Opening a Rollover IRA
When you take a lump sum payment from a qualified retirement plan and use it to establish an IRA account, that’s called opening a rollover IRA. There’s a 60-day period here, too, for transferring your qualified plan assets (see General rollover rules).

Roth Conversion
Starting in 1998, the Roth IRA came into effect. If you qualify, you may convert a traditional IRA to a Roth IRA (see Conversion to a Roth IRA).

Spousal Rollover
A surviving spouse as the beneficiary of a deceased spouse’s qualified plan account may convert that account into an IRA.

Divorce Rollover
A court order may allow a spouse to receive part or all of the retirement benefits of a spouse or former spouse. Those benefits may be rolled over into an IRA.

General IRA Rollover Rules

1.  The first rule to follow is the 60-day rule. If you do any type of rollover, you have to deposit the full amount within 60 days of the distribution. If you miss this deadline, then the funds are treated as having been distributed to you and become part of your taxable income.

You’ll probably want to avoid personally handling the assets before they are put into another IRA. Here’s why. With direct distributions to you, the payout check will be only 80% of the total amount from the qualified plan. The other 20% is required to be withheld as tax when distributions are made directly to you. That means if you’re going to deposit the full amount into the rollover IRA, you’ll have to tap another source-like your savings-to come up with the 20% that’s been withheld. If you deposit the full amount within the 60 day period, you’ll get the 20% back after you file your income tax return for that year. However, your wait for the return of your money could be a year or more.

It could get worse. If you can’t come up with enough money to cover the 20% that was withheld, that 20% is considered to be a distribution to you (even though you never received or touched it). Distributions are taxable income to you and, if you’re not yet age 59½ (or are disabled, separated from service after age 55 or have deductible medical expenses exceeding 7.5% of your adjusted gross income), you’ll have to pay a 10% early distribution penalty, too. The good news is that there is an easy way to avoid this withholding and penalty problem.

Instead of a direct payout to you, have the retirement money transferred directly to the institution handling your rollover IRA. If you don’t handle the money, then the 20% withholding is avoided and the full amount goes into the rollover IRA. But, if you need access to the cash during the 60 day period, this approach won’t help you out.

2. Keep rollover IRAs separate for future flexibility In the future, you may want to transfer your rollover IRA from your old employer’s plan into a new employer’s plan. To be eligible to do so, you need to keep rollover IRA money separate from other IRAs you may have. If you don’t keep the money separate, you won’t be eligible to move it to your new employer’s plan. To be in a position to possibly make this move down the line, set up a rollover IRA-known as a conduit IRA-to hold your rolled over money and do not commingle it with any other IRA funds. One reason to keep your options open is that although you can’t borrow from an IRA, you may be able to do so from your new company’s plan.

3. Don’t mix pre-taxed and already taxed qualified plan money Except for a conversion to a Roth IRA, the only contributions to a qualified retirement plan that can be moved into a rollover IRA are those that weren’t already taxed. If you’ve made after-tax contributions or if your employer has made supplemental contributions that aren’t tax deductible, that money needs to be invested separately. This rule can be a blessing because it will simplify separating out taxable and non-taxable distributions in the future.

4. Keep rollover IRAs separate for future flexibility If you receive a lump sum pension payout, you can put all or part of it in a rollover IRA. Also, if the payout is made in a series of substantially equal payments over a period of not more than 10 years, you can usually put some or all of those payments in a rollover IRA, too.

Converting to a Roth IRA
Virtually all qualified retirement accounts and plans may be converted to a Roth IRA (pending legislation may allow the one exception, 457 plans, to also be rolled over to an IRA). In some cases (e.g., a traditional IRA), the conversion to a Roth IRA may be done in one step. In other cases, it’s a two-step process where you first roll over your retirement plan assets into a traditional IRA, and then you convert the traditional IRA into Roth IRA.

Eligibility for Converting to a Roth IRA
Whether you qualify to do a conversion to a Roth IRA depends upon your modified adjusted gross income (“MAGI”) and your marital status. If your MAGI is no more than $100,000, you may qualify to convert to a Roth IRA. What is your MAGI? It’s the number on the last line of page 1 of your federal income tax return, Form 1040 (your adjusted gross income), which may be modified for certain items.

It is important to note that you do not include the amounts you are converting to determine whether you are above the $100,000 MAGI limit.

The $100,000 limit applies if you’re single or you’re married. However, there are special rules for married couples converting to a Roth IRA. A married person who has lived apart from his or her spouse for the entire taxable year can treat himself or herself as unmarried for conversion purposes, and file a separate income tax return (subject to the $100,000 limit on his or her separate MAGI). In all other cases, a married person filing a separate return is not permitted to convert an amount to a Roth IRA, regardless of the person’s MAGI.

