Andrea Coombes for MarketWatch writes Thanks to the new law, workers saving for retirement in a 401(k) have an easier time switching over to the Roth option in their 401(k), assuming their employer offers one. Meanwhile, people age 70½ or older can once again turn their government-mandated IRA distribution into a donation to charity.
This benefit, which lets you shield your IRA distribution from income tax, isn’t new—but some other provisions of the new law make the charity rollover a better idea for more people.
Until now, for many people the choice was a wash: they could either take the distribution, donate the money and claim a charitable deduction for that amount, or, equally valuable from a tax perspective, they could donate the money directly from their IRA and avoid income tax on that distribution, said Michael S. Jackson, a partner in tax services with Grant Thornton LLP, in Philadelphia.
“This really wasn’t something that a lot of my clients took advantage of over the last couple of years, because the income and deduction were washing out,” he said.
Jackson was speaking as part of a roundtable discussion at a recent MarketWatch Retirement Adviser event in San Francisco, hosted by columnist Robert Powell, editor of MarketWatch’s Retirement Weekly e-newsletter.
The law changed that decision for some high-income taxpayers, thanks to the return of the Pease limitation, which limits deductions based on your adjusted gross income.
“Now that we have several different types of AGI-based increases in the tax rate, it is going to make a difference and will save them a few dollars if they go through the mechanics of actually distributing it directly to the charity,” Jackson said.
Others agreed. “This is a really great provision,” said Mary Kay Foss, who also participated in the MarketWatch roundtable discussion. Foss is a CPA and director with Sweeney Kovar Financial Advisors Inc., in Danville, Calif.
There are a variety of benefits to the charity rollover rule, Foss said. “You don’t get a charitable deduction for it, but it doesn’t increase your adjusted gross income which [means] the amount of Social Security benefits that are subject to tax may be lower,” she said.
Also, “If somebody is charitable, but doesn’t itemize deductions, they’re still going to get the benefit by doing things this way. If somebody has a charitable contribution carry-over it’s going to benefit them,” she said. “It’s really a win-win situation and I think a lot of people should consider it.”
Still, it’s available solely to people aged 70-1/2 and older; you have to be at least that age when making the donation, Foss said. She added that the $100,000 limit is a maximum; charitable-minded taxpayers can give less, but they should check with their IRA custodian—some firms may not be willing to transfer very small amounts.
Also, Foss said, it’s possible to donate to more than one charitable organization via the charity rollover.
The fiscal-cliff deal in January also brought changes to rules governing Roth 401(k)s, offered by some employers in their 401(k) plans. (People who contribute to a Roth put in after-tax dollars—unlike the traditional 401(k), contributions to which are pretax—but the money grows and is withdrawn tax-free.)
“If the employer does offer a Roth 401(k), I would strongly encourage individuals to look at that as a potential strategy,” said Frank Paré, a certified financial planner and president of PF Wealth Management Group LLC, in Oakland, Calif., who also took part in MarketWatch’s panel discussion.
“You may want to take a portion of the amount that you’re putting in your traditional 401(k) and allocate it to the Roth 401(k),” Paré said. “It’s definitely an opportunity to diversify one’s tax strategy between tax-deferred and tax-free” retirement distributions.
One aspect of the new rules is that any 401(k) participant—not solely those who are eligible for a qualified distribution—now can choose to rollover their 401(k) funds to the Roth 401(k), assuming the employer offers the option.
But, while the panel participants said the Roth option can be a valuable tool for some savers, the new rollover perk isn’t necessarily the best way to invest in a Roth.
“I have strong feelings about that,” Foss said. “Roth conversions are a good thing. But within the plan it’s a little messier. You can’t do the recharacterization. I think it’s just a little more complicated. I think it’s neater to do an IRA conversion to a Roth or the whole 401(k) conversion to a Roth and not do it within the same plan.”
Some workers might want to consider converting just a portion of their 401(k) funds to a Roth, Jackson said. “You don’t have to do an all or nothing on this,” he said.
The Roth question
Of course, the big issue with a conversion is the tax bill, Paré said. “That’s really the driver here in terms of, can you afford to give up some of that income deduction, so to speak, in the sense that you’re channeling this money to a traditional 401(k) and it’s pretax dollars,” he said.
Taxes are “the painful part,” agreed Jackson. “A lot of people see [that] as the limiting factor to making the conversion happen,” he said.
“They are going to be out money and, while their 401(k) and Roth 401(k) statement will say the same amount regardless of whether they make the conversion or not, it’s not until years and years down the road when they actually take the money out that they will see the benefit from the tax-free distributions. But they’re out of pocket up front,” he said.
Contributing or converting to a Roth may be more ideal for a younger worker, Paré said. “If you’re near to retiring, maybe [a conversion] is not a strategy. …However, if you’ve got 10, 15, 20 years before you retire, it might make sense to do something like that.”
Jackson agreed. “The longer you have to enjoy that tax-free growth, the better it’s going to be to convert,” he said. “If you have a very, very short time horizon between taking a distribution now versus taking one later, it’s probably not going to be enough time to recoup that tax.”
For her part, Foss said people thinking about converting should consider their income-tax bracket.
“For instance, the 25% and the 28% brackets are very, very wide brackets. With many of my clients, they’re in those brackets while they’re working and they’re probably going to be in those brackets when they retire. So, they would not want to do a conversion that’s going to put them in a higher bracket than the 28%,” she said.
“You have to look at bracket creep, as it were,” Foss said, “because you don’t want to pay tax now that you would never pay it in the future.”
0 comments:
Post a Comment