Is Now a Good Time for a Roth Conversion?

Is-Now-a-Good-Time-for-a-Roth-Conversion

The downturn in the stock market may have caused the value of your retirement account to decrease. But if you have a traditional IRA, this decline may provide a valuable opportunity: It may allow you to convert your traditional IRA to a Roth IRA at a lower tax cost. Keep reading to learn more.

Traditional vs. Roth: What Sets Them Apart?

Here’s what makes a traditional IRA different from a Roth IRA:

Traditional IRA. Contributions to a traditional IRA may be deductible, depending on your modified adjusted gross income (MAGI) and whether you (or your spouse) participate in a qualified retirement plan, such as a 401(k). Funds in the account can grow tax deferred.

On the downside, you generally must pay income tax on withdrawals. In addition, you’ll face a penalty if you withdraw funds before age 59½ — unless you qualify for a handful of exceptions — and you’ll face an even larger penalty if you don’t take your required minimum distributions (RMDs) after age 72.

Roth IRA. Roth IRA contributions are never deductible. But withdrawals — including earnings — are tax free as long as you’re age 59½ or older and the account has been open at least five years. In addition, you’re allowed to withdraw contributions at any time tax- and penalty-free. You also don’t have to begin taking RMDs after you reach age 72.

However, the ability to contribute to a Roth IRA is subject to limits based on your MAGI. Fortunately, no matter how high your income, you’re eligible to convert a traditional IRA to a Roth. The catch? You’ll have to pay income tax on the amount converted.

Minimize Your Tax Hit?

This is where the “benefit” of a stock market downturn comes in. If your traditional IRA has lost value, converting to a Roth now rather than later will minimize your tax hit. Plus, you’ll avoid tax on future appreciation when the market goes back up.

It’s important to think through the details before you convert. Here are some of the issues to consider when deciding whether to make a conversion:

Having enough money to pay the tax bill. If you don’t have the cash on hand to cover the taxes owed on the conversion, you may have to dip into your retirement funds. This will erode your nest egg. The more money you convert and the higher your tax bracket, the bigger the tax hit.

Your retirement plans. Your stage of life may also affect your decision. Typically, you wouldn’t convert a traditional IRA to a Roth IRA if you expect to retire soon and start drawing down on the account right away. Usually, the goal is to allow the funds to grow and compound over time without any tax erosion.

Keep in mind that converting a traditional IRA to a Roth isn’t an all-or-nothing deal. You can convert as much or as little of the money from your traditional IRA account as you like. So, you might decide to gradually convert your account to spread out the tax hit over several years.

Ask the Financial Planning Pros

So, is now a good time for a Roth conversion? It could be. There are also other issues that need to be considered before executing a Roth IRA conversion. If this sounds like something you’re interested in, contact the financial planning pros at Ramsay & Associates. We can answer your questions and discuss whether a conversion is right for you.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Opportunities and Challenges: Valuation in the Age of COVID-19

Valuation and estate planning go hand in hand. After all, the tax implications of various estate planning strategies depend on the value of your assets at the time they’re transferred.

The COVID-19 pandemic has had a significant impact on the value of many business interests and other assets, which may create some attractive estate planning opportunities. It also presents unique challenges for valuation professionals. As a result, it’s more important than ever to involve experienced valuation experts in the estate planning process.

What are the opportunities?

With the value of many assets depressed (in many or most cases temporarily), now may be an ideal time to gift them, either directly to family members or to irrevocable trusts and other estate planning vehicles. Transferring assets while values are low also allows you to use as little of your gift and estate tax exemption as possible, maximizing the amount available for future gifts or bequests. As the economy fully recovers and assuming your asset values rebound, your beneficiaries should enjoy substantial growth outside your taxable estate.

What are the challenges?

The pandemic has created a situation that’s truly uncharted territory for the valuation profession. Unlike other economic crises in recent years, most of the damage to the economy resulted from business closures and restrictions and other measures designed to help contain the virus.

For business valuations, the current environment presents several challenges, including:

Known or knowable. A fair market valuation generally doesn’t consider “subsequent events” — that is, events that occur after, and weren’t “known or knowable” on the valuation date. Experts generally agree that the COVID-19 pandemic wasn’t known or knowable as of December 31, 2019. Yet for valuation dates after that, determining whether the pandemic was known or knowable and should be considered in valuing a business or other asset can be a formidable task.

