BOSTON – Alfred North Whitehead once said that ideas won't keep -- that something must be done about them. That may indeed be true. But first you need the idea. And in the case of retirement-planning ideas, sometimes you need experts who will share an idea or two with you to act upon.
Here then is a sampling of some of the best retirement-planning ideas you've never heard of.
1. When to take your required minimum distribution
You must begin taking at least a specified minimum amount of distributions from your qualified plans and traditional IRAs by April 1 of the year after the year you turn 70 1/2, says Bernard Kent, co-author of "PricewaterhouseCoopers Guide to the 2005 Tax Rules."
But when you take those distributions, required minimum distributions or RMDs, is a matter of great debate. Some people, he says, take their distribution "ratably" throughout the year or early in the year.
"These people would generally be better off waiting until the end of the year to take their distribution for two reasons," he says. "First, this will allow the earnings during the year to grow on a tax-deferred basis. Second they can have income tax withholding taken out of their distribution. This permits them to lower or eliminate the estimated tax payments and defer the payment of tax until the latest possible time without incurring a penalty."
Unlike estimated tax payments, which are applied to the particular quarter for which they are paid, Kent says withholding tax is treated as paid ratably throughout the year. "Thus you can use your December 2006 IRA withholding to reduce your April, June and September 2006 estimated tax payments."
2. Avoiding required minimum distributions
How to fend off distributions from an IRA even if you're over 70 1/2? If you're still working at age 70 1/2 for a company that has a qualified retirement plan and you are not at least a 5% owner of your company, then transfer your IRA into that plan, says Martin Nissenbaum, national director of personal income tax planning for Ernst & Young.
The reason? "You don't have to take distributions from a company retirement plan until April 1 of the year after you retire," he says.
3. Convert to a Roth IRA
Conversion makes sense, especially if you: were a high-income earner during your career, have retired, are now living frugally on Social Security and investment income, have not yet reached age 70 1/2 and have a large IRA which you are not tapping. Yes, we're always in the highest income tax bracket while working, but if you are now in or near the lowest bracket, you may be in for a big surprise when you hit 70 1/2. Why?
"That IRA is going to start pumping out minimum required distributions and you could shoot back up into the top tax bracket," says Natalie Choate, author of "Life and Death Planning for Retirement Benefits." So what's a taxpayer to do? "Consider using up the lower income tax bracket levels now by converting some of your traditional IRA to a Roth IRA each year," she says.
For instance, a married couple can have over $300,000 of taxable income before they even hit the top bracket of 35%. So if your annual income now is $90,000, she says you could convert more than $200,000 of your IRA to a Roth each year without even hitting the top bracket.
Such conversions would provide four advantages, says Choate. One, it will reduce future required distributions from your traditional IRA. Since the IRA will be smaller, the required distributions will be smaller. Two, it will increase your "in-plan" accumulations -- Roth IRAs do not have any required distributions during your lifetime. Three, it will give you a tax-free fund to draw from in case of extra needs later in life. Drawing extra money from a regular IRA increases your income taxes, but drawing from a Roth does not. And four, it will make your beneficiaries happy.
"They are usually better off inheriting a Roth IRA than a traditional IRA, because the tax-free distributions are much simpler to deal with," she says.
4. Use the Roth segregation conversion strategy
It's a mouthful and it can be time consuming, but Robert Keebler, a partner with Virchow, Krause & Company in Green Bay, Wis., says this strategy, if done right, can save you a bundle in taxes.
When taxpayers convert a traditional IRA to a Roth, some of the assets typically go up in value after the conversion while others go down. The taxpayer can recharacterize the Roth back to a traditional IRA and later re-convert to a Roth at a lower tax cost, but ordinarily cannot take advantage of the losses without factoring in the gains as well. Uncle Sam refers to this as the anticherry-picking rule.
"But there is a strategy that allows the taxpayer to have it both ways: recharacterizing the loss assets while leaving the gain assets in the Roth IRA," he says. Here's how: Instead of creating one Roth IRA, create many Roth IRAs.
"The anticherry-picking rules can be avoided by specifically identifying assets to be transferred to newly established Roth IRAs, one Roth IRA for each grouping of assets," Keebler wrote in Family Tax Forum. "Typically, the grouping of assets would be a particular fund, particular stock or particular grouping of stocks within a market sector."
This way, a taxpayer can recharacterize the Roth IRAs that have declined in value back into a traditional IRA and keep those that have risen in value. Of note: A taxpayer will pay a tax on the combined value of the initial Roth conversion (the amount of the IRA transferred to a Roth is included in gross income), but a taxpayer would get to reduce that tax bill when they recharacterize their Roth IRA that has declined in value.
5. Consider 'asset location' and taxes
When people are doing an analysis of their cash flow for retirement they need to look at the after-tax returns of investments, says John Battaglia, a director in the Deloitte Tax private client advisers practice and a contributor to "Essential Tax & Wealth Planning Guide for 2006."
They should especially evaluate what investments should be in a retirement plan and what investments should be outside of a retirement plan and they should evaluate their effective and marginal income tax rates taking into account state taxes and the alternative minimum tax. In many cases, putting growth stocks in a taxable account and fixed-income securities in a retirement plan can make the most tax sense.
"Proper planning can save dollars," says Battaglia.
That's especially true if your contribution to a traditional IRA is not deductible. "It's simple," says Barry Picker, author of "Barry Picker's Guide to Retirement Distribution Planning" "If you contribute to a traditional IRA and it is not deductible, you will not pay tax on the contribution [portion] but you will pay tax on the value above your contribution [when you withdraw funds]. With a Roth IRA, as long as you hold it the required time, you will never pay tax on any amount that comes out of the Roth IRA."