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Alan Haft

IRAs and 401(k) Plans

Four important strategies in a declining market.

October 17, 2011
by Alan Haft

No doubt, this is shaping up to be another ugly year in the stock markets but all hope is not lost. With every dark cloud, there’s always a silver lining and as such, here are a few linings and strategies that come to mind:

  1. Review the plan

    This is the most basic of the four but it’s so often missed due to the “bury the head in the sand” syndrome that I see all too often. In a declining market, many clients just don’t want to look at their statements and while making sure one understands their allocations may seem incredibly basic, you’d be surprised as to how many people look the other way during these tough times.

    Needless to say, turning away is by far the worst investment strategy anyone can ever employ for their retirement. After all, it’s easy to watch chips pile up when one’s on a roll at the market table, but when things turn for the worse, watching the table and making adjustments is what any success is often about.

    Be sure to nudge your clients into reviewing their overall retirement plan or with a financial professional and ask important questions such as:

    • What, if any, adjustments can be made to help reach your client’s retirement goals? If a client is planning to retire in a certain year, help determine if such a plan is still realistic, and they might also calculate how much longer their assets would last if they worked a few years longer.
    • Can your clients reach their goals by using a smaller withdrawal rate or by increasing the individual retirement account (IRA) or 401(k) savings?
    • Does the current allocation make sense? Especially for people who are planning to live off their money anytime soon, now might be the best time to trim exposure to stocks.

    Lastly, if they don’t have a plan for retirement, good markets or bad, it’s always an ideal time to think about establishing one.

  2. Convert a traditional IRA or transfer an old 401(k) to a Roth

    This is perhaps the only truebenefit” I can think of when markets turn for the worse.

    Due to the likelihood of declining values this year, the tax cost of converting to a Roth IRA has dropped dramatically for many investors. For some clients, consider whether converting their traditional IRA to a Roth IRA makes good financial sense. Keep in mind, the taxable portion of a traditional IRA will be subject to ordinary income tax in the year of conversion, but future and qualified distributions from a Roth will be entirely free from taxes (generally, five years after the conversion along with other important qualified factors).

    Thankfully, this is another year the government has lifted the $100,000 modified adjusted gross income (AGI) limit that has historically disallowed some folks from making a conversion. These days, anyone willing to pay the tax can convert a traditional IRA to a Roth, regardless of their income level or marital status.

    Similarly, if with your assistance a client determines a Roth IRA conversion makes sense for them and they’re entitled to a distribution from their 401(k) plan, keep in mind that they can roll over (that is, essentially convert) their non-Roth assets to a Roth IRA (hardship withdrawals, certain periodic payments, and required minimum distributions (RMDs) can’t be rolled over). This may be especially attractive if a client is entitled to an in-kind distribution of an employer stock whose values are seriously depressed. In such a case, your clients will pay tax on this reduced value and any additional appreciation may be tax free.

  3. Undo a conversion

    What if a client already converted their traditional IRA to a Roth and their balance has taken a significant hit since then? The tax cost of converting was probably much greater, had they had a crystal ball and waited until now to do the conversion.

    Don’t fret, all hope isn’t lost.

    This is something very few clients know about and can be a real bonanza for some -- they can undo last year’s conversion up until the due date for filing their tax return, including extensions. Technically called a “recharacterization,” this procedure allows them to treat the conversion as though it never occurred.

    To undo last year’s conversion, your client needs to carefully follow these steps:

    • Inform the IRA custodian (the one holding the Roth IRA and the one providing the traditional IRA, if different) that a client intends to recharacterize their Roth back to a traditional IRA. A client must provide this notice on or before the date the assets are transferred back to the traditional IRA.
    • Make sure the transfer is completed by the due date for filing the federal income tax return, including extensions. For most taxpayers, this can be as late as October 15th of this year, which, by the time this article is published, will be too late to recharacterize conversions done last year (unless, however, some CPAs submit explanations soon after that date; something I’ve seen worked before). That said, the concept still reigns quite important: if a client did a Roth conversion earlier this year, they essentially have until October 15th of next year to change their minds and undo the action. If a market downturn continues, keeping this in mind can be a huge help to those who suffer losses on their accounts. One person I recently came across hailed his CPA for informing him of this and as such, wound up saving tens of thousands of dollars in taxes he otherwise would have paid had he not recharacterized back to the IRA.
    • One important note: I would highly suggest when recharacterizing a Roth back to an IRA, to be sure to write: “Filed pursuant to Section 301.9100–2” on Form 1040–X.) On occasion, when watching some CPAs in action, this has proved to be an important step in the recharacterization process.
    • Lastly, just a polite reminder for your busy days: Don’t forget to report the recharacterization to the IRS (see Form 8606 for more information).

    One question that frequently comes up when discussing recharacterizations: “when can I re-convert back to the Roth IRA after I undo the conversion?”

    I’ve heard this many times before and the answer is beginning on the 31st day after the recharacterization is complete. To be safe and to avoid any conflicts, I usually hold out at least six weeks to eight weeks after the recharacterization is complete before jumping back into conversion mode.

  4. Continue to contribute

    Despite the recent downturn, for most people, IRAs and employer-sponsored retirement plans remain their sole vehicle(s) for retirement savings. During these tough times, many people stop contributing all together, which is a certain recipe for a lackluster retirement.

Conclusion

When it comes to investing, one of the toughest things to understand is that historically, the greatest bull markets immediately follow the absolute worst bear markets and as long as a client’s assets are positioned correctly in their IRA/401ks, for most people, they really should plow through these tough times and look further down the road. Otherwise, losses or gains, without contributions, they are most certain to end up on the short side of the stick.

During these difficult times, I hope these ideas are helpful to you and your clients and I wish you the very best of success.

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Alan Haft is an investment advisor, author of three books including the national bestseller, You Can Never Be Too Rich and makes frequent appearances in national print, television and radio media such as The Wall Street Journal, Money magazine, CNBC, BusinessWeek and many others. The amounts represented in this article should all be considered hypothetical, for example only and the facts should always be checked with a qualified tax professional before any actions are ever taken.

For full disclosure, Haft is a part of a firm that utilizes all industries which typically includes us receiving percentage based fees for brokerage services as well as commissions when implementing insurance based plans. Haft does not work for any particular financial company or industry nor should this column be construed as an endorsement or condemnation for any particular product. Readers should note that all views and vendor recommendations as expressed in this article are solely the author’s and do not necessarily reflect the views of the AICPA CPA Insider™ or the AICPA.

* This article is not intended to provide financial planning, tax or legal advice and should not be relied upon as such. Any specific tax or legal questions concerning the matters described in this article should be discussed with your tax or legal advisor.

The AICPA PFP Section provides information, tools, advocacy and guidance to CPAs who specialize in providing tax, retirement, estate, risk management and investment advice to individuals and their closely held entities. Included is access to Forefield Advisor, an online library with information that can help describe topics like this for clients. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter apply to become a PFS Credential holder.