Things to Think About Before Making a Roth IRA Conversion

Old couple having coffee"The Roth IRA, with its unique tax advantages, can be a powerful financial-planning tool. However, rolling funds from a traditional IRA into a Roth is not the right move for everyone."

The Motley Fool's article, "5 Things to Consider Before Making a Roth IRA Conversion," says that although Roth IRA conversions are popular, there are a few key things to consider before moving forward. Here are the five considerations identified by the article:

  1. Your tax bracket. These days it's not unusual for retirees to be in a higher tax bracket during retirement. However, many of us have the option of investing in a Roth IRA, which doesn't offer an up-front tax break—but lets you withdraw funds in retirement tax-free. If you think you are going to be in a higher tax bracket when you retire, you might consider converting some or all of your retirement savings to a Roth before you retire. Converting some or all of your traditional IRA money to a Roth IRA will also give you some tax diversification in retirement to hedge against future changes in tax rates and related rules.
  2. Estate planning. One of the great things about a Roth IRA is that it isn't subject to required minimum distributions (RMDs) at age 70½, unlike a traditional IRA, where you must withdraw an IRS-mandated amount annually at that age. Plus, it's subject to income taxes. Roth IRAs can continue to grow tax-free for as long as you live, and if your beneficiary is your spouse, he or she can roll over the account and make the Roth IRA his or her own with the same rules (non-spousal beneficiaries are subject to an RMD, but that distribution isn't taxed). In addition, non-spousal beneficiaries can take the RMDs over their entire life expectancy. This is a terrific benefit for younger beneficiaries like children or grandchildren.
  3. Be ready for the tax hit. The big minus for a Roth IRA conversion is that any funds you roll over will be subject to income tax in the year of the conversion. That means older folks should consider whether they can cover the tax bill and generate enough investment growth to offset the impact. Plus, there may be other considerations—like estate planning—that become more important than "payback" concerns.
  4. College financial aid. If you have college-age children who will be applying for financial aid, you may want to avoid Roth conversions when their aid is calculated. The extra taxable income could affect their eligibility or the amount of aid.
  5. Stock market declines. A drop in the stock market may give you a great opportunity for a Roth IRA conversion and get you more bang for your buck. You will be converting a lower amount and paying less in taxes. If you're thinking about rolling over your traditional IRA, consider taking advantage of the stock market correction by converting a larger portion of your old account, or think of it as another way of "buying low and selling high."

Converting your traditional IRA to a Roth IRA is a powerful tool that can provide financial planning options for many. But before you make a Roth conversion, consider the pros and the cons.

Reference: Motley Fool (February 27, 2016) "5 Things to Consider Before Making a Roth IRA Conversion"


Do I Take My Chances with a Tax Audit?

Business_meeting"In 2015, the Internal Revenue Service audited only 0.84% of all individual tax returns. So the odds are generally pretty low that your return will be picked for review."

Even though the odds are pretty low, Kiplinger states in its February 2016 article, "9 IRS Audit Red Flags for Retirees," that your chances of being audited or otherwise getting a call from the IRS increase based on various factors.

Math errors may draw an IRS inquiry, but they don't usually mean an audit. Nonetheless, review these red flags that could increase the chances that the IRS will give the return of a retired taxpayer some very special and unwanted attention.

The overall individual audit rate is only about one in 119, but the odds go up significantly as your income increases—like if you sell a valuable piece of property or get a big payout from a retirement plan.

IRS statistics show that folks with incomes of above $200,000 had an audit rate of 2.71%—about one out of every 37 returns. If you report an income of $1 million or more, there's just a one-in-13 chance your return will be audited. The reverse is also true as the audit rate plummets for those reporting less than $200,000, with just 0.78% or one out of 128 of those returns audited—the majority of these exams were conducted by mail.

Make sure you report all required income on your return because the IRS is good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a tax form showing income that isn't yours or listing incorrect income, you need to ask the issuer to file a correct form with the IRS.

Taking Higher-Than-Average Deductions. If the deductions on your return are disproportionately large compared with your income, the IRS may pull your return. For example, a costly medical expense could alert the IRS, but if you have the proper documentation for your deduction, you shouldn't be afraid to claim it.

Claiming Big Charitable Deductions. If your charitable deductions are very large compared to your income, it'll be a red flag. Likewise, if you fail to get an appraisal for donations of valuable property or fail to file Form 8283 for noncash donations over $500, you are a bigger audit target. Retain all of your supporting documents, such as receipts for cash and property contributions made during the year.

Failing to Take Required Minimum Distributions. The IRS will check to see that you're taking and reporting required minimum distributions (RMDs). The penalty for not taking your RMD is equal to 50% of the shortfall. Also, IRS looks at early retirees or others who take payouts before reaching age 59½ and who don't qualify for an exception to the 10% penalty on these early distributions. Those age 70½ and older must take RMDs from their retirement accounts by the end of each year, but there is a grace period for the year in which you turn 70½, allowing you to wait until April 1 of the following year.

If you're still employed at age 70½ or older, you can delay taking RMDs from your current employer's 401(k) until after you retire (this doesn't apply to IRAs). The amount you have to take each year is based on the balance in each of your accounts as of December 31 of a prior year and a life-expectancy factor from the IRS.

Reference: Kiplinger (February 2016) "9 IRS Audit Red Flags for Retirees" Business_meeting

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