Valuation approaches. Generally, valuators consider all three of the major valuation approaches: the income, market and asset approaches. The pandemic may affect the relative appropriateness of each approach and the amount of weight they should be assigned.

For example, market-based methods, which rely on data about actual transactions involving comparable businesses, may be less relevant today if the underlying transactions predate COVID-19 (although it may be possible to adjust to reflect the pandemic’s impact).

Many valuators are emphasizing income-based methods, such as the discounted cash flow (DCF) method, which involves projecting a business’s future cash flows over a defined period (such as five years) and discounting them to present value. The advantage of DCF is that it provides a great deal of flexibility to model a business’s expected financial performance based on current conditions as well as assumptions about its eventual return to “normal” over the next several years.

Regardless of the method or methods used, it’s important for valuators to consider a business’s available cash and expected cash needs to assess its viability as a going concern. These considerations will be critical in evaluating a business’s risk and the impact of that risk on value.

What’s it worth?

Depressed asset values can create attractive estate planning opportunities. While the pandemic has dropped the value of some assets, others haven’t been affected or have even increased in value. Contact us with questions regarding the valuation of your assets.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

The Tax Score of Winning

tax score of winning

Studies have found that more people are engaging in online gambling and sports betting since the pandemic began. And there are still more traditional ways to gamble and play the lottery. If you’re lucky enough to win, be aware that tax consequences go along with your good fortune.

Review the tax rules

Whether you win online or at a casino, a bingo hall, a fantasy sports event, or elsewhere, you must report 100% of your winnings as taxable income. They’re reported on the “Other income” line of your 1040 tax return. To measure your winnings on a particular wager, use the net gain. For example, if a $30 bet at the racetrack turns into a $110 win, you’ve won $80, not $110.

You must separately keep track of losses. They’re deductible, but only as itemized deductions. Therefore, if you don’t itemize and take the standard deduction, you can’t deduct gambling losses. In addition, gambling losses are only deductible up to the amount of gambling winnings. Therefore, you can use losses to “wipe out” gambling income but you can’t show a gambling tax loss.

Maintain good records of your losses during the year. Keep a diary in which you indicate the date, place, amount, and type of loss, as well as the names of anyone who was with you. Save all documentation, such as checks or credit slips.

Hitting a lottery jackpot

The odds of winning the lottery are slim. But if you don’t follow the tax rules after winning, the chances of hearing from the IRS are much higher.

Lottery winnings are taxable. This is the case for cash prizes and for the fair market value of any noncash prizes, such as a car or vacation. Depending on your other income and the amount of your winnings, your federal tax rate may be as high as 37%. You may also be subject to state income tax.

You report lottery winnings as income in the year, or years, you actually receive them. In the case of noncash prizes, this would be the year the prize is received. With cash, if you take the winnings in annual installments, you only report each year’s installment as income for that year.

If you win more than $5,000 in the lottery or certain types of gambling, 24 % must be withheld for federal tax purposes. You’ll receive a Form W-2G from the payer showing the amount paid to you and the federal tax withheld. (The payer also sends this information to the IRS.) If state tax withholding is withheld, that amount may also be shown on Form W-2G.

Since the federal tax rate can currently be up to 37%, which is well above the 24% withheld, the withholding may not be enough to cover your federal tax bill. Therefore, you may have to make estimated tax payments — and you may be assessed a penalty if you fail to do so. In addition, you may be required to make state and local estimated tax payments.

Talk with us

If you’re fortunate enough to win a sizable amount of money, there are other issues to consider, including estate planning. This article only covers the basic tax rules. Different rules apply to people who qualify as professional gamblers. Contact us with questions. We can help you minimize taxes and stay in compliance with all requirements.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Tax-Favored Ways to Build Up A College Fund

build up a college fund

If you’re a parent with a college-bound child, you may be concerned about being able to fund future tuition and other higher education costs. You want to take maximum advantage of tax benefits to minimize your expenses. Here are some possible options.

Savings bonds

Series EE U.S. savings bonds offer two tax-saving opportunities for eligible families when used to finance college:

  • You don’t have to report the interest on the bonds for federal tax purposes until the bonds are cashed in, and
  • Interest on “qualified” Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified education expenses.

