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MONTHLY TAX NEWSLETTERMarch 2016
Anyone with money in the market can't be happy with the recent correction. If you've been thinking about converting some of your IRAs and other retirement accounts to a Roth IRA, however, the current down market might provide you with the perfect opportunity.
As we explained 10 years ago in our August 2006 newsletter, the Tax Increase Prevention and Reconciliation Act, signed into law on May 17, 2006, eliminated the income limitation for people looking to convert their IRAs to a Roth IRA, effective in 2010. For the past five years, anyone can move retirement savings held in IRAs, 401ks, and 403b plans into a Roth IRA regardless of their income.
Yes, you will owe income taxes on some or all of the amount converted. But money held in your Roth account will grow tax-free as of the conversion date (assuming the government doesn't change these rules during your lifetime.) That means you won't owe a dime of federal income taxes on money withdrawn from your Roth account down the road.
Roth Versus Traditional
Just to make sure we're all on the same page with these two type of retirement savings accounts:
Should You Convert?
What steps should you take now as you consider whether to convert your IRAs and other retirement accounts to a Roth IRA during the current down market?
Step 1: Check Your Balances
The first step is to see how much you have in your IRA accounts. Yes, even though the Dow is still way down from it's recent peak, I'm asking you to do the unthinkable and open your statements to tally up the value of all of your IRA accounts. Don't forget to include all of your traditional IRAs, rollover IRAs, SEP IRAs, and SIMPLE IRA accounts.
Step 2: Verify Your Non-Deductible Contributions
Next, figure out the total of your non-deductible contributions you've made over the years. The easiest place to find this number is to pull out your most recent personal tax return, and take a look at the Form 8606 attached. This is the IRS tax form used to keep track of your cumulative post-tax IRA contributions.
Don't despair if you haven't submitted a Form 8606 each year or the number reflected on the current year's 8606 is incorrect. The IRS allows you to file this form as a stand alone form.
Simply enter the correct totals for the non-deductible contributions made through 2015, sign the form on the bottom of page 2, and submit the signed Form 8606 to the Internal Revenue Service where you would otherwise file your Form 1040. It's very important that the IRS have the correct info on file in anticipation of your converting your IRAs to a Roth IRA in 2016.
Step 3: Figure the Tax Burden
Here is where things might get a little tricky. Does it make sense for you to convert your IRAs to a Roth IRA?
If the value of all of your IRA accounts is less than the total of your non-deductible contributions as reflected on your 8606, there is no reason not to convert to a Roth in 2016. As an added bonus, you can even claim your remaining IRA basis as a miscellaneous itemized deduction provided you convert 100% of your IRAs by the end of the year.
What if your IRAs are worth more than your after-tax contributions? Expect to pay taxes on the percentage of each dollar converted that represents the pre-tax portion of all of your IRAs.
For example, let's say your IRAs are worth $60,000, and you made a total of $20,000 of non-deductible contributions over the years. In this example, there would be $40,000 of pre-tax dollars built into the $60,000 of IRA value, which means two-thirds of each dollar converted would be taxed.
Basically, the smaller the percentage of post-tax dollars within your IRAs, the tougher this decision becomes. And remember, if you have multiple IRA accounts, you need to determine the pre-tax amounts included within all of those accounts - even if you only ever made your non-deductible contributions into just one IRA account, and that's the only IRA you plan to convert.
Step 4: Roll A Portion of Your IRA Into Your 401k or 403b Accounts
Moving pre-tax dollars out of your IRA into an employer sponsored retirement plan by 12/31/16 will reduce the taxes owed on a Roth conversion by increasing the percentage of post-tax dollars in your IRAs. A common strategy for many people is to move all the pre-tax dollars out of their IRAs through a direct rollover into their non-IRA retirement accounts.
In the example above, you'd roll $40k of your traditional IRAs into your work 401k or 403b plan (assuming the plan accepts rollovers from IRAs), and then would convert the money remaining in your IRA. With your IRA now worth $20k which is equal to the $20k of post-tax dollars in your IRA, there would be no federal income taxes due on any amounts converted.
What if you are self-employed and don't have access to an employer sponsored retirement plan? Consider setting up a Solo 401k, and then rolling over your SEP IRA and other pre-tax IRA dollars into your new plan. Pre-tax assets held in the Solo 401k do not count as part of your total IRAs included in the denominator when figuring the percent of the converted assets that will be taxed.
De-Convert If Necessary
If the market continues to correct after you convert your IRA, or you don't have money next year to pay taxes on the income portion of the Roth conversion, you can always undo the Roth conversion prior to the due date of the conversion year's tax returns.
Don't forget that you are not allowed to reconvert your recharacterized IRA account during the same calendar year. According to the IRS, "You cannot convert and reconvert an amount during the same tax year or, if later, during the 30-day period following a recharacterization. If you reconvert during either of these periods, it will be a failed conversion." So be careful about reconverting a previously de-converted account.
We're pleased to announce that our YouTube channel has exceeded more than 10,000 views. "I'm not sure what percent of YouTube channels have hit this milestone," says Andrew Schwartz CPA, "but we're definitely very happy that our videos have been viewed more than 10,000 times."
Please check out our YouTube channel for a listing of all the videos currently available.
Suggestions for Future Recorded Presentations???
If you have any suggestions for information you'd like us to include in our 2016 recorded presentations, please e-mail me. Please note that we plan to add a few more videos to our channel after April 15th.
Here is a recap of this year's "Dirty Dozen" scams:
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In a shocking development, the IRS recently announced that they will be honoring the FICA tax refunds submitted by residency programs and individual doctors. The catch is that only FICA taxes paid prior to 4/1/05 qualify.
Let's work together to keep current on this hugely valuable tax break. Please post whatever you read or hear regarding this FICA issue on our new Message Board we set up just for this topic.