May 2010
CAVEAT FOR ROTH CONVERTERS
by
Andrew D. Schwartz, CPA
Roth conversion season is in full swing. Remember, 2010
marks the first time since Roth IRAs were introduced back
in 1998 that people earning more than $100k can convert their
IRAs and other eligible retirement accounts to a Roth IRA.
Plus, anyone who converts their retirement savings to a Roth IRA this year has the
option of reporting that income on their 2010 return, or
splitting the income equally over the subsequent two tax years.
During this past
winter, I heard from a handful of clients who began the process of converting
some of their retirement accounts to a Roth IRA, and was surprised by one
specific issue that many of those clients called me to discuss. Apparently, certain
financial institutions seem to be recommending that their customers elect to
withhold federal and state income taxes on the money being converted.
If you plan to
convert, please be aware that withholding income taxes
on a Roth conversion is a huge pitfall. While you'll owe income taxes on the amount converted,
you
don't owe the 10% early withdrawal penalty on money rolled into your Roth
account within 60 days. Since any money withheld for taxes is not
deposited into your Roth account, expect to pay income taxes plus a 10%
early withdrawal penalty on the taxes withheld.
According to the
IRS in
Publication 590 on Individual Retirement Accounts:
You can
withdraw all or part of the assets from a traditional IRA and reinvest them
(within 60 days) in a Roth IRA. The amount that you withdraw and timely
contribute (convert) to the Roth IRA is called a conversion contribution. If
properly (and timely) rolled over, the 10% additional tax on early distributions
will not apply.
You can roll
over part of the withdrawal into a Roth IRA and keep the rest of it. The amount
you keep will generally be taxable (except for the part that is a return of
nondeductible contributions) and may be subject to the 10% additional tax on
early distributions.
Another huge problem
with having taxes withheld on the Roth conversion is that you end up with less money
within your retirement savings accounts following the conversion. Unless the money will remain invested for decades, wouldn't you
be better off having 100% of your money growing tax-deferred within your IRA
than having 75% of your money growing tax-free within a Roth IRA?
As part our
revised 2010 Roth Conversion
Quiz, we include whether you have enough money to pay the taxes due on the Roth
conversion as one of the ten criteria to consider prior to converting. Please note that
our
Roth Conversion quiz is like golf where the
lower the score the better. Let's take a look at question
number 4 from the Quiz as reprinted below:
Question 4: How will you pay the
taxes that will be due in connection with the conversion? Remember, the taxes on
the 2010 conversion can be spread over two years starting in 2011.
- You currently have enough
money sitting in a savings account to pay the taxes that will be due. (2
points)
- You will be able to adjust
your withholding at work to cover the additional taxes that will be due
without impacting your family budget too badly. (4 points)
- The money needed to pay the
taxes is fully invested in stocks and mutual funds. To pay the taxes that
will be due, you will need to sell some of those investments. (6 points)
- You will not be able to come
up with the money to pay the taxes on the conversion without withdrawing
money from the Roth IRA. (8 points)
60 Day
Solution
What happens if
you already converted your IRAs to a Roth IRA, and you elected to have taxes
withheld? If 60 days have not elapsed from the date of the conversion, you
can transfer money from your non-retirement savings account into the Roth IRA
to cover the taxes withheld. When you complete your tax returns next
winter, you'll get back those taxes withheld on the Roth conversion.
De-Convert If
Necessary
If more than 60
days have passed, or you do not have the money to repay your Roth account for
the taxes that were withheld, you can always undo the Roth
conversion. Just make sure that the financial institution reverses any
taxes that were previously withheld.
And don't forget
that you are not allowed to reconvert your recharacterized IRA account during
the same calendar year. According to the IRS, "You cannot convert and
reconvert an amount during the same tax year or, if later, during the 30-day
period following a recharacterization. If you reconvert during either of these
periods, it will be a failed conversion."
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SPRING CLEANING
by
Andrew D. Schwartz, CPA
Spring is traditionally a time to clean up your yard upon
the completion of another winter. While you're in the cleaning mood,
why not take a few steps to clean up your personal credit as well.
Review and Revise
May is a great month to take a step back and review
your outstanding credit card debt. That's because the summer spending season is still
more
than one month away, and you have more than a half a year before you will
even commence your shopping for the 2010 holidays (unless you're really a
Type A holiday shopper).
Start by taking an inventory of what you currently owe on
each of your credit cards. Then, take a few minutes to reset how much you plan to pay
towards your credit card debt each month for the remainder of the year.
Need help crunching these
numbers?
Downloading our (Microsoft
Excel) debt/savings calculator
should save you a lot of time with this step.
Order Your Free Credit Report
Currently, three companies, Equifax, Experian, and
TransUnion, track everyone's credit histories. Don't forget that banks, lenders, retailers,
landlords, and other "credit grantors" use credit reports generated by these
companies to determine your creditworthiness.
Your credit report reflects quite a bit of information
about you and your financial affairs.
-
The bulk of your credit report
focuses on your various loans and credit card accounts. Included is the name
of each of your creditors, as well as the type of account, the minimum
monthly payment, the account's limit or high balance, and the current
outstanding balance.
-
Your credit report also reflects the most recent
twenty-four month payment history for each creditor, showing whether each
month's payments were current, delinquent, or in default.
-
Your credit report also includes "public records" such
as tax liens, bankruptcies, and judgments made against you. Most public
records remain part of your credit history for seven to ten years. If you
have any tax liens, they won't be removed from your credit report until they
are paid off.
The best way to find out how your credit report looks
is to order one. You're now allowed to order three free credit reports per year - one
from each credit bureau - through
annualcreditreport.com.
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2009 & 2010 TAX FACTS
- For 2009 and 2010, the standard deduction for a single individual is $5,700 and
for a married couple is $11,400. A person will benefit by itemizing once
allowable deductions exceed the applicable standard deduction. Itemized
deductions include state and local income taxes (or sales taxes), real estate
taxes, mortgage interest, charitable contributions, and unreimbursed employee
business expenses.
- For 2009 and 2010, the personal exemption is $3,650.
Individuals will claim a personal deduction for themselves, their spouse, and
their dependents.
- The maximum earnings subject to social security taxes is $106,800
for 2009 and 2010.
- The standard mileage rate is $.50 per business mile as of
January 1, 2010, down from $.55 per mile for 2009.
- The maximum annual contribution into a 401(k) plan or a
403(b) plan is $16,500 in 2010. And if you'll be 50 or
older by December 31st, you can contribute an extra $5,500 into your 401(k) or
403(b) account this year.
- The maximum annual contribution to your IRA is $5,000 for 2010. And if you turn 50 by December 31st, you can contribute an extra
$1,000 that year. You have until April 15, 2011 to make your 2010 IRA
contributions.
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