Advanced IRA & 401(k) Topics - Waukesha Wisconsin

 

Individual Retirement Accounts & 401(k) Plans

For the basics regarding Traditional and Roth IRAs please see our IRA page first.

For the basics regarding 401(k) Rollovers please see our 401(k) Rollover page first.

 

"Back Door" Roth Contributions

If you’re married, filing taxes jointly, and your adjusted gross income is over $119,000 then you’re unable to deduct your Traditional IRA contributions in 2017. Moreover, if your modified adjusted gross income exceeds $196,000 then you’re ineligible to make a direct contribution to your Roth IRA. However, there is a way to get money in your tax-deferred account(s).

A “back door” Roth contribution involves contributing to your Traditional IRA despite not qualifying for a tax deduction. Once the money is in your Traditional IRA you can convert it to a Roth IRA. Roth conversions have no income limitations. Assuming you have no prior deductible contributions in any Traditional IRA, then there will be no taxes due on the conversion since no deduction was taken in the first place.

There are a lot of moving parts here, but the key is that you cannot have any deductible IRA money anywhere. If you do, then any Roth conversion would be pro-rata, meaning a portion of the conversion would be taxable and a portion would be tax-free. 

 

Inherited Non-Spousal IRAs

In June 2014 the U.S. Supreme Court ruled that IRAs inherited by non-spouses are not protected from creditors the way that a person's own IRA would be. If you're concerned about keeping your IRA assets protected from the your beneficiaries' creditors please call us at 262-798-3788.

 

Roth vs Traditional IRAs

The money in a Roth IRA has already been assessed income taxes. Therefore, when you withdraw money from a Roth IRA you won't owe income taxes again.*
Scenarios and reasons to consider contributing and/or converting to a Roth IRA:

1.    Time is on your side. In this scenario you assume:

a.    10+ years before needing to take withdrawals from your Roth.
b.    You can earn a reasonable return on your Roth savings.
c.    Income tax rates will remain constant or increase in the future.

Often this scenario involves younger savers or retirees who are certain that they're not going to need the Roth/converted portion of their money and plan to pass it along to the next generation.

2.    Tax rates are rising. In this scenario you assume:

a.    Your income tax rate today is lower than it will be in the future. By paying taxes on your contributions/converted amount today you’ll pay fewer taxes than you will if you keep the money in a Traditional IRA and withdraw it later.

This scenario is not just for those who foresee a rise in marginal income tax rates. It’s also for those who foresee a rise in their incomes. For example, a young person with the hope of many promotions ahead may reasonably believe that when they retire their marginal income tax rate will be higher than it is currently.

3.    You’re unsure what the future holds. In this scenario you assume:

a.    You’re unsure where tax rates are going.
b.    You’re unsure where your personal income is going.
c.    You’re unsure when you’ll need to withdraw money from the Roth.

In this scenario you may want to consider contributing/converting some money to a Roth and contributing/leaving some money in a Traditional IRA. This is commonly called “tax diversification”. If you split your IRA and 401(k) plans between Roth and Traditional contributions then you’re somewhat hedged or indifferent to where income tax rates go. If they go up, you’re happy you converted/contributed some to a Roth. If they go down, you’re happy you have money in a Traditional IRA.

Traditional IRA distributions are taxed as ordinary income. Qualified Roth IRA Distributions are not subject to state and local taxation in most states. Qualified Roth IRA distributions are also federally tax-free provided a Roth account has been open for at least five years and the owner has reached age 59½ or meets other requirements. Both may be subject to a 10% Federal tax penalty if distributions are taken prior to age 59½.

Required Minimum Distributions (RMDs)

The IRS requires investors to withdraw money from their Traditional IRAs and 401(k) plans (not Roth accounts) in the year following the year the owner turns 70½. The amount required depends on the age of the IRA owner, the value of all Traditional IRA and 401(k) accounts on December 31st, and can be affected by the age of the primary IRA beneficiary. To calculate your RMD you can contact us or visit the IRS website.

There are a couple of things that complicate the RMD calculation:

  • The rule of aggregation. This rule says that you must add up all your Traditional IRA and 401(k) balances and calculate your RMD off of this total. Note: you can withdrawal your RMD from any combination of your Traditional IRA and 401(k) accounts, but the total withdrawn must be equal or greater than the amount of your RMD.
  • Annuities. When you hold certain annuities with implied benefits, such as income and death benefits, calculating your RMD may not be as straight forward as adding up the values shown on your year-end statements. You may need to contact your advisor (if you don’t have an advisor please contact us) or your annuity company to determine the value you should use to determine your RMD.