To qualify for the tax exemption for college use, you must purchase the bonds in your name (not the child’s) or jointly with your spouse. The proceeds must be used for tuition, fees and certain other expenses — not room and board. If only part of the proceeds is used for qualified expenses, only that part of the interest is exempt.

The exemption is phased out if your adjusted gross income (AGI) exceeds certain amounts.

529 plans

A qualified tuition program (also known as a 529 plan) allows you to buy tuition credits for a child or make contributions to an account set up to meet a child’s future higher education expenses. Qualified tuition programs are established by state governments or private education institutions.

Contributions aren’t deductible. The contributions are treated as taxable gifts to the child, but they’re eligible for the annual gift tax exclusion ($15,000 for 2021). A donor who contributes more than the annual exclusion limit for the year can elect to treat the gift as if it were spread out over a five-year period.

The earnings on the contributions accumulate tax-free until college costs are paid from the funds. Distributions from 529 plans are tax-free to the extent the funds are used to pay “qualified higher education expenses.” Distributions of earnings that aren’t used for qualified expenses will be subject to income tax plus a 10% penalty tax.

Coverdell education savings accounts (ESAs)

You can establish a Coverdell ESA and make contributions of up to $2,000 annually for each child under age 18.

The right to make contributions begins to phase out once your AGI is over a certain amount. If the income limitation is a problem, a child can contribute to his or her own account.

Although the contributions aren’t deductible, income in the account isn’t taxed, and distributions are tax-free if used on qualified education expenses. If the child doesn’t attend college, the money must be withdrawn when he or she turns 30, and any earnings will be subject to tax and penalty. But unused funds can be transferred tax-free to a Coverdell ESA of another member of the child’s family who hasn’t reached age 30. (Some ESA requirements don’t apply to individuals with special needs.)

Plan ahead

These are just some of the tax-favored ways to build up a college fund for your children. Once your child is in college, you may qualify for tax breaks such as the American Opportunity Tax Credit or the Lifetime Learning Credit. Contact us if you’d like to discuss any of the options.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Put pen to paper: How a letter of instruction can benefit family harmony

letter of instruction

You may view your will as the centerpiece of your estate plan. But other documents can complement it. For example, if you haven’t already done so, consider writing a letter of instruction.

Elements of the letter

A letter of instruction is an informal document providing your loved ones with vital information about personal and financial matters to be addressed after your death. Bear in mind that the letter, unlike a valid will, isn’t legally binding. But its informal nature allows you to easily revise it whenever you see fit.

What should be included in the letter? It will vary, depending on your personal circumstances, but here are some common elements:

Documents and financial assets.

Start by stating the location of your will. Then list the location of other important documents, such as powers of attorney, trusts, living wills, and health care directives. Also, provide information on birth certificates, Social Security benefits, marriage licenses, and, if any, divorce documents.

Next, create an inventory of all your assets, their location, account numbers and relevant contact information. This may include, but isn’t necessarily limited to, items such as bank accounts; investment accounts; retirement plans and IRAs; health insurance plans; business insurance; life and disability income insurance; and records of Social Security and veterans’ benefits.

And don’t forget about liabilities as well. Provide information on mortgages, debts, and other obligations your family should be aware of.

Funeral and burial arrangements.

A letter of instruction typically includes details regarding your funeral and burial arrangements. If you prefer to be cremated rather than buried, make that clear. In addition, details can include whom you’d like to preside over the service, the setting, and even music selections.

List the people you want to be notified when you pass away and include their contact information. Finally, write down your wishes for specific charities where loved ones and others can make donations in your memory.

Digital information.

As many of your accounts likely have been transitioned to digital formats, including bank accounts, securities, and retirement plans, it’s important that you recognize this change in your letter of instruction or update a previously written letter.

Personal items.

It’s not unusual for family members to quarrel over personal effects that you don’t specifically designate in your will. Your letter can spell out who will receive items that may have little or no monetary value, but plenty of sentimental value.

Final thoughts

A letter of instruction can offer peace of mind to your family members during a time of emotional turmoil. It can be difficult to think about writing such a letter — no one likes to contemplate his or her own death. But once you get started, you may find that most of the letter “writes itself.”

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.