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June Focus – Funding Roth IRAs

Funding Roth IRAs

Roth IRAs can be funded from the following sources:
Rollovers from Designated Roth Accounts (DRA): Balances in Roth 401(k) and Roth 403(b) accounts, referred to as DRAs, can be rolled over to Roth IRAs, providing the individual meets requirements to make withdrawals from the DRA.

• Regular Roth IRA contributions of up to $5,000 or $6,000 for individuals who are at least age 50 by the end of the year. For a married couple, aggregate contributions for the year can be $10,000 or $12,000 if they are both age 50 or older by the end of the year.
• Roth IRA Conversions: An individual can move his balances from his Traditional IRA, SEP IRA and SIMPLE IRAs to his Roth IRA, providing his modified adjusted gross income (MAGI) does not exceed $100,000 and his tax-filing status is not married-filing-separately. This is referred to as a Roth IRA conversion. The $100,000 MAGI and married-filing-separately limitations are repealed beginning in 2010, which means everyone can convert to Roth

• A partial conversion is an option. Therefore, an individual can choose to convert only a fraction of his non-Roth retirement account balance to his Roth IRA instead of converting the entire balance in one year.
• Spread the conversion over several years. Individuals who cannot afford to pay the taxes on a conversion of a large amount can choose to convert the balance in smaller amounts each year. For instance, someone who wants to convert $200,000 in total can choose to convert $50,000 each year instead of the entire $200,000 in one year.
• The income tax break. For conversions done in 2010, the income from the conversion can be spread ratably over 2011 and 2012.
• Assess the impact on the tax return. Individuals must understand the impact of including the conversion on their tax return. The additional income can impact deductions, phase-outs, exemptions, credits, taxability of Social Security payments and AMT.

Roth Conversion Don’ts

• Don’t Convert RMD Amounts: Only amounts that are rollover eligible can be converted to a Roth IRA. Therefore, required minimum distribution (RMD) amounts must be taken from the retirement account before the conversion occurs. Otherwise, the conversion will include the RMD amount and create an excess contribution (of the RMD amount) in the Roth IRA.
• Don’t Convert SIMPLE IRA assets in the first 2 years: SIMPLE IRA assets can be converted to a Roth IRA only if it has been at least two years since the first contribution was deposited to the SIMPLE IRA. If the conversion occurs before the 2-year period, it will be considered an ineligible conversion by the IRS and subject to a 25% penalty if the conversion occurs when the owner is under age 59 ½ .
• Don’t pay your withholding taxes from your IRA: If you request to have taxes withheld from your Roth conversion, the amount withheld for taxes is not considered part of the conversion. Instead, it is treated as a regular distribution and is subject to the 10% early distribution penalty unless an exception applies. If you cannot afford to pay the taxes out of pocket, consult with your tax or financial professional to determine whether it makes sense for you to do a conversion that year.

News, Rulings and Other Updates

• Additional Guidance on qualified HSA funding distributions: The IRS issued Notice 2008-51, in which they provide additional guidance on qualified HSA funding distributions (QHFD) from IRAs. Among other things, Notice 2008-51 provides that a QHFD is not subject to income tax or the 10-percent early distribution penalty. In order to qualify for this provision, the IRA owner must remain an eligible individual during the entire testing period. According to the IRS, the testing period begins with the month in which the qualified HSA funding distribution is contributed to the HSA and ends on the last day of the 12th month following that month.
• Relief for Withdrawals of Stimulus Payments: The IRS issued Announcement 2008-44, which provides for tax-free and penalty-free withdrawals of stimulus payments credited to IRAs, HSAs, MSAs and Section 529 plans, if the amount was credited to the account via direct deposit. In order to qualify for the exception, the amount must be withdrawn from the account by the deadline for filing the account owner’s 2008 tax-return, plus extensions.

June’s Retirement Planning Tip

Highlights from Ed Slott’s IRA Advisor Newsletter - June 2008 Issue

• Only one IRA to IRA rollover per year is permitted and there is no relief on mistakes in this            area. In this month's issue we highlight recent rulings where costly errors could not be corrected.
• Some of the tax rebate checks are getting trapped in IRAs. IRS has ruled on how to remove those funds without tax or penalties.
• IRAs and Wash Sales: This month's Guest IRA Expert is Mike Jones. He recaps the IRS ruling stating that the wash sale rules apply to IRAs and Roth IRAs.

Feature Article

Avoiding Once-per-Year IRA Rollover Disasters

• No Relief on Additional Rollover
  60-Day Rollover vs. Trustee-to-Trustee (Direct) Transfer
• Once-per-Year IRA Rollover Rules
• Exceptions to the Once-per-Year Rule
• Possible Fixes
• Advisor Action Plan

• IRS Announcement 2008-44
• Direct Deposit Background
• Withdrawing the Stimulus Payment (The Tax Rebate) from an IRS