Should I have an IRA?

[scooter260]

Here's our situation:
-My wife and I have a combined gross income of roughly $300M.
-We are in our mid-30's.
-We just set up traditional IRA's for both of us 3 years ago. Each year, we have contributed the max amount ($4,000, $4,000, $5,000).
-We both max out our 401k and also have other money in taxable mutual fund accounts

During our tax review this year, our accountant told us to get out of the IRA's and just transfer the money to traditional taxable investment accounts. I'm not exactly sure how he explained it, but I believe he said we make too much money to get any tax benefit from the IRA. He said something about the tax-free growth benefit NOW won't be that big of a deal once we start tapping into the money in retirement due to capital gains. Then he said, bottom line, it would likely just be easier and simpler just to have the money in a taxable account. Otherwise, "there are things" we need to do each year for taxes that will make it more of a hassle to have the money in an IRA.

Anyone care to help clarify or provide advice? Should we have the money in an IRA or just move it to a taxable account?

Also, is there something about the 2010 Roth IRA "opportunity" that makes it worthwhile to keep the IRA in place and move it to a Roth in 2010?

 

[LOL!]

Your IRA is just a complication in your life. You are not able to deduct from your income any of the contributions, but the earnings grow tax-deferred. That is, you have a non-deductible traditional IRA. Let's see what that gets you:
1. No tax deduction. Upon withdrawal your gains are taxed at your marginal income tax rate. Before withdrawal gains are tax-deferred.
2. If you die, your beneficiaries will pay taxes on it at their rate.
3. You have to fill out the pesky 8606 form when you contribute.
4. The amounts you can contribute are limited.
5. When you reach age 70.5, you must begin mandatory withdrawals and pay the taxes.
6. Penalties for early withdrawal before age 59.5.

In contrast, if you just contributed the money to a tax-efficient passively managed, very low expense ratio stock index fund, this is what you get:
1. No tax deduction, but upon withdrawal your gains are taxed at your much lower long term capital gains tax rate. Before withdrawal gains are tax-deferred.
2. If you die, your heirs get all the gains tax-free.
3. No pesky forms to fill out when you contribute, but you must save your annual statements so you can work out the cap gains in the future.
4. The amounts you can contribute are unlimited.
5. When you get old, you are not forced to begin withdrawals.
6. You can withdraw at any time. No penalties.

The idea that you can convert to a Roth IRA in 2010 is true. You will pay the taxes on any gains at your marginal income tax rate and then the funds will be tax-free. But at your marginal income tax bracket that's a big price to pay. Because these accounts are so small relative to the rest of your finances, they are not really going to make any impact.

So while I would not cash them in today, I would not contribute any more to them. I would convert to Roth IRA when I retired.

 

[LOL!]

And more on saving on taxes for high income folks. I would strive to have no Schedule B and and no Schedule D income each year. Take a look at your tax returns. What do they have on those forms? You should be able to get them to $0 or even negative with judicious tax planning.

For example, you should use only tax-efficient index funds in your taxable accounts. You should put all your tax-inefficient investments in your 401(k) and IRAs. If you want 90% stocks and 10% bonds, you may have to fill up your 401(k) with 100% bonds while your taxable accounts are 100% stock index funds. You may have to use tax-exempt muni bonds if there is not enough room in your tax-deferred accounts for fixed income. Etc.

 

[FinanceDude]

2. If you die, your beneficiaries will pay taxes on it at their rate.

You are fogetting about "stretching" the IRA, which mitigates the tax consequences significantly............

 

[LOL!]

My spouse has an inherited IRA. She is stretching it. She still pays taxes on it at her rate which is 33%. The deceased was in the 0% tax bracket. And the deceased was probably in the 0% tax bracket when she contributed to the IRA in the first place. So much for mitigation.

 

[FinanceDude]

My spouse has an inherited IRA. She is stretching it. She still pays taxes on it at her rate which is 33%. The deceased was in the 0% tax bracket. And the deceased was probably in the 0% tax bracket when she contributed to the IRA in the first place. So much for mitigation.

