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Roth Conversion

Roth Recharacterization is No Longer Allowed

Although used by few taxpayers, the Roth conversion recharacterization strategy is no longer allowed after the passage of the TJCA 2017.

Roth 401(k) In-Plan Conversions

As of the beginning of 2013, a new provision became available for participants in 401(k), 403(b) and 457 deferred compensation retirement plans: the Roth 401(k) In-Plan Conversion.  This provision allows current employees participating in one of these Qualified Retirement Plans to convert funds from the traditional 401(k) (or other) account into the Designated Roth Account (DRAC) that is part of the plan. This is new and different because previously the only way to convert funds from the 401(k) plan to a Roth-like account was to have left employment by the sponsoring employer.

Roth 401(k) Rules

If your employer has a 401(k) plan available for you to participate in, you may also have a Roth 401(k) option available as a part of the plan. (We’re referring to 401(k) plans by name here, but unless noted the rules we’re discussing also apply to other Qualified Retirement Plans (QRPs) such as 403(b) or 457 plans.)  Roth 401(k) plans are not required when a 401(k) plan is offered, but many employers offer this option these days. The Roth 401(k) option, also known as a Designated Roth Account or DRAC, first became available with the passage of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, with the first accounts available effective January 1, 2006.  The Roth 401(k) was designed to provide similar features present in a Roth IRA to the employer-provided 401(k)-type plans. Similar to traditional 401(k) Certain features of the Roth 401(k) are similar to the traditional […]

Types of Rollovers Not Subject to the Once-Per-Year Rule

In a previous article we discussed the changes to the IRA One-Rollover-Per-Year rule.  There are certain types of rollovers that are not included in that restriction, detailed below. As mentioned in the earlier article, trustee-to-trustee transfers are not considered “rollovers” by the IRS regarding this rule.  So you are allowed to make as many trustee-to-trustee transfers in a year as you like – no restrictions on these kinds of transfers at all.  This includes trustee-to-trustee transfers from or to IRAs, 401(k)s, 403(b)s, or any eligible plan. In addition, a rollover from an IRA into a 401(k) or other Qualified Retirement Plan (QRP) is not impacted by this rule.  This means that you can roll funds out of your IRA and into your employer’s 401(k) plan with no restriction – regardless of whether or not you have already made an IRA-to-IRA rollover in the previous 12 months. Similarly, a rollover from […]

Be Careful When Converting

When converting from a 401(k), traditional IRA, 403(b), SIMPLE IRA, SEP or 457(b) to a Roth IRA there are some important tax considerations to keep in mind. First, converting from a tax deferred plan to a tax free plan it’s not always the best idea. Generally, it’s going to make sense to convert if the tax payer believes that he or she will be in a higher income tax bracket in retirement. For example, John, age 28 has a 401(k) and recently left his employer. He’s currently in the 15% bracket but expects to be in the 28% bracket or higher in retirement. It may make sense for John to convert his 401(k) to his Roth IRA. This makes sense for John because when he converts from a pre-tax, employer sponsored plan like the 401(k) it’s money that has not yet been taxed. If he converts while in the 15% […]

How the 3.8% Surtax Could Influence Roth Conversions

Note: This is a dust-off of an article written in April 2010 that dealt with the special two-year taxation of Roth Conversions that was available in that year.  An astute reader noted that the original was a bit dusty and not applicable to today’s decision-making (thanks S!). One of the provisions of the Affordable Care Act is a new tax – a surtax on investment income over certain amounts.  This surtax has come into play this year, for tax returns filed in 2014 on 2013 income.  The income amounts are, admittedly, rather high, but nonetheless will likely impact a lot of folks.  What you may not realize is that, due to the application of this surtax, Roth IRA conversion strategies that you may have had in play may be impacted.  Depending upon your overall income, you may have to pay the surtax on some or all of your conversion amount. […]

