Tag Archive for: Conversion

Print Friendly Version Print Friendly Version

Retirement Proposals in the 2024 U.S. Budget

/in /by

“I heard the 2024 Budget for the U.S. contains some restrictions on retirement savings and Roth conversions. Can you explain the provisions and when they take effect?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in California involved a question on President Biden’s 2024 Budget.

Highlights of Discussion

Let’s start with the second half of your question first—when do the provisions take effect? The federal budget contains estimates of federal government income and spending for the upcoming fiscal year (October 1 through September 30) and includes suggestions or proposals—not laws—on how to achieve income and spending goals. Consequently, while there are recommended effective dates tied to the provisions of the budget, nothing has been enacted. The provisions are merely suggestions. The president’s release of the budget to Congress is an early step in the entire budget process.

That said, the budget does reflect what is on the Administration’s mind, and the retirement proposals are ones that are recurring themes (e.g., included in the 2021 “Build Back Better” bill). The related General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals includes a description of “modifications to rules relating to retirement plans.”

Among other items, the budget suggests imposing $10 million and $20 million caps on savings in tax-favored retirement accounts for “high income taxpayers,” and requiring distributions of a portion of the excess based on the applicable cap.

A high-income taxpayer would be someone with gross income over

  • $450,000, if the taxpayer is married and filing jointly (or is filing as a surviving spouse); or
  • $425,000, if the taxpayer is a head-of-household; or
  • $400,000, in other cases.

High-income taxpayers with accumulations of more than $10 million would be required to distribute 50 percent of the excess amount, and if accumulations exceeded $20 million, then the required distribution would be the lessor of the excess or all Roth accumulations.

Second, plan administrators of a tax-favored retirement arrangements would be required to report to the Treasury Secretary any vested account balance of a plan participant or beneficiary that exceeds $2.5 million.

Third, certain Roth conversions would be eliminated for high-income taxpayers (as described above).

While action on these initiatives is not expected this year, targeting large retirement account balances has some populist appeal, and has had the support of Democrat policymakers for some time. The idea of capping retirement accumulations is likely to persist beyond the next election.

Conclusion

The president’s budget proposal, containing suggestions on how to achieve income and spending goals, is an early step in the budget process. None of the budget’s provisions are law at this point. But several themes targeting excessive retirement savings in the budget reflect the current focus of the Administration and are likely to be points of discussion and debate in Congress.

© Copyright 2024 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Can investors still complete Roth Recharacterizations?

/in /by

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Wisconsin is representative of a common inquiry related to recharacterizations.

“A colleague of mine told me that it is still possible to complete a Roth recharacterization. I thought those transactions were discontinued. If recharacterizations still exist, does that mean my client can recharacterize an unwanted Roth IRA conversion?”

Highlights of the Discussion

While investors still have the ability to recharacterize Traditional or Roth IRA annual contributions as the other type of IRA contribution if done so by their tax return due date plus extensions, investors no longer have the ability to recharacterize Roth IRA conversions.

Prior to 2018 investors did have the ability to undo or recharacterize a conversion (rollover) of IRA or retirement plan assets to Roth IRAs. However, effective January 1, 2018, pursuant to the Tax Cuts and Jobs Act (Pub. L. No. 115- 97), a conversion from a traditional IRA, simplified employee pension (SEP) or savings incentive match plan for employees (SIMPLE) IRA to a Roth IRA cannot be recharacterized. Likewise, the law also prohibits recharacterizing amounts rolled over or converted to a Roth IRA from workplace retirement plans, such as 401(k) or 403(b) plans.

Conclusion

Recharacterizations still exist, but only to treat a regular annual contribution made to a Roth IRA or to a traditional IRA as having been made to the other type of IRA.

© Copyright 2024 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

De-villainizing Backdoor Roth IRAs

/in /by

“Backdoor Roth IRAs sound bad. Are they?”  

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from California is representative of a common inquiry related to Roth IRA conversions.

Highlights of the Discussion

You won’t find the phrase backdoor Roth IRA in the Internal Revenue Code or Treasury regulations. Nor is it a specific product, but the industry has known about the phenomena for years.  A backdoor Roth IRA is merely a series of transactions or steps an individual can take to have a Roth IRA—regardless of income level.

The ability to make a 2019 Roth IRA contribution is phased out and eliminated for single tax filers with income between $122,000-$137,000; and for joint tax filers with income between $193,000-$203,000. Consequently, if a person earns too much, he or she cannot make a Roth IRA contribution directly (i.e., through the front door). But, many can still take another route—through a traditional IRA.

For traditional IRA contributions, there are modified adjusted gross income (MAGI) thresholds that apply above which individuals are prevented from making deductible contributions.[1] However, anyone under the age of 70½ with earned income can make a nondeductible contribution to a traditional IRA, regardless of income level.  Anyone with a traditional IRA can convert it to a Roth IRA regardless of income level. The traditional-IRA-to-Roth-IRA conversion is another route to having a Roth IRA—what has become known as the backdoor Roth.

