New tax breaks for retirement savings

December 15, 2006

Recent federal reforms provide a slew of perks for high-earners and their families.

Seeking to avert a meltdown and taxpayer bailout of traditional pension plans, Congress passed two important pension reform bills this spring. Both the Pension Protection Act of 2006 and the Tax Increase Prevention and Reconciliation Act not only strengthen traditional pension plans, but they also extend and improve more than 20 retirement tax savings benefits. It's important that you understand and utilize aspects that will both help your practice and help you plan for retirement.

Although the standard advice is to pay taxes later, I've always made an exception for Roth IRAs, especially for high-income taxpayers. Assuming you're in the top tax bracket of 35 percent and have $1 million in your qualified plan or IRA, you'll be better off to the tune of about $500,000 in 2030 if you make the conversion in 2010. The benefit multiplies if you leave your Roth IRA to your children because, as your beneficiaries, they won't have to pay income taxes on that money. One important caveat: For a Roth conversion to be most beneficial to you and your heirs, you must pay any tax liability with outside funds-not with funds from the converted account-so that the maximum amount is working for you in the Roth.

Nonspouse beneficiaries. Starting in 2007, nonspouse beneficiaries can transfer amounts from a qualified retirement plan or tax-sheltered annuity directly into an IRA, which will be treated as an inherited IRA for minimum distribution rules. If you're unmarried, or if you have sufficient other assets to pass to your surviving spouse, naming a child, grandchild, or other beneficiary could allow this person to defer income taxes. For how long depends on the minimum distribution rules that apply to nonspouses, including whether you had been receiving payouts at the time of your death. If you were at least age 70½ and minimum distributions had begun, your nonspouse beneficiary must continue to take them at least as rapidly; if payouts hadn't begun, they can be taken over the beneficiary's life expectancy, stretching them over many years.