Social Security Benefits and Taxes

When you’re receiving Social Security benefits, you may be subject to income tax on those benefits.  At the end of the year, you’ll receive a form SSA-1099 from the government that details the benefits that you’ve been paid, as well as the amount that has been deducted for Medicare premiums, and any federal income tax that you’ve had withheld from the benefit checks. When you prepare your tax return for the year, if you’re using a software program (does anyone prepare them by hand any more?), the program will give you a place to enter the figures from your SSA-1099 form.  Then after you’ve entered all of your other income information into the system, it will calculate how much of your Social Security benefit is subject to income tax. But that’s no fun, is it?  How do you know how much of your benefit is going to be taxable? Here’s […]

Don’t Forget to Pay Tax on Your 2010 Roth Conversion

Remember back in those heady days in 2010, when you finally had carte blanche eligibility to convert your IRA funds to a Roth IRA regardless of your income?  And then there was a special provision that the IRS made available: you could convert money to your Roth IRA in 2010, and delay recognizing the income and paying the tax over the next two years… remember that?  That was so cool. However. (Ever notice how there’s always a “however” in life?) Here we are, two years later, and NOW you have to pay tax on the Roth conversion that happened way back then.  You might have forgotten it altogether, but you can bet the IRS hasn’t forgotten. Hopefully you didn’t forget this on your 2011 tax return that you filed in 2012 as well.  At that time, you should have recognized half of the deferred Roth IRA conversion from 2010 on […]

History of the 401(k)

Back in 1978, the year of 3 popes, Congress passed the Revenue Act of 1978 which included a provision that became Internal Revenue Code section 401(k). The 401(k) has roots going back several decades earlier, with many different rulings (Hicks v. US, Revenue Ruling 56-497, and Revenue Ruling 63-180, among others), providing the groundwork for the specialized tax treatment of salary deferrals that Section 401(k) enabled. More groundwork for the 401(k) as we know it was laid with the passage of the Employee Retirement Income Security Act (ERISA) of 1974, in that the Treasury Department was restricted from putting forth a particular set of regulations that would have reduced or eliminated the tax-deferral benefits of deferred compensation plans. After the Treasury Department withdrew the proposed regulations in 1978, the way was cleared to introduce the 401(k) plan with the Revenue Act. This particular section of the Code enabled profit-sharing plans […]

Ideal Roth Conversion Candidate – Protecting Non-Taxation of SS Benefits

This is the second in a series of posts about Ideal Roth Conversion Candidates.  See the first post, Low or Zero Tax, at this link. One of the planning options that most all folks have available to them is the Roth IRA Conversion.  For the uninitiated, a Roth IRA Conversion is a transaction where you move money from a Traditional IRA or a Qualified Retirement Plan (QRP) such as a 401(k) into a Roth IRA.  With this transaction, if any of the funds in the original account was pre-tax, that amount would be included in income as potentially taxable in the year of the Conversion. As you might expect, making a decision like this can result in a considerable tax impact, depending on the individual circumstances.  A Roth IRA Conversion may make a great deal of sense for one individual, while another may decide that the Conversion cost is too […]

Ideal Roth Conversion Candidate – Low or No Tax

One of the planning options that most all folks have available to them is the Roth IRA Conversion.  For the uninitiated, a Roth IRA Conversion is a transaction where you move money from a Traditional IRA or a Qualified Retirement Plan (QRP) such as a 401(k) into a Roth IRA.  With this transaction, if any of the funds in the original account was pre-tax, that amount would be included in income as potentially taxable in the year of the Conversion. As you might expect, making a decision like this can result in a considerable tax impact, depending on the individual circumstances.  A Roth IRA Conversion may make a great deal of sense for one individual, while another may decide that the Conversion cost is too great for the result.  Detailed below is one specific circumstance that indicates a Roth IRA Conversion is a good move – although each individual needs […]

When Is a Roth IRA Subject to Income Tax?

