Roth Conversion Undo Deadline Coming Soon

If you made a conversion or partial conversion to a Roth IRA in 2010 and the value of your investments has decreased you may want to consider “undoing” the conversion.  If so, you need to act fast as the deadline is October 17, 2011.

Why would you want to “undo” the conversion?  When you converted the Traditional or Rollover IRA to a Roth IRA, you agreed to pay taxes on the gains.  If the value has decreased, you are still responsible for paying based on the gain at the time of conversion.  If you make this change, you are limited to when you can make another conversion.

In 2010, there was a one time opportunity to pay the taxes on the conversion over 2011 and 2012 tax years.  If you undo the conversion, you will loose this opportunity.  Future conversions will require paying all the tax due in one tax year.  Of course, you can always make partial conversions to manage your tax bill.  More information here.

“When I retire, I should take withdrawals from my non-tax deferred investments first.”

The typical rule of thumb is “spend your taxable investments and let your tax deferred investments grow”. While this may result in a higher overall tax adjusted value for many people, it may not always be the optimum withdrawal strategy. It does make sense to withdraw from your Roth IRA, and HSA, accounts last because there is no tax due on the growth or withdrawals.

If you have a large balance in your Traditional or Rollover IRA and you delay withdrawals, you may be forced to take larger Required Minimum Distributions (RMDs) after age 70 1/2 than you desire. Depending on the tax rates when you make the withdrawals, you may pay more tax than if you managed your withdrawals over a longer period, in a lower tax bracket.

To determine the optimum strategy for your situation, gather up your expected expenses, account balances, Social Security and other guaranteed income. Run scenarios taking income from different sources over your lifetime and compare. This will help you decide which withdrawal strategy is best for you.

Audit Your Beneficiaries

Have you purchased a new life insurance policy or annuity recently?  When completing the section designating your beneficiaries, did you consider the impact on your estate plan?   Beneficiary designations are independent of and trump directives in your estate plan documents.  For example, if you intend to leave an equal amount of your wealth to your children and designate this in your will but name your daughter as your IRA beneficiary, you may significantly change the balance.  You can avoid these problems in a few simple steps:

First, make a list of all your bank and investment accounts, retirement accounts (401k, IRAs, 403b), insurance policies and annuities.  Contact the companies and ask for a copy of the current beneficiary or Transfer on Death designation.  Do this even if the accounts or policies are old.  Often these require changes to account for death, divorce and changes in children’s status.  Ask for a change of beneficiary form while you are at it.  Using a copy of the company file is preferable to your records since what is in the company files, will rule.

Now you can review the designations along with your estate documents and make sure they match your intents.  You may want to consult with your financial planner and attorney to assure you are clear how the plans will work.

Finally, make any changes needed in your estate plans and beneficiary forms.  If you are making changes, I recommend you consult your estate planning attorney to assure you do not accidentally cause a problem.  You must use the change of beneficiary forms from each company.  After the change is made, get a copy back for your files.

Don’t wait!  You will feel better knowing you are accomplishing your goals and your heirs will thank you for having it all in one place.

Can A Soft Top Smooth Your Ride?

Convertible tops allow car drivers to enjoy sun and fresh air when conditions are right. You are not cooped up in an enclosed vehicle and you can put up the top when it rains or temperatures are not ideal. You have the best of both worlds although, like everything else, there may be some quirks to address.

In the investment world, convertible bonds have similar characteristics. These investments are a hybrid of a fixed rate bond that has the ability to be converted to stock if conditions are right. As a bond, they provide steady interest payments. The contract spells out how the bonds can be exchanged or used to buy stock at a specified rate. If the stock price increases, you can benefit by having access to shares. If the stock price declines, you still receive the interest. Some caveats; the interest rate is less than a similar bond and the value of the convertible rises at a slower rate than the company’s common stock prices. The contract may also contain provisions for the bond to be called by the company as well as the option for you to sell the bond back at a specified price.

The advantages are that you can receive return via interest if the stock market is flat while not giving up the potential for appreciation, capital gains. Another advantage is the smoothing of returns, lower volatility, of this investment. The disadvantages include lower interest rates, inflation risk, company credit risk and slower price increases. If the markets have been wandering with no clear direction, convertibles tend to perform well relive to plain vanilla bonds or stock holdings of the same company.

There are fewer avenues to purchase convertibles than other stocks and bonds. In addition to purchasing convertibles directly, there are a few mutual funds and ETFS.

