By SCOTT HANSON
Scripps Howard News Service
04-JUL-05
Q:
I am 65 years old and I have $57,000 in one annuity and $43,000 in another. I probably won't need to draw on them until I'm 70 1/2 when I have to make the required withdrawals each year. Should I change each of the annuities into IRAs? I was told that it was better for an heir to inherit an IRA than to inherit an annuity.
_ Muriel, Fremont
A:
There is no requirement that you take withdrawals from your annuities. Unlike IRAs, 401(k)s and 403(b)s, there are no required minimum withdrawals from annuities at age 70 1/2.
It is true that beneficiaries of IRAs have more favorable options than beneficiaries of annuities. However, you cannot simply change your annuities into IRAs.
Assuming the annuities you own are "nonqualified," meaning that the money you put into the plans was not part of an employer's retirement plan, they must remain nonqualified annuities. A transfer to anything other than another annuity will result in taxation.
On the other hand, if your annuities have been established through your employer using 403(b) accounts, they follow the 403(b) rules. They are qualified retirement plans that own annuities. If that's the case, you can transfer your 403(b) accounts to one or more IRAs. By doing so, you'd increase your beneficiary options, but you'd be giving up the ability to borrow from the 403(b)s in the future.
Q:
I recently read your article about how 401(k)s are protected. I have money in my company's deferred compensation program. I am wondering: If something should happen to my company, how secure is my compensation program? All of the money in the fund is from my contributions, and the company does not contribute anything to the fund.
_ Tim, Troy, Mich.
A:
Deferred compensation plans, such as 457s and nonqualified deferred comp plans, do not receive the same protections as 401(k)s. Assets in these plans can be subject to creditors in the event of bankruptcy.
If your company goes bust, you could lose a large portion of your deferred comp plan. The money in the plan could be used to pay off your employer's debts. If you're worried about the future of your company, don't put money into the plan unless you can afford to lose it.
Q:
I am 70 and will soon be forced to take withdrawal from my $200,000 IRA. I'm in the 15 percent tax bracket and currently pay no tax on my Social Security. However, the IRA withdrawals will cause my Social Security to become taxable and give me an effective tax rate of 23 percent, even though I'm in the 15 percent bracket. I'm thinking about doing a Roth conversion for the entire account, paying the taxes now and then avoid paying tax on my Social Security in the future. What do you think?
_ Dan, Sacramento
A:
I commend you for paying such close attention to your income tax situation. Tax planning to reduce income taxes is one of the best financial strategies one can employ.
You are right in that your required withdrawals can cause your effective tax rate to increase. Retirees with lower incomes can avoid paying income taxes on their Social Security benefits. But as a retiree's income increases, benefits become taxable. Higher income retirees must include up to 85 percent of their benefits as income on their income tax returns. And mandatory withdrawals from retirement plans will push your income higher.
If you convert your entire IRA into a Roth, you could wind up in the 31 percent tax bracket. To make matters worse, you could lose some of your itemized deductions and standard exemptions (which are reduced or phased out for higher income earners).
A major problem with doing a full Roth conversion is this: No one knows the future of our tax system. Will the formula for taxing Social Security benefits be changed? Will required withdrawals from retirement accounts be reduced? Will income tax rates rise or fall? It's impossible to predict such things.
If I were in your shoes, I wouldn't be in a rush to do a Roth conversion. You could pay a fortune in taxes today only to find your Social Security benefits taxable under a new formula in the future.
(Scott Hanson, CFP, is a senior adviser with Hanson McClain, an investment advisory company and registered principal with Securities America, member NASD/SIPC. E-mail questions to questions@moneymatters.com.)
