Employer plan to Roth rollovers… Can you make a tax free rollover if you have after-tax dollars?

I’ve seen alot of gnashing of teeth over this, and I’m not sure why. Here’s the issue. Someone has $90,000 of pre-tax dollars in a 401(k) plan, and $10,000 of nontaxable after-tax contributions. Can they simply take a distribution of the after-tax dollars, and roll them over into a Roth IRA tax free

Most say no, that any distribution from the 401(k) plan will consist of a pro-rata amount of pre-tax and after-tax dollars (90% taxable in the example above), with the taxable dollars then deemed rolled over first to the Roth, per IRC section 402(c)(2).

But no one seems to discuss IRC section 72(d)(2) which states: “For purposes of this section [section 72] employee contributions (and any income allocable thereto) under a defined contribution plan may be treated as a separate contract.” Plans that use section 72(d)(2) can distribute the employee’s after-tax dollars and earnings separately, without implicating the pre-tax dollars. While there will still be some taxable income upon a rollover to a Roth, because of the earnings component, this should be a much smaller tax hit for most employees. There wouldn’t seem to be any downside for a plan to use the separate contract rule, and many I dealt with in a prior life did in fact use it.

Retirement #s stay the same for 2010… for the most part

There were few IRA and employer plan COLA adjustments for 2010, per IR-2009-94. The few that are changing:

• The phase-out range for deductible IRA contributions for 2010 for Single/Head of Household taxpayers covered by an employer plan is $56,000 to $66,000 (it’s $55,000 to $65,000 for 2009)
• The phase-out range for deductible IRA contributions for 2010 where the taxpayer isn’t covered by an employer plan, but the taxpayer’s spouse is covered (and they file a joint return) is $167,000 to $177,000 ($166,000 to $176,000 in 2009)
• The phase-out range for making Roth contributions for Joint Filers in 2010 is $167,000 to $177,000 ($166,000 to $176,000 in 2009)
• The Saver’s Credit 20% phase-out range for Joint Filers in 2010 is $33,500 to $36,000 ($33,000 to $36,000 in 2009)
• The Saver’s Credit 20% phase-out range for Heads of Household in 2010 is $25,125 to $27,000 ($24,750 to $27,000 in 2009)
• The Saver’s Credit 20% phase-out range for Single Filers in 2010 is $16,750 to $18,000 ($16,500 to $18,000 in 2009)

Estate planning for genetic material

I just read another interesting article regarding estate planning and genetic material. Medical advances are being made on a daily basis, so it seems. Clients are able to store eggs, sperm, and other genetic material that survives after the client’s death. Instructions must be left so that this material is stored and used properly and according to the client’s wishes. Estate planners and trustees should be aware of the importance of becoming more educated on this science and the new responsibilities that may result. For example, what if an unknown mistress who becomes impregnated using the frozen sperm of a multi-million dollar client comes  forward after the client’s death to claim an inheritance? Is there a provsion in the will to address this situation?

Estate planners and trustees need to be on their toes. Read up and be prepared to discuss these matters with clients and implement the necessary tools to handle and control your client’s genetic material.

Estate Tax Update

Of course, we all know the federal estate tax is not really going to go away in 2010. Here is a brief summary of the tax’s status as of today.

There are three major bills in Congress:

Senate Bill 722 would make permanent the 2009 $3.5 million exemption and top 45% tax rates, reunify the estate and gift tax credit, allow for portability (allow a transfer of a deceased spouse’s unused exemption to the surviving spouse), and, index the exemption for inflation.

House Bill 2032 would make permanent the exemption level at $2 million, index that level for inflation, establish progressive tax rates of 45% for estates valued between $2 million and $5 million; 50% for estates valued at $5 to $10 million; and 55% for estates valued over $10 million, reunify the estate and gift tax, create exemption portability, restore the state estate tax credit, and provide indexing for inflation.

House Bill 436 would freeze the exemption and rate at 2009 levels, reunify the estate and gift tax so that the cap on tax free lifetime gifts would go from its present $1 million to $3.5 million (but use up that protected amount so whatever exemption was used during lifetime would not be available at death), limit the valuation discount for family limited partnerships, and provide strict valuation rules for transfer of non-business assets.

Further, the Congressional Budget Office has presented Congress with four options:

Option 1 would set the exemption for the combined tax at $5 million starting in 2010, index that amount for inflation, set the tax rate equal to the top rate on capital gains (currently 15% in 2010 and 20% thereafter), allow a stepped-up basis for assets transferred from a decedent, and deny a deduction or credit for state death taxes.

