Roth IRA Conversion: Offset Taxes by Supporting ARI
As of 2010, individuals may convert all or part of their traditional IRAs to Roth IRAs regardless of their income level. (Previously, Roth IRA conversion was limited to those whose modified adjusted gross income was $100,000 or less.) There are still income and contribution limits on new contributions to Roth IRAs, but not on contributions that are converted, i.e., “rolled over,” from other IRAs. Why might an IRA owner take this action, and what might the implications be for his support of the Ayn Rand Institute?
We hope you will find the following FAQ helpful to your understanding of this tax planning strategy. We remind readers that many factors go into making financial decisions, and that the rules governing IRAs are complicated. Thus we strongly encourage consultation with your financial advisor before taking action based on the information presented here.
What is an IRA?
IRA stands for “Individual Retirement Account,” a creation of the Employee Retirement Income Security Act of 1974 (ERISA) offering tax incentives to save for retirement. Its chief advantage is the ability to make tax-deductible contributions to an account on which tax is deferred until the IRA owner begins taking taxable distributions. Generally speaking, distributions may begin as early as age 59.5, and are mandatory after age 70.5.
In this FAQ, “IRA” refers to any of three types of IRAs: traditional (both deductible and nondeductible), SEP (Simplified Employee Pension) and SIMPLE (another type of employer-sponsored IRA). “Roth IRA” refers to a different type of IRA than these others.
What is a Roth IRA?
The Roth IRA is a creation of the Taxpayer Relief Act of 1997 and is named after the late Senator William V. Roth, Jr., of Delaware. A Roth IRA is funded with money on which you have already paid tax. Thus your contributions to it are not tax deductible as with a traditional IRA, but a Roth IRA offers several distinct advantages: qualified distributions are tax-free to the IRA owner and/or his heirs; investment earnings accumulate tax-free; there are no mandatory withdrawals at any age; and there are fewer withdrawal restrictions compared to a traditional IRA.
What are the consequences of converting a traditional IRA to a Roth IRA?
If you convert, you provide more tax-free income for yourself in retirement and/or for your heirs, without mandatory withdrawals, and thus more control over your financial affairs in the future. The trade-off is that you must realize the converted amounts as income for tax purposes now and pay the tax due on this year’s tax return.
Pay the tax now? Why would I want to pay taxes sooner rather than later?
Tax deferral is usually preferable. But if you believe that tax rates will increase in the future, and you can afford to pay the tax now, doing so could be advantageous. Also, if your IRA assets lost value during the financial crisis and are still recovering, your tax liability for converting now could be less than in future years because you would be paying tax on a smaller amount. And, we can suggest some charitable giving options to help offset the tax hit (see #13).
I am under the age of 59.5. Isn’t there a penalty if I withdraw funds from my IRA?
Ordinarily, yes. But conversion to a Roth IRA is an exception (there are other exceptions as well; see IRS Publication 590 for details).
I am over the age of 70.5 and am required to take money from my IRA each year. Must I take this year’s Required Minimum Distribution (RMD) before converting to a Roth IRA?
Yes. Your RMD is not eligible for conversion.
Can’t I donate my RMD amount to ARI tax-free, and then convert?
Yes. See our IRA page for information about this opportunity.
Do the new Roth IRA rules allow me to contribute more in new dollars to my Roth IRA this year, regardless of whether I convert?
No. The contribution and income limits for new (versus rollover) Roth IRA contributions still apply. For most people, the 2013 contribution limit is $5,500 ($6,500 for those age 50 and older). The income limit depends on your filing status; for single taxpayers, the phase-out for Roth IRA contributions begins at $112,000 Modified Adjusted Gross Income (MAGI).
For example, if you are single, under age 50, and have MAGI of $112,000 or less, you can make a new contribution of up to $5,500 to your Roth IRA in 2012. If you are single and have MAGI of more than $127,000, you cannot make a new contribution to your Roth IRA. But in both cases you can convert any amount from other IRAs to your Roth IRA.
I do not have a traditional IRA, but I have a 401(k). Could I convert my 401(k) to a Roth IRA?
Yes—and you could do it directly, i.e., without having to first roll the 401(k) into a traditional IRA and then convert to a Roth IRA. However, there may be reasons to stay in your current plan (e.g., surrender charges, ERISA protection). Consult your financial advisor before taking this step.
If I decide to convert, how do I go about making the conversion?
If you are age 70.5 or older and have not yet taken your annual RMD, do that first (but see #7 above).
Then contact your IRA administrator for instructions. If you already have a Roth IRA or want to create the Roth IRA at the same financial institution as your other IRAs, an internal trustee transfer is the simplest way to effect the conversion. If your Roth IRA is or will be at a different institution, you can either request a trustee-to-trustee transfer, or take the distribution yourself and deposit it at the new institution within sixty days.
