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Converting Your IRA
While April 15 is comfortably far off enough not to induce panic, you can never be too early to tackle tax planning. This week, Jeff Fleming discusses converting your traditional IRA to a Roth IRA and making tax deferred investments.
Dear Jeff:
I am planning to convert my traditional IRA to a Roth IRA this year. I know that I can pay the resulting income taxes over four years, but I would prefer to pay it all this year. Is this possible?
Jeff Says:
Would you believe that the original legislation establishing the Roth IRA made it mandatory to spread the conversion amount as income over four taxable years? Technical correction provisions now allow taxpayers to include the full amount in income for 1998.
There have been other corrections as well. For example, the five-year holding period requirement now begins with the first taxable year in which a Roth IRA is funded. Previously, a separate Conversion Roth IRA, which was measured separately, was required to identify qualifying distributions.
One other noteworthy correction. Individuals may now convert their SEP-IRA or SIMPLE-IRA to a Roth IRA. However, a two-year holding period must have elapsed before the conversion can take place.
Dear Jeff:
I contribute the maximum to my Roth IRA. Are there tax-deferred investments available that I should be considering?
Jeff Says:
You should consider using a variable annuity if you are considering alternative first tax deferred investment vehicles. Variable annuities have been referred to as the product of the 90s because of several attractive features.
First, of course is their tax-deferred nature. You do not pay taxes on any earnings until you actually withdraw the funds. The downside to this benefit is that the IRS imposes a 10 percent penalty for withdrawal of the annuity funds prior to age 59 1/2.
Annuities provide the investor with a number of different investment options so that you can properly diversify your holdings under the umbrella of one annuity contract. Most annuities offer a fixed account option, which is not subject to the market risks associated with equities. This may be attractive for conservative investors who wish to allocate a portion of their annuity contribution to something "safe."
One of the most unique features, however, is the guaranteed death benefit. If the participant dies, the annuity will pay to the named beneficiary the greater of the account value or the amount initially contributed, minus withdrawals. Since this benefit is defined differently in the different variable annuities offered, it is imperative to read the prospectus.
Variable annuities can serve as a very powerful weapon in your retirement planning arsenal.
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