IRA Strategies for 2012-2013
The amount of money in IRAs is climbing. Most of us have at least one IRA, and eventually many people roll over their main retirement as-sets, 401(k) accounts, to IRAs. Unfortunately, a lot of the value in IRAs isn’t being maximized. People don’t focus on the key strategies that can make an IRA more valuable in their lifetimes and beyond. You won’t benefit from each of these strategies, but you should consider them and decide which will increase the value of your IRA.
Own the right assets. An IRA has the advantage of tax deferral. Gains and income compound free of taxes until they are distributed. They have the disadvantage of converting long-term capital gains into ordinary income. All taxable distributions from an IRA are taxed as ordinary income.
My research reveals that assets that pay high ordinary income are best held in IRAs. These include high-yield bonds, real estate investment trusts, and investment grade bonds. Also, stocks, mutual funds, and other investments that tend to be owned for less than one year generate short-term capital gains and are best owned through an IRA. Investments that generate long-term capital gains, such as stocks and mutual funds held for more than one year, should be owned in taxable accounts.
You also might own nontraditional assets in an IRA, such as real estate, small business interests, gold, and master limited partnerships. There are tax consequences to these investments, and some are prohibited in IRAs. Be sure you know the tax rules for investing IRAs. You can find details in my report, IRA Investment Guide, available through Bob’s Library tab on the web site.
Practice tax diversification. No one can forecast how the tax code will alter. Different types of accounts have different tax treatments now, and that could change. Instead of forecasting one tax outcome and arranging your finances accordingly, it’s safer to have different types of accounts so you won’t be burned in any scenario. Try to own investments in taxable accounts, traditional IRAs, and Roth IRAs.
Convert to a Roth. Every year, consider whether it makes sense to convert all or part of a traditional IRA into a Roth IRA. We discussed in detail in past visits how to decide, and those discussions are available in the IRA Watch section of the Archive on the members’ web site and in my books. Whether conversion is a good idea for you depends on factors such as the expected rate of return, the difference between your current tax rate and future tax rates, the source of the cash to pay the taxes, whether future required minimum distributions would exceed your spending needs, and more.
Consolidate or split? I’m a big advocate of simplifying your finances, and that often means consolidating your finances at one financial institution. Many people have multiple IRAs, and simplifying means rolling them over into one IRA when practical. But suppose you have multiple heirs and expect IRAs to be a significant legacy to them. You could name all the heirs as joint beneficiaries and let them decide what to do with the account. Or you can split the IRA now and name one person as the primary beneficiary for each. If the heirs aren’t likely to agree on how to manage an IRA, you might want to split the IRA now.
Spend accounts in the right order. As a general rule, it’s best to spend taxable accounts first, traditional IRAs next, and Roth IRAs last. Spending in this order makes your wealth last a few years longer. This is another issue we discussed in detail in past visits and that is available on the web site Archive and in my books.
Review your beneficiaries. Most estate planners have horror stories of people who haven’t changed their beneficiaries for decades and have their IRAs going to ex-spouses, siblings instead of their spouses, or deceased people. Others name their estates or other entities that require distributions to be made quickly after they pass away, causing unnecessary tax bills. Be sure to review your beneficiaries regularly and any time there is a change in your family. In some cases, you’ll want to name a trust as beneficiary, but you’ll have to navigate complicated tax rules to do this effectively. Discuss with your estate planner the effects of choosing different beneficiaries.
Consider charity. When you’re going to leave part of your estate to charity, the most tax efficient way to do that might be to name the charity as beneficiary of an IRA. When individuals receive distributions from an inherited IRA, they must pay income taxes on the distributions just as the owner would have. He or she benefits only from the after-tax value of the IRA. But an individual can receive most other assets from an estate income-tax free. A charity, on the other hand, doesn’t pay taxes on IRA distributions it receives as a beneficiary. It’s more tax efficient to make a charitable bequest through an IRA when you can.
Don’t forget catch-up contributions. When you’re still working and making contributions to IRAs, you can make higher catch-up contributions when you’re age 50 or older. In 2012, the maximum contribution for those 50 and over is $6,000 instead of $5,000.
Consider spousal contributions. Generally IRA contributions can be made only to the extent you have earned income from a job or business. There’s an exception for married couples when one spouse has earned income and the other doesn’t. When they file a joint return, contributions to separate IRAs for each spouse can be made up to the maximum. That means a couple age 50 or older can contribute $6,000 to an IRA for each spouse for a total of $12,000.
Required distributions. People continue to make mistakes when taking and computing required minimum distributions after age 70½. The IRS has been lax on this in the past but is stepping up its tracking and enforcement. Check our February 2012 issue for details.
RW July 2012.
