Financial Ducks In A Row • Independent financial advice: IRA, Social Security, income tax, and all things financial

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Should You Separate Your Rollovers From Your Contributory IRAs?

Mar 13th, 2023

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For the most part, it is recommended to merge all of your IRA money together into a single account, to simplify record-keeping, allocation, and paperwork in general. However, there may be circumstances where it could make very good sense to separate your contributory IRAs from 401(k) plan rollovers – and it pertains to creditor’s rights.

If you look at the article Creditor Protection for Retirement Plan Assets, you’ll see that IRAs in general have protection from creditors in the case of bankruptcy, up to $1 million. On the other hand, separated rollover assets from a 401(k) or other ERISA-protected account enjoy indefinite protection from creditors.

Rolling over the ERISA-protected funds into an account that contains contributory IRA funds (that is, an IRA that you have made deductible or non-deductible contributions to) automatically removes the ERISA protection and therefore the indefinite protection from creditors.

So it may make sense for folks who could be impacted by this protection (or rather the removal of the protection) to maintain separate accounts for rolled-over ERISA funds. This would be anyone whose total IRA account is (or may become) over $1 million – and regardless of whether or not you think bankruptcy is a possibility. In today’s sue-happy world, unusual circumstances could creep up on you at any moment and put you in the position where you might need this protection.

It’s very important to note that this protection only applies to actual bankruptcy – if you’re merely being sued by a creditor and you haven’t declared bankruptcy, your protection depends on federal non-bankruptcy law and state law. The article mentioned at the outset includes links to state law information with regard to these kinds of situations.

Posted on Mar 13th, 2023

by author: jblankenship.

Posted in: IRA, retirement plan.
Tagged: IRA · retirement plan

More reasons to keep on rolling (to an IRA, that is)

Mar 6th, 2023

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Photo credit: jb

We have discussed in the past that it is usually better to rollover an old 401(k) plan from a former employer to an IRA – more flexibility in investments, (usually) lower costs, more control, etc., are among the chief reasons to do so.

However, in some cases your old 401(k) plan may have access to desirable investments that you couldn’t otherwise access, or possibly you have access to other benefits from participation, such as availability of a financial advisor. As long as the overall costs remain low in the plan, you might want to leave the funds there. Plus there are also some additional benefits inherent within 401(k) accounts that are not available to IRAs – you can read up on the reasons to leave your money in the 401(k) in the article Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k).

On the flip side, there are certain things that you can’t do in a 401(k) (or other Qualified Retirement Plan) that you can ONLY do with an IRA while you’re under age 59½.

IRA-Only Options

With an IRA, there is no penalty for withdrawal for (click the link following each for more detail):

Health Insurance Premiums while unemployed – §72(t)(2)(D)
Qualified Higher Education Expenses – §72(t)(2)(E)
Qualified First-Time Homebuyer Expenses – §72(t)(2)(F)
Qualified Reservist Distributions – §72(t)(2)(G)

And none of those are available without penalty from your 401(k). Of course you would have to pay tax on the distribution, but otherwise you can take the money from your IRA for these purposes.

In addition, setting up a Series of Substantially Equal Periodic Payments (SOSEPP) is generally easier to qualify for and to set up from an IRA than from a 401(k), so this may be an additional reason to consider rolling over.

Posted on Mar 6th, 2023

by author: jblankenship.

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Posted in: 72t, Early Distribution, IRA, retirement plan.
Tagged: IRA · retirement plan

Tax Diversification for Investments

Feb 20th, 2023

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In past articles I have advocated the concept of spreading your tax-treatment out – so that you have money allocated in three major types of accounts: deferred tax (such as IRAs and 401(k) plans), tax-free (Roth IRAs), and capital gains taxable accounts. The reason behind this is that our fine government has this tendency to change the rules, and often. By spreading your tax treatment out you can help to ensure that funky new rules don’t throw off your entire retirement investing plan. In addition, having multiple modes of taxation can give you much flexibility in planning your income for tax purposes, once you get to the distribution phase of life.

The trick to all of this is to think about the timing of contributions to each kind of account… of course there are no hard and fast rules to determine what’s best for each kind of plan. Below is a discussion of some of the factors that you should consider as you balance out your tax treatment.

Early in life…

Early in your investing career it may makes a lot of sense to load as much of your savings into your 401(k) or other tax-deferred savings vehicle as possible, in order to maximize the benefit from tax savings up front. The biggest reason for this (beyond the tax savings) is so that you take advantage of your employer’s matching benefit, along with deferring taxes on your income as it increases over time.

If your tax bracket is really low though, you might want to utilize the Roth option in your 401(k) and maxing out your Roth IRA during this earliest, lowest-taxed time of life. A bit later when your tax bracket has increased somewhat, the tax reduction benefits of traditional 401(k) contributions and IRA contributions will be more valuable.

Later in your career when your income is higher, maximizing contributions to tax-deferred accounts will have a greater benefit to you from a tax savings standpoint. This is assuming that you expect for the taxes you’ll pay later during retirement will be lower due to your diversification of tax treatment.

As mentioned, as your income supports it you should begin making contributions to your Roth IRA as soon as possible. This is partly due to the restrictions on income around investing in Roth IRAs – but mostly because you are paying tax at lower rates in your lower-earning days than you might later on in your career when your income increases.

And then on top of it all, when your income has grown to a point that you can maximize the other options (401(k) and Roth), you should begin investing in an account that is taxed by capital gains tax. This will give you the third leg of the tax-diversification stool. Since capital gains are presently taxed at a much lower rate than ordinary income – which is what your IRA or 401(k) distributions are taxed at – it makes a great deal of sense to have some of your money invested in these accounts as well.

Later in life…

Later on in your life, as you come near to that point where you will have to begin taking Required Minimum Distributions (RMDs) from your IRA and 401(k) accounts, it might make sense to take significant portions of those accounts and either convert them to Roth accounts or capital gains taxed accounts. The preference would be to place the funds distributed into a Roth IRA as a conversion, especially if you are in a position where you will not need access to the funds for some time and therefore can benefit from tax-free growth of the account. You may also want to balance those conversions to Roth with some non-tax-deferred investments as well – because you never know what may happen with the tax code. Either way, Roth conversion or distribution and re-investment in a taxable account, you’ll pay income tax when you withdraw the funds from your tax-deferral account such as a 401(k) or traditional IRA.

