Making Lemonade out of Lemons

Ginny Gribble, QPA, QKA, Director of Retirement Plan Services   email | bio
May 2010

Popular opinion is that tax rates are going to go up. Here are a few strategies for qualified retirement plans that might be advantageous in an increased tax environment.

Beginning in 2010, traditional Individual Retirement Accounts (IRAs) can be converted to Roth IRAs regardless of income level. When converting to a Roth IRA, taxes typically need to be paid immediately on any tax-deferred dollars in traditional IRAs. However, for 2010 only, the tax can be spread over the next two years, 2011 and 2012. (For more information regarding the new Roth IRA conversion rules please refer to the following articles previously published in The Adviser: "Changing the Game: A Look at the New Roth IRA Conversion Rules – Part I," "Roth IRA Conversion – Part II" and "Wisconsin Adopts Federal Roth IRA Conversion Rules.")

Conventional wisdom states, if tax rates are going up, pay taxes now rather than later. Roth IRAs grow tax-free, as long as you don't make any withdrawals before meeting certain criteria (generally, the money has to be in a Roth IRA for 5 years, and you have to be 59 ½ or older).

If you do not currently have a traditional IRA, an option is to take an in-service withdrawal from your 401(k) plan, roll it into a traditional IRA and then convert to a Roth IRA. You could also do a direct rollover from your 401(k) plan to a Roth IRA under current retirement plan rules. Note that the 401(k) plan would have to allow for in-service withdrawals, and you would have to be eligible. Consult your retirement plan adviser about your plan's provisions.

If your plan doesn't currently allow for Roth deferrals (employee contributions), or if it does and you're not making any, you may want to consider this option. Inside a 401(k) plan, there are no income restrictions for making Roth deferrals, and the limits are higher than in IRAs. A 401(k) plan allows you make up to $16,500 in Roth deferrals per calendar year ($22,000 if you are age 50 or older), while a Roth IRA is capped at $5,000 ($6,000 if age 50 or older).

Company contributions to retirement plans are one of the largest tax shelters available. Certain design techniques may allow owners to contribute more while maintaining, or at least minimizing, costs for employees. If you currently have a 401(k) plan and you are not already allocating your profit-sharing contributions on a cross-tested (also known as new comparability) basis, you may want to consider it. It is not always advantageous, as it is age-based. In addition, your employee demographics need to be conducive to it, but many times, it is the most advantageous method of weighting contribution allocations toward key individuals.

Also consider adding a defined benefit plan in addition to your 401(k) plan. Defined benefit plans are the only plans that allow you to put in more than the current $49,000 limit for individuals in 401(k) plans. Similar to cross-testing in 401(k) plans, defined benefit plans generally work better when key individuals are older, on average, than staff. There are many ways to design the combination of plans to try to increase contributions for owners while minimizing costs for staff. Defined benefit plans are pension plans and contributions are required. An actuary is required to compute contributions, so these plans generally have higher costs to maintain. But the costs are almost always mitigated by the additional tax savings.

If you have any questions about any of these techniques, please contact Ginny Gribble at ggribble@KolbCo.com at 262/754-9400 ext. 285.