Retirement Focus - Year-End Retirement Sugarplums
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by Mike Posey


  1. Mandatory IRA Distributions
  2. IRA Charitable Contributions
  3. Roth Conversions
  4. Max Out Retirement Contributions
  5. Plan Your 2009 Investment Strategy


The Christmas season is upon us and the end of 2008 will be here before we know it. At this time of year, many people "coast" for the rest of the year, enjoying the holidays and using those vacation days before they are lost at the end of the year. Actually, coasting is probably not the most appropriate term, since it seems that the holidays are sometimes busier than even our toughest work schedule.

However, the end of the year is also a very busy time for retirement planning, both for those who provide plan and investment services, as well as for sponsors and participants. This is especially true this year due to the bear market having decimated many retirement portfolios. Not only do smaller nest eggs sometimes require special year-end planning, but there have also been calls for the Treasury to waive certain requirements related to retirement distributions.

Specifically, some members of Congress and even AARP have joined together to request that the minimum distribution requirements applicable to taxpayers over the age of 70½ be frozen for 2008 due to the hit most IRAs and other defined contribution plans have taken in the market this year. This may or may not be a good idea, depending upon your circumstances, but no matter what form it may take, you need to be prepared to take appropriate action if you have not already done so.

This week, I'll discuss the proposal to waive the minimum distribution rules, as well as discuss what to do if they are not waived. I'll also toss in a number of other retirement sugarplums to dance in your heads before kicking back for what's left of 2008.

Mandatory IRA Distributions

As I mentioned above, various members of Congress and other interested groups have requested that Congress and/or Treasury Secretary Paulson waive the rules that require minimum annual distributions be made to taxpayers age 70½ or older from IRAs and certain other types of defined contribution retirement accounts. The Required Minimum Distribution (RMD) rule exists, by the way, to insure that these retirement plans do not postpone payment of taxes on accumulated balances in perpetuity.

Since there are some account holders who may not ever need to access this money for retirement income purposes, the IRS requires that a certain portion be liquidated each year, beginning in the year in which the account holder turns age 70½. The payout is calculated based on a formula that liquidates the entire account over the estimated remaining lifetime of the individual.

However, one small glitch in the calculation is that the distribution for 2008 would be based on the accumulated value as of 12/31/2007. Since most retirement accounts hold stocks, bonds and/or mutual funds, there's a very good chance that the account value is FAR LESS now than it was at the beginning of the year. Thus, unless the rule is modified in some way, the percentage of the account required to be liquidated would be much larger than if the current value were to be used.

Various proposals have been floated to address the situation, ranging from allowing the current value to be used for the calculation to waiving the RMD rule entirely for a period of time. Financial industry experts have been somewhat divided on waiving the RMD rule. Some say that cashing out shares of stocks or mutual funds at a depreciated value locks in losses and eliminates any chance to participate in any market rebound we might see in the future.

Others, however, say this provision would primarily help those wealthy enough to take only minimum distributions from their Traditional IRAs. And let's not forget that any modification of the RMD rules would also affect income tax revenues. Maintaining the RMD rule for 2008 would be best from a Treasury tax revenue standpoint since the 12/31/2007 cumulative IRA account values are likely much larger than they are now.

To address the growing chorus of organizations calling for RMD relief, the House and Senate have recently passed the Worker, Retiree and Employer Recovery Act of 2008 (HR7327). Among other things, this bill contains a provision that would suspend the RMD rules for 2009 (but not 2008!!!). The bill is now headed to President Bush and he is expected to sign it.

It is unfortunate that the bill did nothing to help those who are required to take 2008 RMDs, which are still required by December 31st (or April 1st, if you just turned 70½ in 2008). If you fail to take the RMD, you will be subject to a penalty tax of 50% of the amount that should have been withdrawn. Therefore, do NOT assume that passage of this bill relieves you from having to take a RMD for 2008 – it doesn't.

