Taxpayer asks:
Hi,
I am currently retired, age of 60.
I have pension income of $48K / yr and investment income of 20K/ yr.
What are the tax consequences of converting a 401k of $120K to a Roth IRA?
To limit taxes, should the conversion be structured over several years?
Thanks,
Taxgirl says:
Retirement planning is so not my forte. So I’m gonna tell you the tax consequences of your transaction – but I’m not going to advise as to whether it makes sense for you or not. I would strongly advise that you check with a retirement or financial planner to make sure that this is the best option for you.
This is the scoop. As of last year, you can roll over a 401(k) into a Roth IRA. When Roth IRAs were originally conceived, this wasn’t something that was allowed.
Since Roth IRAs are funded with after tax dollars, the amount that you roll over is subject to federal income tax. Specifically, any amounts that would have been taxable had you simply pulled out the funds and not funded the Roth IRA are reportable as gross income.
You’re under the income limit for making the rollover – though that will not matter in 2010. In 2006, President Bush signed a bill that changed the eligibility rules for Roth IRA conversions. For 2010 (and so far, only for 2010), taxpayers with modified adjusted gross income of more than $100,000 can convert qualified retirement funds to a Roth IRA. Additionally, for 2010, income tax due on conversions can be spread included as income and paid in 2011 and 2012. This can be a great help, assuming that you remember to put aside enough money to pay the tax bill in those years.
The advantage, of course, is that after all is said and done, future distributions from the Roth IRA are income tax free.
There are some other conversion, limitations and ordering rules that you should familiarize yourself with before making the decision to make the roll over. You may wish to take advantage of that 2010 exclusion – so don’t rush into anything. Find someone who knows what they’re talking about and can run the numbers for you for comparison. Roth IRAs can be great vehicles but they’re not for everyone.
Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation.
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Taxpayer asks:
is a person suppose to take his 401 k statement with him when he gets his taxes done! even though im not taking anything out of it as a penalty and i dont plan on it! sure the 401 k plan is another income but im not taking anything out of it until i retire
Taxgirl says:
You’re right that you don’t pay tax on your 401(k) plan until you take a distribution. It’s likely that your tax preparer just wants to verify that it is a 401(k) plan (as opposed to another type of retirement plan); that you didn’t take any distributions; and that you didn’t have any transactions that might be a deemed distribution (such as a non-admin rollover or certain loans).
My advice is to take it with, just in case. I can tell you that in all of my years of practice, I’ve never seen a tax preparer who was upset that a client brought too much info (and trust me, I’ve seen folks bring in Samsonites full of statements!) but I have seen tax preparers send clients home for not having the right info.
For an idea of what might be handy to bring with you to have your taxes prepared, click here.
Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation.
Have a question? Ask the taxgirl! – Now on Facebook!
Just before the holidays, President Bush signed a bill that eliminated the hefty penalty for not taking the required minimum distributions (RMDs) from certain tax-deferred retirement accounts such as traditional IRAs and 401(k) plans for the year 2009.
Under the traditional rules, you must begin RMDs for traditional IRAs and 401(k) plans by April 1 of the year after you reach age 70-1/2. In other words, the April 1 that follows your 70-1/2 birthday is the first day that you must take a RMD. The amount of the RMD is calculated by your life expectancy – you can figure it out yourself using the tables from the IRS but it’s usually much easier to have your financial advisor do it (they have fancy software). This amount is recalculated each year since your life expectancy changes each year. You can always take out more than the RMD but you can’t take out less without being subject to a fairly significant penalty.
In 2009, however, you catch a break. You won’t be subject to the penalty if you choose (for whatever reason) to leave your money in your retirement account and not take the RMD. Note that this is NOT applicable to 2008, 2010, or any other year – just 2009. Congress likes to do quirky things like that.
Of course, there are some complications. If you were required to make your first RMD in 2008 and chose to push it off until the April 1, 2009 deadline for newbies, you must still take your RMD. You wouldn’t be exempt under the new rules since it’s technically a 2008 obligation.
If you turn 70-1/2 in 2009, you won’t be required to make your first RMD in 2009. You will, however, have to make a 2010 withdrawal by the end of 2010 (assuming that the rules don’t change). It’s odd, but under the new rules, the 2010 withdrawal will be considered your “second” distribution by the IRS even though it’s really your first. So you don’t get to take advantage of the “extension” through April 1, 2011 – you have to take it by the end of 2010. I know. It’s weird. But there you go.
Similarly, if you inherit an IRA and you are required to take a RMD in 2009 under the 5 year rule, you can skip 2009 – if you want to.
Remember, these rules don’t mean that you can’t take out your RMD, just that you don’t have to – and it only applies to 2009.
And one more thing: I don’t want to play financial advisor – because I’m not. But I do know a thing or two about taxes. And with changes in the rules, there are investment folks who, having taking a beating in the market over the last year, may see this as an opportunity to sell you a Roth IRA.
I think Roth IRAs can be wonderful investment vehicles under the right circumstances. Shifting tax brackets – paying lower taxes now on the Roth to avoid higher taxes later – can work to your advantage. But, in the case of many (though admittedly not all), the tax bracket for retirees remains relatively flat, so there may not be a benefit to paying now. Roth IRAs can also be good if the period of time for tax free withdrawals is significant – not always the case for retirees who have already reached age 70-1/2. It’s also not optimal if you have to pay tax on the distribution out of the funds that you’re contributing to the Roth.
So, a conversion under the new rules may be a good idea but don’t assume that it is. Be smart. Ask questions. Run numbers.
Finally, there’s been some chatter that this RMD penalty exemption may be extended past 2009. For now, it’s just chatter, so don’t count on it. As of today, the only year for which the penalty is eliminated for not taking your RMD is 2009. Traditional income tax rules as they relate to distributions still apply.
Effective for the year 2008, some taxpayers can save for retirement and earn a special tax credit. This credit, referred to as the “saver’s credit” can offset the first $2,000 contributed to the taxpayer’s IRA, 401(k) and other retirement plans.
There is a catch. The credit is only available to taxpayers which meet certain income criteria. The credit has been available as a permanent fixture since 2006 but the income amounts are indexed each year. Currently, they are:
Singles and married filing separately with incomes up to $26,500 in 2008 ($27,750 in 2009);
Married couples filing jointly with incomes up to $53,000 in 2008 ($55,500 in 2009); and
Heads of Household with incomes up to $39,750 in 2008 ($41,625 in 2009).
The maximum saver’s credit is $1,000 for individuals, or $2,000 for married couples. The amount can be reduced by adjusted gross income (AGI), tax liability and amount contributed to your IRA or other qualifying retirement programs. The average credit paid in 2006 was $213 for married filing jointly, $149 for heads of household and $128 for singles.
To claim the credit, use form 8880 together with your 1040. There are some additional eligibility requirements, so be sure and read the instructions or consult with your tax professional (hey Robert, see, I said it).
Be sure and keep deadlines in mind… Eligible taxpayers have until April 15, 2009, to set up a new IRA or make a contribution to an existing IRA and have it *count* for 2008. However, contributions to deferral-type plans, like 401(k) plans, must be made by the end of the calendar year; those taxpayers have just 23 days to qualify for a 2008 credit.
