What is a Roth IRA recharacterization?
When a taxpayer converts a traditional IRA to a Roth IRA he/she will pay income tax on the taxable portion of the converted IRA. He/She has the option to recharacterize the transaction and return it to being a traditional IRA. Said another way, recharacterization allows taxpayers to undo having a tax assessed. There are two main reasons why a taxpayer would choose recharacterization: 1) The investments did not perform well or 2) the taxpayer cannot afford to pay the taxes.
Suppose we look at a hypothetical situation: Chris chose to convert a $100,000 traditional IRA to a Roth IRA on January 5, 2013 and he would have to pay taxes on that $100,000 when he files his 2012 tax return. Let's say that by October 31, 2013, the account has lost value and is worth $85,000. Chris can choose to recharacterize the Roth conversion as a traditional IRA, and, for tax purposes, the conversion never happened. Chris owes no taxes on the $100,000 conversion, and the IRA is restored to the type of account (traditional IRA) it was before any changes took place.
In this example, Chris could have waited until October 15, 2014 to trigger the recharacterization. Waiting this long and then recharacterizing would cause Chris to amend his 2012 tax return but the delay could also create some investment perspective; allowing him to see if the account regains its losses before going through recharacterization machinations.
Recharacterization allows taxpayers to reconvert the account to a Roth IRA (presumably the value remains lower as would the potential tax liability) after 30 days or in the tax year following the conversion if later.
What does it mean when someone talks about converting an IRA account to a Roth IRA?
Converting means that all or a portion of an individual's IRA becomes taxable and the account is reclassified as a Roth IRA. If the account is held until age 59 ½ and for at least five years, all the Roth IRA proceeds, including the earnings, will be income tax free. IRAs that can be converted include traditional, rollover, SEP and SIMPLE.
How is it determined whether or not a traditional IRA contribution is tax deductible?
If the individual is married and one of the spouses is covered by a retirement plan then the non-covered (does not have to be non-working) spouse may deduct all IRA contributions if joint income is less than $178,000 for a 2013 contribution. At $188,000 for 2013 the deduction is phased out. If their joint 2013 income is between $178,000 and $188,000 ($181,000 to $191,000 for 2014), then a partial (pro-rata) deduction is allowed.
If both individuals are covered by a retirement plan, deduction eligibility phase out begins at $95,000. If their adjusted gross income (AGI) is less than $95,000 then their IRA contributions can be deducted. If their AGI is greater than $115,000 then their IRA contributions are not deductible. If their joint income is between $95,000 and $115,000 ($96,000 to $116,000 for 2014) then a partial (pro-rata) deduction is allowed.
If someone is single and covered by a retirement plan, then $59,000 is the first income threshold used in determining deduction eligibility. If income is below $59,000 a full deduction is allowed while the IRA is not deductible once the income exceeds $69,000. If income is between $59,000 and $69,000 ($60,000 to $70,000 for 2014) a partial (pro-rata) deduction is allowed.
Did the contribution and income limits change in 2014?
Individuals who are under age 50 may contribute up to $5,500 per year. Individuals who are age 50 or older can contribute an additional $1,000. Whether or not the traditional IRA contribution is deductible still depends on whether or not the individual is covered by a qualified plan and if yes, how much he/she earns based on marital status.
What are the basic IRA Required Minimum Distribution (RMD) rules?
Individuals must begin receiving RMDs by April 1 of the calendar year following the calendar year the individual attains age 70½ and continue to receive the RMD before each subsequent December 31. Two distributions will be required in the first year if the individual waits until the calendar year following 70½ to commence RMDs. To avoid taking two RMDs in the same year the individual would take the first RMD by December 31 of the year he/she turns 70½.
If the full RMD is not taken in a given year, a 50% tax is assessed on the amount not taken; reported on IRS Form 5329.
What should an account owner know about tracking after-tax dollars contributed to a traditional IRA?
Accurately accounting for after-tax dollars contributed to or distributed from an IRA is called basis tracking. The account owner should focus on the following general guidelines:
Treat all non-Roth IRAs (traditional, rollover, SEP and SIMPLE) as one account
After-tax contributions are part of the whole.
IRS Form 8606 provides a means to record contributions and distributions on a year by year basis avoiding double taxation.
A distribution from any IRA means some after-tax dollars are being paid out. The calculation is prorata and utilizing Form 8606 the computation is straightforward.
