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1. Is your IRA (including Roth IRAs) fully funded up to the $5,000 limit—$6,000 if you turned or were age 50 or older during 2012?
A. Sure, you can wait until April 15, 2013, but if you have the money, why not fund it now? Why not have the money working for you on a tax-favored basis?
2. Can you make an IRA contribution even if you received or made a contribution to a qualified retirement plan?
A. Many people believe that an IRA contribution can only be made if the contribution is deductible. If you are covered by a qualified plan, the IRA contribution may or may not be deductible, but having earned income and being under 70½ is all that is required to make an IRA contribution. If it's a Roth IRA funding decision, then eligibility is determined solely based on having earned income and that income being below statutory thresholds. Lord Abbett's website can be referenced to determine whether the contribution is deductible or Roth IRA eligible.
3. Did you turn 70½ in 2012?
A. When you turn 70½, IRS rules stipulate that a required minimum distribution (RMD) be made each year from any non-Roth IRA. You are, however, permitted to postpone your first minimum IRA distribution until April 1, 2013. If you do, you must take a second distribution before the end of 2013. Will taking two distributions in 2013 affect your tax rate? If "yes," consider taking your first distribution before the new year.
4. If you are older than age 70½, did you take your required minimum distribution from your IRAs in 2012?
A. Based on IRS rules, this figure becomes available each January 1. This is important, because there is a 50% tax on amounts not taken. For example, if someone had to take $10,000 by December 31, 2012, but only took $2,000, he or she would owe an excise tax of $4,000 on the $8,000 shortfall, plus would need to pay taxes on the $8,000 when distributed. If you need the funds, you can always take more than the minimum.
5. If you are 70½ or older and have several IRAs, do you have to take money from each IRA to satisfy the minimum distribution rules?
A. The sum of all your IRAs, excluding Roth IRAs, and your age determine the minimum distribution. Once determined, the minimum can be taken from just one or several IRAs. This is especially helpful if there is an investment you would like to avoid touching.
6. Are all beneficiary designations in order?
A. People often have several IRAs. It's unlikely they were all established at the same time. It also would not be a stretch to imagine that the individual got married, divorced, had a child, or experienced other life events since opening one or several IRAs. Is the correct person positioned to receive the benefit? IRAs do not pass through probate, so the beneficiary designation on file with the IRA provider governs.
7. Did you inherit an IRA or employer-sponsored retirement plan account from a nonspouse in 2011?
A. If you did, you also must begin taking distributions, even if it's a Roth account, before the end of 2012. If you miss the deadline, IRS rules require the account to be paid out in full before the end of 2016 rather than over your lifetime. You can always take more than the minimum.
8. Why is it important to create separate IRAs for each beneficiary?
A. When multiple beneficiaries inherit an IRA, it's often wise to "split" the account into multiple separate IRAs, established for each beneficiary. This strategy, when finalized by December 31 of the year following the year of the IRA owner's death, offers the ability for each beneficiary to use their own life expectancy for future minimum distributions.
9. How can you optimize the tax implications of converting a traditional IRA to a Roth IRA in 2012?
A. Each taxpayer's situation is somewhat unique, so we cannot offer specific tax advice. However, in general, each of these strategies could potentially help lower one's taxes:
Consider spreading the taxable income over two or more tax years. By converting part of an IRA in 2012 and another part in 2013, the taxable income generated does not fall in one tax year and has the potential not to raise your tax bracket.
When there are aftertax dollars in the traditional IRA and you are not going to convert the whole IRA, know that partial conversion taxation is based on the ratio of your aftertax dollars to your total IRA dollars at the end of the year, so either (1) transfer, if you can, the taxable dollars in your IRA to a qualified plan before December 31, 2012, or (2) do not roll over money from another qualified plan to your IRA until after December 31, 2012, as this will dilute the concentration of aftertax dollars in your IRA accounts for purposes of determining what is taxable.
Consider opening a separate Roth IRA for each investment you select. You have until October 15, 2013, to reverse your conversion on an IRA-by-IRA basis, and you'd only want to reverse accounts that did not perform. If all investments are under one Roth umbrella, reversal, called "recharacterization," does not allow you to allocate the loss to a specific investment; the recharacterization would be pro rata.
10. What happens if you convert to a Roth IRA, but do not have the money to pay the taxes?
A. Taxpayers should be careful about this "strategy." There are no penalties on IRA dollars converted to a Roth IRA. However, if you convert and do not have the assets to pay the taxes outside the IRA, the under age 59½ penalties will be added to your tax bill on the dollars used to pay the taxes, and the size of your Roth IRA account will be less. There are no penalties on the dollars used to pay the taxes if you are over 59½. In addition, if you decide to reverse your Roth IRA conversion (see question 9), you cannot recover the taxes paid as part of the conversion.
11. What should you consider when making an IRA distribution?
A. If the distribution is taxable, make sure you have sufficient tax withholding taken at the federal and the state levels, and if applicable, also the local level. There may be penalties for under-withholding.
When establishing systematic withdrawals from a particular fund, make sure you know what happens if that fund runs out of money. For example, let's say someone needs to take out $5,000 to satisfy their age 70½ minimum withdrawal by December 31, 2012. The individual established a procedure with his or her investment company to have the payment drawn from a money market account. However, there is only $1,500 in the money market account. From which other investments will the remaining $3,500 be drawn? Many IRA custodians do not default to any particular fund, but simply wait to receive further instructions.
Minimum distributions must be taken from traditional IRAs by April 1 following the year that a person turns 70½. A minimum distribution must be taken from the IRA in each subsequent year. Failure to take the required minimum distribution will result in a 50% penalty on the amount that was not distributed. Mandatory distributions that represent deductible contributions and all earnings are taxed as ordinary income. Mandatory distributions based on nondeductible contributions are tax-free.
An investment in a money market fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.