Can you reconvert an IRA?
Suppose you converted your IRA to a Roth IRA just before the bottom fell out of the stock market last year. Because the tax liability for the conversion is based on the value of the account on the last day of the prior year – Dec. 31, 2007 — you would have paid tax on an inflated value. So you may have opted to recharacterize your Roth into a traditional IRA.
But now you see signs of a market rebound. And you’d like to take advantage of the Roth IRA setup for all the same reasons that attracted you to it in the first place.
In this case, you might “reconvert” your IRA. In other words, you can convert your recharacterized traditional IRA back into a Roth IRA. This is essentially treated as a new conversion for tax purposes.
With a Roth IRA in existence at least five years, qualified distributions are completely exempt from federal income tax. A qualified distribution is one that is paid after reaching age 59 1/2, received on account of death or disability or used for first-time homebuyer expenses (up to a lifetime limit of $10,000). In contrast, traditional IRA distributions are taxed at ordinary income rates as high as 35% — probably even higher in future years.
However, the IRS doesn’t allow you to keep flip-flopping back and forth between the two types of IRAs. You must meet specific time restrictions for a reconversion. Specifically, a traditional IRA can’t be reconverted to a Roth before the later of:
1. The beginning of the tax year following the tax year of the conversion
2. The end of the 30-day period beginning on the day of the recharacterization.
This rule applies regardless of whether the recharacterization falls into the year of the conversion or the following year.
This is an important decision for taxpayers rapidly approaching retirement. We can help you analyze your personal needs. Call us to arrange a consultation.
Roth IRA conversion in 2010
The buzz about Roth IRA conversions is getting louder. And why not: For the first time ever, higher-income taxpayers can convert their traditional IRAs into a Roth. Beginning in 2010, the prior restriction for taxpayers with an adjusted gross income (AGI) above $100,000 is eliminated. Also, you can split the tax bill for a 2010 Roth conversion evenly over 2011 and 2012. (You report 50% of the income in each of those years.)
But should you convert to a Roth? That’s another story. Don’t assume that a conversion is right for you just because you can do it for the first time. Also, if it suits your purposes, you might convert only part of your traditional IRA assets and leave the rest alone.
Qualified distributions from a Roth (e.g., distributions after age 59 ½ and after having a Roth IRA in existence for more than five years) are federal-income-tax-free. Plus, you’re not required to take minimum distributions after age 70 1/2 like you are with a traditional IRA. These future benefits offer plenty of incentive to convert to a Roth this year.
However, there are other variables to consider. For example:
- Many online calculations assume that you’ll be paying the full amount of tax on the conversion with funds outside of your IRA. That might not the case. If you have to use some or all of the IRA assets to pay the tax piper, this will dilute or even wipe out the benefit of the conversion.
- The numbers will also change if you’ve contributed to IRAs on a nondeductible basis. There’s no tax on the portion attributable to these contributions.
- Consider the impact of any state and local income taxes owed in addition to federal income tax. This is especially critical if you live in a high-tax state.
- The additional tax liability on the conversion could push you into a higher tax bracket. Conversely, if you delay the conversion until you’re in a lower tax bracket, you might come out ahead.
This critical decision requires a thorough analysis of the facts. Remember: Every situation is different. Do not hesitate to contact our office to schedule a consultation for personal guidance.
Simplified Employee Pension Plan
What is a SEP?
A SEP is a simplified employee pension plan. A SEP plan provides employers with a simplified method to make contributions toward their employees’ retirement and, if self-employed, their own retirement. Contributions are made directly to an Individual Retirement Account or Annuity (IRA) set up for each employee (a SEP-IRA).
Note: The IRS has a system of correction programs for sponsors of retirement plans, including SEPs, which are intended to satisfy Internal Revenue Code requirements but have not met the requirements for a period of time. This system, the Employee Plans Compliance Resolution System (EPCRS), permits employers to correct plan failures and thereby continue to provide their employees with retirement benefits on a tax-favored basis.
How is a SEP established?
A SEP is established by adopting a SEP agreement and having eligible employees establish SEP-IRAs. There are three basic steps in setting up a SEP, all of which must be satisfied.
-
A formal written agreement must be executed. This written agreement may be satisfied by adopting an Internal Revenue Service (IRS) model SEP using Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement. A prototype SEP that was approved by the IRS may also be used. Approved prototype SEPs are offered by banks, insurance companies, and other qualified financial institutions. Finally, an individually designed SEP may be adopted.
-
Each eligible employee must be given certain information about the SEP. If the SEP was established using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. If a prototype SEP or individually designed SEP was used, similar information must be provided.
-
A SEP-IRA must be set up for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. The SEP-IRA is owned and controlled by the employee and the employer sends the SEP contributions to the financial institution where the SEP-IRA is maintained.
What types of employers can establish a SEP?
Any employer can establish a SEP.
If an employer has a SEP, can it also have other retirement plans?
An employer can maintain both a SEP and another plan. However, unless the other plan is also a SEP, the employer cannot use Form 5305-SEP; the employer must adopt either a prototype SEP or an individually designed SEP.
If an employee participates in his or her employer’s retirement plan, can he or she set up a SEP for self-employment income?
Yes. A SEP can be set up for a person’s business even if he or she participates in another employer’s retirement plan.
Is there a deadline to set up a SEP?
A SEP can be set up for a year as late as the due date (including extensions) of the business’s income tax return for that year.
How is a SEP plan amended for EGTRRA?
If a prototype plan was used, the employer should have received an amended plan from the financial institution that provided it with the plan. If for some reason the employer didn’t receive a new plan document, the financial institution should be contacted.
While the financial institution provides many administrative services for the plan, it is the responsibility of the employer – the plan sponsor – to ensure that the plan is kept up-to-date with current law.
