North Carolina Estate Planning Blog : North Carolina Estate Planning Lawyer & Attorney : Trust Counsel, PA : Trust Administration : Serving Chapel Hill, Durham, Raleigh, Pittsboro, Orange County, Chatham County

Do you think you have to pay income tax on large ($500k++) Roth IRA conversions at the top marginal tax rates? Think again.  I have recommend the following strategy to several of my clients.  In most cases, you can stay with your current investment manager.

By utilizing the Jagen™ investment strategy, you may be able to lock in a 24.5*% rate on big IRA conversions.

A lot of advisors don’t like the idea of clients paying taxes early. They adhere to the mindset of “never pay a tax if you don’t absolutely have to.” Some advisors also still believe that clients might be in lower tax brackets later in life and don’t want to recommend taxable transactions at today’s top federal rate of 35%. But what if clients didn’t have to pay at top rates today? A Roth conversion at a 25% or less tax rate now will almost guarantee long-term tax savings for high net worth clients with large IRAs. How many clients with large IRAs will be in a retirement tax bracket less than 25%?

Jagen™ funds are eligible IRA investments and offer access to very high level institutional money management platforms. In addition, the Jagen™ fund design provides for a variance between the net asset value (NAV) and fair market value (FMV) of each investor’s interest in the funds.

For example, an investor might have an IRA holding Jagen™ fund units valued at $1 million NAV. This same account may only have a $700,000 FMV based on a qualified appraisal of those fund units. The reason for this valuation adjustment involves various features of Jagen™ funds which must be taken into account when determining FMV. Each fund is privately owned by a limited number of investors and fund units are not traded on open exchanges. Investors must commit to holding their fund units for specified terms. Thus FMV will typically be less than NAV during the holding period.

 Let’s see how this affects a Roth conversion:

*Note:  State income tax is additional.

Adapted from blog post by Jagen Investments, LLC.  Used with permission.

 

 

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Three of four prominent IRA experts have either already utilized a Roth conversion or plan to do so, and the fourth says he plans to if the market gets even worse.

Click here to see what Ed Slott, Robert Keebler, Seymour Goldberg and Natalie Choate have to say about their personal Roth conversion decisions.

While I have attended programs by Slott, Keebler and Choate, I certainly don't have the same status in the tax world as do they (nor their wealth, I would venture to guess).  But for what it's worth, at age 49 I am leaning against doing a Roth conversion for two primary reasons:  1)  Even with the coming tax increases, I believe my tax rate during retirement will be lower that it is presently, and 2)  I don't want to spend my cash reserves paying the taxes that will be due as a result of the conversion.

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As most people know by now, the $100,000 income limit on the ability to convert a traditional IRA to a tax-free Roth IRA will disappear next year.  In addition, a taxpayer who does a conversion in 2010 can pay the tax due from the conversion in 2011 and 2012 (by including 50% of the conversion income in each year).  There are innumerable articles about Roth conversions and the math involved, with many differing opinions about the advisability of converting.  Bottom line, make sure you hire the appropriate professionals to crunch the numbers and otherwise advise you before making a decision.  You really need to consult your financial advisor, CPA and estate planning attorney to ensure that you are fully informed.

Here's a quick list from tax guru Bob Keebler, CPA:

(1)  Taxpayers have special favorable tax attributes including charitable deduction carry-forwards, investment tax credits, high basis non-deductible traditional IRAs, etc.

(2)  Suspension of the minimum distribution rules at age 70½ provides a considerable advantage to the Roth IRA holder.

(3)  Taxpayers benefit from paying income tax before estate tax (when a Roth IRA election is made) compared to the income tax deduction obtained when a traditional IRA is subject to estate tax.

(4)  Taxpayers who can pay the income tax on the IRA from non-IRA funds benefit greatly from the Roth IRA because of the ability to enjoy greater tax-free yields.

(5)  Taxpayers who need to use IRA assets to fund their Unified Credit bypass trust are well advised to consider making a Roth IRA election for that portion of their overall IRA funds.

(6) Future distributions to beneficiaries are generally tax-free.

(7)  Because federal tax brackets are more favorable for married couples filing joint returns than for single individuals, Roth IRA distributions won’t cause an increase in tax rates for the surviving spouse when one spouse is deceased because the distributions are tax-free.

(8)  Ability to recharacterize a Roth IRA conversion is a significant tactical advantage because it provides the taxpayer the benefit of 20/20 hindsight (by allowing the taxpayer to specifically choose which conversions to keep)

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Professor Christopher Hoyt of the University of Missouri School of Law has proved a useful summary of IRS Notice 2007-7, 2007-5 IRB 1, which provides guidance about Charitable IRA Rollovers.  This law, which became effective in 2006, allows anyone over age 70 1/2 to have up to $100,000 distributed directly to a qualifying charity and be excluded from income.

1. Yes, charitable IRA distributions can satisfy pledges without violating the self-dealing prohibited transaction rules. "The Department of Labor, which has interpretive jurisdiction with respect to section 4975(d), has advised Treasury and the IRS that a distribution made by an IRA trustee directly to a section 170(b)(1)(A) organization (as permitted by section 408(d)(8)(B)(i)) will be treated as a receipt by the IRA owner under section 4975(d)(9), and thus would not constitute a prohibited transaction. This would be true even if the individual for whose benefit the IRA is maintained had an outstanding pledge to the receiving charitable organization."

2. Yes, a person over age 70 ½ who is the beneficiary of an inherited IRA can take advantage of the charitable IRA exclusion.

3. The prohibition of using an SEP IRA or a SIMPLE IRA for the charitable exclusion only applies to an "ongoing " SEP IRA or SIMPLE IRA. Such an IRA is an ongoing IRA only if a contribution was made to it during the year. Thus , a retired individual who had an SEP IRA or a SIMPLE IRA to which contributions were made during a working career but who is now retired can make charitable distributions from that IRA since no employer contributions were deposited in the same year.

4. No withholding of income taxes -- A qualified charitable distribution is not subject to withholding under section 3405 because an IRA owner that requests such a distribution is deemed to have elected out of withholding under section 3405(a)(2).

5. The exclusion applies to any such charitable distribution made during 2006, even those made before the law was enacted on August 17, 2006. This may be advantageous to people who have "IRA checkbooks" (typically at brokerage houses) where they can write checks directly from an IRA. A person over age 70 ½ who wrote such a check to a qualifying charity early in 2006 can take advantage of the exclusion.

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Owning real estate in a self-directed IRA can seem like a great way to save for retirement.  However, I have found that most clients want to structure the ownership and/or management of the real estate in such a way that they will run afoul of the prohibited transactions rules.  Once they learn of the restrictions involved, they are not so keen on the idea.  Real estate or business ownership in an IRA can work, but knowledgeable tax counsel should be consulted.  Many attorneys and CPAs are not familiar with the laws regulating self-directed IRAs.

Check out this article by Lynn O'Shaughnessy: Sweat Equity in IRA Real Estate can be no-no

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