South Florida Estate Planning Law : Florida Estate Planning Lawyer & Attorney : David Shulman Law Firm : South FL Wills & Trusts

I'm sure a lot of you are reading the headline above and thinking "Say wha?"

Let's back up.  There are (generally) two types of IRAs, which stands for Individual Retirement Arrangements (Yes, "Arrangements" and not "Accounts."  Look it up).  There is the "Traditional" IRA and the Roth "IRA".  (Also note that Roth is not written in all caps as it's not an acronym but named after the late Sen. William Roth of Delaware).

Without going into more specific detail, the contributions to a traditional IRA are generally deductible, but the distributions are taxable income when withdrawn. On the other hand, with a Roth IRA, the contributions are with after tax money, but the withdrawals are tax free.  There are other advantages to the Roth, including the fact that the owner is not required to start taking minimum distributions at the age of 70 1/2.

There are income limitations as to who can contribute to a Roth IRA, and who can convert their traditional IRA to a Roth IRA.  In 2010, the income limitation preventing wealthier individuals from converting their traditional IRA to a Roth disappears.  Anyone can convert their traditional IRA to a Roth, but they have to recognize the amount converted as taxable income.  In other words, if your traditional IRA is worth $100,000 at the time of conversion, then if you convert you will have $100,000 in additional income, subject to taxes.  There is a special rule for those that convert in 2010, allowing them to spread the taxes owed over 2 years.

I've seen numerous articles on the internet and have heard a few presentations debating who should convert their traditional IRA to a Roth and who shouldn't.  These articles state that a number of factors should be looked at before converting: (1) the person's age; (2) the person's tax bracket; (3) whether they can pay for the conversion from funds outside of the IRA; (4) how long they have until retirement; (5) whether they think they will have a higher or lower tax rate in retirement.

All of this is true, and all of those factors should be examined.  But they should be examined after everyone converts on Monday, January 4, 2010.  Why?  Because if you convert you have until October 15 of the following year (i.e. October 15, 2011) to undo it (known as a recharacterization), penalty and consequence free.  You can even do a partial recharacterization, meaning some of the IRA will stay as a converted Roth IRA and some will go back to the traditional.

The amount of income that you are required to recognize for tax purposes, is the value of the traditional IRA at the time of the conversion.  If you wait to convert, you are risking missing a substantial increase in the market.  If the market goes up, it could cost you substantially more in taxes to convert than it would have if you had not waited.  If the market goes down, or, if based upon the above factors you later decide that converting was not the best option for you, you have almost two years (if you convert in January) to change your mind.  Not only that, you can still reconvert to a Roth IRA, provided that the reconversion is not in the same year as the initial conversion and not within 30 days of the recharacterization. 

So I think everyone should convert their traditional IRA to a Roth IRA in early January of 2010, and then they should wait and see whether or not it was a good choice, because believe it or not, Congress is giving you a do-over.

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I found this article from Newsday interesting.  They list six ways to save taxes, based mostly on depressed asset values, something that I've written about before.

1. Convert your traditional IRA to a Roth IRA.
2. "Undo" or recharacterize a Roth IRA conversion if your initial conversion was in 2008 when values were significantly higher.
3. If you have begun taking Required Minimum Distributions from your IRA, don't take one in 2009.
4. Take what the articles calls "inherited IRA deductions" which is an income tax deduction for the estate taxes paid on an inherited IRA for something that is known as income in respect of a decedent (IRD).
5. "Get ready" for higher taxes rates that are coming.
6. Transfer assets out of your estate while they are at a low value. 

Each of these may be a good idea depending upon your individual situation.  Before going through with any of them you should see an expert -- a tax attorney, CPA, or financial planner that specializes in this area.

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In the past, I have discussed the importance of everyone, single or married, gay or straight, to have either their Will or Revocable Trust properly drafted and executed.  The reason for this, of course, is so that you can decide how your property is distributed upon your death and the state doesn't decide for you through the rules of intestacy.

Today, I want to tell you that for certain of your assets, this might not be enough  There are certain assets that pass outside of probate, meaning their disposition is not governed by your will or your trust.  Although this list is not complete, the most common assets are as follows:

1. Section 401(k) plans
2. IRAs including both traditional and Roth IRAs
3. Other Retirement Plans
4. Annuities with a pay on death feature
5. Life Insurance Policies.

This is not a complete list, and you can see that there are some common features in the above items.  In each of these, the "owner" does not necessarily own the underlying asset directly.  Instead, the asset is held by a third party, for example an IRA custodian or a 401(k) plan sponsor for the benefit of the owner.  These assets are not "probate" assets and are not disposed of by your Will or Trust.

Instead, they are distributed pursuant to the Beneficiary Designation.  If you have a life insurance policy, and an IRA and a 401(k), you need to properly complete the Beneficiary Designation form for each and every one of them to make sure that those assets are properly distributed upon your death.  The individual beneficiary designation controls what happens to each of these assets, and not your will.  Also note that if you are married, there are restrictions as to who you may designate on your 401(k) only.  

The reason that it is so important to have a properly executed beneficiary designation is that because if these assets pass outside of probate, they should be outside the claims of your creditors.  If done properly, your heirs can generally inherit your retirement plans and life insurance policies without having to first pay that creditors of your estate (but you need to check with an attorney in your state to be sure).

A few more items you should know:

1. You do not have list an individual on your Beneficiary Designation.  You can list multiple people, or even a trust.  The more money there is, the better idea a trust is.
2. You can (and should) designate alternate Beneficiaries, in case the person you listed first is no longer living
3. If you do not properly designate a beneficiary, then the asset will be distributed to the "default" beneficiary.  Who this is is generally based on the contract with the company holding the asset (life insurance company, IRA custodian, etc.).  The default beneficiary is often your estate (which then subjects your assets to creditors), or sometimes your surviving spouse.

A well crafted estate plan includes not only properly drafted and executed wills, trusts, and advanced directives, but also properly drafted beneficiary designations.  If you have these type of assets, it is important that you discuss with your estate planning attorney the best way to complete the beneficiary designation forms, so that they are disposed of as part of your overall estate plan.

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The year 2009 is shaping up to be interesting when it comes to making decisions regarding your IRA.  First, despite the mini-rally of the past four days, the market is still at a longtime low.  But second, there are two unique and temporary laws that have never coincided before.

First, Congress enacted a law late last year lifting the obligation to take Required Minimum Distributions (RMDs) for 2009.  That means that if you had already started taking RMDs from your IRA (which are generally subject to income tax), you can keep your distribution amount in the IRA for one year only.  (Note, most people reading this probably have not reached the age where they are required to take, or have started taking RMDs).

Second, Congress has extend the rules regarding "IRA Charitable Rollovers" through 2009 also.  This allows individuals who are 70 1/2 or older to contribute up to $100,000 directly from their IRA to a charity.  Normally, a person would have to take a distribution from the IRA (subject to tax) and then turn around and make a charitable contribution and take a corresponding charitable deduction.  However, because of the various limitations on deductions in the Internal Revenue Code, the individual might not be able to deduct the entire amount.

These two different rules don't necessarily overlap -- one allows people to keep their money in their IRAs and one gives them a way to take it out (without paying tax), and they are both temporary.  But it's interesting to see which one will be more important in this economy.

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