As President-Elect Obama continues to name the members of his economic team, there seems to be a degree of optimism budding in the country that experienced leadership is coming to Washington. Our challenges are not over; these taxing times will continue for months to come. Year-end planning in a down market remains prudent. Last week I shared some preliminary year-end tax planning thoughts with you. As a result of recent conversations I have had with investment firms and tax attorneys, two additional thoughts come to mind.
The first is conversion from a traditional IRA to a Roth IRA. Even though contributions to Roth IRAs are not tax-deductible, Roths provide significant tax benefits. Roth IRAs provide:
- tax-free growth,
- tax-free income distributions in retirement (provided you are over age 59-1/2 and you have held your Roth IRA for five or more years),
- you may continue to make Roth IRA contributions after your reach age 70-1/2, and
- after you reach age 70-1/2 you do not have to take required minimum distributions each year.
For 2008, your Roth conversion limitation is reduced (phased out) as follows:
For married taxpayers filing joint returns (or a qualifying widow or widower), the phase-out begins with modified adjusted gross income of $159,000. You cannot make a Roth conversion if your modified adjusted gross income is $169,000 or more.
If your tax filing status is single, head of household, or married filing separately (and you did not live with your spouse at any time in 2008), the phase-out begins with modified adjusted gross income of $101,000. You cannot make a Roth conversion if your modified adjusted gross income is $116,000 or more.
- If your tax filing status is married filing separately and you lived with your spouse at any time during the year you cannot make a Roth IRA conversion if your modified adjusted gross income is $10,000 or more.
- The maximum amount that you may convert (or otherwise contribute) to a Roth IRA is the lesser of $5,000 or your taxable compensation for the year if you are 49 years of age or younger at the end of 2008. If you are age 50 or older before 2009, your maximum contribution is the lesser of $6,000 or your taxable compensation for the year.
- You must roll over into the Roth IRA the same property you received from the traditional IRA. I recommend a trustee-to-trustee transfer. If your Roth will be with the same investment firm that holds your traditional IRA, simply have them re-designate the traditional account as a Roth, rather than opening a new account or issuing a new contract. Conversions from other qualified retirement plans to a Roth are also possible, but may be subject to additional rules.
So, what’s the downside to converting a traditional IRA to a Roth? The amount converted is subject to regular income taxation in the year of the conversion. However, with the decline in the value of investments held in traditional IRAs and the prospect of higher individual income tax rates after 2008, this might be a good year to make a conversion.
My second thought for the day involves dividends. Currently, “qualified dividends” are subject to the same 15% maximum tax rate as long-term capital gains. This rate is expected to increase to 20 or 25% in 2009. However, the provision in the law that permits dividends to be taxed at this very favorable tax rate was originally scheduled to expire after 2008. It was subsequently extended through 2010. There is a strong possibility that this extension will be repealed and the dividend rate will revert to regular income tax rates after 2008. With an expected maximum individual tax rate of 39.6% in 2009, this represents a potential tax increase of 164% on dividends received after 2008. Planning suggestions; take all dividends possible in 2008; corporations contemplating a dividend should pay them this year for the benefit of your shareholders.
I will continue to share year-end tax planning thoughts with you as they come to mind. If you have any questions concerning your year-end tax strategies, email me or call me at 214-957-3366.
Ronnie
Copyright 2008 Ronnie C. McClure, PhD CPA
