Fourteen Things to Do – and Not to Do – With Your IRA

Timely Tips for IRAs

Most people recognize the tax and savings benefits of having an individual retirement account, or IRA. Millions of Americans make contributions to company-managed 401(k) accounts, as well as independent IRA accounts.

But are you managing your IRA accounts as well as you could, for your own benefit and that of your heirs? Make sure that you not only contribute significant assets to these accounts, but take the appropriate actions to maximize the return on your investment.

1. DO list one or more beneficiaries on your IRA. If you fail to list a beneficiary, the IRA passes into your estate. When this happens, the timing of your death will determine whether your heirs must receive all assets either by the end of the fifth year after your death, by the end of the year following the year of your death, or according to a schedule based on your life expectancy (as if you were still alive). Any way you look at it, the inheritor is likely to gain much more flexibility if he or she has been listed as a beneficiary. This is because, if the beneficiary is your spouse, the spouse can treat the IRA as his or her own; if it's not your spouse, the beneficiary can transfer the IRA into a separate account and then base minimum required distributions on his or her own life expectancy, rather than yours.

2. DO make sure that your list of beneficiaries is kept up-to-date on all your IRAs. Many people do not review their beneficiaries as often as they should and end up with a deceased person as beneficiary. Of course the IRA passes into the estate, with all the disadvantages mentioned above.

3. DO make sure you keep age limits clearly in mind. The youngest age at which you can receive distributions without penalty from a traditional IRA is 59-1/2. If you withdraw funds below this age, you will not only pay taxes on the distribution, but also pay an additional 10% penalty. (Exceptions may be made for certain circumstances, such as withdrawing money to buy a first home.)

On the other hand, you must begin receiving minimum required distributions (MRDs) from a traditional IRA by April 1 of the year after you turn 70-1/2. While you will naturally want to allow your assets to grow tax-deferred in a traditional IRA for as long as possible, any failure to receive MRDs results in a whopping 50% penalty on the MRD, which you will be required to withdraw anyway.

There is an important exception to the MRD rule for the year 2009: the Pension Protection Act has suspended the MRD for 2009. However, it is likely to be reinstated in 2010. Consult with your financial advisor for the year 2009 if you are due to receive a minimum required distribution. And whatever the consequences for this year, make sure you're not taken by surprise in the year 2010.

4. DO consider your IRA in the light of your total estate tax situation. You would not want your heirs to find themselves in the position of selling IRA assets to pay estate taxes, possibly incurring extra taxes and even penalties. There are a number of strategies to avoid this situation.

5. DO continue to make contributions to your IRA in the face of market uncertainty. Remember, the tax benefits of an IRA give you greater control over your assets, whether the market is up or down.

6. DO continue to make contributions even if you don't have enough cash to make the full yearly amount. You can make smaller contributions over the course of the year to add up to the yearly maximum. There may even be advantages in spreading out contributions in this way, as it avoids the possibility of making a large investment when the market is peaking.

7. DO consider converting a traditional IRA to a Roth IRA. This may be a particularly good time to do so, for several reasons:

• Earnings are down generally, so chances are you won't have to pay as much tax on the conversion as you normally would, because you pay the tax on earnings and deductible contributions.
• Starting in 2010, there are no income limits for converting your traditional IRA to a Roth IRA. In addition to this change in the law, there is another benefit for taxpayers: if you convert in 2010, you'll be able to spread out the tax hit through 2012. Unfortunately, the new no-income-limit rule for conversion does not apply to contributions; the limit for 2009 is $120,000 for individuals and $176,000 for taxpayers filing jointly.
• Many economists predict a rise in tax rates, particularly for higher-income brackets. This would make it advantageous to pay the tax now at the lower rate, rather than waiting for possibly higher rates. Of course, if you believe you'll be in a lower tax bracket upon retirement, this advantage might not work for you; likewise if a conversion would bump you into a higher bracket in the year you make it. Additionally, if you would need to sell off some of your IRA assets to pay the tax bill upon conversion, this might not be the right option for you.

8. DO consider setting up a spousal IRA if you work but your spouse doesn't and you file a joint return. This permits you to double your tax-deferred investment.

9. DO make sure your IRA custodian knows your wishes in the event of your death. Even if you have listed beneficiaries on your IRA, complications could arise. For example, suppose you have three children who are all listed as beneficiaries, but one of them passes away before the individual Inherited IRAs have been set up. Would you want an Inherited IRA to pass onto the family of the deceased child, or would you prefer that the other two siblings split the assets? Make sure that your IRA custodian understands your position on these matters. If necessary your attorney can prepare a document which spells out exactly what will happen with your IRA upon your demise.

10. DON'T leave your assets in the 401(k) account of a former employer. If your 401(k) account is the exception in having ultra-low fees and excellent returns, you might want to consider breaking this rule, but in general it's best to rollover the funds into your own IRA account. You're likely to have more investment options and possibly lower fees. In addition, many company 401(k) programs don't offer inheritors of an IRA the full flexibility permitted by IRS rules.

11. DON'T make rollover mistakes that can cost you thousands in taxes, penalties or lost investment opportunity. Remember these key rules:

• The once-a-year limit on rolling over funds from one IRA account to another. You can't conduct a rollover from an IRA account if another rollover (full or partial) has been made from that same account less than a year before. This isn't true, however, if you're conducting a rollover from a 401(k) due to job change or loss.
• The sixty-day rule. If you receive the assets from an IRA account, you must roll them over into a new IRA account within sixty days to avoid paying taxes or penalties. The best way to obviate this problem is to arrange a direct trustee-to-trustee transfer between institutions, so you need never receive the assets at all. (Even if the assets of a 401(k) account are sent to you as a check, you can often arrange to have the check made out to the financial institution of your new IRA. Since the check isn't made out to you, this doesn't count as a distribution.)
• The same-property rule. If you do receive the funds directly from your old IRA and transfer them into the new account within sixty days, you must make sure you don't purchase any new assets with those funds and include them in the transfer. The assets must all consist of the "same property." If you break this rule, the IRS will consider the funds used to purchase the new assets as a cash distribution, taxable and possibly penalized. Again, a direct trustee-to-trustee transfer will eliminate the possibility of making this mistake.

12. DON'T assume that you must refrain from contributing to your IRA in order to meet shorter-term goals. Certain shorter-term financial goals, such as buying a first home, can enable you to take distributions from an IRA free of penalty even if you're below the age limit. If you are anticipating such shorter-term financial needs, consult with your advisor to see if they are compatible with penalty-free IRA withdrawals.

13. DON'T hesitate to set up additional IRA accounts along with your 401(k). Even if you meet your full contribution limits for your 401(k), there are good tax reasons for setting up additional IRAs. For example, a Roth IRA will provide you with a source of tax-free assets in retirement; a nice supplement to the assets in your 401(k), particularly if you're hit with a heavy bill on the taxable earnings. In addition, a Roth IRA has no MRDs so you can keep the assets in the Roth IRA indefinitely, whereas you normally must take MRDs from a traditional 401(k) account after passing the age of 70-1/2.

14. DON'T use your IRA for sheltering tax-advantaged investments, such as municipal bonds. Keep such investments in a taxable account. Use the IRA for taxable investments and particularly for any investments you may have that incur higher taxes, such as fast-turnover stock funds.

 For more information, please contact Jonathan E. Brochstein at Weston Wealth Strategies—(203) 319-9876 or contact Jonathan via email.

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