As a practical matter this bill is like most political solutions – long on form and short on substance. While politicians can hold press conferences and brag that they are helping senior citizens, they failed to address the key issue of having to sell depreciated assets for this tax year. As a bonus, the politicians also get to reap the benefits of tax revenues based on substantially higher values than retirees now enjoy. What else is new?

Importantly, you may still be able to minimize the effects of having to sell assets at a loss by requesting your IRA or 401(k) plan trustee or custodian to do what's known as an "in-kind" distribution. This means that the custodian transfers stock or mutual fund shares to you rather than cashing them out and sending you a check. You still have to take an equivalent amount of shares to equal the distribution required by the 12/31/2007 value and pay tax on this amount, but you will still hold the shares in case of a possible rebound in value in the future.

Even better, you can usually direct the custodian or trustee as to which investments you want to take as a distribution. For long-term income tax planning, you might want to transfer shares in 2008 that you feel may have a higher potential for future gain and leave others in the IRA for subsequent required distributions. The thinking is that identifying investments with greater gain potential may result in lower future income taxes, assuming long-term capital gains tax rates remain considerably lower than ordinary income tax rates in the future. Just be sure to talk to your tax professional and/or financial advisor if you have questions about which assets to take as an in-kind distribution.

Charitable Donations From An IRA

Earlier this year, Congress passed legislation that allows individuals age 70½ or older to make a one-time transfer of up to $100,000 from an IRA to a qualified charity. While IRA account holders do not get a tax deduction for the gift, they also do not have to claim the IRA distribution as income. Thus, for someone who does not need their IRA for retirement income purposes, this allowance permits them to use up to $100,000 of it to benefit the charity of their choice.

Admittedly, this provision applies to a very small segment of the population, but those who can take advantage of this opportunity find that it can be an integral part of their estate and gift planning. Since IRAs are often subject to both estate and income taxes at death, the ability to make what amounts to a pre-tax contribution can be very attractive.

Also note that it may be beneficial to make a transfer this year while the IRA value is down due to the bear market. Making an in-kind rollover contribution to a charity may potentially result in a much bigger bang for the buck on behalf of your favorite charity should the market experience a rebound in the near future.

While charitable IRA rollovers have been extended through December 31, 2009, you need to move quickly if you want to make such a contribution effective for 2008. Since you must involve your IRA trustee or custodian in the transaction, time is of the essence. Fortunately, many major charities and IRA custodians are familiar with processing these transactions and can provide their help to expedite the transaction.

Roth IRA Conversions

If you have a traditional IRA, retirement distributions will generally be subject to ordinary income tax in the year in which you take the money. The conventional wisdom used to be that retirees would be in a lower tax bracket than they were in during their working years, so tax deferral was always beneficial. However, as this is written, current tax rates are among the lowest we've ever seen, so it is no longer a given that future tax rates applicable to retirees are likely to be lower (especially with the Democrats in control of the White House and Congress).

Back in 1997, the Roth IRA was introduced to offer an alternative to taxpayers who wanted to save for retirement. Without going into full detail, Roth IRAs differed from traditional IRAs in that contributions to the Roth IRA would not be deductible from current income, but if held for a minimum period of time, all earnings would escape future taxation.

Individuals with traditional IRAs were also given the option to convert their existing IRAs to Roth IRAs under certain conditions. Roth IRA conversions are currently available only to IRA account holders whose modified adjusted gross income (MAGI) is less than $100,000. While not everyone with a traditional IRA can benefit from a conversion, they can be beneficial if the right set of circumstances exist.

The conversion process involves deciding whether conversion makes sense for you, working with your IRA trustee or custodian and then paying income tax on the amount converted. While taxes are currently due, there is no 10% penalty tax applied if you convert your traditional IRA to a Roth IRA before age 59½. You will need to contact your IRA trustee or custodian to determine the exact process you must go through to effect a conversion.

