As you are painfully aware, the before-tax money you’ve put away for retirement, and which has been growing tax deferred, has a co-owner: Uncle Sam. The tax laws say you must start withdrawing and paying taxes on this money when you reach age 70½. If you fail to take the Required Minimum Distribution (“RMD”) there is a penalty tax of 50% on the amount you should have taken and did not. The reason the government mandated the RMD is to assure they get their share in taxes before you expire. For 2009, the government will not impose a penalty for skipping the RMD, because withdrawing money would compound the market losses suffered by many. But, in 2010 you will again be required to withdraw from your qualified retirement money if you are 70½ or older. What can you do if you don’t want to take withdrawals?
The only solution is to convert some or all of your qualified retirement to a Roth IRA if you can qualify. If you make more than $100,000 in taxable income during 2009, you cannot convert money to a Roth IRA; however, in 2010 this income limit will be suspended and you can qualify. When you convert your retirement money to a Roth IRA, you will pay income taxes on the amount converted, but the converted amount will not be included in the $100,000 income qualification limit. Thereafter, all the principal converted and future earnings will be 100% tax-free to you and whoever inherits the money after your death. What’s more, annual distributions from a Roth IRA are not required. You can let it accumulate tax-free, or you can make tax-free withdrawals: your choice. There is one small drawback: even if you’re over 59½, you cannot withdraw earnings tax-free until after five years. You will still have immediate tax-free access to 100% of the money converted to a Roth, but withdrawn earnings will be taxed during this five-year period. Withdrawals come from converted money first.
If you cannot now qualify for a Roth IRA conversion due to your annual income, you will qualify in 2010. If you convert in 2010, you will get all the benefits discussed above, but you will have to take your RMD for 2010 prior to converting. You can stretch the taxes on the amount converted over the following two tax years. One-half of the taxes will be due with your 2011 return filed in 2012 and the remainder with your 2012 tax return. Best of all, you can change your mind on a Roth conversion up until the time you file your tax return for the year in which you converted, including extensions. This means that if you convert in 2009, you can change your mind, undo the conversion anytime before October 15, 2010, and avoid the taxes. If you think you could benefit from a Roth, you should convert knowing that you can change your mind anytime up to the tax filing deadline for the year of conversion.
Other than avoiding the RMD, why would you want to convert to a Roth IRA? First of all, the IRS now owns a percentage of your qualified retirement money, and the best time to buy them out is when the price, and tax, is the lowest. If you have suffered market losses – and who hasn’t – your tax bite will be less than if you wait until after the market recovers. What’s more, if you expect future tax rates to rise – and that is the consensus forecast – you’ll want to pay now in advance of the tax hike. Additionally, if you move retirement money from the “taxable” category to “tax-free” you will probably pay fewer taxes on your Social Security benefits since Roth IRA income is not counted when computing taxes on SS benefits.
Converting to a Roth IRA is not for everyone, especially if you’ll need to use part of your qualified retirement money to pay the associated taxes. If you have investment losses to offset the taxes associated with Roth conversion, you certainly need to consider converting some retirement money to a Roth IRA. You’ll want to work with your financial advisor to make sure you can benefit. If converting to a Roth makes sense for you, it can be done easily, without delay and at no cost other than the taxes. The Roth IRA conversion is undoubtedly one of the best ways to lower taxes and manage your estate without giving up flexibility. If you haven’t already, you need to investigate this opportunity immediately.
Shelby J. Smith, Ph.D.
August 2009
TheRetirementPros.com
Related Resources: Managing Retirement Money Withdrawals
If you had a plan for retirement, chances are it has been up-ended in the latest market meltdown. As I mentioned in this retirement blog, Retirement-minded savers and retirees that committed their hard earned money to the “market” have been on a roller coaster ride since 2000. First came the dot.com craze that drove stock prices to dizzy heights. The bubble burst and stock prices sunk dramatically with tech stocks as a group dropping 80%. From 2003 until late 2007, the market trended upward and came close to its inflation adjusted pre-2000 level before again plummeting dramatically. From late 2007 until March 2009, the market shrank by 50%, abruptly surged upward by 30% and for the past two months has vacillated around this plateau. Keep in mind that a 50% loss means a 100% gain is needed to get back to breakeven. Where will the market go from here?
