I have been asked two questions pertaining to contribution limits and conversions to a Roth IRA. The following are my answers:
Q: I am 54 years old, and have $80,000 in a traditional IRA. I want to do a Roth conversion. Is there is anything I can do to decrease my tax rate? I am still working. My other source of income is capital gains and dividends. I do my own investing which would allow me to have only long, or short term gains in a year. Also, I could work part time during the year to lower my earned income. Will any of these affect the taxes on the converted money?
A: Converting a traditional IRA to a Roth IRA is a great strategy for many taxpayers. However, there is a trade-off. You are paying taxes now in exchange for enjoying tax-free earnings down the road. There is no way to completely avoid the taxman when converting. Working part-time in the year of the conversion probably is not the answer. Your Roth IRA conversion income will increase your ordinary income for the year of the conversion — potentially causing the loss of valuable exemptions, credits, tax deductions — but, here is the good news, this only happens for the year of the conversion. Also, there are ways to minimize the tax bite. You may consider a strategy of partial conversions to a Roth IRA. You can do many small Roth conversions year after year to keep your income in a low tax bracket.
Q: I have a company 401(k) with significant appreciation in company stock. I am 72 years old and have been taking distributions since I retired. I was never advised about the net unrealized appreciation) option before I started taking distributions, that would allow me to pay ordinary income tax rates on the value of the stock when contributed to the 401(k) and capital gains on the appreciation in lieu of paying ordinary income taxes on the entire distribution. It has been determined that the approximate cost to me for the difference between the ordinary income rate versus the long-term capital gains rate was over $30,000! Is there anything I can do to save the net unrealized appreciation option.
A: The rules for net unrealized appreciation can be tricky. To take advantage of NUA, there must be a lump sum distribution after a triggering event such as retirement. This means that the entire plan balance must be withdrawn in one tax year after a triggering event. Unfortunately, this didn’t happen. In your case, the only way the NUA tax break could be salvaged would be if there were another triggering event. For example, if you leave the funds in the plan, the NUA tax break would be available to your plan beneficiaries after the triggering event of your death. If you or your heirs roll the plan funds to an IRA, the NUA opportunity is lost forever.
Taxes can be tricky. You need to do your research to determine your best strategy before you make changes to your retirement accounts. A mistake can be costly.
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Author’s email: wolff2000@earthlink.net