Yes, she still pays taxes, but NOT on the ENTIRE IRA, like under the "old rules"............

Based on your comments above, NOONE should have an IRA..........

 

[FinanceDude]

My spouse has an inherited IRA. She is stretching it. She still pays taxes on it at her rate which is 33%. The deceased was in the 0% tax bracket. And the deceased was probably in the 0% tax bracket when she contributed to the IRA in the first place. So much for mitigation.

How was the deceased in a 0% bracket when she was contributing??

 

[Maurice]

Scooter - I did the math and I think it makes sense for my wife and I to continue contributing to an IRA, specifically to take advantage of the 2010 exception. I think its almost a no-brainer, as long as you can pay the taxes for the conversion out of income in 2011 and 2012 (and don't have to sell investments to do so).

After 2010 I agree with your accountant.

By the way, my accountant told me the same thing, which is what got me to do the math.

 

[LOL!]

How was the deceased in a 0% bracket when she was contributing??

Over 65, minimum wage job, less than $5,000 in annual income. Living off SS and muni bond income. You can think of many scenarios that would fit the situation. Not necessarily smart scenarios, but people who absolutely hate to pay any taxes do not always do rational things.

 

[Maurice]

I see merit in the argument above that the amounts are so little it hardly worth the bother (in my case we've each rolled over old 401ks into the IRA, so we're talking ~0.5MM).

I understand the sentiment, but disagree with the conclusion. Since you already have the IRAs, it will make financial sense to convert them in 2010, hence you're already in for the bother. Might as well maximize the benefit by contributing in 08,09, and 10.

There's something to be said for having a never-to-be-taxed-again account, especially at your young age. And when you're retired, it will be nice to have a source of funds to draw on that are tax free, it will be a nice resource to help you manage your overall tax situation each year.

 

[LOL!]

Yes, she still pays taxes, but NOT on the ENTIRE IRA, like under the "old rules"............

Based on your comments above, NOONE should have an IRA..........

As clearly stated in my post, my comments applied to a non-deductible traditional IRA. And yes, basically, practically no one should have one of those.

 

[Maurice]

By the way, I'll post my calculations and assumptions later.... I need to dig up my spreadsheet.

 

[FinanceDude]

As clearly stated in my post, my comments applied to a non-deductible traditional IRA. And yes, basically, practically no one should have one of those.

Many folks had them before 1998.......... Roth IRAs changed things for a lot of folks.

 

[scooter260]

Thanks for everyone's replies. So, here's what I plan to do:

1. Continue contributing the max to the IRA in 2009 and 2010.
2. Convert the IRA to a Roth in 2010.

Question: after I convert the IRA to a Roth, should I still contribute to it annually or just leave it alone and let it grow tax free and invest my money elsewhere in taxable accounts?

 

[Art G]

I think you left out a part of the equation. Since you have a 401k, your IRA contributions were after tax contributions and therefore, your taxes will only be paid on the gains. In three years (especially the last three years) it's probably not that much. I'd definitely suggest you convert to a Roth and continue contributing if you can do so without it squeezing your budget. The tax free growth will be worthwhile and your heirs will be able to take the money tax free (unless you hit estate tax levels). You also won't be forced to take mandatory withdrawals at age 70 1/2.
For a real life example. Back when Reagan was in office, he allowed for fully deductible IRA contributions and a man I know put $2k into an IRA for a mere three years (1981-83) I believe. Anyway, that $6k invested in decent mutual funds is now worth around $140k or so. Worth it? I'd think so.

 

[youbet]

I would strive to have no Schedule B and and no Schedule D income each year. Take a look at your tax returns. What do they have on those forms?

So, how do I hide the 2% dividend that my significant holding in VTSMX kicks out and shows up on my Schedule B?