It’s (very!) possible, given the government’s need to increase tax revenues to pay for things like COVID giveaways, that there could be changes in the works for how tax-deferred plans are taxed. Just a few options that have been put forth in recent memory include:

extra taxes on IRA assets (this was in place back in the mid-80’s)
changes to the minimum distribution rules to require faster distribution or to eliminate “stretch” capabilities (this happened with the SECURE Act)
adding investment restrictions, such as requiring a portion of IRAs to be invested in “socially responsible” investments (not as likely but you just never know)
nationalization of retirement accounts – e.g., governmental takeover of all IRA and 401(k) plans in exchange for a superannuization plan like some socialized countries use (also somewhat unlikely but again, there’s always a however in life)

Yet another option, especially if you have very few assets outside your IRAs and 401(k) plans, you can reduce your taxable estate (when normal folks have an estate tax again, that is) by taking extra distributions from your IRA or 401(k) and making gifts to your children and grandchildren. You could place the assets in a trust that represents a completed gift, or give the money directly to your future heirs – this way you are able to see your children and grandchildren enjoying the fruits of your labors while you’re still living.

Posted on Feb 20th, 2023

by author: jblankenship.

Posted in: financial planning, investing, IRA, retirement plan, Roth conversion, tax.
Tagged: financial planning · IRA · retirement plan · tax

Family Maximum Benefit (Disability)

Feb 13th, 2023

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In a previous article we talked about the Social Security Family Maximum Benefit for a retired worker – and we mentioned that there was a separate calculation for the Social Security Family Maximum Benefit for a disabled worker.

This calculation is much simpler than the retired worker calculation for Family Maximum Benefits. Nonetheless, hang on to your hat, keep your arms and legs inside the car at all times, cuz this may still get a little outtahand:

The family maximum for the spouse and children of a disabled worker is 85% of the worker’s Average Indexed Monthly Earnings (AIME), but the family maximum cannot be less than the worker’s Primary Insurance Amount (PIA) nor more than 150% of the PIA.

If you’ll recall, the FMB for a retirement benefit is solely based on the PIA. This allows for an adjustment upward in some cases if the AIME is smaller, at the lower end of the spectrum. The crossover point from the PIA floor occurs (for 2023) on a AIME between $1,200 and $1,300, and the crossover from 85% of AIME to 150% of PIA occurs between $2,600 and $2,700.

Example

Let’s use an example AIME amount: $4,400.00. For this worker reaching age 62 in 2023, the PIA would be $2,054.70.

So, the maximum family benefit for the disabled worker’s family would be equal to the lesser of 85% of the AIME or 150% of the PIA, but in no case not less than the PIA.

85% of the AIME: 85% times $4,400.00 = $3,740.00
150% of the PIA: 150% times $2,054.70 = $3,082.05

The maximum family benefit is the lesser of those two factors, or $3,082.05 – rounded up to the nearest dime as $3,082.10.

Posted on Feb 13th, 2023

by author: jblankenship.

Posted in: Social Security.
Tagged: Social Security

Your Appeal Rights at the IRS

Jan 16th, 2023

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Photo credit: jb

If you have received a result from an IRS examination that requires an adjustment to your tax liability and you don’t agree with the result, you have certain rights to appeal – your opportunity to state your case and perhaps get an overturn of the result of your examination. (It’s always possible!)

Facts About Your Appeal Rights

The IRS has put together a list of seven facts that they want you to be aware of with regard to your appeal rights (for more information see Tax Tip 2022.82):

When the IRS makes an adjustment to your tax return, you will receive a report or letter explaining the proposed adjustments. This letter will also explain how to request a conference with an Appeals Office should you not agree with the IRS finding on your tax return.
In addition to tax return examinations, many other tax obligations can be appealed. You may also appeal penalties, interest, trust fund recovery penalties, offers in compromise, liens, and levies.
You are urged to be prepared with appropriate records and documentation to support your position if you request a conference with an IRS Appeals employee.
Appeals conferences are informal meetings. You may represent yourself or have someone else represent you (such as an Enrolled Agent, an attorney, or a CPA).
The IRS Appeals Office is separate from – and independent of – the IRS office taking the action you may disagree with. The Appeals Office is the only level of administrative appeal within the agency.
If you do not reach agreement with IRS Appeals or if you do not wish to appeal within the IRS, you may appeal certain actions through the courts.
For further information on the appeals process, refer to IRS Publication 5, Your Appeal Rights and How to Prepare a Protest If You Disagree.

Additional Publications

In addition to Publication 5, there are several other IRS Publications that may help you in your appeal process. For example, Publication 556, Examination of Returns, Appeal Rights and Claims for Refund. You can also refer to Publication 1660 (PDF), Collection Appeal Rights, which discusses how you can appeal collection actions and Publication 3605, Fast Track Mediation–A Process for Prompt Resolution of Tax Issues. There is also Publication 1, Your Rights as a Taxpayer.

Posted on Jan 16th, 2023

by author: jblankenship.

Posted in: income tax, irs, tax.
Tagged: tax

Social Security: Average Indexed Monthly Earnings (AIME) Explanation

Dec 19th, 2022

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Photo credit: jb

One of the key components that the Social Security Administration uses to calculate your Social Security retirement benefit is called the Average Indexed Monthly Earnings, or AIME (don’t you just love the acronym-loving Social Security Administration? Errr… SSA.). The AIME is calculated by taking the highest-earning (by index) 35 years of your working life while covered by Social Security, and then computing an average monthly amount based upon those indexed amounts.

Gobbledy-gook, right? Okay, here’s another way to explain it: as you work in a Social Security insured job, your earnings are recorded each year. Each year the SSA applies a multiplier to the year’s wages, based upon an index called the Average Wage Index. Each person’s index is based on the year they reach age 62. The indexes for each year of your earnings is adjusted, reflecting the change from when your earnings were recorded by comparison to the year you reach age 62.

Once you are eligible for retirement (age 62, your Earliest Eligibility Age, or EEA), these years of earnings are put into a table and the indexes applied. Listed below is an example of an earnings table with indexes applied (keep in mind this is an example for a specific age – your own indexes will likely be different):

