Republican presidential nominee Mitt Romney has an IRA valued at $60 million or more. While IRAs are the most valuable asset most people have, not many have IRAs as valuable as Romney’s. There are several factors that contributed to Romney’s IRA growth, as explained in this article. Some of these strategies aren’t available to most of us. As a partner in a private equity firm, for example, Romney could invest in company shares before they were taken public and early in the development of the companies, when their shares were fairly cheap.
But all of us can invest in non-traditional assets in IRAs. You need a non-traditional IRA custodian, but it’s perfectly legal. With a true self-directed IRA, you can invest in real estate, private partnerships, private equity, small non-public companies, hedge funds, and other assets. Like other IRA owners, Romney’s IRA grew largely as a result of retirement benefits received from his employer. He’s had access to some opportunities most of the rest of us don’t, but you aren’t stuck with mutual funds and stocks. For details, you can obtain my IRA Investment Guide.
The Department of Labor issued new regulations last week that allow fiduciaries of 401(k) plans and IRAs to offer investment advice under some circumstances. The law prohibits such advice, but the DOL carved out some exceptions. Fiduciaries may offer advice, beginning Dec. 27, if their compensation doesn’t depend on the investment recommendations or they use a computerized investment system from a certified third party. The first exception means the fiduciary is paid the same amount for the advice regardless of the investment that is recommended, such as receiving a flat fee or a flat percentage of the account’s value. Many fiduciaries already offer advice based on separate exemptions they received from DOL.
These regs don’t resolve a very hot issue that’s been debated in Washington. The DOL issued proposed regulations not long ago that essentially provided that anyone who offered investment advice or had almost any role with a retirement plan would be a fiduciary. The regulations were withdrawn after a lot of complaints from financial services companies and members of Congress. The DOL still is working on those regulations. The financial services industry argued that if the proposed regulations stood, then many firms would decide not to provide advice to retirement plan members. Currently, brokers and investment advisors can offer paid advice to participants without being considered fiduciaries. Fiduciaries have a higher level of legal scrutiny than non-fiduciaries.
The last-minute tax changes Congress made in 2010 make one decision easier.
Taxpayers who converted a traditional IRA or employer plan into a Roth IRA in 2010 have a choice. They can include the converted amount in gross income in 2010 and pay taxes at their 2010 rate, or they can defer recognition of the gross income. The deferral allows the converters to include half the income in 2011 gross income and half in 2012. But Congress extended the 2010 tax rates for the next two years. For most people that means there isn’t much of a decision. You’ll face the same tax brackets in all three years, so for most people there isn’t the potential you’ll pay higher taxes by deferring. You might as well choose deferral and hold onto the money for a while. Maybe you’ll earn a little income on it.
People who should consider paying the taxes in 2010 are those who expect to have lower tax rates in 2010. They might have a large amount of deductions for the year or a shortfall in income. Or perhaps you expect to have higher income in the next couple of years from the sale of a business, collection of deferred income, or some other action. Another reason not to defer is that you expect to have significantly fewer deductions after 2010. Maybe you paid off your mortgage or soon will.
I suspect for most people it will be an easy decision and they’ll defer the income.
I continue to receive a lot of questions about the five-year waiting period for taking distributions after Roth IRA contributions and conversions. There’s a lot of confusion about the rules. It is slightly different for conversions and for contributions. It also is different for income taxation of distributions and the 10% early distribution penalty on distributions. Here’s how I described the rules in the May 2010 issue of Retirement Watch.
The five-year waiting period also generates many questions.
Only qualified distributions from a Roth IRA are tax-free. For a distribution to be qualified, the Roth IRA must be open at least five years. For regular Roth IRA contributions, the five-year rule is met if any Roth IRA owned by the taxpayer is at least five years old. If you opened a Roth IRA in 2000, for example, any distributions you take out of any regular Roth IRA now are tax-free.
The rule is different for converted Roth IRA amounts. A new five-year waiting period starts for each conversion. That means income and gains from the converted amount are taxable if withdrawn within five years of the conversion.
For most people, however, the five-year waiting period doesn’t matter. The rules for taxing Roth IRA distributions are that distributions are first considered to be of after-tax contributions. Distributions of after-tax contributions (such as converted amounts on which you paid the conversion tax) are tax-free. Only after all after-tax contributions (whether regular contributions or converted amounts) are withdraw are you withdrawing potentially taxable income and gains. So, the five-year rule doesn’t matter, unless you withdraw all or most of the IRA within five years. Even then, you’ll pay taxes only on the accumulated income and gains distributed not on the after-tax contributions.
The five-year period for either type of contribution begins on Jan. 1 of the year of the contribution or conversion, not on the date of the contribution or conversion.
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