IRA technicians through the years have raised the specter of the Step Transaction Doctrine to cast a shadow over the efficacy of the backdoor Roth IRA. The Step Transaction Doctrine is a broad application tax law policy in which the IRS may view a series of separate but related transactions as a single transaction and apply any tax liability based on that transaction rather than the individual transactions in the series.

A traditional-IRA-to-Roth-IRA conversion is a taxable event to the extent a person converts pre-tax dollars. There are ways to maximize the tax efficiency of the transaction, for example, by rolling over IRA pre-tax dollars first to a qualified retirement plan. Those strategies are beyond the scope of this writing, but the consultants at RLC’s Resource Desk would be happy to have those discussions.

Informal guidance from the IRS and Congress from a year ago seems to have put to rest the concerns about backdoor Roth IRAs and the Step Transaction Doctrine. First, Congress made reference to the legitimacy of the traditional-IRA-to-Roth-IRA conversion in its conference report for the Tax Cut and Jobs Act (see page 289).

Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.

Second, in a July 10, 2018, Tax Talk Today, Donald Kieffer Jr., a tax law specialist in employee plans rulings and agreements with the IRS Tax-Exempt and Government Entities Division, said the backdoor Roth is allowed under the law. Mr. Kieffer stated: “I think the IRS’s only caution would be whenever we see words like ‘backdoor’ or ‘workaround’ or other step transactions that are putatively enabling a way to get around limits – especially statutory contribution limits – you generally find the IRS is not happy and prepared to challenge those. But in this one that we’re talking about, it’s allowed under the law.”

Conclusion

According to IRS and Congressional guidance, “backdoor” is no longer a cue for a potentially illicit tax activity when linked to Roth IRA. Therefore, it’s time to de-villainize the transaction.

[1] If filing a joint return and covered by a workplace retirement plan $103,000,-$123,000; Single or head of household $64,000-$74,000; and Joint return with spouse not covered by a workplace plan $193,000-$203,000

© Copyright 2024 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

After-Tax Contribution Limits in 401(k) Plans

/0 Comments/in /by

“What are the considerations for a 401(k) plan participant who wants to “max out” his/her after-tax contributions in the plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Ohio is representative of a common inquiry related to after-tax contributions in 401(k) plans.

Highlights of Discussion

  • There are several considerations for making after-tax contributions to a 401(k) plan, including whether the plan allows for after-tax contributions and, if so, what limits apply.
  • In order for a participant to make after-tax contributions to his or her 401(k) plan, the plan document must specifically allow for this type of contribution. For example, using our “Plan Snapshot” library of employer plan documents, RLC was able to confirm that the 401(k) plan in question does permit after-tax contributions.
  • Additional considerations when making after-tax contributions include any plan specified contribution limits; the actual contribution percentage (ACP) test; and the IRC Sec. 415 annual additions test.
  • Despite having a plan imposed contribution limit of 50 percent of annual compensation according to the plan document, the advisor determined his client could maximize his pre-tax contributions and still make a large after-tax contribution as well.
  • After-tax contributions are subject to the ACP test—a special 401(k) test that compares the rate of matching and after-tax contributions made by those in upper management (i.e., highly compensated employees) to the rate made by rank-and-file employees (i.e., nonhighly compensated employees) to ensure the contributions are considered nondiscriminatory. Even safe harbor 401(k) plans are required to apply the ACP test to the after-tax contributions if any are made. If the plan fails the ACP test, a typical corrective method is a refund of after-tax contributions to upper management employees.
  • In addition, each plan participant has an annual total plan contribution limit of 100 percent of compensation up to $54,000 for 2017 and $55,000 for 2018, plus an additional $6,000 for catch-up contributions, under IRC Sec. 415 (a.k.a., the annual additions limit). All contributions for a participant to a 401(k) (e.g., salary deferrals, profit sharing, matching, designated Roth and after-tax) are included in a participant’s annual additions. If a participant exceeds his annual additions limit, a typical corrective method is a refund of contributions.
  • In general, a 401(k) plan participant can convert his after-tax account balance to a Roth IRA while working as long as 1) the plan allows for in-service distributions; 2) the after-tax contributions and their earnings have been segregated from the other contribution types in a separate account; and 3) the participant follows the standard conversion rules (IRS Notices 87-13, 2008-30 and 2014-54).

Conclusion

Roughly one-third of 401(k) plans today offer participants the ability to make after-tax contributions.[1]  While this may be viewed as a benefit from many perspectives, there are several important considerations of which plan participants must be aware.