Average Indexed Monthly Earnings

Age	Earnings	Index	Indexed Earnings
22	$ 5,000.00	7.4186559	$37,093.28
23	$ 5,589.41	7.0133446	$39,200.47
24	$ 5,771.91	6.6817598	$38,566.51
25	$ 5,951.90	6.362084	$37,866.51
26	$ 6,259.69	5.794243	$36,270.16
27	$ 6,598.18	5.453047	$35,980.19
28	$ 6,724.29	5.147081	$34,610.48
29	$ 7,263.44	4.789173	$34,785.89
30	$ 7,652.52	4.480037	$34,283.57
31	$ 8,151.79	4.226722	$34,455.35
32	$ 8,771.10	3.915769	$34,345.61
33	$ 9,095.79	3.600777	$32,751.90
34	$ 9,809.52	3.303241	$32,403.21
35	$10,300.66	3.001138	$30,913.71
36	$11,796.26	2.84454	$33,554.93
37	$12,072.71	2.712404	$32,746.07
38	$13,417.50	2.561809	$34,373.08
39	$15,014.39	2.457123	$36,892.20
40	$16,488.37	2.386295	$39,346.11
41	$17,578.53	2.243234	$39,432.76
42	$19,816.33	2.137938	$42,366.08
43	$20,064.41	2.056512	$41,262.70
44	$22,795.36	1.965713	$44,809.12
45	$25,440.98	1.895091	$48,212.98
46	$26,801.49	1.802233	$48,302.53
47	$27,536.23	1.786866	$49,203.55
48	$30,992.15	1.740161	$53,931.33
49	$34,893.01	1.673097	$58,379.40
50	$36,396.83	1.595089	$58,056.18
51	$36,936.43	1.507145	$55,668.58
52	$41,035.24	1.432187	$58,770.12
53	$42,533.74	1.356586	$57,700.69
54	$45,383.43	1.285498	$58,340.33
55	$50,034.62	1.255546	$62,820.74
56	$51,454.51	1.243079	$63,962.02
57	$55,140.29	1.213416	$66,908.14
58	$61,014.02	1.159513	$70,746.57
59	$64,329.16	1.118584	$71,957.57
60	$67,170.90	1.06943	$71,834.56
61	$73,383.51	1.023004	$75,071.63
62	$82,983.83	1	$82,983.83
Average of top 35 years			$49,898.35
Monthly Average			$4,158.20

This table shows that your wages earned in each year you were working have been indexed to compare with the Average Wage Index for your age 62 year. Then the top 35 indexed earnings years are totaled and divided by 420 to come up with the Average Indexed Monthly Earnings – your very own AIME. The reason they’re divided by 420 is that this is the number of months in 35 years. The AIME is generally always produced by dividing the top 35 years by 420, even if there are fewer than 35 years in the table (such as if you had years without earnings).

With this table in mind, you can see how the AIME can increase if you continue working past age 62 – of course those earnings will be added to the table (but not indexed after age 62), and assuming that this knocks out one of your lower earning years, the average would increase.

And, as you might guess, this AIME isn’t the amount of retirement benefit that you can expect: more factors need to be applied to come up with your PIA, and then your actual retirement age is applied to that, to come up with your benefit amount.

Posted on Dec 19th, 2022

by author: jblankenship.

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Posted in: primary insurance amount, Social Security.
Tagged: Social Security

IRA Investment Planning for Taxation

Dec 12th, 2022

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Photo credit: diedoe

The question often comes up – what types of investments are best for my IRA?

Of course, any investment that you make in a tax-deferred fashion is a good one, at least in theory. But there are some investments that make the most sense for your IRA versus other vehicles… and some investments that make more sense in other kinds of investment accounts, where possible.

Listed below are a couple of considerations to take into account when considering taxation of your IRA and non-IRA investments.

Bonds and other interest-bearing vehicles

Given the nature of the IRA – deferring taxation on current income and growth, investments that would otherwise be taxed at ordinary income tax rates would be best for your IRA.

This includes the likes of interest-bearing investments, such as CDs or bonds. Since, presumably, your tax rate when you begin taking distributions will be either the same or less than your rate before retirement, the deferral will provide for the interest to be taxed at either the same rate or lower, just later in your life.

Growth-oriented and dividend-paying investments

Growth-oriented stocks and investments that pay current dividends make more sense to be held in taxable accounts than in deferred accounts. This is due to the fact that dividends and capital gains are (at least for now) taxed at much lower rates than ordinary income – which is the rate your distributions from the IRA will be taxed at.

Under today’s rules, most folks won’t pay more than 15% tax on dividends and capital gains, and many will pay 0% tax. But if these dividends and capital gains are from investments within an IRA, everything will be taxed at ordinary income tax rates, which can be as high as 37%.

The same would be true of other growth- and dividend-oriented investments such as real estate and commodities, for example.

Bottom Line

So in other words, if you have the ability, you should split your interest earning investments into your IRA, and growth- and dividend-oriented investments into taxable accounts. This way, you won’t be subjecting lower-taxed items to a higher tax rate – if possible.

This doesn’t mean that you should ONLY invest in items that would be taxed at ordinary rates within your IRA. This is known as letting the tax-tail wag the investment dog. Tax planning should always be considered as you plan your investments, but appropriate diversification should always be your first consideration. It may be easiest for you to diversify within each type of account, but for tax efficiency you might want to diversify among all of your accounts as a single item.

In addition, the deductibility of IRA (and 401(k)) contributions provides a benefit that should be weighed against the taxation concepts we’ve talked about above as well. Again, the tax-tail shouldn’t wag the investment dog…

Posted on Dec 12th, 2022

by author: jblankenship.

Posted in: investing, IRA, retirement plan, tax.
Tagged: IRA · retirement plan · tax

A Cash Flow Dilemma – Should I take distributions from my IRA or from my taxable account?

Dec 5th, 2022

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I know, long title… but I wanted to fully describe the content of this article, which is to answer the following dilemma: I have a sizable IRA and a sizable taxable account that holds appreciated stocks. I am in need of additional funds (above any RMD required from the IRA) – so which account should I draw the additional funds from?

Taxable account!

There is one school of thought that says you should take the additional funds from the taxable account, because at today’s capital gains rates you will save a bundle in taxes.

The capital gains on your appreciated stock will at most be taxed at 20% under present law. But quite likely your rate will be less at 15%, and could possibly even be zero. When you compare this tax rate to the ordinary income tax rates, which top out at 37% for 2023 (same as last year), this is a bargain. This also assumes that you’ve held the stock for at least 12 months, otherwise your gains would be taxed at your marginal ordinary income tax rate.

It’s a no-brainer, you should always take this extra money from the taxable account, right? No, not always…

IRA account!

There is another school of thought that says, since appreciated stock receives a step-up in basis at your death, you should leave those funds alone if you can and plan to leave them to your heirs. This way the appreciated portion is never taxed.

So when you consider the concept of paying ordinary tax on your IRA distribution and zero tax on the taxable account (assuming you never need to use those funds) versus paying capital gains on the taxable account and potentially leaving your heirs with a fully-taxable IRA (because IRA funds never receive a step-up in basis), this method seems to make a lot of sense.

Conclusion

In the circumstance where you know you’re going to need most or all of the funds from both accounts, it probably doesn’t make much difference in the long run. But you would likely come out better, at least in the short run, using the taxable funds at today’s low capital gains rates first. This will hold true until changes are made the the capital gains tax rates that might make this method less desirable.

But if your holdings are large enough in either account to cover your needs for the longer term, with some planning of your distributions you might come out better with the second method. Or rather, your heirs will come out better in the long run, since the step-up rule is unlikely to change anytime soon. (Now watch Congress make a change to the step-up rule!)

