By guest writer Bill E. Wilson, ChFC, of Waddell & Reed, Las Vegas
With the lure of tax-free distributions, Roth IRAs have become popular retirement savings vehicles since their introduction in 1998. But if you're a high-income taxpayer, chances are you haven't been able to participate in the Roth revolution. Well, that's about to change.
What are the rules?
There are currently three ways to fund a Roth IRA--you can contribute directly, you can convert all or part of a traditional IRA to a Roth IRA, or you can roll funds over from an eligible employer retirement plan (more on this third method later). Before 2010, you could contribute up to $5,000 to an IRA (traditional, Roth, or a combination of both). If you were age 50 or older, you could contribute up to $6,000.
Regardless of whether you contributed directly to a Roth IRA, if your income level ("modified adjusted gross income," or MAGI) was $100,000 or less, and you were single or married filing jointly, you could convert an existing traditional IRA to a Roth IRA. But if you were married filing separately, or your MAGI exceeded $100,000, you were not allowed to convert a traditional IRA to a Roth IRA.
In 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act (TIPRA) into law. TIPRA repeals the $100,000 income limit for conversions, and also allows conversions by taxpayers who are married filing separately. What this means is that, regardless of your filing status or how much you earn, you'll now be able to convert a traditional IRA to a Roth IRA.
Your ability to make deductible contributions to a traditional IRA may be limited if you (or your spouse) is covered by an employer retirement plan and your income exceeds certain limits. But any taxpayer, regardless of income level or retirement plan participation, can make nondeductible contributions to a traditional IRA until age 70½. And because nondeductible contributions aren't subject to income tax when you convert your traditional IRA to a Roth IRA, they make sense for taxpayers contemplating a 2010 conversion even if they're eligible to make deductible contributions.
And don't forget that SEP IRAs and SIMPLE IRAs (after two years of participation) can also be converted to Roth IRAs. You may want to consider maximizing your contributions to these IRAs now, and then converting them to Roth IRAs in 2010. (You'll need to set up a new IRA to receive any additional SEP or SIMPLE contributions after you convert.)
But there's a taxing problem-
If you've made only nondeductible contributions to your traditional IRA, then only the earnings, and not your own contributions, will be subject to tax at the time you convert the IRA to a Roth. But if you've made both deductible and nondeductible IRA contributions to your traditional IRA, and you don't plan on converting the entire amount, things can get complicated. That's because under IRS rules, you can't just convert the nondeductible contributions to a Roth and avoid paying tax at conversion. Instead, the amount you convert is deemed to consist of a pro-rata portion of the taxable and nontaxable dollars in the IRA.
For example, assume that in 2010 your traditional IRA contains $350,000 of taxable (deductible) contributions, $100,000 of taxable earnings, and $50,000 of nontaxable (nondeductible) contributions. You can't convert only the $50,000 nondeductible (nontaxable) contributions to a Roth. Instead, you'll need to prorate the taxable and nontaxable portions of the account. So in the example above, 90% ($450,000/ $500,000) of each distribution from the IRA in 2010 (including any conversion) will be taxable, and 10% will be nontaxable.
You can't escape this result by using separate IRAs. The IRS makes you aggregate all your traditional IRAs (including SEPs and SIMPLEs) when calculating the taxes due whenever you take a distribution from (or convert) any of the IRAs. But for every glitch, there's a potential workaround. In this case, one way to avoid the prorating requirement, and to ensure you convert only nontaxable dollars, is to first roll over all of your taxable IRA money (that is, your deductible contributions and earnings) to an employer retirement plan like a 401(k) (assuming you have access to an employer plan that accepts rollovers). This will leave only the nontaxable money in your traditional IRA, which you can then convert to a Roth IRA tax free. (You can leave the taxable IRA money in the employer plan, or roll it back over to an IRA at a later date.)
But even if you have to pay tax at conversion, TIPRA contains more good news--if you make a conversion in 2010, you'll be able to report half the income from the conversion on your 2011 tax return and the other half on your 2012 return. For example, if your only traditional IRA contains $250,000 of taxable dollars (your deductible contributions and earnings) and $175,000 of nontaxable dollars (your nondeductible contributions), and you convert the entire amount to a Roth IRA in 2010, you'll report half of the income ($125,000) in 2011, and the other half ($125,000) in 2012.
And speaking of employer retirement plans...