 

[jIMOh]

Here's our situation:
-My wife and I have a combined gross income of roughly $300M.
-We are in our mid-30's.
-We just set up traditional IRA's for both of us 3 years ago. Each year, we have contributed the max amount ($4,000, $4,000, $5,000).
-We both max out our 401k and also have other money in taxable mutual fund accounts

During our tax review this year, our accountant told us to get out of the IRA's and just transfer the money to traditional taxable investment accounts. I'm not exactly sure how he explained it, but I believe he said we make too much money to get any tax benefit from the IRA. He said something about the tax-free growth benefit NOW won't be that big of a deal once we start tapping into the money in retirement due to capital gains. Then he said, bottom line, it would likely just be easier and simpler just to have the money in a taxable account. Otherwise, "there are things" we need to do each year for taxes that will make it more of a hassle to have the money in an IRA.

Anyone care to help clarify or provide advice? Should we have the money in an IRA or just move it to a taxable account?

Also, is there something about the 2010 Roth IRA "opportunity" that makes it worthwhile to keep the IRA in place and move it to a Roth in 2010?

"there are things"= Required Minimum Distributions (RMDs). These begin at age 70.5. It is possible an RMD could put you in a higher tax bracket in retirement.

The ways to deal with an RMD- get money out of IRAs and 401ks and into either Roth accounts or taxable accounts. You are not eligible for a Roth, so a taxable account is being suggested.

Have you done any retirement calculators? Do you know what age you will retire?

Here is my thought:

1) You can use traditional IRAs now if you retire early enough to transfer these to Roths (convert to Roths) in retirement (by capping out tax bracket).
2) This strategy works best if you have at least 20-30 years of early retirement (retire before age 40). Moving 10k-20k per year to a Roth requires time to transfer wealth out of RMD terriritory.
3) taxable accounts can give you some huge benefits. RMDs are taxed at marginal tax rates. 28% or 33% right now for your situation (probably). Taxable accounts will pay dividends (taxed at 15% or less), long term capital gains (taxed at 15% or less), short term capital gains (taxed at 28 or 33%) and interest (taxed at 28 or 33%).
4) You need a detailed plan of what you are going to do, when you think you will do it, and the plan to access the money when you get there. The more details the better.

 

[lucija]

...Also, is there something about the 2010 Roth IRA "opportunity" that makes it worthwhile to keep the IRA in place and move it to a Roth in 2010?

Do you have any other IRAs? If so, keep in mind that 2010 ROTH conversions are across all IRAs for a given SS#. In other words you cannot opt to convert a 100% of a small non-deductible IRA to ROTH while ignoring a funds within a large traditional IRA.

If (or for as long as) you have no other IRAs, I would keep contributing to non-deductible IRAs and keep converting them to ROTHs starting in 2010 (assuming no changes to current laws).

 

[Art G]

Do you have any other IRAs? If so, keep in mind that 2010 ROTH conversions are across all IRAs for a given SS#. In other words you cannot opt to convert a 100% of a small non-deductible IRA to ROTH while ignoring a funds within a large traditional IRA.

If (or for as long as) you have no other IRAs, I would keep contributing to non-deductible IRAs and keep converting them to ROTHs starting in 2010 (assuming no changes to current laws).

Uhhh, I've never heard that. You're telling me you have to convert all your IRA's or none? I don't believe that's correct.

 

[lucija]

Uhhh, I've never heard that. You're telling me you have to convert all your IRA's or none? I don't believe that's correct.

My apologies for being unclear. You certainly have an option to do partial IRA conversion. However, if you have 10k in a non-deductible IRA and a large traditional IRA (say 100k+), you can't say "I would like to convert only the 10k worth of non-deductible IRA and pay tax on only $500 worth of gains" -- you can convert 10k, but it will be pro-rated across all non-ROTH IRAs making your tax hit (potentially) substantially higher.

 

[kaneohe]

Uhhh, I've never heard that. You're telling me you have to convert all your IRA's or none? I don't believe that's correct.

What he is trying to tell you is that IRS treats all your traditional IRAs as one single IRA. You can convert just part of it if you like but it will be treated as coming from all your IRAs in terms of what fraction will be considered a taxable conversion and what part will be non-taxable.

Ex: all you have are non-deductible IRAs. The conversion will be tax free.

Ex: you have a small non-deductible IRA whose contribution is a small %
of the total IRA value. The conversion will be mostly taxable even if it only
came from that non-deductible IRA.