You could also vary your strategy and use IRA funds in one year, and capital gains accounts in another year, “stacking” the ordinary income versus the capital gains income. You might even use the difference (in the capital gains year) to convert some of your IRA money to Roth.

Posted on Dec 5th, 2022

by author: jblankenship.

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Posted in: IRA, retirement plan, tax.
Tagged: IRA · retirement plan · tax

Avoid the Overweight Retirement Plan

Nov 7th, 2022

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While it’s generally a good idea to defer as much income as possible into your available IRAs, 401(k)s and Roth accounts, as with everything else in life, too much of a good thing can be a problem as well.

When you have the bulk of your financial assets in retirement plans, you might accidentally expose yourself to some risks that you haven’t thought about… since retirement plan assets are much more likely to be impacted by changes to legislation – as we have seen in the past.

In these days when Congress is looking for money just about everywhere, it’s not a stretch to imagine new legislation coming down the pike to tax retirement plan assets (like the excess plan accumulation tax that has been proposed). Other possibilities include accelerating required minimum distributions to achieve a faster payout taxation of the plan and eliminating the “stretch” provisions (this has already been put in place to an extent), as well as taxation of inherited Roth accounts.

Assets held outside of retirement plans enjoy capital gains tax treatment (under current law) that is generally much more favorable than the ordinary income tax rate. Plus, these assets also can receive a step-up in basis when passed to your heirs, removing the capital gains on a lifetime’s appreciation in the account. Whereas retirement plan assets do not receive this treatment.

This is not to say that you want to eliminate your retirement plans altogether, but rather to balance your assets by tax treatment. It makes good sense to diversify by tax treatment, as a hedge against the various things that could occur to the retirement accounts.

There is no perfect formula for determining what is the appropriate amount to maintain in tax-deferred retirement plan accounts versus taxable versus Roth accounts – this is determined by the individual, along with his or her trusted advisors.

Sometimes it makes sense for the individual to have the lion’s share of his or her savings in deferred accounts, such as when we’re very young. At other stages in life (early retirement before age 72, for example) it could make a lot of sense to start eliminating the deferred accounts in favor of Roth or taxable accounts.

The idea is to weigh the tax impacts of moving money about against the potentialities that are out there for massive changes to the tax treatment rules on those accounts.

Posted on Nov 7th, 2022

by author: jblankenship.

Posted in: capital gains, capital gains rate, conversion, employer plan, investing, ira account, ira funds, iras, long term capital gain, long term capital gains rate, qrp, qualified retirement plan, retirement plan, retirement savings, Roth conversion, Roth IRA, saving.
Tagged: 401k · investment · IRA · qualified retirement plan · retirement savings

Know Thyself

Oct 31st, 2022

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This ancient two-word phrase, attributed to several Greek luminaries ranging from Socrates to Pythagoras, implores the reader toward introspection. This introspection can be especially helpful when considering how we feel about our financial future – particularly when we are at extremes of emotion.

The recent stock market activity has given us plenty of opportunities to experience extremes of emotion… but then again, you can pretty much choose any time period and make a similar statement. There are quite a few studies that have recently brought to the forefront several things that we need to understand about ourselves and how emotion could impact our decision-making process.

Loss Aversion – as investors in general, we feel the impact of a loss approximately twice as much as we experience the good feelings from a gain. It has further been estimated that as we approach retirement, this ratio increases to a factor of five times more pain for a loss as opposed to the joy we experience for a gain.

This seems to be true no matter whether the loss is realized or simply on paper. The problem is that, in stock market investing, short term losses and gains are simply normal market activity, and we need to temper our emotions to keep things in perspective.

We Want Control… or Do We? – it would seem to follow the train of thought that, if we are feeling pain in our investing activities we’d appreciate some guarantees and protection of some sort in our choices of products. However, guarantees come with a cost – that of giving up control. And as investors we prefer control (or the perception of control) over guarantees, studies have shown.

On the other hand, other studies tell us that a guaranteed income from an investment is preferred over an assured return on investment over time. These studies show that, given a choice between an annuity with a monthly income and an investment portfolio structured to provide the same sort of returns over time, if we’re near retirement we choose the annuity seven times out of ten.

This seems to imply that we value the concept of income, that of receiving a check every month, over the excess costs and lack of control that an annuity represents. At the same time, we prefer to feel like we’re in control of our investing activities, which is counter to the argument in favor of an annuity.

Lack of Understanding of the Numbers – when presented with the outcome of financial calculators, many of us consider whatever calculations were done in the background to be tantamount to magic. For example, the very concept of inflation and its impact on our future finances is a mystery to us – we work best when calculations are discounted to present values.

Even though it’s been decided that it was politically incorrect, one popular baby-boomer who is now age 63 once admitted that math is tough (Barbie, of the doll fame, who actually admitted that “Math class is tough”). There’s no shame in admitting that factor – for a lot of us, math can be very tough. And as we get older (some say by around age 53) our understanding of mathematical calculations begins to decline dramatically, making math even tougher.

This can lead to distrust of the very calculations that could help you make good decisions in your financial life.

So What Does All Of This Mean?

Mostly this just means that we’re carrying with us a lot of preconceived notions and emotional preferences that we must take into account as we make financial decisions. “Know Thyself” means that we should understand how these various notions can paint our perceptions of situations, and if we understand these things, we can recognize when our own limitations are working against us and take actions to consider things in a new, less biased, light.

For example, it’s natural to feel the pain of losses. But as explained in the article The Lost Decade and What It Means, (yes, it’s an oldy, but a goody) the activity of investing, especially in the stock markets, is a long-term activity and short-term losses, even over a few years, are temporary in the scheme of things. Keep this in mind before making any rash investment decisions – you’re likely to regret emotion-driven decisions.

Posted on Oct 31st, 2022

by author: jblankenship.

Posted in: financial planning, investing.
Tagged: financial planning

History of the Individual Retirement Arrangement (IRA history)

Oct 17th, 2022

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Note: it’s interesting to learn about IRA history in order to better understand why some provisions are the way they are. This IRA history is updated occasionally as new provisions are added.

In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) that, among many other provisions, provided for the implementation of the Individual Retirement Arrangement. This original IRA was not deductible from income for tax purposes, and the annual contribution limit was the lesser of $1,500 or 15% of household income.

Two primary goals of the IRA were to provide a tax-advantaged retirement plan to employees of businesses that were unable to provide a pension plan; in addition, to provide a vehicle for preserving tax-deferred status of qualified plan assets at employment termination (rollovers).

The IRA, originally offered strictly through banks, become instantly popular, garnering contributions of $1.4 billion in the first year (1975). Contributions continued to rise steadily, amounting to $4.8 billion by 1981.