Before 2008, you couldn't roll funds over from a 401(k) or other eligible employer plan directly to a Roth IRA unless the dollars came from a Roth 401(k) account or a Roth 403(b) account. In order to get a distribution of non-Roth dollars from your employer plan into a Roth IRA you needed to first roll the funds over to a traditional IRA and then (if you met the income limits and other requirements) convert the traditional IRA to a Roth IRA. And, as described earlier, you needed to aggregate all your traditional IRAs to determine how much income tax you owed when you converted the traditional IRA.
The Pension Protection Act of 2006 streamlined this process. Now, you can simply roll over a distribution of non-Roth dollars from a 401(k) or other eligible plan directly (or indirectly in a 60-day rollover) to a Roth IRA. And you'll still need to pay income tax on any taxable dollars rolled over.
One benefit of this new procedure is that you can avoid the proration rule, since you're not converting a traditional IRA to a Roth IRA. This can be helpful if you have nontaxable money in the employer plan and your goal is to minimize the taxes you'll pay when you convert.
For example, assume you receive a $100,000 distribution from your 401(k) plan, and $40,000 is nontaxable because you've made after-tax contributions. You can roll the $60,000 over tax free to a traditional IRA, and then roll the after-tax balance ($40,000) over to a Roth IRA. Since only after-tax dollars are contributed to the Roth IRA, this rollover is also tax free. (Both your plan's terms and the order in which you make the rollovers may be important, so be sure to consult a qualified professional.)
Is a Roth conversion right for you?
The answer to this question depends on many factors, including your income tax rate, the length of time you can leave the funds in the Roth IRA without taking withdrawals, your state's tax laws, and how you'll pay the income taxes due at the time of the conversion. And don't forget--if you make a Roth conversion and it turns out not to be advantageous, IRS rules allow you to "undo" the conversion (within certain time limits). A financial professional can help you decide whether a Roth conversion is right for you, and help you plan for this exciting new retirement savings opportunity.
Many people who establish Trusts prefer to nominate an individual, often a child or other family member, as a Successor Trustee of their Trust in the event of their death. The law imposes a number of duties and responsibilities on the Successor Trustee which if violated, even unknowingly and with the best intentions, will cause the Successor Trustee to be personally liable for any damages suffered by the Trust or its beneficiaries. For example, an individual Successor Trustee is often also a beneficiary of the Trust. A conflict of interest arises in that the individual on one hand is a Trustee with a number of duties and responsibilities to the Trust and its beneficiaries, and on the other hand is a beneficiary of the Trust with his or her own self-interests. The law allows this conflict of interest, but imposes on the Successor Trustee a duty of undivided loyalty to the Trust and its beneficiaries. In other words, the Successor Trustee must always put the interests of the Trust and it beneficiaries ahead of his or her own self-interests. The fact that a Successor Trustee is an individual and not aware of the duty of loyalty is no defense to an action for damages by one or more of the Trust beneficiaries.
At the law firm of Jeffrey Burr, we have many years of experience assisting and protecting individual Successor Trustees in the administration of a Trust after the death of a Trustor. One of our main objectives in doing so is to educate the Successor Trustee as to his or her many duties and responsibilities, such as the duty of loyalty, the duty to keep the Trust property separate (no commingling), the duty to preserve Trust property, the duty to keep Trust property productive, et cetera. Remember if you are an individual Successor Trustee, do not unwittingly put yourself in a position of possible personal liability, as lack of knowledge of your legal duties is no defense. In the case of a Successor Trustee, ignorance is not bliss.
Our loyal blog readers probably realize that there are several purposes for our blog: an outlet to provide general estate planning updates; marketing and web presence; and acquisition of new clients. Today’s post hopes to reel in new clients that have been hesitant to begin planning their estate. (And we are confident that there are thousands of potential clients anxiously following our blog).
During my teenage years I would frequent my local reservoir for an outing of “early-morning water skiing” with friends and family. When it was my turn I would often stand on the back of the boat for several minutes working up the courage to jump into the cold and glassy water. Just like ping into a frigid pool or lake, thinking and worrying about estate planning only makes the task more difficult. Sometimes you have to “Just Do It.” We do not have knowledge of any client that has ever passed away any sooner (or later) by virtue of having an estate plan in place. In fact, the process for the surviving loved ones is much easier with an existing estate plan.
A recent joint article in the Washington Post and Entreprenuer.com brings attention to this fact. The article discusses parents’ responsibility to put their estate planning in order for the sake of their loved ones. This task is an investment of significant time and effort. And it is most successful when a team approach is used and includes a client’s trusted advisors such as the CPA, Financial Planner, or other general advisors. The attorneys at Jeffrey Burr strive to associate with this city’s best CPA’s, Financial Planners, Investment Managers, and Insurance professionals. We welcome the team approach and we seek the input of other advisors on a plan that works for all aspects of a client’s personal, business, and family goals.
