribution each year will ensure the beneficiary achieves the maximum tax-free growth of tax-free income.

Let’s look at an example. Dad opens a Roth at age 60. He takes no withdrawals in his lifetime, and the funds grow tax-free. His wife inherits the Roth after her husband’s death at age 75. She wisely passes up on the opportunity to take withdrawals from the account. Ten years later she passes away and the Roth is inherited by her son, Dwayne. Thus far, the Roth has enjoyed 25 years of growth, without being depleted by withdrawals or taxes. Dwayne, age 55, must begin minimum distributions and does so for 30 years. Thirty years later, the funds are fully depleted; however, over its lifetime the Roth has provided 55 years of tax-free earnings and withdrawals. The benefits are even greater if the account is left to grandchildren!

No traditional IRA can offer that kind of benefit to your heirs. If they were to inherit a traditional IRA of equal value to a Roth, the IRA of the traditional variety would run dry long before the Roth. Because taxes are due on withdrawals from a traditional IRA, larger amounts must be taken out to match the tax-free sums taken from the Roth. Those hefty withdrawals from the traditional IRA eventually drive it to zero. Meanwhile the Roth account would still be growing and withdrawals could still be made.

So, what can you do if your funds are sitting in a traditional IRA? If you already own a regular IRA, you may have the option to convert it to a Roth. With a Roth conversion, you pay taxes now so that your beneficiaries won’t pay later. Even if you inherited a traditional IRA from your spouse, it is still not too late to convert to a Roth.

Converting to a Roth and paying Uncle Sam now may be a good thing, especially if you plan on leaving more than $2 million to your heirs. Paying taxes for the conversion will mean you reduce the size of your estate, and therefore your estate’s tax liability. Your heirs will pay less estate tax, and they will inherit a tax-free income stream.

Currently, the option to convert to a Roth is only open to those with a modified AGI less than $100,000. But not to worry if your AGI exceeds that number. Thanks to the recent changes in our tax code, Roth conversions will be open to all Americans beginning in 2010.

Even if you are currently taking distributions from a traditional IRA, you can still do a conversion. However, the amount you withdraw for the conversion, also known as your conversion contribution, won’t count toward this year’s required minimum distribution from your IRA. The rules and options are complex, so seeking professional tax advice before doing a Roth conversion is important.

A Roth IRA can provide your heirs with a life-time stream of tax-free income. But, a Roth in itself cannot provide a complete answer to your estate planning needs. Please seek the advice of a financial planning professional who can provide you with a comprehensive financial plan. To find a fee-only financial planner in your area, please visit www.napfa.org.

from http://www.emarotta.com/article.php?ID=197

Roth IRA Conversion Makes Cents (2006-09-18)

Roth IRA Conversion Makes Cents

(2006-09-18) by David John Marotta

Since its inception in 1998, the Roth IRA has been off limits to those with high incomes. Thanks to the Tax Increase Prevention and Reconciliation Act (TIPRA) signed by President Bush in May 2006, wealthy Americans will be allowed to convert their traditional IRAs to Roth IRAs beginning in 2010. There are years and situations when a Roth conversion is not appropriate, but they are often surrounded by years when it should be considered.

Roth IRA contributions are always made with after-tax dollars. The principle grows tax-free and the account holder may make tax-free withdrawals once they hit age 59 1/2. There are also no required minimum distributions for a Roth, which makes them helpful for funding the latter years of retirement.

Conversely, a traditional IRA allows before-tax contributions to grow tax-deferred, but not tax-free. During retirement, the IRS requires minimum distributions, all of which are taxed at ordinary income rates. So, you can either pay now or pay more later.

Getting your money into the Roth tax shelter is currently impossible for those with higher incomes. If your modified adjusted gross income exceeds $150,000 ($95,000 for individuals) you cannot make a full annual contribution to a Roth. The benefit is phased out for couples with a modified AGI between $150,000-$160,000 and for individuals between $95,000-$110,000. Currently, wage earners who exceeded these income limits may not fund a Roth.

But all that changes in 2010. Although TIPRA does not lift the income limits for funding a Roth account—we’ll call this the front door option—it does away with the income restrictions on converting funds from a traditional IRA to a Roth IRA—the back door option. Even though the front door will remain closed to higher wage earners, the back door option will be open to everyone.

To be more precise, the new law lifts a $100,000 modified AGI limit on both joint and individual filers wishing to do a Roth conversion. By creating the back door conversion option, big wage earners will be able to fund a Roth by funneling money through a traditional IRA and then performing a Roth conversion. Until 2010, only those with incomes below the $100,000 mark can convert their traditional IRAs to Roth IRAs.