1978’s Revenue Act implemented the Simplified Employee Pension IRA (SEP-IRA), which provided for a contributory retirement account, primarily for small businesses.

The Economic Recovery Tax Act (ERTA) of 1981 allowed for the IRA to become universally available as a savings incentive to all workers under age 70 1/2. At that time, the annual contribution limit was also increased to $2,000 or 100% of compensation.

With the passage of the Tax Reform Act of 1986, income restrictions were introduced, limiting the availability of deductible contributions to the TIRA for individuals with incomes below $35,000 (single) or $50,000 (MFJ) when covered by an employer plan. In addition, provision was made for the Spousal IRA, wherein the non-working spouse could make contributions to a TIRA from the working spouse’s income. Non-deductible contributions were also allowed, for those individuals above the income limits, providing tax-deferred growth within the account.

In 1992, provisions were made to the TIRA to allow for “special purpose” distributions (known as §72(t) distributions), not subject to the 10% early withdrawal penalty.

1996’s Small Business Job Protection Act saw the implementation of the Savings Incentive Match Plan for Employees (SIMPLE IRA), which provided for employer matching and contributions to the employee plans, a viable alternative in many cases to the 401(k), although with more restrictive contribution limits. This act also increased the amount for Spousal IRA contributions from $250 to the annual limit (at the time, $2,000).

With the Taxpayer Relief Act of 1997, the Roth IRA was introduced. In addition, phase-out limits were increased, plus the distinction was added for limits on deductible contributions if the taxpayer was covered by an employer-provided retirement plan. The Education IRA was also introduced, with features similar to the Roth IRA (non-deductible but tax-free upon qualified distribution). The distributions from the Education IRA are qualified only if used for education purposes. The Education IRA was later renamed the Coverdell Education Savings Account in 2002.

In 2001 came the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), which further increased contribution limits, added a “catch-up” provision for taxpayers age 50 and older, and provided for a nonrefundable credit for certain contributions to IRA and 401(k) plans.

An additional provision in the EGTRRA was the option, available beginning in 2010, for Traditional IRA owners to convert funds to a Roth IRA, regardless of income level. Normally anyone with an income above $100,000 was ineligible to convert funds from a TIRA to a RIRA. In addition to releasing the income cap, converting taxpayers were allowed to split taxation evenly on the funds converted between tax years 2010 and 2011.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 expanded protection for IRA accounts in times of bankruptcy. Traditional and Roth IRAs established via contributions from income are exempt from bankruptcy inclusion up to $1,000,000 balances without having to show necessity for retirement (required previously). Amounts rolled over from employer retirement plans are entirely exempt.

In 2006, the Pension Protection Act allowed for charitable giving (free of tax) from an IRA, known as a Qualified Charitable Distribution (QCD). This provision was originally made only for one tax year at a time and renewed annually as Congress sees fit. In addition, this legislation introduced the Saver’s Credit, an income tax credit for lower income individuals, designed to incent retirement saving habits. The Qualified Charitable Distribution (QCD) has been al-lowed to expire in the past and was extended, but as of the 2018 Tax Cuts and Jobs Act passage, has been permanently extended.

The Consolidated Appropriations Act of 2016 finally made Qualified Charitable Distributions (QCDs) permanent. This feature applies to individuals age 70½ or older and subject to Required Minimum Distributions. These folks are allowed to make direct distributions to charitable entities from their IRAs without having to include the amount of the distribution in gross income for the tax year.

One additional change that came about with the Tax Cuts and Jobs Act of 2018 was the elimination of recharacterization of Roth IRA conversions.

Most recently, the Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in late 2019, made sweeping changes to the IRA landscape. Specifically, Required Minimum Distributions are now required to begin in the year the IRA owner reaches age 72 (used to be 70½); IRA holders are now allowed to continue making contributions to their plan at any age as long as they have earned income (previously not allowed after age 70½); and most significantly, with some exceptions, the stretch IRA has been curtailed for most inherited IRAs. For most non-spouse beneficiaries, the inherited IRA must be distributed within 10 years, where previously an IRA beneficiary could stretch payments out over his or her lifetime.

As of the most recent reports from 2021, the Investment Company Institute indicates 37% of all American households own an IRA account of some type (over 48 million households), and the accounts held more than $13 trillion of retirement funds. Approximately 27.3 million households have a Roth IRA, holding roughly $1.3 trillion in assets, while traditional IRA are owned by 36.6 million households, holding approximately $11.8 trillion.

Posted on Oct 17th, 2022

by author: jblankenship.

Posted in: IRA, ira account, QCD, retirement accounts, retirement savings, tax.
Tagged: 72t · IRA · QCD · tax

When a 60-day Rollover is Not a 60-day Rollover

Oct 10th, 2022

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A Private Letter Ruling (PLR) from 2010 presents an interesting outcome from an indirect rollover – a rollover that was not done in a trustee-to-trustee transfer.

This particular PLR, 201005057, deals with a situation where the taxpayer received a check from her former employer plan, however the check was made out to her new employer, for her benefit.

When the taxpayer failed to deliver the check to the new plan within 60 days, the rollover became questionable – since indirect (non-trustee-to-trustee transfers) are generally limited to be completed within 60 days. (She did deposit it, just a little later than 60 days.)

When the taxpayer received a 1099R from the former employer plan, it was coded with distribution code “G”, which indicates a direct rollover. Therefore the intent for a direct rollover was clear.

The IRS ruled in favor of the taxpayer, since the check was made out to the new plan, and therefore not in the control of the taxpayer. In other words, the taxpayer could not have used the funds for any other purpose than to deposit into the new plan. The check made out to the new custodian effectively acted as a direct rollover into the new plan, in the eyes of the IRS, and as such it was not subject to the 60-day limit.

It appears from this PLR that a taxpayer receiving such a distribution can delay depositing the check after the 60-day limit, since such a distribution is considered to be a direct rollover. I don’t know of any practical reason you would want to do this, but if circumstances brought about such a situation, it’s good news.

Keep in mind that PLRs cannot be used to substantiate a position or cite as a precedent (pursuant to 26 USC § 6110(k)(3)), but can be used as guidance for determining if a matter is worthy of pursuing via your own private letter ruling.

Posted on Oct 10th, 2022

by author: jblankenship.

Posted in: employer plan, IRA, irs, plr, private letter ruling, qualified retirement plan, retirement plan.
Tagged: employer plan · IRA · irs · plr · private letter ruling · qualified retirement plan · retirement plan

Survivor Benefit flexibility

Oct 3rd, 2022

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Many of the Social Security rule changes that have been put into place in the past several years have removed flexibility in Social Security claiming strategies. However, Survivor Benefits, coordinated with your own retirement benefit (if you’re a surviving spouse or surviving divorced spouse), remain as one of the last bastions of flexibility for claiming strategies.