All things being equal, today is a prime time to engage in estate planning for those clients who have a potentially taxable estate. As the article mentions, removing assets from the estate and transferring wealth to the next generation are key principles of estate planning for high net worth individuals. Today’s economy has caused asset values and business valuations to be rock-bottom; the interest rate mandated by the IRS for inter-family transfers is also at a very low level, and both of these facts make today an ideal time to transfer assets and engage in planning for estate tax reduction. Furthermore, the current absence of a generation-skipping transfer tax and low 35% gift tax rates make 2010 a great time to put an estate plan in place.
For those readers who are still standing on the back of the boat, it’s time to jump into the lake.
Attorney Jason Walker
Having volunteered at a pet fair recently, I realized how important people’s pets can be to them. I noticed that many people treat their pets as though they were their children and even refer to them as such in many instances. As estate planners, we typically assist clients in establishing estate plans to provide for the clients’ children after death. Occasionally, clients are also interested in providing for their pets after death. It is no wonder then that many states, including Nevada, recognize the validity of Pet Trusts and, thus, allow pet owners to legally provide for their “children” after death via testamentary trusts.
NRS 163.0075 allows for a trust to be created for the care of one or more animals that are alive at the time of the settlor’s (the person creating the trust) death. Pet Trusts terminate upon the death of all the animals covered by the terms of the trust. Pet Trusts are legal and enforceable instruments in Nevada. Some helpful hints to keep in mind when establishing a pet trust are as follows:
1. Be sure to name a trustee of the trust and if the caregiver of the pet is someone other than the trustee, be sure to name this individual or entity, as well.
2. Clearly identify the pet for whom the trust is being established. For instance, identify pet’s microchip if there is one or any DNA information to prevent identity fraud by a trustee/caregiver in the future. Include provisions requiring a periodic verification of the pet’s identity, as well.
3. Describe assets to be used to fund the trust and how those assets are to be used, including the standard of living that is to be maintained. These provisions can be as detailed and as specific as needed.
4. Name a remainder beneficiary to receive any property remaining in the trust once the pet for whom the trust was established dies and directions regarding the burial/cremation of the pet’s remains.
It is important to consider all of the items listed above to establish a thorough pet trust. However, if a pet trust is not right for you, you can always leave your pet to someone or leave assets to someone to care for your pet.
-Attorney Jeremy Cooper
Clients regularly struggle with the decision of how to allocate and distribute their estates between their favorite individuals and their ideal charitable causes. A few years back, I, along with one of my esteemed associates penned what is now affectionately referred to as the Grant-Walker Hierarchy of Worthier Beneficiaries. This model attempts to establish a moral construct for making such decisions. While inherently biased toward an individual's personal values and preferences, the Grant-Walker Hierarchy of Worthier Beneficiaries does provide some level of guidance for testators wrestling with this important decision. Following is our register, listed in order of worthiest to least worthy:
Responsible, well-educated, appreciative and moral individuals, who exhibit strong charitable character traits and inclinations.
Irresponsible, poorly-educated individuals with proper oversight and legal controls in place, along with appreciative, moral and qualified charitable organizations.
Unappreciative, immoral individuals and charitable organizations, along with the United States Treasury.
If helpful, feel free to incorporate our construct into your decision-making process when deciding who gets what at your death.
Most of our clients understand the benefits of the living, revocable trust. One obvious benefit is that at the trust creator’s death, the named successor trustee can step in very easily and administer the estate generally without the involvement of the court system. When the trust creator dies, a death certificate is provided and our office prepares a document called the “Affidavit of Successor Trustee” which gets filed in the counties where real property is located; this document is also provided to banks, investment companies, etc. and allows the successor trustee to gain control of these accounts for ultimate distribution.
We advise our clients with trusts to be aware that they don’t have to wait until death to bring in the successor trustee. If the trust creator is getting to the point where they want to slow down and let their successor trustee assist in taking care of the trust assets, paying bills, collecting rents, etc., then the trust creator can execute a document naming the successor trustee as a current trustee. That successor trustee can take the document to the bank and thereby have power to write checks to pay bills, handle investments and so forth. Then at the trust creator’s death, the successor trustee is already on the accounts and so can begin immediately to carry out the trust creator’s wishes. If you feel like you could use the help of your named successor trustee, you might want to consider naming them as a current trustee with you. Just be sure that the person you name is “trustworthy”.
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