Depending upon the size of the traditional IRA, the taxes due can be quite a large sum. However, if you believe that tax rates are lower now than they may be in the future during your retirement, then it may make sense to make the conversion. This is especially true this year, since the bear market has reduced the value of many traditional IRAs, thus reducing the income taxes that would be due upon conversion of the entire account.

The details of the decision process of whether or not to convert a traditional IRA to a Roth IRA is one that involves a number of factors that are beyond the scope of this section of the E-Letter. But as a general rule, Roth IRAs are more beneficial for younger investors who have lots of time for tax-free earnings to grow. Even so, a conversion can also be beneficial for older IRA account holders in certain situations.

The potential advantages of converting your traditional IRA to a Roth IRA include the following:

  1. A Roth IRA of the same size as a regular IRA actually has a greater economic value since distributions will not be reduced by income taxes;

  2. There is no requirement that minimum distributions begin at age 70½ as is the case with a traditional IRA;

  3. Roth IRAs remove the risk of higher future tax rates, since amounts can be withdrawn tax-free in retirement;

  4. Partial conversions can be done if the taxpayer does not have enough money from other sources to pay the income taxes necessary upon a full conversion; and

  5. Roth IRAs can also simplify estate planning since the balance of a Roth IRA transferred to an heir will not be subject to income taxes, though it may be subject to estate taxes.

There are, however, potential disadvantages of making the conversion to a Roth IRA, including:

  1. It is possible that future tax rates could be lower than current tax rates, though I doubt it;

  2. The amount of tax due upon conversion can be considerable, and could push the account holder into a higher tax bracket. Plus, some IRA account holders cannot pay the taxes on a full conversion from other resources and resort to withdrawing money from the IRA to pay the tax, possibly subjecting themselves to a 10% penalty tax if they are under age 59½. In both of these situations, it is sometimes better to do a partial conversion to minimize these disadvantages;

  3. State income tax issues can also sometimes come into play when making a Roth IRA conversion;

  4. Older traditional IRA account holders may not have enough time prior to retirement to make up the current taxes that must be paid on the conversion; and

  5. The taxation upon conversion is determined by the value of the account at the time of conversion. Thus, if the value drops later on in the year, like we saw in October and November of this year, the taxes due can be a much larger share of the year-end traditional IRA value than they were at the date of conversion (more about this later on).

If it appears that making the conversion would be beneficial for you, then doing so before the end of 2008 may reduce the taxes due upon conversion due to the effects of the bear market. However, time is short as the money must be removed from your traditional IRA before the end of the year to be effective. Fortunately, you do have until after the end of the year to place the money into the new Roth IRA, but the process must begin before the end of this month.

I mentioned above that one of the disadvantages of conversion is that if you converted a traditional IRA to a Roth IRA earlier in 2008, the taxes due will be based on the value at the time of conversion. However, we all know that many IRAs have experienced large losses in October and November of this year. Thus, the taxes due on an early 2008 conversion will likely be much larger than if they had been calculated based on the December value of the IRA.

Fortunately, there is a way to fix this, but it involves a bit of paperwork. The rules allow for a Roth IRA "recharacterization" in which the Roth IRA is converted back to a traditional IRA, thus eliminating the income taxes due upon conversion. This recharacterization can be done any time up to the tax return due date, including extensions, so you effectively have until October of 2009 to "undo" the transaction.

Oh, and for those of you thinking ahead and considering recharacterizing a prior Roth conversion and then immediately converting the IRA again at a lower value, the IRS is one step ahead of you. The conversion rules provide that if you recharacterize an IRA conversion, you have to wait until the next tax year to do another conversion.

Again, this has been just a very brief discussion of the conversion and recharacterization process. The final decision must be based on all the tax and other consequences applicable to your individual situation. Thus, it is imperative that you consult a qualified tax professional or financial advisor prior to taking any action in regard to the conversion process.

