Mike Wallin VP of Advisor Development
	Important Strategies

Maximizing Retirement Accounts and Reducing Tax Liability

In today’s environment, individuals have a heightened sense of concern over making a mistake with their retirement accounts. Decisions over whether to convert to a Roth IRA, pay taxes now or later, and how much of their funds to leave at risk are daily issues. To eliminate the individual’s feeling of making a permanent mistake, share with them the “Do, Undo, and Redo” approach. Let me explain how this works.

Since October 2008, we have experienced the most volatile levels of stock market decline since the Great Depression. For many pre-retirees and retirees, they have watched from the sidelines as their retirement accounts have slumbered by 25% or more. While a dark cloud loomed over the investment world, a silver lining in tax planning appeared brightly.

Conversion of a Traditional IRA to a Roth IRA – The “Do” Step

An individual can convert a Traditional IRA to a Roth IRA if the following criteria are met. First, in the year of the conversion the individual’s modified adjusted gross income (MAGI), found on line 43 of the IRS Form 1040, must be $100,000 or less. The amount of funds being converted from the Traditional IRA to the Roth IRA does not count in the individual’s income to determine eligibility of the conversion. (sidebar: In 2010, the income limitation will be removed and everyone will have the opportunity to convert their Traditional IRA to a Roth IRA.)

To the contrary, the taxable portion of the conversion does count as ordinary income for tax purposes in the year of the conversion. This is except in 2010, when taxes on the converted amount will be split in half with 50% being applied as income in 2011 and 50% being applied as income in 2012.

Secondly, the individual’s filing status cannot be ‘married filing single’, unless they have lived separately from their spouse for the full tax year.

With the sharp decline in the market, this is the opportunity for many pre-retirees and retirees to convert a traditional IRA to a Roth IRA and pay taxes on a much lower amount. Clients should ask themselves this simple question, “Would I rather pay taxes on the current value of my account or wait till my accounts recover and then pay taxes?” This should be a very easy question for them to answer. If they client is willing to leave their converted funds in the Roth IRA for 5 years, then a conversion from a Traditional IRA to a Roth IRA is the right approach to take. The taxpayer can pay the taxes, with under-performing assets, from outside of the account or from the existing Traditional IRA funds. As the underlying investment strategies of the Roth IRA increase, the Roth IRA will grow tax free for the owner, spouse and beneficiaries; and will be RMD free for the owner and spouse.

Oops the Conversion was a Mistake – The “Undo” Step

There are two scenarios that you will need to advise your clients to be aware of.
One is when an individual decides to convert their Traditional IRA to a Roth IRA and the market and their account balance continues to decline throughout the balance of the year, creating an unnecessary tax liability. Fortunately for the taxpayer, they can treat the conversion as if it never happened by re-characterizing the Roth IRA back to a Traditional IRA. No harm-no foul; if the re-characterization is done by the due date, plus extensions, of that tax year! A taxpayer has, with an extension, until October 15 to re-characterize the Roth IRA back to a Traditional IRA.
The second is when the individual’s MAGI for the affected tax year increases above the $100,000 income limitation. This would cause the conversion to be ineligible.

Let’s Try it Again – The “Redo” Step

The individual can try again to convert the Traditional IRA to the Roth IRA as long as the conversion does not happen before the later of...

(1) the beginning of the tax year following the tax year in which the amount was converted to a Roth IRA; or

(2) the end of the 30-day period beginning on the day on which the IRA owner transfers the amount from the Roth IRA back to a Traditional IRA by way of a re-characterization. (rule #2 applies either at the April 15 or October 15 tax dates)

Sharing with your client the “Do, Undo, and Redo” approach will allow you to ease their mind and see that you will be with them each step of the way. We know that it’s when we change a client’s fears to confidence that we have the opportunity to truly serve their needs.

If you have any questions regarding this approach or need assistance with designing the best recommendations for your clients, please call the Advisor Development department at Covenant Reliance Producers. We are your True Partner in building your success!