 

[Art G]

Aha. Thank you. From his example stated, he has had an IRA and a 401k, so the IRA's have had to be after tax I believe.-
I'm reading all the recommendations here and I can't think of a reason why you wouldn't want to convert at his age as soon as possible.

 

[mathjak107]

converting may or may not be a good idea. our big thing is i dont see being in a higher tax bracket with no paycheck coming in later on unless social security pays us 6 figures. and you have to figure in whether or not you will be living in another state. right now we live in nyc. when we retire we will live in PA. no comparison in state and local taxes . id never want to pay all that state tax on a conversion now i cant see much roth converting in the cards for us. in fact our state and local taxes are so high that just the combo of our income and the state and local taxes paid zonks us with an amt penalty.

only way i see a conversion paying off is if the market tanks big time. then do the conversion while its value is low and ride it back up tax free in a roth

 

[mathjak107]

Your IRA is just a complication in your life. You are not able to deduct from your income any of the contributions, but the earnings grow tax-deferred. That is, you have a non-deductible traditional IRA. Let's see what that gets you:
1. No tax deduction. Upon withdrawal your gains are taxed at your marginal income tax rate. Before withdrawal gains are tax-deferred.
2. If you die, your beneficiaries will pay taxes on it at their rate.
3. You have to fill out the pesky 8606 form when you contribute.
4. The amounts you can contribute are limited.
5. When you reach age 70.5, you must begin mandatory withdrawals and pay the taxes.
6. Penalties for early withdrawal before age 59.5.

In contrast, if you just contributed the money to a tax-efficient passively managed, very low expense ratio stock index fund, this is what you get:
1. No tax deduction, but upon withdrawal your gains are taxed at your much lower long term capital gains tax rate. Before withdrawal gains are tax-deferred.
2. If you die, your heirs get all the gains tax-free.
3. No pesky forms to fill out when you contribute, but you must save your annual statements so you can work out the cap gains in the future.
4. The amounts you can contribute are unlimited.
5. When you get old, you are not forced to begin withdrawals.
6. You can withdraw at any time. No penalties.

The idea that you can convert to a Roth IRA in 2010 is true. You will pay the taxes on any gains at your marginal income tax rate and then the funds will be tax-free. But at your marginal income tax bracket that's a big price to pay. Because these accounts are so small relative to the rest of your finances, they are not really going to make any impact.

So while I would not cash them in today, I would not contribute any more to them. I would convert to Roth IRA when I retired.

if you have a sizable ira and other assets and it looks like you will be over the estate exemption amount take some of your ira, pay the tax when your in a lower bracket and beyond penaly age , buy life insurance with the money making your ira beneficiary as the policy owner and pass many more times that amount tax free from the life insurance payout to your heirs and estate tax free if your subject to it.. you can save a ton of estate taxes later on by doing this. it makes the cost of insurance a drop in the bucket compared to the estate tax rate both federal and state

 

[Art G]

I'm going to refer back to the original situation....

Here's our situation:
-My wife and I have a combined gross income of roughly $300M.
-We are in our mid-30's.
-We just set up traditional IRA's for both of us 3 years ago. Each year, we have contributed the max amount ($4,000, $4,000, $5,000).
-We both max out our 401k and also have other money in taxable mutual fund accounts

So, he's not going to get bumped into a higher tax bracket.

He's only in his mid 30's so he's got 25 years of tax free growth to look forward to AND there's a good chance his IRA has dropped back in value recently.

He has only been in these IRA's for three years and thus should have very little in earnings so far.

If he's maxing out his IRA's and 401k's, he apparently isn't struggling currently to get by, nor does it seem he's likely to need to draw out the money early and pay a penalty.

So, he and his wife have about $26k combined in IRA's plus any earnings that will be taxable. If he's up 8% per year for the last three years than he will have an additional $6500 or so of taxable earnings. For the $2k or so he'll have to pay in taxes, he is gaining tax free growth forever after. At that same assumed 8% growth for 25 years will turn his $26k into $208,000 TAX FREE.
It's a no brainer....convert poste haste. JMO.