There are plenty of tips and tricks to maximizing your
retirement benefits, and more than a few are considered “loopholes” that
taxpayers have been able to use to circumvent the letter of the law in order to
pay less to the government. But as often happens when too many people make use
of such shortcuts, the government may move to close three retirement loopholes
that have become increasingly popular as financial advisers have learned how to
exploit kinks in the law.
1. Back-door Roth IRA
conversions
The U.S. Congress created this particular loophole by lifting income
restrictions from conversions from a traditional Individual Retirement Account
(IRA) to a Roth IRA, but not listing these restrictions from the contributions
to the accounts. People whose incomes are too high to put after-tax money
directly into a Roth, where the growth is tax-free, can instead fund a
traditional IRA with a nondeductible contribution and shortly thereafter
convert the IRA to a Roth.
Taxes are typically due in a Roth conversion, but this
technique will not trigger much, if any, tax bill if the contributor does not
have other money in an IRA. President Obama’s 2016 budget proposal suggests
that future Roth conversions be limited to pre-tax money only, effectively
killing most back-door Roths.
Congressional gridlock, though, means action is not likely
until the next administration takes over, said financial planner and enrolled
agent Francis St. Onge with Total Financial Planning in Brighton, Michigan. He
doubts any tax change would be retroactive, which means the window for doing
back-door Roths is likely to remain open for awhile.
2. The stretch IRA
People who inherit an IRA have the option of taking distributions over their
lifetimes. Wealthy families that convert IRAs to Roths can potentially provide
tax-free income to their heirs for decades, since Roth withdrawals are
typically not taxed. That bothers lawmakers across the political spectrum who
think retirement funds should be for retirement – not a bonanza for inheritors.
Most recent tax-related bills have included a provision to
kill the stretch IRA and replace it with a law requiring beneficiaries other
than spouses to withdraw the money within five years. Anyone contemplating a
Roth conversion for the benefit of heirs should evaluate whether the strategy
makes sense if those heirs have to withdraw the money within five years.
3. “Aggressive”
strategies for Social Security
Obama’s budget also proposed to eliminate “aggressive” Social Security claiming
strategies, which it said allow upper-income beneficiaries to manipulate the
timing of collection of Social Security benefits in order to maximize delayed
retirement credits. Obama did not specify which strategies, but retirement
experts said he is likely referring to the “file and suspend” and “claim now,
claim more later” techniques.
Married people can claim a benefit based on their own work
record or a spousal benefit of up to half their partner’s benefit. Dual-earner
couples may profit by doing both. People who choose a spousal benefit at full
retirement age (currently 66) can later switch to their own benefit when it
maxes out at age 70 – known as the “claim now, claim more later” approach that
can boost a couple’s lifetime Social Security payout by tens of thousands of
dollars. The “file and suspend” technique can be used in conjunction with this
strategy or on its own. Typically one member of a couple has to file for
retirement benefits for the other partner to get a spousal benefit.
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