Max Out 401(k) contributions

While it is very late in the year, you may also want to consider maxing out your 401(k) contributions. Many employer plans allow for very high contribution percentages, which can be used to increase the amount of your 2008 pre-tax 401(k) contributions here at the end of the year. You will need to consult with your Human Resources Department to determine how much you can contribute and when your payroll request must be submitted, but if you can afford the extra deduction, it's a good way to "top-off" your 401(k).

The same idea can apply to year-end bonuses paid on or before December 31st. Many employer 401(k) plans allow employees to elect whether or not to include or exclude bonuses from the 401(k) contribution election. However, you may also be able to contribute a larger percentage of your bonus to your 401(k). This not only increases the amount of pre-tax contribution for 2008, but may also increase your employer matching contribution, depending upon the specific provisions of your plan.

Now is also a good time to make any adjustments in your payroll deduction for next year. The maximum 401(k) employee contribution has been increased from $15,500 to $16,500 for 2009. In addition, the "catch-up" contribution limit for participants age 50 or older has increased from $5,000 to $5,500 for 2009. You may want to increase your applicable contribution percentage to take advantage of these new limits.

In addition, it is important to note that payroll systems usually do not recognize employees age 50 or over and allow catch-up contributions. For example, let's say you are over age 50 and have a contribution percentage that allows you to reach the $16,500 maximum contribution level in September of 2009. If you want to continue your contributions after that under the catch-up contribution rule, you may need to take additional action.

Check with your Human Resources Department to see if your employer's payroll system will automatically recognize that you are eligible to contribute an additional $5,500 due to your age, or if it will require you to set up a separate catch-up contribution deduction. I suspect that most payroll systems require you to make an additional election in order to take advantage of the catch-up contribution.

Plan Your Investment Strategy

One of the most frequent questions we get from 401(k) participants is when they should get back into the market. It's a very good question, and we're always happy to hear that some participants elected to move to cash, thus escaping some of the carnage we've seen in the market. However, there may still be a lot of risk of being in the market, so the decision of whether to stay in cash or get back into the market is a hard one, even for those of us in the investment business who participate in our employers' 401(k) plans.

For investors with IRAs or personal investment portfolios that are now largely in cash, we offer a number of risk-managed alternatives that have the ability to go to cash or hedged positions, or even go short in an effort to minimize the effects of uncertain markets. In many 401(k) plans, however, choices are limited to a variety of mutual funds that may or may not incorporate active management techniques to control risk.

While it is not possible to provide investment advice without knowing the specific situation of the investor, there are some very general rules that may be helpful to you in your 401(k) investing at a time like this when the market is extremely volatile and advice from the talking heads on financial shows seems to go in all different directions.

What 401(k) investors want to know when they call us is whether it is safe to invest in the stock market again, essentially asking if we've hit "the bottom" and prices will rise from this point on. While there have been some notable financial gurus saying that the market has reached the bottom and it's poised for a rebound, no one can know this for certain. The only predictable thing about the subprime crisis and resulting bear market has been their unpredictability.

The subprime contagion has spread to different sectors of the global economy over time, so no one really knows whether we have seen the final effects, or whether there's more to come. The uncertainty currently gripping the stock market has made it emotionally difficult for many 401(k) participants to direct the investment of their accounts. They hear advice saying to buy in when the market is low in order to maximize future returns, but then hear other "experts" say that the US is headed for another Great Depression.

The only thing we do know is that the market is nearer the bottom now than it was earlier this year, and certainly a better buy than when it hit new record highs in October of 2007. However, buying in now could lead to losses should the market fall further in the future. So how should you invest your 401(k) money in such a situation?

If you have a large cash or fixed-income investment position in your 401(k) plan, one answer to this question may be to consider using a technique called "dollar cost averaging" (DCA). In a nutshell, dollar cost averaging means to invest money in increments over time rather than doing it in one lump sum. The premise is that you purchase shares at different price levels over time, so you worry less about whether you're buying in at the bottom or not.