Survivor benefit first, retirement benefit later

As we’ve discussed in other articles, claiming Survivor benefits early and then claiming your own Retirement benefit later provides one flexible claiming strategy that you might be able to employ.

For example, Dina is divorced (after more than 10 years), unmarried, age 60, and her ex-husband passed away recently. Dina could file for and receive a Survivor benefit based on her late ex-husband’s record right away, and collect that benefit for a while. Then, at any point she could switch over to her own retirement benefit if it is larger than the Survivor benefit, and continue collecting that benefit.

This strategy works well if the surviving spouse has earned his or her own retirement benefit during his or her career, and at some point the retirement benefit will grow to a point when it’s greater than the Survivor benefit. This crossover might occur within a few months after she starts taking the Survivor benefit, or at any point along the spectrum between start of Survivor benefits and his or her age 70.

In Dina’s case, her own retirement benefit will be greater than the Survivor benefit at once when she reaches age 62. (Keep in mind, if she’s started the Survivor benefit at age 60 this benefit will be reduced; likewise if she starts her own benefit at age 62 the retirement benefit will also be reduced.) Dina could start receiving the larger retirement benefit at age 62, or at any point through the years up to age 70 if she wants.

When Dina starts receiving the retirement benefit, since the retirement benefit is larger than the Survivor benefit, the Survivor benefit will end. Technically (and this is important to the rules) the Survivor benefit will terminate if Dina’s PIA is larger than the PIA upon which her Survivor benefit is calculated. It’s a technicality, because generally if Dina’s reduced retirement benefit is greater than the reduced Survivor benefit, more than likely the PIA of each benefit will correspond in size.

At any rate, that’s how the “Survivor benefit first, retirement benefit later” strategy works. The key to this strategy is that starting the Survivor benefit early has no impact on Dina’s later ability to file for and receive a retirement benefit. The delayed receipt of the retirement benefit is added to Dina’s record as if she had not filed for a previous benefit (in other words, no deeming is applied).

Retirement benefit first, Survivor benefit later

This strategy can work in the reverse as well. Dina could wait until her age 62 and start receiving her own retirement benefit, reduced due to the early filing. Then she could wait until as late as her Full Retirement Age (for survivor benefits, slightly different from the regular FRA) and file for the Survivor benefit. This filing would be unaffected by the early filing for her retirement benefit.

Survivor benefit first, then retirement benefit, then Survivor benefit again

You might think that this is where the flexibility story ends, but you’d be wrong. There is one other strategy that the rules allow. In Dina’s case, she could start taking the Survivor benefit at age 60 (reduced to the minimum), and then at or after age 62 (but before her Survivor benefit FRA) file for her own retirement benefit. If, upon filing for her retirement benefit the retirement PIA is greater than the Survivor benefit PIA, the Survivor benefit will terminate at this point, as discussed earlier.

Now is when this final flexibility option comes into play. If it turns out that Dina’s Survivor benefit might at some point become larger than her Retirement benefit, she has the option to re-entitle the Survivor benefit. (Reentitlement is SSA’s term for filing for and receiving a benefit that had been received previously, but had terminated.)

The numbers have to work out in her favor, but follow this: starting her Survivor benefit at age 60 resulted in a reduction of the maximum amount, 28.5%, to Dina’s Survivor benefit. This is based on her Full Retirement Age of 67, which means a reduction period of 84 months (7 years).

But if she starts her own retirement benefit at age 62, thus terminating the Survivor benefit, she has the option to re-entitle the Survivor benefit, with the calculation eliminating those months during which she was receiving the retirement benefit (and the Survivor benefit was terminated). So if she waits until her FRA for Survivor benefits, her newly re-entitled Survivor benefit would be calculated based on a reduction of only 24 months – those months that she had collected earlier. Full Retirement Age is the latest that it makes sense to apply this re-entitlement, as beyond FRA the Survivor benefit will not increase except for annual COLAs. (For the rules geeks in the audience, see POMS RS 00615.301A.2, second bullet point for the explanation and another example.)

So instead of an 84 month reduction of 28.5%, Dina’s new Survivor benefit would only be reduced by 24 months, which calculates to a reduction of 8.14%. If, for example, her original reduced Survivor benefit was $1,000, this adjustment upon re-entitlement would bring the benefit up to $1,285, plus the COLAs from the intervening years.

Not a lot of surviving spouses and ex-spouses will have this flexibility available to them, but for the ones that do have it, this strategy can help out quite a lot, I imagine.

The strategy outlined above only applies in a situation where the Survivor benefit that is re-entitled is the same Survivor benefit that had been previously received. Otherwise, if a new Survivor benefit (based on the record a different spouse, also deceased) is applied for, it will be treated as the first time you’ve filed for a Survivor benefit. The prior reduced Survivor benefit has no bearing on the amount of this new Survivor benefit.

This one doesn’t work in vice versa

It’s critical to note that the above strategy (Survivor benefit first, then retirement benefit, then Survivor benefit again) does not work in the reverse. Dina could not, for example, begin her retirement benefit at age 62, then switch to Survivor benefits at (for example) 64, and then switch back to retirement benefits later on. This is because of the technical matter that I mentioned above, where the Survivor benefit becomes terminated upon receipt of a higher retirement benefit. The retirement benefit does not similarly terminate when a higher Survivor benefit starts up. In that case, the Survivor benefit (if higher than the retirement benefit) becomes an “excess” benefit, and the difference between the retirement benefit to the Survivor benefit is simply added to the retirement benefit.

Posted on Oct 3rd, 2022

by author: jblankenship.

Posted in: Social Security, social security retirement, social security survivor benefits.

Disability Benefits at Retirement Age

Sep 26th, 2022

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What options do you have available to you when you’ve been receiving Social Security disability payments – and you’re nearing Full Retirement Age (FRA)? A reader recently asked this question as she and her husband are facing decisions with just such a situation…

Disability Benefits at Retirement Age

As you reach FRA, your Social Security Disability Benefit will automatically convert over to a Retirement Benefit, at the same amount.

What does this mean? Essentially, once you reach FRA, since you’re now on a Retirement Benefit, you have all of the features available to you as if you had not received any benefit prior to this point and you’re now retired. So your spouse can collect Spousal Benefits based on your Primary Insurance Amount; Survivor Benefits are also available; and you can choose to Suspend your benefits at FRA (no need to File before suspending, you have effectively filed when your Disability Benefit converted to Retirement Benefits).

Just keep in mind that by suspending your benefits, you’re suspending all benefits associated with your record. Any spousal or dependent’s benefit will likewise be suspended and not paid.