[1] Plan Sponsor Council of America, 59th Annual Survey; and Retirement Learning Center Plan Document Database, 2018

© Copyright 2024 Retirement Learning Center, all rights reserved
IRA
Print Friendly Version Print Friendly Version

Taxability of IRA Conversions

/0 Comments/in /by

I believe the IRS requires a person to treat a Roth IRA conversion as consisting of a pro rata share of the individual’s pre- and after-tax retirement assets. When determining the taxable amount of a traditional-to-Roth IRA conversion, does my client include his 401(k) plan balance in the calculation?

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.  A recent call with a financial advisor in Illinois is representative of a question we commonly receive related to Roth conversions.

Highlights of Discussion

  • Your client would not include his 401(k) balance when determining the taxable amount of a traditional IRA-to-Roth IRA conversion. Please see IRS Publication 590-A for further guidance.
  • When calculating the taxability of a conversion in this case, your client would include all of his nonRoth IRAs for which he is the direct owner, including traditional IRAs, simplified employee pension (SEP) IRAs, and savings incentive match plan for employees (SIMPLE) IRAs.
  • Retirement accounts that are not considered include
    • Inherited traditional, SEP or SIMPLE IRAs (unless a spouse beneficiary has elected to treat the inherited IRA as his or her own);
    • Defined contribution plans (e.g., 401(k) plans);
    • Defined benefit pension plans;
    • 403(b) plans;
    • 457 plans;
    • Nonqualified accounts and plans; and
    • Annuities (unless they are individual retirement annuities under Section 408(b) of the Internal Revenue Code).
  • The steps for calculating the taxable amount of a traditional IRA-to-Roth IRA conversion are part of the IRS Form 8606, which your client must complete and file to report the conversion.
  • Encourage your client to discuss the conversion with his tax advisor.

Conclusion

Because a traditional IRA-to-Roth IRA conversion is (generally) a taxable and (always) a reportable transaction, investors should consult their tax attorneys or professional tax advisors concerning their particular situations.

 

© Copyright 2024 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

October–Think “Recharacterization Deadline”

/0 Comments/in /by

Is it too late to recharacterize a Roth conversion for 2016?

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in New Jersey is representative of a common inquiry involving recharacterizations.

Highlights of discussions

A 2016 conversion to a Roth IRA, generally, can be undone (“recharacterized”) as late as October 16, 2017 [IRC Sec. 408A(d)(6)].  However, if your client completed a conversion of 401(k) assets to a designated Roth account within the 401(k) plan (rather than to an external Roth IRA), he or she would not be able to recharacterize the in-plan conversion, regardless of when the conversion occurred (IRS Notice 2010-84, Q&A 6.)

The IRS will allow taxpayers to recharacterize an unwanted Roth IRA conversion for any reason without tax or penalty as long as it is done by the deadline, which is generally October 15th of the year following the year of conversion. (If the time for completing the rechacterization falls on a Saturday, Sunday or legal holiday, the deadline becomes the next businesses day. October 15, 2017, is a Sunday, so the deadline becomes the 16th IRC Sec. 7503.)

The recharacterization timeframe is connected to when your client filed his or her tax return. For a conversion to a Roth IRA completed in 2016, if your client filed his or her 2016 tax return on time (i.e., by April 17, 2017) he or she could recharacterize the unwanted conversion without tax or penalty at any time up to October 16, 2017. Of course, he or she would have to properly amend the 2016 tax return to reflect the recharacterization.

For a conversion completed in 2017, if your client files his or her 2017 tax return on time (i.e., by April 16, 2018) the individual would have until October 15, 2018, to recharacterize the unwanted conversion without tax or penalty.

To accomplish a recharacterization, your client would need to transfer the converted amount, along with any gains or losses, back to a traditional IRA within the prescribed IRS timeframe. Even in the case of a qualified plan-to-Roth IRA conversion, the rechacterization must go to a traditional IRA; it cannot go back to the original qualified plan (Treasury Regulation 1.408A-4, Q&A 3 and IRS Notice 2008-30, Q&A 5).

Following a recharacterization, your client has the option to “reconvert” a similar amount to a Roth IRA after satisfying the required waiting period for a “reconversion.” The required waiting period ends on the date that is the later of

  • 30 days after the recharacterization or
  • January 1 of the year following the conversion

EXAMPLE:

Thom converted a portion of his 401(k) plan assets in 2016 to a Roth IRA. He filed his 2016 tax return timely on April 17, 2017. Thom elects to recharacterize his 2016 Roth IRA conversion to a traditional IRA by October 16, 2017, and amends his 2016 tax return. The soonest Thom could reconvert a similar amount would be November 15, 2017.

As a rule of thumb, if a client converts and recharacterizes in the same year, he or she must wait until the following year to reconvert.

Conclusion

The IRS’ Roth IRA conversion/recharacterization/reconversion rules give taxpayers a great deal of flexibility if the proper process steps are completed within the set deadlines. Clients who are contemplating any of the three actions should carefully discuss them with their tax advisors.

© Copyright 2024 Retirement Learning Center, all rights reserved