From the February 2005 issue of Investment Advisor • Subscribe!

February 1, 2005

More Opportunities for Roth Conversions

The Internal Revenue Service has opened the door for older, wealthier individuals to convert their traditional IRAs into Roth IRAs.

Previously, individuals earning more than $100,000 in a taxable year were barred from rolling assets from a traditional IRA into a Roth. As of January 1, 2005, however, the IRS no longer includes a person's required minimum distributions from qualified retirement plans or IRAs when determining the taxpayer's modified adjusted gross income (AGI).

For instance, take an individual who's had a $115,000 modified AGI over the last few years, says Michael Hatlee, manager of retirement services at Chemung Canal Trust Company in Elmira, New York. "Due to the required distribution rules that apply to qualified plans and IRAs, this person had to take $30,000 per year from their IRAs." This year, "assuming that the income assumptions remain the same, they will now be eligible to convert a traditional IRA to a Roth because that $30,000 required minimum distribution no longer counts toward the modified adjusted gross income limit," he says. "Instead of the $115,000 modified AGI for these purposes, they now have an $85,000 modified AGI, which makes them eligible to convert to a Roth IRA."

Hatlee says the new rules provide a great estate planning tool for wealthy IRA owners. For individuals with "substantial assets and other sources of income [that] really don't need or use the required minimum distribution from a traditional IRA, converting a portion or all of that traditional IRA to a Roth quite often results in much more being passed on to their heirs," Hatlee says. So that estate planning tool, "which has always been around," he notes, is now available to more individuals.

Meanwhile, the IRS recently issued its first guidance on nonqualified deferred compensation plans under the new Section 409A of the IRS Code. The American Jobs Creation Act of 2004, the huge tax bill passed by Congress last year, created Section 409A, which is designed to make these plans less flexible, thereby curtailing abuses that occurred in these plans at failed energy giant Enron. Non-qualified deferred compensation plans include bonus and salary deferral plans, and stock option plans. The IRS wants to make it harder for employees to switch out of a deferred comp plan once they select one. And distributions will also be made less flexible.

Call for Simplicity

The Taxpayer Advocate Service--an independent organization within the IRS that seeks to resolve tax problems-- released its annual report to Congress in January. Nina Olson, a Taxpayer Advocate who authored the report, told Congress the "overwhelming complexity" of the tax code "is the largest source of compliance burdens on taxpayers and the IRS." Olson cites the alternative minimum tax (AMT), the earned income tax credit (EITC), and the large number of provisions designed to encourage taxpayers to save for education and retirement as areas that need to be reworked. "One nagging problem that has not been adequately addressed [is] the alternative minimum tax for individuals," Olson told Congress. "The need for AMT relief looms like the proverbial elephant in the room, and for that reason we once again, for the third year, recommend its repeal." President Bush has said he wants to create a bipartisan commission to reform and simplify the tax code.--Melanie Waddell

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