This month and next, help your clients by advising them to use a 2008 Roth IRA conversion to take advantage of the stock market decline.
That will be the case for clients who meet these two criteria: They have traditional individual retirement accounts, 401(k)s or other company retirement plans (if they are eligible to take a distribution from the company plan) that are invested in stocks, and have 2008 income that doesn't exceed $100,000 on a single or joint tax return.
Such clients can convert those traditional IRAs (or plans) to Roth IRAs now at lower tax cost.
For example, Monica had $200,000 in her traditional IRA a year ago, when stocks were at their peak. Assuming a 28% tax rate, she might have paid $56,000 to convert that account to a Roth IRA.
Now Monica's traditional IRA is worth just $100,000. A Roth IRA conversion today will cost her just $28,000 or even less if the lower conversion amount leaves her in a lower tax bracket.
There is another benefit to a Roth IRA conversion that occurs at or near yearend for a taxpayer establishing his or her first Roth. All 2008 Roth IRA conversions have a Jan. 1 starting date, regardless of when the conversion occurs during the year.
Roth IRA distributions are completely tax-free five years after a conversion, as long as the account owner is at least 591/2 years old.
Thus, if Monica converts to a Roth IRA by yearend 2008, she will reach the five-year mark Jan. 1, 2013.
If you think that tax rates may increase next year, you want to make sure your conversion is done in 2008 to lock in this year's tax rates. Regardless of whether tax rates increase, it still pays to convert, since you have until Oct. 15 to change your mind and undo (re-characterize) the 2008 Roth conversion.
To make sure the conversion counts as a 2008 Roth conversion, the funds must be withdrawn from either the IRA or company plan by yearend. Then, as long as the funds withdrawn are deposited in the Roth IRA within 60 days, it counts as a 2008 Roth conversion, even though the actual funds won't get into the Roth until January or February 2009.
For a Roth IRA conversion to be fully effective, the tax due should be paid from other assets. Some clients may not have the funds to pay the tax on a conversion.
In that case, suggest a partial Roth IRA conversion, which would generate less taxable income and might keep clients from moving into a higher tax bracket.
When you are discussing partial Roth IRA conversions with eligible clients, be sure that they use up low tax brackets in full. In 2008, for example, the 15% tax rate goes up to $32,550 in taxable income for single taxpayers and up to $65,100 for couples filing joint returns.
Suppose, near yearend, a married couple calculates that they will have $50,000 in taxable income (after deductions) in 2008. This couple can convert up to $15,000 of their traditional IRAs to Roth IRAs by yearend and still remain in the 15% bracket.
Such a conversion would cost them just $2,250: 15% of $15,000. They would move $15,000 into tax-free territory and start the five-year clock running.
Suppose a client says to you, "I think stocks will go even lower, and I'll get a better deal by converting later." You should tell such a client to convert by yearend anyway since they can change their mind until Oct. 15.
In our example, Monica can re-characterize her account by Oct. 15, making it a traditional IRA again. Any tax she already has paid on the $100,000 conversion can be re-claimed on an amended tax return if the tax already has been paid with her 2009 tax return.
If Monica wishes, she can wait 30 days after the re-characterization and reconvert to a Roth IRA. She will owe less tax then if the Roth IRA is worth less than $100,000 when she reconverts.
This process can go on year after year until Monica implements a Roth IRA conversion at the market bottom and pays a minimum amount of income tax.
By the same reasoning, before yearend 2008, you should find out if any clients have converted traditional IRAs to Roth IRAs this year. Suggest that they re-characterize now, while the market is down and their Roth IRA has been devalued.
Ed Slott, a certified public accountant in Rockville Centre, N.Y., created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace. He can be reached at irahelp.com.
For other IN Retirement columns visit InvestmentNews Retirement Center.
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