Option 2 would make the same changes as Option 1, but a two-tiered rate would be used — the first $25 million of taxable assets would be subjected to the top capital gains rate, then taxable transfers above $25 million would be taxed at 30% (and the $25 million threshold would be indexed for inflation).

Option 3 would retain the $3.5 million exemption, index that amount for inflation, set the top tax rate at 45%, retain a step-up in basis, and allow a deduction for state death taxes.

Option 4 would repeal the estate tax in 2010, retain a $1 million gift tax exemption, and institute a carryover basis regime.

End of Road for “Clunkers”

U.S. Transportation Secretary Ray LaHood has announced that the Car Allowance Rebate System, better known as ”Cash for Clunkers” will end on Monday, August 24th at 8PM EDT.

Just two weeks ago the President signed legislation that provided an additional $2 billion in funding for the program–an amount estimated at the time as sufficient to sustain current activity levels through the end of August (the original $1 billion in funding that the program received had been projected to last through October). Attributing the early end of the program to unexpectedly high consumer demand (rather than poor projections), the announcement was made yesterday that the plug was being pulled on the program.

The Department of Transportation has provided some details on how the program will wind down over the next few days.

Up-to-date information can be found at www.cars.gov.

George Soros makes $35 million gift

I’m posting this because I’m just so in awe and inspired by George Soros’ $35 million gift to the state of New York. The gift may actually be worth up to $170 million because the state must put up 20% matching funds in order to receive federal stimulus money. With his gift, low-income families will receive assistance to cover the cost of their children’s back-to-school supplies and clothing. I believe Mr. Soros is showing that there is no greater time or better way for philanthropists to act. Hopefully, his example will be taken to heart by like-minded wealthy individuals.

Proposed legislation assists end-of-life planning

An article in today’s Boston Globe directed my attention to several pieces of proposed legislation that should be of interest to my fellow estate planners. These proposals attempt to promote end-of-life planning in a number of ways, including provisions that would help seniors pay for both medical and legal advice. Keep an eye out for new laws regarding this vital concern that might benefit your clients and your practice.

“Cash for Clunkers” Keeps Rolling

The Car Allowance Rebate System (popularly known as “cash for clunkers”) was almost a victim of its own success. The program, which provides $3,500 or $4,500 vouchers that can be used toward the purchase or lease of a fuel-efficient new vehicle when an old “gas guzzler” is traded in, burned through its initial $1 billion funding well short of its projected expiration of November 1, 2009. On Friday, President Obama signed legislation that provides an additional $2 billion in funding for the program, an amount estimated to be enough to sustain current activity levels through the end of August.

For current information on the Cash for Clunkers program, see www.cars.gov.

Taking care of Fluffy after your death

Steve Leimberg offers some good advice on pet trusts, which are becoming more common as pet owners who love their pets want to make sure they’re cared for after their deaths (remember Leona Helmsley leaving $1 million to her dogs?). If a testamentary trust is created to provide for the animals, the trust must first pass through probate. Probate proceedings can take some time, during which the trust may be unable to make the desired provisions, putting the onous on the trustee or others to feed, house, and otherwise care for the pets. The solution may be to draft an inter vivos trust instead.

Bad Moon Rising

Remember when the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) was going to make it, in the words of Senator Chuck Grassley, “more difficult for people to file for bankruptcy?” Well, it did — briefly. But now, according to statistics released by the Administrative Office of the U.S. Courts, bankruptcy filings (1,202,503) for the 12-month period ending March 31, 2009, were up 33.3% over the number of filings (901,927) for the 12-month period ending March 31, 2008. That’s the biggest increase since BAPCPA was passed.

Sure, most of those (1,153,412) were individual (non-business) bankruptcies. But the means test, which was designed to prevent “abuse” of the Chapter 7 discharge by channneling into Chapter 13 those with the means to repay at least some of their debt, hasn’t had much impact. Chapter 7 filings rose 46.3% compared to a 10.9% increase in Chapter 13 filings. Given the shape of the economy these days, it’s no wonder that so many don’t have the means…

But the biggest increase of all was in Chaper 11 (business reorganization) filings. For the 12-month period ending  March 31, 2009, Chapter 11 filings rose a whopping 69.1%. It seems it’s not only individuals without the means these days….