Smart IRA opportunities exist under new U.S. tax law,
but hurry
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[June 28, 2018]
By Mark Miller
CHICAGO (Reuters) - (The writer is a
Reuters columnist. The opinions expressed are his own.)
Ed Slott is a certified public accountant by training, but he admits
that his professional colleagues have their faults. “By nature, we are
history teachers - we’ll tell you what you should have done last year,
after it’s too late.”
Slott is an author and retirement expert, and one of the nation’s
leading authorities on individual retirement accounts or IRAs. Right
now, he sees a couple of opportunities that IRA owners should consider
in light of the new U.S. tax law. But they will not be available at tax
time next spring when you talk with your accountant - the window for
taking action will start to close later this year.
One of those opportunities concerns new rules governing the conversion
of assets from traditional to Roth IRAs.
Roths accept only post-tax dollars, and gains going forward are
tax-free, assuming the distribution is made after age 59-1/2 and the
account has been held at least five years. Unlike a traditional IRA,
contributions can be withdrawn at any time without penalty. And Roths
usually are not subject to required minimum distributions after age
70-1/2.
Conversions are available to anyone, but often make the most sense for
higher-income retirement savers seeking to get more dollars into Roths
than can be done via direct contributions. Roths are subject to the same
annual contribution limits as traditional IRAs ($5,500 this year, or
$6,500 if you are age 50 or older). And direct Roth contributions are
also phased out for higher-income workers (for example, joint filers
with adjusted gross income less than $189,000 may contribute up to the
limit this year; the cutoff for single filers is $120,000).
There are no limits on conversion amounts from traditional to Roth IRAs.
But they come with a cost: conversions are treated as ordinary income in
the year of the conversion - generating an income tax bill at your
current tax rate.
The Tax Cuts and Jobs Act of 2017 (TCJA) places one new restriction on
Roth conversions by eliminating recharacterizations or reversals. Under
the old rules, an investor could convert a traditional IRA to a Roth,
but then reverse the decision anytime before the following year’s tax
return deadline. That could be advantageous, for example, if you
converted $20,000 in mutual fund assets to a Roth before the end of the
year, only to see the fund’s value fall to $12,000 by the following
March. “In that case, you’d be stuck paying tax on value that no longer
exists,” Slott notes.
The new rule applies to conversions done in 2018 and in the future - but
one recharacterization opportunity remains. According to the Internal
Revenue Service, 2017 Roth conversions can still be undone until Oct. 15
this year.
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NO ONE-SIZE-FITS-ALL ANSWER
In the current volatile stock market, changes in a fund value might not be an
easy call. But if you moved to a lower tax bracket this year due to the TCJA (or
if your income simply dropped), a change in tax brackets could present a
recharacterization opportunity: reverse the 2017 Roth conversion and replace it
with a Roth conversion this year at lower tax rates.
Slott offers one caveat to this strategy. “If you are looking at large gains on
a 2017 conversion, I wouldn’t undo it even if you pay a bit more in taxes -
since the gain is tax-free.”
That point underscores a key point about Roth conversions - there is no
one-size-fits-all answer. Conversions do raise a pay-now or pay-later question.
They make the most sense for older retirement investors who tend to be in higher
tax brackets, and a bit less for those who expect income - and tax rates - to
fall in retirement. “Everyone needs to do their own analysis,” Slott said.
He offered a middle ground: make a series of smaller annual Roth conversions,
working up to the top of your tax bracket. For example, a married couple with
income of $100,000 is in the 22 percent tax bracket; the 24 percent bracket
kicks in at $165,000. “They could convert another $60,000 without kicking
themselves into the higher bracket,” he said.
For older IRA owners, the TCJA has created an incentive to use a little-known
route to making charitable contributions: The Qualified Charitable Distribution
(QCD).
The QCD allows IRA account holders who are at least 70-1/2 years old to make
direct donations up to $100,000 annually without first taking a distribution.
The TCJA raised the standard deduction to $24,000 for married couples - and for
taxpayers above age 65 it is $26,600. That means many more people will be taking
the standard deduction, Slott noted, making charitable contributions more
“expensive.”
The QCD donations are excluded from taxable income, which means this amount
effectively is added to your $26,600 standard deduction. “Excluding something is
the same as deducting,” he said.
The QCD also counts any required minimum distributions that you must take
starting at age 70-1/2. And keeping these donated dollars out of your adjusted
gross income also can help avoid income tax bracket creep, and reduce taxation
of Social Security benefits. It also can help avoid Medicare’s high income
premium surcharges.
(Editing by Matthew Lewis)
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