By suspending, you can earn Delayed Retirement Credits (DRCs) of 8% per year up to age 70, which will permanently increase your own benefit and your spouse’s potential future Survivor Benefit.

Obviously, there is no requirement for you to change anything at all once you reach FRA – you can continue receiving the Retirement Benefit the same as you have been receiving the Disability Benefit up to this point.

It’s an unusual situation, but something to keep in mind if you happen to be facing this circumstance.

Posted on Sep 26th, 2022

by author: jblankenship.

Posted in: delayed benefit, disability benefits, reader questions, retirement benefits, Social Security.
Tagged: delayed benefit · disability benefits · retirement benefits · Social Security

Disability and Your IRA

Sep 19th, 2022

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Among the many things that are important to deal with regarding your retirement accounts, you must consider the impact of your own disability and how your IRAs will be dealt with. A very good way to do this is to have a durable power of attorney (DPOA) document signed that gives someone you trust the authority to make investment decisions, take distributions, and create new IRAs from your current accounts.

Maybe you consider this to be overkill – a belt to go along with your suspenders, so to speak – but then again, it might prove to be a very important document. In the event of your incapacity, without such a DPOA, you would not be able to continue carrying out actions that you intended, such as a Roth conversion strategy.

Take for example a situation where a terminally-ill father has decided that his gift to his children upon his passing will be the total of his IRA, converted fully to Roth and with the taxes paid from his other sources, so that the Roth account will be available tax-free to the children. The remaining balance of those other sources (a taxable investment account) is to be distributed to his alma mater per his will. He has discussed this with his children and his attorney, however, prior to enacting this maneuver he is involved in a severe auto accident and slips into a coma, which lasts until his passing.

Now his children will still have the benefit of the IRA, but they will be paying tax on each distribution from the account. And since his will stipulates that the taxable investment account’s balance is to be distributed to his alma mater, those funds are not available to pay the tax on the IRA distributions. This isn’t what the father had hoped would occur at all.

Having a DPOA in place would have allowed the power-holder to complete the process of converting the funds to Roth, and paying the tax from the investment account, even though the gentleman in question was incapacitated. After his death, the DPOA would not apply, so the conversion would need to be completed quickly.

One other factor that you shouldn’t overlook when putting such a document into place is that you should work with the IRA provider or plan administrator to ensure that the DPOA will be honored by them, should the need ever arise. Sometimes the IRA provider will have a specific form that they request you to use in order to name a DPOA for accounts under their custodianship. It’s critical to know in advance that your plans will be allowed to play out the way you’ve orchestrated them.

Posted on Sep 19th, 2022

by author: jblankenship.

Posted in: dpoa, financial planning, IRA, ira account, power of attorney, retirement plan.
Tagged: financial planning · IRA · retirement plan

Contingent Beneficiary Designation

Sep 13th, 2022

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We usually do a good job of determining who is to be the Primary Beneficiary or Beneficiaries of our retirement accounts – this is often our Spouse or some significant other such as a child (although others may be designated, more on that below). However, the contingent beneficiary designation is, in my experience, left wide open much of the time.

The idea is that your Spouse as the Primary Beneficiary would take ownership of the account, and then designate a new Primary Beneficiary. This way your spouse will get the benefit of the account and he or she can choose whomever he or she wishes to be the Primary Beneficiary(s) of the account – possibly a new spouse, or the couple’s children, or even a favorite charity.

But what happens if the Spouse predeceases the account owner, or they die simultaneously? Without a contingent beneficiary designation, the estate will determine how the account will be distributed, and this can cause some problems if there is no will specifically naming beneficiaries for such situations. For one thing, without specific beneficiaries named, it is likely that the entire account would have to be distributed within 5 years – rather than allowing for a stretch distribution, or even the 10-year default distribution for named beneficiaries.

Naming a contingent beneficiary (or class of beneficiaries) can help to resolve this situation. For example, you could name your children specifically as contingent beneficiaries and define the percentage each child should receive. Another way to do this would be to name the class – “All my children” – as contingent beneficiaries. This way all the children would share equally. (This could also be a way to name a Primary Beneficiary class as well.)

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But what if one of your children pre-deceases you when you’ve named the class of beneficiaries? How do you want that situation to be handled: to have the remainder of your children split the benefit equally, or for the deceased child’s heirs to receive that child’s share? In order to do this, you need to specifically denote that the beneficiary is “All my children, per stirpes”. This phrase will cause the account to be divided equally among your children, living or dead, with the share for each deceased child going to his or her children.

The alternative to per stirpes is to distribute to a class of beneficiaries “per capita”, and this could be by generation or by number of beneficiaries. See the chart to have a better explanation of per capita versus per stirpes.

Multiple Primary Beneficiaries

If you have designated a class of beneficiaries (as described above) as your Primary Beneficiary – you may have other plans that you’d like to have enacted in the event of one or more of the class pre-deceasing you.

Instead of your spouse or your children, what if you’re not married and have no children? In this case, you might wish to leave a portion of your account to your sibling(s), and perhaps a portion of the account to a charity.

For a complex example, let’s say you have a favorite charity that you wish to designate to receive 1/2 of your IRA at your passing, and the other half you’d like to go to your brother. In the event that your brother should happen to pass away before your own demise, unless you’ve designated a contingent beneficiary, his estate will receive the half designated to him.

But what if you really wanted it all to go to the charity in the event your brother pre-deceased you? Properly designating the charity as the contingent beneficiary in the event of the brother’s early death would take care of this.

Disclaiming, Too

One more thing: in designating your contingent beneficiaries, you should also make provision for the contingent(s) to take claim in the event that the Primary Beneficiary disclaims the inheritance. In this case, the Primary could determine that he or she prefers to have the account in the hands of the contingent(s), and so disclaims the inherited account.

Without specifically addressing this in your beneficiary designation, your estate could become the beneficiary of the account, which may or may not carry out the wishes of the disclaimer. This is especially important for ERISA-controlled plans (401(k) or 403(b), for example) due to the rules ERISA has for distribution.

You may need to work closely with your custodian to properly make this contingent beneficiary designation, as the forms they give you are purposely simple. And sometimes the custodian will refuse to give you the option of drafting your own letter of instruction for beneficiary designation. In that case, the only way you can get your designation corrected would be to change custodians – and this might be a problem if it’s an employer-sponsored plan.

Just keep this in mind as you consider your beneficiary designations – but do what you can to make sure that your wishes are going to be carried out the way you hoped.

Posted on Sep 13th, 2022

by author: jblankenship.