During a conversion, account owners withdraw funds from their traditional IRA, report the funds as income, and roll them over to a Roth IRA account. The tax implications from the conversion will vary based on whether you took a deduction on the principal. If you deducted your IRA contributions, you’ll have to pay taxes on both the principal and the earnings. If you didn’t, you’ll just pay taxes on the earnings. I say ‘just,’ but either way, this could be a big bill. The good news is you can withdraw funds from your traditional IRA and convert them to a Roth without incurring the 10% early withdrawal penalty.

If you don’t have enough to cover the taxes on a full conversion, you can cherry-pick the securities you convert and do a partial conversion each year. To lighten the tax bill for conversions in 2010 (only), TIPRA will allow you to split the tax bill and pay half in 2010 and half in 2011. In anticipation of the new provisions, some are stashing away money in traditional IRAs with the hopes of converting to a Roth come 2010. But, the conversion doesn’t always come out on top.

Should you consider a Roth conversion? Probably. The lower your tax bracket and the longer you have until retirement, the more likely a Roth conversion will play in your favor.

Imagine John, age 60, owns two traditional IRA accounts. Each is funded with $5,000. Let’s assume he keeps the $5,000 in one IRA. But with the other, he uses some of the funds to pay the taxes due and then converts it to a Roth. Assuming John remains in the same tax bracket and the accounts deliver the same return on investment, each account will generate the same spending money in retirement. If John drops into a lower tax bracket after his retirement, the traditional IRA would have been the better bet. But if John’s taxes rise, the Roth IRA proves to be the better option.

Guessing your future tax rates is nearly impossible. Traditionally, it was thought your tax rate in retirement would be less than when you were working, but this is increasingly not the case. Tax rates are not adjusted for inflation, so many retired couples continue to creep into higher tax brackets. Also, tax rates are at a historic low and likely to rise if the political winds change. There are, however, two cases where the outlook is clearly in favor of doing a Roth conversion.

Clients who expect to see their tax bracket increase significantly—from say, 15% to 25%—will likely benefit from a Roth conversion. This is true for younger workers and also for new retirees. In the early retirement years, many couples dip into a lower tax bracket just after retirement but before Social Security checks start arriving. The taxes due on the conversion are more than made up once they are back in a higher tax bracket and able to take tax-free withdrawals.

Second, we encourage clients to consider a Roth conversion if they experience wild fluctuations in their pay from year to year. Again, converting while you are in a lower tax bracket will mean you keep more of your hard earned dollars in the long run.

Remember, no matter when you do your conversion, it must be done before Dec. 31st of the current tax year. One other important rule: you must be age 59 1/2 or older and have held the account for at least five years before you can take a tax-free disbursement from your Roth.

Before you convert your traditional IRA, you’ll need to do some careful tax planning with your tax professional. You should consider your current and future tax brackets, your current and expected income, your time horizon until you begin withdrawals, and your estate plans. Taken together, these factors will tip the balance in favor of either the traditional plain vanilla IRA or the Roth. A professional can help you determine which path will yield the most value. To find a fee-only financial planner in your area, visit www.napfa.org.

from http://www.emarotta.com/article.php?ID=196

Roth IRA vs. the Traditional IRA (2006-09-11)

Roth IRA vs. the Traditional IRA

(2006-09-11) by David John Marotta

Albert Einstein referred to compound interest as "the greatest mathematical discovery of all time." However, earning compounding interest in a tax free environment is even better. Individual Retirement Accounts were created to give Americans an incentive to save for retirement by combining the benefits of compounding interest with a favorable tax status.

While both traditional and Roth IRAs allow investments to grow tax-free, they differ in their tax treatment. Your particular circumstances will determine which IRA is most tax-efficient for you. But in many cases, a Roth IRA offers some of the biggest tax advantages. So, how do you know which IRA to choose?

The Traditional IRA

As long as you (or your spouse) receive a paycheck, you are eligible to open a traditional IRA. And, depending on the size of your paycheck, your contributions may even be tax deductible. All contributions to an IRA grow tax-free, allowing you to take full advantage of compounding interest year after year. However, when it comes time to take a withdrawal, you'll pay taxes on the money withdrawn - the vast majority of which may be earnings.

For example, T.J. opens an IRA and makes a tax-deductible contribution of $1,000. After ten years he retires and decides to drain the entire account. His initial investment has grown to $10,000. Because T.J. owns a traditional IRA, he must pay taxes on the full withdrawal amount of $10,000.