The Roth IRA has existed for ten years but is under utilized by financial advisors and retirees alike. Converting your retirement money to a Roth IRA holds outstanding potential, but unfortunately many that need it most cannot qualify and most that can qualify have bypassed the opportunity. You can qualify if your total annual income is not more than $100,000. While higher income individuals cannot currently convert qualified retirement money to a Roth IRA, the income limit will be suspended in 2010. If you can qualify now, you need to immediately check into this opportunity. If you do not currently qualify, now is the time to start preparing for 2010 when you can. Following are suggestions you may find helpful.
Most of us measure our retirement money by how “tall” it is rather than how “long” it is. It’s not how much money you’ve got that’s important, but how long it will last. Because of uncertainties like inflation, taxes, investment losses, emergencies and more, retirees don’t know how long they might live; thus, it is hard to determine how long the “tall money” will last. This is why retirees’ greatest fear is outliving their money, referred to as “longevity risk”. If the “tall money” is laid down over the retirement years it becomes “long money” and longevity risk can be managed. How can this be done?
There has been a lot in the press recently about the solvency of Social Security and how it could go broke by 2016. As has been previously mentioned in this Retirement Blog, seniors and late boomers are concerned about their future Social Security benefits and want answers. The following will shed some light on the matter.
Outliving their money is the greatest fear of most retirees. Because of massive market losses since 2007, high and rising medical costs and more taxes & inflation as fallout from the unprecedented federal deficit spending, retiree fear is at an all-time high. But for the stronger gender, females, it is especially alarming, because they are expected to live longer and more likely to encounter financial problems late in life.
Many Americans of yesteryear relied on employers to provide a defined benefit pension at retirement. They were guaranteed a lifetime income whose amount was based upon how long they worked for the employer and their ending salary. For example, a defined benefit pension plan might pay a retired worker 2% of their last year’s salary for every year over twenty they worked for the employer. This meant a 40-year employee could expect to receive 80% of their final year’s income as a lifetime pension at retirement. The income would continue for their lifetime and then the surviving spouse might be entitled to reduced income until death.
When leaving an employer at retirement, changing jobs, down-sizing or starting your own business, leave behind only what belongs to your ex-employer. That means not forgetting your retirement plan money! About forty percent of departing employees, ages 60 to 65, leave their retirement money behind in former employers’ plans. They cite several reasons: loyalty, hassle of transferring, fear of managing the money or bad advice. There are many good reasons why you should take your retirement money with you, but we’ll discuss only the very important ones.
As I mentioned in a previous retirement blog post, at the end of the day, all retirement money is treated in one of three ways: taxable, tax-deferred or tax-free. Taxable income is taxed during the year in which it is received, but can also be tax-favored if from capital gains, dividends, Social Security, etc. Interest rates on tax-free municipal bonds are lower than their taxable counterparts; thus, taxes are implicit and municipals are in reality the same as taxable. Tax-deferred earnings are not taxed as income now but will be in the future when withdrawn. If passed to the next generation, the deferred taxes will be paid by the beneficiary or the estate of the deceased. Tax-free income may have been taxed earlier but is not again taxed when withdrawn. The best example of tax-free income is the Roth IRA.
As I mentioned in my retirement blog, the greatest fear of most retirees is the risk of longevity: outliving their money. The meltdown of retirement accounts, rising medical costs, uncertain entitlement programs and higher taxes have added to the risk. Facing 30 years of retirement living on past savings and Social Security benefits is a scary reality. What can be done?