What if I convert and later decide it wasn’t a good idea. Can I undo the conversion?
Yes, the conversion is reversible via a “recharacterization” until October 15 of the year following the conversion.
Why might I decide not to convert?
The primary reason not to convert for most people is having to pay the conversion taxes. In addition, the taxable income generated by the conversion could put you into a higher tax bracket; for some seniors this could result in increased tax on social security income and higher Medicare premiums. Another reason to not convert this year would be if you are confident that you will be in a lower tax bracket next year or later.
I have decided to do a Roth IRA conversion this year. If I also decide to make a larger-than-usual gift to ARI this year, to help offset my tax liability from the conversion, what are my contribution options?
Here are some of the possibilities:
An outright gift of cash: For example, if your tax rate is 30 percent and you convert $10,000 to your Roth IRA, your tax liability on the conversion is $3,000. A contribution of $10,000 to ARI provides you with tax savings of $3,000, thereby cancelling out your tax liability.
An outright gift of marketable securities: For example, your tax rate is 30 percent and you convert $25,000 to your Roth IRA, resulting in a tax liability of $7,500. You donate to ARI $25,000 of stock which you purchased many years ago for $10,000. You obtain tax savings of $7,500, cancelling out your tax liability—and because ARI is tax-exempt, you avoid capital gain tax on the $15,000 gain as well.
A contribution in exchange for a charitable gift annuity, one of several types of “life income” arrangements: For example, you are 71 years old, your tax rate is 30 percent, and you convert $35,000 to your Roth IRA, resulting in a tax liability of $10,500. You contribute $100,000 to ARI in January 2013, in exchange for a contract under which ARI pays you $5,300 annually (a 5.3 percent annuity) for the rest of your life, $4,277 of which is tax-free—and you also get a one-time tax deduction of $35,020 in 2013, which generates tax savings of $10,506.
A contribution of the remainder interest in your principal residence, vacation home, or farm: For example, you are 76 years old and your home is worth $350,000. In January 2013, you enter into an agreement with ARI in which you own the life interest in the property and continue to live there, and ARI owns the remainder interest after your lifetime. This arrangement provides you with a tax deduction of approximately $275,000, without requiring you to part with any liquid assets.
A gift of long-term, noncash property related to ARI’s mission: For example, you donate books, manuscripts and other items of interest to the Ayn Rand Archives, valued at the amount needed to cancel out your conversion tax liability.
Note: Depending on the type of asset you contribute to ARI, you may claim a charitable deduction for up to 50 percent or 30 percent of your MAGI. If your deduction exceeds the limit, you may “carry forward” the unused portion of the deduction for up to five additional years.
I have concluded that combining a Roth IRA conversion with a one-time larger gift to ARI is not compatible with my financial goals at this time. Do you have any other suggestions?
Yes: Review your IRA beneficiary forms. Leaving your Roth IRA to your children or other non-charitable heirs is a logical choice, because it provides them with tax-free income. Leaving your taxable IRA to ARI is also a logical choice, because in most cases income tax will be due on the balance in your account at your death unless you leave it to a tax-exempt organization like ARI. You may name ARI as a primary or secondary beneficiary of all or part of your taxable IRA.
If you have already named ARI as the beneficiary of your IRA and do not need the IRA income, consider a loan from your IRA to ARI as a way of accelerating your bequest. This technique would allow you to see your IRA dollars at work during your lifetime.
If this FAQ proves useful and you decide to do a Roth IRA conversion with taxes offset by a gift to ARI, please let us know! For more information on creative, tax-advantaged ways to support ARI now and in the future, explore our Atlantis Legacy Web pages and/or contact Gift & Estate Planning Manager Kathy Cross at 732-242-9408 or firstname.lastname@example.org.
Atlantis Legacy Pages
ARI is committed to providing donors with accurate and authoritative information about planned giving. However, we cannot render legal or tax advisory services, and the information in these Web pages is not intended to serve as legal or tax advice. We urge donors to consult their own advisors regarding the tax and legal consequences of potential gifts. We are pleased to work with donors’ advisors as well as our own to ensure the best result for all concerned.
The Ayn Rand® Institute is a 501(c)(3) non-profit organization recognized by the U.S. Internal Revenue Service. ARI’s federal identification number is 22-2570926.
Atlantis Legacy® is a registered trademark owned by the Ayn Rand Institute. All rights reserved.
Tax-Free IRA Gifts to ARI Possible Once Again
Are you age 70.5 or older, or will you turn 70.5 before the end of 2013? Do you have an Individual Retirement Account? If your answer to both questions is “Yes,” you may be able to save taxes by making a tax- free transfer from your IRA to ARI.
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Is Roth IRA Conversion Right for Me?
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