If you are tempted to postpone withdrawals from your IRA to avoid paying the taxes, think again. Soon after your 70½ birthday, all IRA owners must begin their Required Minimum Distributions. A traditional IRA will not let you enjoy the tax-free earnings forever.

Whether you are hoping to fund a traditional IRA or Roth IRA, caps on yearly contributions are the same. Account owners may contribute $4,000 per year in 2006 and 2007. Contributions limits rise to $5,000 in 2008. Thereafter, contribution limits will increase in $500 increments, indexed to inflation. All account owners 50 and over are permitted an additional "catch up" contribution of $1,000 per year.

In order to get money back out of your IRA without incurring a penalty, you must be 59½ or older. A handful of special circumstances will permit you to take early withdrawals. However, all non-qualified distributions will be subject to a 10% penalty in addition to any federal and state income tax.

The Roth IRA

The Roth IRA bears some similarities to its counterpart. Like the traditional IRA, contributions grow tax-free. But the defining difference of the beloved Roth IRA is in the way funds are taxed, or - better said - not taxed. While all contributions to a Roth IRA are made with after-tax dollars, the growth on the account is not subject to taxation. When funds are withdrawn, neither the contribution nor the earnings are taxed. That's right. All the growth in the account is tax-exempt, not just tax-deferred as with the traditional IRA.

Let's assume that, this time, T.J. decides to open a Roth IRA. He funds his Roth with an after-tax payment of $1,000. Ten years later, he decides to drain the entire account. Again, T.J.'s initial investment has grown to $10,000. But this time, with a Roth, he can withdraw all the funds, tax-free.

And if that wasn't enough, Roth IRAs do not force you to begin required minimum distributions at age 70½. This difference is an effective planning strategy. Because there are no required distributions from a Roth, it should always be the last tax qualified dollars to be used in retirement. You are best to leave your Roth investments untouched and happily compounding.

While the face value of two IRAs may be the same, the taxes owed on traditional IRAs may dramatically reduce the actual amount you bring home. Sometimes it is clearer to plan ahead by looking behind. Remember back in the '50s and '60s when the top marginal tax brackets were close to 90 percent? In comparison, today’s top tax bracket of 35 percent is a deal. Historically, income taxes have not been this low since 1931. Now is good time to move money into a Roth. Tax rates are probably going to increase, not decrease.

Making the right choice between a traditional IRA and Roth IRA is not always clear. Changing tax laws, your current tax bracket, your current and expected income, and how long you have until retirement are important factors in the formula. The foresight of an experienced professional can help you plan ahead. To find a fee-only financial planner in your area, visit www.napfa.org.

from http://www.emarotta.com/article.php?ID=195

Virginia is for Business Lovers (2006-09-04)

Virginia is for Business Lovers

(2006-09-04) by David John Marotta

The nation’s first Labor Day celebrations were held by the Central Labor Union in New York City in 1882. By 1894 every state was celebrating the accomplishments of American workers. While all states claim to be pro-labor, some have proven more effective at creating jobs for their labor force than others. Jobs follow economic freedom, not economic regulation. A recent article published by Forbes names Virginia the best place in America to do business... and where there is business there are jobs.

To many Americans, the movement of jobs to places like Bangalore and Beijing seems to be the biggest threat facing our employment opportunities. The truth is that the majority of job relocation is intra-national, not international, according to the Department of Labor. In other words, more job migration actually takes place within our own borders. So, states like California should be more concerned about job migration between Bakersfield, California and Albuquerque, New Mexico than between California and Mexico.

Driving most job relocation is the need for companies to maintain or improve a competitive edge. States with more economic freedom see businesses migrating across state borders to take advantage of lower corporate tax rates or a better legal environment, or both. Business-friendly practices translate into economic growth and rising employment rates.

Today, the biggest drains on U.S. corporations stem from our tax system and our tort system. Our top corporate tax rate of 35 percent remains one of the highest among the world’s industrialized nations. And, our tort system—which determines the ethics of care and restitution—further bleeds off productivity and employment opportunities.

In fact, litigation expenditures are so high, the ripple effects cost the average family of four approximately $2,654 annually, reports the Pacific Research Institute. And while state lawmakers have no control over the state’s weather or natural resources, much can be done to minimize tax and tort liabilities for businesses.

Kurt Badenhausen of Forbes magazine set out to rank all 50 states based on their overall business-friendliness. Each state was evaluated in the following categories: business%2