2006 is a little more than half way over but we have already seen some major changes in the IRA rules. This article will summarize two of these changes and what they mean to you.
Income Limit for Roth IRA Conversion Repealed
Clients often ask me whether they should do a traditional IRA or a Roth IRA. Contributions to a traditional IRA are tax deductible while contributions to a Roth IRA are not. Traditional IRAs grow tax deferred (any money you take out is taxed as income) and you must start withdrawing money by April 1 of the year after the year you turn 70 ½. Roth IRAs grow tax free and money doesn't have to be taken out during your lifetime. You are allowed to convert a traditional IRA to a Roth IRA (and pay taxes today on the amount you convert), and for many people this makes a lot of financial sense. However, under current laws, if you make over $100,000/year you cannot do a Roth conversion.
Effective in 2010, all taxpayers regardless of income will be able to convert to a Roth IRA. Furthermore, the tax due on conversions done in 2010 can be spread out over two years and paid out in 2011 and 2012.
Obviously, Congress realizes that Roth IRAs are a good thing and they want to make it as enticing as they can for you to do a conversion. Since this rule opens up the possibility of a Roth conversion to everyone, you should put a note on your calendar to have a discussion with your advisors on January 1, 2010 about whether a Roth conversion makes sense for you.
Company Sponsored Retirement Plans Can Now Be Rolled Into Inherited IRAs by Non-Spouse Beneficiaries
The Stretch IRA is a very powerful concept. Properly structured, your non-spouse beneficiary (your spouse can always just rollover your IRA into their own and treat it as theirs) can take small distributions each year, and pay taxes on them, and leave the balance or your IRA growing tax deferred for their lifetime. However, in the case of a non-spouse inheriting a company sponsored retirement plan (401k, 403b, TSA, etc) they usually have to take the money out over a short period of time and pay taxes on it, forfeiting a lifetime of tax deferred growth.
Effective in 2007, a non-spouse beneficiary (your kids, grandkids, cousins, etc) can roll over a company sponsored retirement plan into a properly titled inherited IRA. The new rules will now allow non-spouse beneficiaries the ability to stretch distributions, and taxes, out over their lifetime.
The new rules also allow company sponsored plans to be transferred into trusts that can stretch out distributions. In the case where you do not trust your beneficiaries to make smart choices with the money, a trust can be used.
There are a couple of key details with the new rules; The company has to allow the transfer, which it may not, and it must be a direct transfer to the inherited IRA.
This new rule means that if you want to leave money in a company sponsored plan after you retire it will not take any tax advantages away from your beneficiaries. Of course, there are still a number of other issues that might argue for rolling the company sponsored plan into an IRA----required minimum distribution simplicity, more investment options, less paperwork, etc.
Congress seems to understand the important roll IRAs play in retirement savings, and so far this year they have been very accommodating on making the rules easier and more attractive. This area of the law is constantly changing so stay tuned.