Posted in: 401 k, 401 k 403 b, 401k, 403 b, estate tax, IRA, ira account, iras.
Tagged: 401 k · 401k · 403 b · IRA · ira account

Roth Conversion and the Pro-Rata Rule

Aug 29th, 2022

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I received the following question from a reader. It’s a unique situation that you may find interesting, so I thought I’d share the interaction with you:

Here’s my situation, this year I started with the following:

(A) Rollover IRA (from rollover funds several years ago with no new funds added since. $157K was rolled over in 2020, but account is now valued at ~$146K).
(B) Roth IRA (that was opened years ago with minimal amount, but no new funds added in the past decade due to income limitation).
(C) Non-deductible (separate) traditional IRA account opened in 2016 with contributions deposited in each year, but have only been depositing NON-DEDUCTIBLE dollars (a total of $23K invested). However, the account was only worth ~$17K/$18K at the time I went to convert).

In early 2022, after making the 2022 contributions, I converted the entire value of the non-deductible traditional IRA account to a Roth IRA.

My question is: since I’ve kept my non-deductible contributions in a separate account and converted to the Roth IRA, am I subjected to the pro-rata rule for taxes due for 2022 even though I have no other IRA account other than the Rollover IRA? I had thought that since I had a “loss” with my non-deductible account, and that I kept the funds separate, I would not, but not sure.

This was my response:

It seems like this could be pretty complex, but it really isn’t too bad if you keep two things in mind (and unfortunately it’s not going to work out like you hoped):

1) the IRS looks at all of your traditional IRAs (includes rollovers, deductible contributory and non-deductible contributory) as one single balance.

2) given #1, you cannot separate deductible and non-deductible amounts when taking distributions.

Since a Roth conversion is a distribution, and knowing what we know from #1 & #2 above, part of your conversion would be taxed and part of it would be tax-free – and the amounts would be pro-rated, based upon a calculation factoring your end-of-year balances in all of your IRA accounts, plus any amount that was distributed during the year.

So, if you take the balance of your first IRA at the end of this year (we’ll assume it’s still $146k) and add the amount of your non-deductible IRA (again we’ll assume $18k), you come up with a total of $164k (also assuming there are no other distributions this year). Of that, you indicated that there was $23k from non-deductible contributions. Dividing that non-deducted amount by the total we come up with ~14.02% (23k / 164k = .14024). Of the $18k that you converted, 14.02% or $2,523.60 would be considered tax-free distribution, and the remaining $15,476.40 would be taxable. (This calculation was done with the very round figures that you provided. Actual end-of-year 2022 figures must be used to calculate the true pro-rata amounts.)

And then there was a follow-up from the reader:

Just a few additional follow-up questions for you:

(1) If only a percentage of my distribution is tax-exempt this year, am I not being “double-taxed” (so-to-speak) on the $15,476.40, since this is after-tax dollars that funded the non-deductible traditional IRA? If I make NO additional conversions or distribution until I reach of age, 59 1/2 (by the way, I’m currently married and in my mid-forties), what amount is tax-exempt when I make the next distributions? Can I expect $15,476.40 ($18K – $2,523.60) + $15,476.40 (taxes due this year) = $30,952.80 now considered as non-deductible because taxes have already been paid (50% was non-deductible conversion, the other 50%, taxes paid in 2022)? Assuming NO new non-deductible funds moving forward, is my “new” non-deductible amount now stand at $30,952.80?

(2) Since my current Roth IRA is UNDER $30,952.80, how can I now correctly earmarked my Rollover account with taxes already paid to $15K so that when it’s time for me to take distribution from that account, I’m not going to be taxed again (!)? In other word, for argument sake, let’s just say my Rollover IRA does not grow beyond $146K until I’m 59 1/2, can I then use $15,476.40 as non-deductible dollars of my $146K, thereby, only ~$130K is taxable? Additionally, I would assume that my Roth would now grow tax-free from here-on-in, so any gains is not subjected to taxes.

(3) Finally, is there any way that I can undo what was converted to my Roth IRA in 2022 before I file my taxes on April 15? I did the non-deductible to Roth IRA conversion back in Jan 2022. I did A LOT of research and there was a lot of advice that stated that if one had non-deductible funds in a separate traditional IRA, that one would be able to make a Roth conversion TAX-FREE. It was touted as a way for those of us who had not been able to make Roth IRA conversions because of income limits to now be able to take advantage of the Roth. There was not any mention of the Pro-Rata. It appears that somewhere recently, the pro-rata rule came into play, and now those conversions are not only NOT tax-free, but potentially can be double-taxed! I can’t quite understand how this can be done so that I’m not being double-taxed on my non-deductible funds.

… and here is my response to the follow-up:

Back to my #1 and #2 – you had total basis of $23k (the non-deductible amount) in all of your traditional IRAs. With the distribution and the pro-rata taxation, you will have used up $2,523.60 of the $23k. As you distribute funds from your IRA, each year the rate will adjust to match the new figures. YOU MUST KEEP TRACK OF YOUR BASIS ON YOUR OWN – no one else will track this for you, unless you have your tax guy do it and then I’d keep my own record anyhow if I were you.

In other words, as long as you maintain your records and mark your future distributions as pro-rata partly taxed and partly non-taxed to the extent of the remaining ~$15k, there is no double-taxation going on.

The amount in your Roth account is not considered non-taxable basis for your Traditional IRA. The balance of your Roth IRA is classified as: amounts you’ve contributed, amounts you’ve converted, and growth on the value of the first two amounts. The only figure in the Roth account that’s important to track is the total of the amount you contributed or converted, since if you begin taking distributions before age 59½ you’ll need to know how much has already been taxed. Early distributions from the Roth account are not subject to a pro-rata rule – your taxed contributions come out first, then conversions, and then growth last. If it’s been more than 5 years since conversion, those amounts can be penalty free as well.

Unfortunately there is no longer the ability to “undo” the Roth conversion. This was eliminated a few years ago, so you’re stuck with your conversion as-is.

After my response, the reader replied:

Can I roll all the deductible portion, $130K of my Rollover IRA (i.e. $146K – ~$16K = $130K) to my current Employer’s 401K, and then convert the $16K tax-free to my Roth IRA this year since I would have paid taxes on this? Tracking the non-deductible versus deductible seems too complicated — can I just do it this way? That way, outside of the company’s 401K plan, after it’s all said and done I’d only have a Roth IRA and zero balance in a non-deductible IRA?

To which I responded as follows:

Yes, such a move would work. This would be one way of getting around the problem with your future conversion/taxation – rollover the monies from the deductible account (except for the remaining non-deducted basis) to your 401(k), and then convert the non-deducted remainder to Roth. The biggest problem with this is getting the 401(k) plan to accept the roll-in of your IRA, which isn’t a big deal for most plans.

Posted on Aug 29th, 2022

by author: jblankenship.