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How Do I Rescue My Retirement?
Posted: Wednesday, August 11, 2010 8:14 am
You are asking yourself that question because you're honestly worried about your future lifestyle. A significant portion of your career achievement is represented by the accumulated assets in your 401K/IRA plans. Now you feel as if you're walking around with a target painted on your back. Tax law changes from a Federal Government desperately needing revenues are threatening to confiscate a major portion of your savings.
Is there any way to derive adequate lifetime income from your retirement accounts to afford a reasonable life style—perhaps even into your late nineties?
You are not alone in your concern. You are part of a large group that have worked, even sacrificed, for many years to build a nest egg in accordance with the tax rules of the day, that now appear to be easy prey for the government tax machine which is revving up the engine to gulp down big chunks of your savings.
When you see the size of the current budget deficit compared to the amount of revenue that will be generated by our current income tax structure, is there any doubt that taxes will increase? Where will that leave you?
Realistically, the tax increases have already started.
The Medicare tax increase will take effect in 2013. But, due to the sunset provision of the "Bush tax cuts," several forms of investment income (interest, annuities, royalties, rents, and short-term capital gains) are scheduled to increase to 39.6 percent beginning in 2011. Once the new Medicare tax hits in 2013, the top rate will jump to 43.4 percent, a 24 percent increase over the current tax rate.
At this point, retirement plan distributions are exempt from the new tax. However, literally a stroke of the pen could allow the government to tap into the enticing pot of gold known as tax deferred retirement funds. Why defer the tax? It's needed now!
Here are the questions and potential solutions to these issues. Simply speaking, thesolution is to get your money out of the tax-deferred position of a retirement plan now, before taxes rise. Indeed, why wait for higher tax rates?
Your "silent partner" (AKA the IRS tax code), will own approximately 40 percent of your retirement accounts and wants more. The key to your survival is to transfer your funds, to an after-tax position before the almost certain increases. Furthermore, you can do more by transferring the funds at a sizeable discounted total.
What's the secret to getting more funds free of all the tax? How do I qualify for the discounted value? Isn't the balance of 401K accounts restricted and subject to heavy penalties, taxation? The secret is the process.
The first step - transfer your retirement funds from your 401K to an IRA.
You can accomplish this and still remain a participant by invoking the In-Service Non- Hardship (ISNH) distribution provision. With the emphasis by interested parties on retaining assets in the plan, the ISNH is a seldom-used, uncomplicated provision which is readily available if not already in your 401K plan. Just a "check-the-box" amendment to add the provision to your plan if you're the owner-employee in control. Thereafter, you can rollover funds to an IRA by means of the ISNH, and continue as a member of the 401K plan without triggering a taxable event.
By using a direct rollover to an IRA you have avoided a convoluted taxable distribution altogether. Otherwise, you are facing taxable ordinary income, possibly some tax free income and the 10 percent early withdrawal penalty if you are under age 59 1/2; all to be calculated on your next tax return. The direct rollover to an IRA is definitely a good thing.
The second step – A fund program of alternative investments.
Once the rollover is complete, you are positioned to make moves that will provide big rewards. The key at this point is to invest the assets of your self-directed IRA into funds/programs that generate a discounted present value—a common practice for estate tax planning. The lack of liquidity, marketability, and control over the individual investments are the factors in determining the discounted value. If your IRA invests in a non-liquid REIT, for example, the carrying value in the IRA account would be less than the purchase price until such time as the REIT or the underlying assets can be sold. The same is true of certain ETF's and even fixed income securities with balloon maturities. The IRA custodian must report the individual present value supplied by the investment sponsors at a range of 70 percent to 75 percent of the acquisition cost.
The next step: convert the Traditional IRA to a Roth.
After the discounted value is established, the third step is to convert the traditional IRA to a Roth IRA. This is a transfer of in-kind assets. Thus, the conversion results in a taxable event with a substantial discount even if tax rate remains constant. By paying the tax now, you have limited your expense to the current rates, not the forecast increases. But, best of all, you have paid on a discounted value of perhaps 30 percent or more. As the chart below shows, on a million dollar 401K this can amount to a tax savings of $120,000, even more if the rates increase.
Additional advantages with the Roth IRA such as:
This is a broad overview of the three-step process and, of course, the "devil is in the details." However, if you qualify, the substantial savings are most certainly worth the effort.
Note: In order to maximize the assets growing tax-free in your Roth, taxes should be paid from funds other than those removed from the 401K. While the Roth conversion is the current rage of the financial world today, most are of the quick hit-and-run variety that do not maximize the benefits. Very few, if any, offer the complete process of extracting assets from the 401K, discounting the taxable value and transferring to the tax free Roth.
The unique three step process developed by Delta Advisory Group, Inc. of moving funds from the tax deferred status of the 401K, discounting the IRA value, paying reduced taxes while freeing your retirement funds of future taxes became possible with Federal tax regulation changes in 2010. Unfortunately, the clock is ticking toward tax increases that will mitigate the effectiveness of the rescue.
Donald C. Nestor is a Certified Financial Planner (CFPC) and a Certified Public Accountant (CPA). He specializes in retirement and estate planning and currently is Senior Vice President of Delta Advisory Services, Inc.
With more than 20 years as an independent financial advisor, Don has conducted numerous seminars, workshops, and educational programs. He hosted a radio program on WDBO in Orlando for several years titled "Money Matters" and has made frequent guest appearances on local TV. Tags:NoneBookmark:
Member Opinions:
By: Scott on 10/29/11
One of our most popular tax/retirement strategies we offer affluent clients is discounted IRA to Roth Conversions. Anyone in estate planning, most CPA's and trust attorneys would be familiar with discounting methods granted by the IRS for valuing assets. These regs, IRS rules were made law 1959. They allow owners of certain assets to discount the value of assets with minority interest and liquidity constraints. These rules may also be applied to certain assets owned within an IRA. We have been able to secure valuations of their IRA's by seasoned valuation specialists, of as much as 40 to 60% discounts. This means that a $1million IRA with the right assets, such as oil or natural gas royalty programs, that are paying 10-12% annual income on the $1 million, while the actual value for tax purposes was reduced, discounted to only $520,000 (a 48% discount). Now the income of $100,000 to $120,000 annually is tax-free for 35 to 50 years, and continues to the owners spouse, kids, grandkids – all receiving tax-free income. The difference from taxable to tax-free income for life makes up, many times over, the cost of paying the taxes today. The tax savings is about half the normal Roth Conversion taxation - with the lowest tax rates in history. What happens to IRA’s that are not converted, when next year, or the year after, income tax rates could be back at 1970’s levels of 77%, and the IRA owner, having reached age 70 ½ is forced to start drawing the Required Minimum Distributions (or RMD’s). Then it will be a little late to take advantage of this IRS approved tool. If the Roth IRA is one of the greatest gifts granted by the IRS what would you call a Roth for which the owner will receive the same tax-free income for life, but with half the taxes normally attributed to a conversion – Even Better! This is possibly one of the best tax tools ever made available to financial advisors and their highly taxed clients. |
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