What the US Debt Hangover Means to Investors

It’s no secret that we have a spending problem. Just as you will find your credit score going down if you spend up to your credit limits and more than you bring in, the US is facing a potential credit downgrade. It doesn’t matter if S&P or Moody’s makes it official. What really matters is what large investors think about the US’s ability to pay it debts in the long run. At this time, investors still gravitate to US debt and the dollar when markets look risky. However, they have decided that it makes sense to diversify into other countries that may have stronger balance sheets, better cash flow and smaller long term obligations.

One such investor is PIMCO Total Return , the nation’s largest mutual fund with $240 billion in assets. Fund manager Bill Gross continues to reduce exposure to the US Treasury market. By the end of April, the fund had increased its net position in government bonds to negative 4% (that is, net short). The fund has shifted its holdings to mortgage based securities, non-US debt, municipal bonds and currency. Other investors, such as China, are also diversifying away for US debt.

What does this mean for you? The cost to the Treasury will go up to attract investors. For buyers this means higher returns. For taxpayers this means higher bills. As an investor, I encourage clients to diversify their bond and debt investments outside the US. However, aren’t those investments riskier? Diversified investing may better address the list of financial risks better than “safe, US government” investments. Higher rates of return can help avoid inflation risk. Diversification can also avoid company, industry or country risk.

The best investments for you may not be the ones your neighbor has. Take a look at your situation and needs. We buy many of our products from foreign suppliers; it is time to look at being a global investor. If you want more detail, I’ll be happy to send you a Vanguard report, which outlines the benefits and risks of investing globally.

Should You Have a Trusteed IRA?

The tax code allows IRAs to be created as trust accounts, custodial accounts and annuity contracts. The federal tax rules are generally the same for all IRAs. But the structure of the IRA agreement can have a significant impact on how your IRA is administered. This article will focus on a type of trust account commonly called a “trusteed IRA,” or an “individual retirement trust.”

Why might you need a trusteed IRA?

In a typical IRA, your beneficiary takes control of the IRA assets upon your death. There’s nothing to stop your beneficiary from withdrawing all or part of the IRA funds at any time. This ability of your beneficiary to withdraw assets at will, may be troublesome to you for several reasons. For example, you may simply be concerned that your beneficiary will squander the IRA funds.

Or it may be your wish that your IRA “stretch” after your death–that is, continue to accumulate on a tax-deferred (or in the case of Roth IRAs, potentially tax-free) basis–for as long as possible. IRA owners sometimes select much younger IRA beneficiaries because their young age means a longer life expectancy, and this in turn requires smaller required minimum distributions (RMDs) from the IRA each year after your death – allowing more of your IRA to continue to grow on a tax-favored basis for a longer period of time. Your intent to stretch out the IRA payments may be defeated if your beneficiary has total control over the IRA assets upon your death.

Even if your beneficiary doesn’t deplete the IRA assets, you normally have no say about where the funds go when your beneficiary dies. Your beneficiary, or the IRA agreement, usually specifies who gets the funds at that point. In a typical IRA, your beneficiary is responsible for investing the IRA assets after your death, regardless of his or her inclination, skill, or experience.

A trusteed IRA can help solve these problems. With a trusteed IRA, you can’t stop the payment of RMDs to your beneficiary but you can restrict any additional payments from this IRA. For example, you could maximize the period your IRA will stretch by directing the trustee to pay only RMDs to your beneficiary. You can also ensure that your beneficiary’s needs are taken care of by providing the trustee with the discretion to make payments in addition to RMDs as needed for your beneficiary’s health, welfare, or education.

Another option is to impose restrictions on distributions only until you’re comfortable your beneficiary has reached an age where he or she will be mature enough to handle the IRA assets.

In each case, the balance of the IRA passing, upon your beneficiary’s death, can be paid to a contingent beneficiary of your choosing. For example, if you’ve remarried, you may want to be sure your current spouse is provided for upon your death and also that any funds remaining on your spouse’s death pass to the children of your first marriage. You may also want to ensure that if your surviving spouse remarries, his or her new spouse won’t be the ultimate recipient of your IRA assets.

A trusteed IRA can be structured to qualify as a marital, QTIP, or credit shelter (bypass) trust. This could potentially simplify your estate planning.

Finally, a trusteed IRA can even be a valuable tool during your lifetime. For example, the IRA can provide that if you become incapacitated the trustee will step in and take over the investment of assets and distribute benefits on your behalf as needed. This ensures that your IRA won’t be in limbo until a guardian is appointed.

There are a number of ways you can structure your IRA to protect your assets.  Consult with a qualified financial planner and estate planning attorney to set up you IRA so your desires will be carried out.