Diversified Portfolios & Roth Iras Are Opportunities Not To Be Missed

By Author: Paul Sutherland
Total Articles: 13
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For the majority of you, the timely tax filers, you now possess your 2009 returns. For some, there might be a nice planning gem built into your tax returns that you should be aware of. Recently, while our diversified portfolio managers have been reviewing our clients' 2009 returns, we noticed a few situations where a client was at a net operating loss (or negative income) for reasons such as very high itemized deductions from unusually high medical expenses or charitable donations, pass-through losses from rental activities or business pursuits, or investment loss carry forwards from prior years. In these situations our clients had the ability to incur additional income and pay little or no tax. If you expect your taxable income and expenses to be similar in 2010 or future years, this is a prime planning opportunity of executing a Roth IRA conversion roughly equal to your negative taxable income. Not too many people can brag that they legally have taken money out of their IRAs tax free. Ultimately, when you withdraw from the Roth IRA in retirement, these dollars will come back to you tax-free.

Also, with the significant ...
... media coverage of Roth IRAs in 2010, we have received some frequent questions from clients. Below are a few of those questions, along with our responses:

Can I contribute to a Roth IRA after I turn 70-1/2?

Yes, as long as you have earned income and adequate cash flow to make the contribution. Your contribution for 2010 would be limited to $6,000, assuming that you have earned at least that amount. This is in contrast to a Traditional IRA, where you cannot contribute to the IRA once you begin required minimum distributions.

What is the income tax impact for my children inheriting the Roth IRA when I die?

One of the great benefits of the Roth IRA is the inheritance value, especially for beneficiaries who are in a much higher tax bracket than you. Assuming that the Roth IRA has been in existence for more than five years, all the distributions taken from the inherited Roth IRA by your beneficiary are tax-free. This is in contrast to an inherited Traditional IRA, which is taxable to your beneficiaries as distributions are taken.

Are there required minimum distributions from a Roth IRA?

During your lifetime there are no required minimum distributions from a Roth IRA. However, upon your death, your beneficiaries will be required to take a modest annual minimum distribution from the inherited Roth IRA. This continued compounding of investments stretched over both yours and your beneficiary's lifetime is one of the most powerful benefits of a Roth IRA. In addition, if the beneficiaries so desire, they could use the required minimum distributions from the IRA to fund a Roth IRA of their own. The result would be continued tax-free deferral throughout their lifetime and beyond.

Does the adjusted gross income waiver for a Roth conversion in 2010 only apply to this year?

No. Based on current IRS regulations, anyone has the ability to convert their IRAs in 2010 and in future years. The only unique provision that applies to 2010 alone is the ability to recognize the income from the Roth conversion equally in your 2011 and 2012 income.

I have contributed to my Traditional IRA in the past and have not been able to deduct the contributions. How does this basis affect the taxation of the Roth conversion?

Hopefully you have tracked these contributions for the years you did not receive a deduction on your tax return. The first place to check would be Form 8606 on your federal return. If you do indeed have basis in your IRA, a pro rata share of the Roth conversion is not taxable. For instance, if you have an IRA with a value of $100,000 and $20,000 of basis, 20% of any Roth conversion would not be taxable. As a note, if you have many IRAs, you need to consider all values in the denominator to determine the percentage that is not taxable.

If you have any questions on Roth IRAs and conversions, please contact one of our advisers at FIM Group. Now would also be a great time, if you have not done so already, to forward a copy of last year's tax return to your local FIM office so we can update your pertinent information.