There are special rules on re-characterizing (converting back) a Roth IRA to a traditional IRA. You may need to do this, for example, if your income turns out to be too high to be eligible for a conversion.

Benefits for Converting to a Roth IRA
The primary motivation for converting to a Roth IRA is to ensure that future earnings on the account are income tax free.

If you convert to a Roth IRA, you may need to pay some additional income tax now on the converted amount. It depends upon the amount converted and your other income and deductions.

When you do a conversion, the amounts transferred to the Roth IRA are considered as income to you in that year, so you need to be prepared to possibly pay income tax (but no penalty) on the converted amount. The converted amount is added to your income in the year of conversion. If you need to use IRA funds (as compared to funds held in your personal name) to pay the income tax due on the conversion, you may also pay a 10% penalty on the funds used to pay the income tax. Payment of income tax from IRA funds will also reduce the amount you have growing in the potentially income tax free Roth IRA. Note that prior non-deductible IRA contributions are not considered as income to you on the conversion.

Besides having more income to pay tax on, converting may lead to some unexpected tax consequences. If you convert to a Roth IRA, you may be in a higher income tax bracket by including the converted amount in your income. As a result, your income level may be high enough so that the extra income from the conversion will reduce your allowable amount of personal exemptions, itemized deductions, and rental losses and possibly cause otherwise non-taxable Social Security benefits you are receiving to become taxable. Also, you may need to increase your estimated tax payments due to the conversion increasing your income. Finally, since the converted amount is added to your income, this may limit or eliminate your eligibility under the income limits to make a regular contribution to a Roth IRA that year.

Converting to a Traditional IRA to a Roth IRA
The main reason to convert to a Roth IRA is to have an income tax-free retirement account.

You need to determine whether paying income tax now is worth making the change to a Roth IRA that can be income tax-free at the time of distributions. Keep in mind that if you do not convert to a Roth IRA, distributions in the future can be subject to ordinary income tax.

Reasons for Converting to a Roth IRA

1. You expect your anticipated income tax bracket to be higher at the time that you take distributions

2. You expect larger growth and earnings from your IRA until distributions are completed

3. You want the option to allow continued tax free growth by avoiding starting distributions at age 70½ or any age--you do not have to take distributions from your Roth IRA

4. The ability to leave income-tax free money to beneficiaries

Reasons for Not Converting to a Roth IRA

1. You expect your anticipated income tax bracket to be lower at the time that you take distributions

2. You expect lower growth and earnings from your IRA until distributions are completed

3. You may possibly pay income tax now at the time of conversion on the converted amount (depending upon your income and deductions)

4. Other potential income tax consequences of converting (e.g., the effect on itemized deductions)

5. You don’t have non-IRA funds to pay income tax due on the conversion

6. Possibly, protection against creditors with a traditional IRA and Roth IRA may not apply in your state

Other Roth IRA Rules
The general rule is that for you to receive distributions free of income tax and penalties, your Roth IRA needs to be open at least five years and you need to be at least age 59½ when you take distributions.

Retirement Planning Considerations
Part of your IRA tax planning is looking ahead to the interests of your beneficiaries. You may want to get legal and tax advice on how to complete your beneficiary designations and coordinate them with your estate plan. Properly completed designations can allow better income tax opportunities, help save estate (death) tax, avoid probate, and avoid creditor claims on retirement assets.

Income Tax Benefits
You can extend the life of a tax-deferred IRA for five years and sometimes more by leaving it to a living beneficiary rather than to your estate. That’s because IRA distributions are based on life expectancies and an estate doesn’t have one. If you name your estate as the beneficiary, that can speed up when income tax is due on your IRA.

Extra care also needs to be taken in naming trusts as a beneficiary of most retirement assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger income tax sooner than it would otherwise be owed and reduce the amount ultimately shielded from death tax.

Estate Tax Benefits
Retirement assets are added to your other assets and may be subject to federal and/or state death (estate) tax. Consult with your advisor about ways to defer or avoid estate tax.

Avoiding Probate
Properly completed beneficiary designations can avoid probate upon a death. Avoiding probate can reduce attorneys’ fees, executor fees and court costs and minimize delays.

Avoiding Creditor Claims
IRAs that avoid the probate court may have special creditor protection. That protection may be lost if your estate is named as the beneficiary. Consult with your attorney for guidance on the creditor protection issue.

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Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.

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