Elaine Roth (Photo credit: Wikipedia) Ah, the Roth IRA. That single bastion of non-taxable money in our arsenal of accounts. When you have investments in a Roth IRA, you can take the money out tax-free, right? Not always. There are several situations where a Roth IRA’s monies can be subjected to tax, penalty, or both.  Listed below are some of those circumstances. When a Roth IRA is Taxable It should be noted that contributions to a Roth IRA may always be withdrawn from the account tax-free, for any purpose whatsoever.  There are no restrictions on these withdrawals. 1.  Taking the money out of the account within the first five years of the account’s existence can result in taxation of a portion of the funds.  The portion that is taxable is any withdrawal that exceeds the total of all contributions and conversions into the account.  This rule applies without exceptions. 2.  […]

A Tax-Free Roth Conversion Question of Timing

Fern Overgrowth (Photo credit: MightyBoyBrian) We’ve discussed here in the past about how it is (at least under present law) a perfectly legal maneuver to make a non-deductible contribution to a traditional IRA and then at some point later convert the same contribution to your Roth IRA (see Is it Really Allowed? for more).  If you have no other IRA accounts, this conversion to Roth can be a tax-free event, especially if there has been no growth or gains in the investments in the account. However (and there’s always a however in life) I recently came across a situation that was sent to me by a reader, where he wanted to do such a conversion, but he also wanted to rollover some money from his 401(k) plan into an IRA.  The question is in the timing – understandably, if he does the conversion from the traditional IRA to the Roth […]

8 Things to Consider Before Rolling Over Your 401(k)

K’nex (Photo credit: -Snugg-) Employers have been giving us lots of opportunities to make this decision of late: when leaving an employer, whether voluntarily or otherwise, we have the opportunity to rollover the qualified retirement plan (QRP) such as a 401(k) from the former employer to either an IRA or a new employer’s QRP. This decision shouldn’t be taken lightly – although often it is the best option for you.  Moving to an IRA gives you much more control over your destiny, so to speak, by allowing you to choose from the entire universe of allowable investment choices.  Using your new employer’s QRP can give you a better sense of control over the account as well, although the flexibility of an IRA is generally preferable to another QRP. But sometimes it makes the most sense to leave your money in the old plan.  Listed below are eight possible reasons that […]

Ordering Rules for Roth IRA Distributions

Tax (Photo credit: 401K) Did you know that there is a specific order for distributions from your Roth IRA? The Internal Revenue Service has set up a group of rules to determine the order of money, by source, as it is distributed from your account.  This holds for any distribution from a Roth account. Ordering rules First, over-contributions or return of your annual contribution for the tax year.  This means that if you’ve made a contribution to the Roth IRA in the tax year, the first money that you withdraw from the account will be the money that you contributed that year.  If you over-contributed to your account a prior year. Growth on this over-contribution or annual contribution needs to be removed at this time as well, with tax and penalty paid as required. Second, regular annual contributions to the account.  The next money that comes out is the total […]

Converting an Inherited 401(k) to Roth

Image via Wikipedia One of the provisions that is available to the individual who inherits a 401(k) or other Qualified Retirement Plan (QRP) is the ability to convert the fund to a Roth IRA. This gives the beneficiary of the original QRP the option of having all of the tax paid up front on the account, and then all growth in the account in the future is tax free, as with all Roth IRA accounts. What’s a bit different about this kind of conversion is that, since it came from an inherited account, the beneficiary must take distribution of the account over his or her lifetime, according to the single life table.  This means that, in order for this maneuver to be beneficial, the heir should be relatively young, such that there will be time for a lengthy growth period for the account – making the tax-free nature of the […]

Roth Conversion/Recharacterization Strategy

Image via Wikipedia 1/1/2018 Note: Recharacterization of Roth conversion is no longer allowed as of tax year 2018. The last tax year that you could recharacterize Roth conversions is 2017. See Roth Recharacterization is No Longer Allowed for more details. If you have an IRA you probably know about the concept of a Roth IRA conversion – where you take distribution of a portion of your IRA and directly transfer that money into your a Roth IRA, paying tax as you go.  Then the Roth IRA can continue to grow tax-free (as Roth IRAs do) and you’ll never owe tax on your qualified distributions from the Roth IRA. In addition, if the investments you’ve made in the Roth IRA have lost money, before October 15 of the following year you have the opportunity to recharacterize your Roth conversion.  If you didn’t recharacterize, you’d be paying tax on a conversion amount […]

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