The account owner needs to know the value of all IRAs at the end of the year money is taken to determine, using Form 8606, exactly what’s taxable and what’s not taxable.
Accumulated earnings can possibly be transferred to a qualified plan allowing the basis to be converted to a Roth IRA tax free.
What impact does charitable giving have on IRAs?
Individuals 70 ½ or older may make a qualified charitable distribution (QCD) up to $100,000 from their traditional IRA or inactive SEP-IRA and have the proceeds sent directly to a registered charity. The charitable donation is neither income nor a deduction but may be used to offset all of part of their 2013 RMD.
QCD’s do not apply to employer sponsored plans (i.e. 401(k)
This provision, without congressional action, is set to expire at the end of 2013
Is there anything new regarding non-spouse beneficiaries?
All qualified plans such as a 401(k) must now allow a deceased participant's beneficiary to rollover the late participant's account to an IRA (traditional or Roth) whether or not the beneficiary is the participant's spouse. A non-spouse rollover must go directly to the IRA or it becomes taxable to the non-spouse beneficiary. If the beneficiary were the spouse, then the spouse could take possession of the distribution for 60 days, without tax consequence, before completing the rollover.
The rollover is also taxable to the non-spouse if the funds are sent directly to a Roth IRA from a non-Roth retirement plan account. This is the only way a non-spouse may convert an inherited retirement plan account to a Roth IRA. When a non-spouse inherits a participant's account and rolls it to an IRA, the account must be set up as a decedent (beneficial) IRA and not commingled with the individual's other IRA accounts, if any. He/She must begin taking distributions by 12/31 of the year following the participant's death otherwise the IRA (traditional or Roth) account would need to be completely redeemed by 12/31 of the calendar year that includes the fifth anniversary of the participant's death.
Can minors contribute to an IRA?
If the minor has reportable earned income he/she may be eligible to contribute to a traditional or a Roth IRA. For example, if 14 year old Sam earned (and will be otherwise taxed on) $2,200 on his paper route, he, or his parents, can contribute up to $2,200 to a traditional or Roth IRA. One parent would be the account's custodian, signing all the applications and naming the beneficiary, until Sam attained the age of majority which is generally age 18.
If Sam's income of $2,200 came from babysitting, for example, and Sam simply pocketed the money the various families paid him, without filing a tax return, Sam could not have an IRA.
What is the Saver's Tax Credit?
The saver's tax credit is a nonrefundable federal income tax credit available to individuals with an adjusted gross income (AGI) of less than $59,000 fo 2013 and $60,000 for 2014. Salary deferral contributions to a 401(k), 403(b), governmental 457(b), SIMPLE IRA, and SAR-SEP can reduce an individual's AGI, creating Saver's Tax Credit eligibility. In addition, the credit is available for contributions to a traditional or Roth IRA. The maximum annual contribution eligible for the saver's credit is $2,000. The makimum credit is 50% of that, making the maximum saver's credit $1,000. The amount of the credit varies with income and tax filing status. Please review eligibility with a tax professional.
This information is being provided as general information and is not intended to be legal or tax advice. Lord Abbett does not provide legal or tax advice.
Adjusted Gross Income includes wages, interest, capital gains, income from retirement accounts and alimony paid to the taxpayer adjusted downward by specific deductions (including contributions to deductible retirement accounts and alimony paid by the taxpayer); but not including standard and itemized deductions.
Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.
Please note: 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 percent 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.
A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.
SEP-IRA is an acronym which stands for a Simplified Employer Pension Plan whose investments are placed in IRA accounts selected by each participant. All contributions generally equal the same percentage of an eligible employee’s pay (maximum 25%) and are made by the employer.
A SIMPLE IRA plan is an IRA-based plan that gives small business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or non-elective contributions. All contributions are made directly to an Individual Retirement Account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.
Combining and consolidating assets in an IRA rollover may involve administrative fees and other charges.
There may be fees, expenses, taxes and penalties associated with early IRA withdrawals.
Lord Abbett will waive (or otherwise pay) the yearly $10.00 custodial fee that would be charged each year on an ongoing basis to every new IRA account and, therefore, will not assess a custodial account fee in 2014 or any year afterward. Fund level fees and expenses are still applicable. Please see the current prospectus.
To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.
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December 13, 2013
Knowing the different rules about lifetime minimal withdrawals for IRAs and qualified plans may help you avoid a costly error.