Time for a year-end IRA checkup

Here are some key individual retirement account items to check on before the end of the year:

2009 Roth conversions

In 2009, not everyone will qualify for a Roth conversion. If a client's modified adjusted gross income exceeds $100,000, or they are married filing separately, they cannot convert. But that all changes next year, when both of these restrictions are eliminated. To qualify for a 2009 Roth conversion, the funds must be distributed from the IRA or employer plan in this calendar year. That started the five-year clock on that conversion on Jan. 1, and may use up the lower (15%) tax brackets for this year. For example, a client who files married-joint for 2009 can have up to $67,900 in taxable income and still be in the 15% tax bracket, so it pays not to waste any part of this low tax bracket. “Fill up” the bracket by converting only enough plan or IRA funds to a Roth IRA in 2009 to bring the client's income up to $67,900. If you are unsure about how much income a client will have, convert anyway and adjust the amount later (when the client's 2009 taxable income is known) by re-characterizing a portion of the Roth conversion. You have until Oct. 15 to undo a 2009 conversion. A client who qualifies for a 2009 Roth conversion, however, might want to consider waiting until next year to convert. By waiting a few days, the tax on the converted amount can be deferred using the two-year deal in which conversion income can be spread over 2011 and 2012, with no income included in 2010.

Charity transfers

Qualified charitable distributions from IRAs must be completed by year-end. The provision is set to expire after this year. Even though required minimum distributions were waived for 2009, it still pays to transfer IRA funds to charities. This provision is available only to IRA owners and beneficiaries who are at least 701/2. The amount that can be transferred is limited to $100,000 per IRA owner or beneficiary. The transfer must be a direct transfer and must be completed by year-end to qualify for the expiring 2009 tax break. It is likely that this provision will be extended, but there has been no news on that yet.

Unrealized appreciation

With all the layoffs this year, it is likely that some clients qualify for the net-unrealized-appreciation tax break if they have appreciated company stock in their 401(k) plan. They get to withdraw the stock as part of a qualifying lump-sum distribution of the plan assets and pay tax only on the cost of the company stock to the plan. Any appreciation in the stock (the NUA) is not taxed until the stock is sold, and even then, it is taxed at favorable long-term capital gain rates (currently 15%) regardless of how long the stock is held (even if less than one year). To qualify for the NUA tax break, the client must first have one of four triggering events: separation from service, reaching 591/2, death and disability. Once a plan participant qualifies, he or she can take a lump-sum distribution, which is a complete distribution of the account within one calendar year. The company stock must be transferred to a taxable brokerage account “in kind,” that is, as stock. The stock cannot be sold in the plan. If clients have taken plan distributions this year intending to qualify for this tax break, make sure that all of the plan assets are distributed by year-end or the NUA deal will be lost. Non-company stock assets can be rolled over to an IRA since the NUA tax break does not apply to those assets.

IRA Beneficiaries

If an IRA owner died in 2008 and had named more than one beneficiary, the inherited IRA should be split by the end of this year to create separate inherited IRAs for each beneficiary. Doing so will allow each beneficiary to use his or her own life expectancy for calculating future required minimum distributions. Even though no RMDs are required in 2009, this split must still be done by year-end. Properly titled inherited IRAs must be set up for each IRA beneficiary, meaning that the name of the deceased IRA owner must appear in the account title, and it must somehow indicate that it is a beneficiary IRA. Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace. He can be reached at irahelp.com. For archived columns go to InvestmentNews.com/iraalert.