Pro-Rata Rules

Roth Conversions & IRA Withdrawals

If you have after-tax and pre-tax contributions in your IRAs, conversions and withdrawals are considered "pro-rata". You can't simply choose which portion (pre-tax or after-tax) you'd like to withdraw or convert.

For example:

You have a $100,000 IRA with $10,000 of after-tax contributions. You'd like to convert $10,000 to a Roth. Ideally, you'd be able to choose to convert just the $10,000 of after-tax contributions. However, in this case you'll pay taxes on 90% of the $10,000 conversion.

Important Note: It doesnt matter if you've kept your pre and post-tax contributions in seperate IRAs. For the purpose of a conversion or withdrawal all your IRAs are aggregated.

401(k) Plan Withdrawals

In-Service Withdrawals

In-service withdrawals are withdrawals or rollovers from a 401(k) plan while the employee remains employed at the company. Not all 401(k) plans allow for in-service withdrawals. To find out if your employer allows in-service withdrawals you can contact us and we’ll do the legwork, or you can call your human resources/benefits department.

Benefits of an in-service withdrawal:

  • Tax-free transfer of assets to an IRA or Roth IRA.
  • IRAs typically allow for a broader range of investment options rather than a limited menu.
  • IRAs typically allow for more control of your investments and fewer restrictions on asset movement.
  • IRAs often allow for easier access to your funds in the event of an emergency.

Tax and IRS penalties may apply. Withdrawals from non-qualified deferred compensation plans or 457 plans are not subject to the 10% premature distribution penalty and may not be tied to a triggering event.

In-service distributions may not be suitable for all investors and may be subject to certain criteria such as minimum age or years of service requirements.

Many qualified retirement plans offer a loan option not available in IRAs. Also, if you currently have an outstanding loan from your qualified plan, an in-service distribution may cause the loan to be deemed a taxable distribution. Investment management and annual account fees for investment funds offered in qualified plans are generally lower than the investment expenses and account fees in IRAs. In addition, most IRA plans require a minimum balance and charge transaction fees. There are typically no transaction fees for buying and selling funds in most employers’ qualified plans and no low-balance fees. While IRAs may offer more investment options, qualified plans may offer unique investment options not available through IRAs. Qualified retirement plans provide creditor protection that, unlike an IRA, is dependent upon your state law. Taking an in-service distribution may have an impact on your ability to make contributions to your employer sponsored plan, receive bonuses or receive a company match.

If your plan permits in-service distributions, you’ll need to talk with your plan administrator to determine the rules of eligibility. You must also weigh the benefits against any potential disadvantages and will want to work with your Financial Advisor, and your tax and legal advisors to determine that you are not negatively impacted by changes in creditor protection, Net Unrealized Appreciation (NUA) treatment, age limitations or after-tax contribution rules.

Hardship Withdrawals

Hardship withdrawals are withdrawals from a 401(k) plan due to financial hardship. The following items are considered by the IRS as acceptable reasons for a hardship withdrawal:

  • Un-reimbursed medical expenses for you, your spouse, or dependents.
  • Purchase of an employee's principal residence.
  • Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
  • Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
  • For funeral expenses.
  • Certain expenses for the repair of damage to the employee's principal residence.

Every 401(k) plan is different and their flexibility regarding hardship withdrawals will vary. Contact your human resources/benefits department for more information about your plan’s provisions for hardship withdrawals.

Distributions taken under a hardship provision are not eligible to be rolled into an IRA. If investors are younger than 59½ when they take the distributions, those distributions may be subject to the IRS 10% early withdrawal penalty in addition to ordinary income tax if certain requirements are not met.

401(k) Rollovers

 

Contact us and/or click here to learn more about 401(k) rollover options.

 

The content on this page has been provided for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Since each person’s situation is different you should review your specific investment objectives, risk tolerance and liquidity needs with your financial, tax and legal professionals before selecting a suitable savings or investment strategy.

Wells Fargo Advisors does not provide tax or legal advice. Be sure to consult with your own tax and legal advisors before taking any action that may have tax or legal consequences.