In essence, you are already using DCA in your 401(k) since your monthly contributions buy shares of investments at different prices during your employment. While using DCA to invest a large cash balance requires more of your personal involvement than do regular monthly contributions, it can also relieve some of the emotional stress from trying to guess when we hit "the bottom" in the stock market.

The amount of your cash reserve that is invested and the timing of those investments are variables that you control. Some investors may be comfortable with only moving 10% of the cash position into investments at any given time, while others may want to do much more. The timing can be every month, every quarter or even just whenever you feel comfortable in making another investment. The important thing is that timing "the bottom" becomes less important as your average share cost reflects a variety of price levels.

I would be remiss if I didn't mention that studies have been published which indicate investing a lump sum all at one time can lead to higher eventual returns than using DCA to gradually enter the market. Since I have not studied the detailed methodology behind each of these studies, I can't comment on their validity, but I did want to mention that not all brokers and financial advisors agree with using DCA (especially those who get paid only as the money is invested).

Since it's impossible to tell whether future market conditions will be similar to those covered in the studies mentioned above, I think it's also important to focus on the emotional issues that are addressed by DCA. If you can be comfortable with averaging your cash position into the market, this may be better than agonizing over when to pull the trigger and invest a lump sum.

In fact, we sometimes see 401(k) participants who simply can't decide when to invest a large cash position, so they remain on the sidelines even after the market begins to rebound. By the time they finally decide, the bull market rally is in full force, and they may have missed out on much of the market's rebound.

Again, dollar cost averaging is an investment strategy that may or may not fit your investment goals or risk tolerance, but it is one you can consider as we continue to watch the market's large up and down swings. If you would like to learn more about using this technique to ease back into the stock market, give one of our Investment Consultants a call at 800-348-3601 or send us an e-mail at We'll be happy to help you.

Conclusions and Happy Holidays

Since I won't likely be writing another Retirement Focus issue prior to the end of the year, I'd like to take this opportunity to thank all of you who have been regular readers during the year, and especially those who have contributed comments and suggestions along the way. This feedback helps me to target the retirement issues that are of most concern.

As we look forward to 2009, it's almost certain that we will see additional legislation and regulatory changes as the federal government seeks to mitigate the effects of the credit crunch and resulting bear market. As new pronouncements are made, I will do my best to bring them to your attention so that you can take advantage of those that apply to your financial situation.

In the meantime, I hope you have the merriest of Christmases, or whichever holiday you may be celebrating, and a safe and happy New Year.

P.S. - From Gary

I would like to thank Mike for all the very good information he provides to all of us in his periodic Retirement Focus issues. With his background as the former president of a large trust company, he is certainly better qualified to understand and explain these often complicated retirement account issues than am I.

In addition to all the good information Mike provides, it also gives me a much-needed break from writing every so often. So, I also thank him for that!

With Warmest Holiday Wishes,

Mike Posey


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"Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend any product or service advertised herein, unless otherwise specifically noted."

Forecasts & Trends is published by ProFutures, Inc., and Gary D. Halbert is the editor of this publication. Information contained herein is taken from sources believed to be reliable, but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgment of Gary D. Halbert and may change at any time without written notice, and ProFutures assumes no duty to update you regarding any changes. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Any references to products offered by Halbert Wealth Management are not a solicitation for any investment. Such offer or solicitation can only be made by way of Halbert Wealth Management’s Form ADV Part II, complete disclosures regarding the product and otherwise in accordance with applicable securities laws. Readers are urged to check with their investment counselors and review all disclosures before making a decision to invest. This electronic newsletter does not constitute an offer of sales of any securities. Gary D. Halbert, ProFutures, Inc. and all affiliated companies, InvestorsInsight, their officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Securities trading is speculative and involves the potential loss of investment. Past results are not necessarily indicative of future results.

Posted 12-16-2008 2:27 PM by Gary D. Halbert
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