DACA Financial Group

There are five estate planning documents you may need, regardless of your age, health, or wealth: Durable power of attorney Advanced medical directives Will Letter of instruction Living trust The last document, a living trust, isn’t always necessary, but it’s included here because it’s a vital component of many estate plans. Durable power of attorney A durable power of attorney (DPOA) can help protect your property in the event you become physically unable or mentally incompetent to handle financial matters. If no one is ready to look after your financial affairs when you can’t, your property may be wasted, abused, or lost. A DPOA allows you to authorize someone else to act on your behalf, so he or she can do things like pay everyday expenses, collect benefits, watch over your investments, and file taxes. There are two types of DPOAs: (1) a standby DPOA, which is effective immediately (this is appropriate if you face a serious operation or illness), and (2) a springing DPOA, which is not effective unless you have become incapacitated. Note: A springing DPOA is not permitted in some states, so you’ll want to check with an attorney. Advanced medical directives Advanced medical directives let others know what medical treatment you would want, or allows someone to make medical decisions for you, in the event you can’t express your wishes yourself. If you don’t have an advanced medical directive, medical care providers must prolong your life using artificial means, if necessary. With today’s technology, physicians can sustain you for days and weeks (if not months or even years). There are three types of advanced medical directives. Each state allows only a certain type (or types). You may find that one, two, or all three types are necessary to carry out all of your wishes for medical treatment. (Just make sure all documents are consistent.) First, a living will allows you to approve or decline certain types of medical care, even if you will die as a result of that choice. In most states, living wills take effect only under certain circumstances, such as terminal injury or illness. Generally, one can be used only to decline medical treatment that “serves only to postpone the moment of death.” In those states that do not allow living wills, you may still want to have one to serve as evidence of your wishes. Second, a durable power of attorney for health care (known as a health-care proxy in some states) allows you to appoint a representative to make medical decisions for you. You decide how much power your representative will or won’t have. Finally, a Do Not Resuscitate order (DNR) is a doctor’s order that tells medical personnel not to perform CPR if you go into cardiac arrest. There are two types of DNRs. One is effective only while you are hospitalized. The other is used while you are outside the hospital. Will A will is often said to be the cornerstone of any estate plan. The main purpose of a will is to disburse property to heirs after your death. If you don’t leave a will, disbursements will be made according to state law, which might not be what you would want. There are two other equally important aspects of a will: You can name the person (executor) who will manage and settle your estate. If you do not name someone, the court will appoint an administrator, who might not be someone you would choose. You can name a legal guardian for minor children or dependents with special needs. If you don’t appoint a guardian, the state will appoint one for you. Keep in mind that a will is a legal document, and the courts are very reluctant to overturn any provisions within it. Therefore, it’s crucial that your will be well written and articulated, and properly executed under your state’s laws. It’s also important to keep your will up-to-date. Letter of instruction A letter of instruction (also called a testamentary letter or side letter) is an informal, nonlegal document that generally accompanies your will and is used to express your personal thoughts and directions regarding what is in the will (or about other things, such as your burial wishes or where to locate other documents). This can be the most helpful document you leave for your family members and your executor. Unlike your will, a letter of instruction remains private. Therefore, it is an opportunity to say the things you would rather not make public. A letter of instruction is not a substitute for a will. Any directions you include in the letter are only suggestions and are not binding. The people to whom you address the letter may follow or disregard any instructions. Living trust A living trust (also known as a revocable or inter vivos trust) is a separate legal entity you create to own property, such as your home or investments. The trust is called a living trust because it’s meant to function while you’re alive. You control the property in the trust, and, whenever you wish, you can change the trust terms, transfer property in and out of the trust, or end the trust altogether. Not everyone needs a living trust, but it can be used to accomplish various purposes. The primary function is typically to avoid probate. This is possible because property in a living trust is not included in the probate estate. Depending on your situation and your state’s laws, the probate process can be simple, easy, and inexpensive, or it can be relatively complex, resulting in delay and expense. This may be the case, for instance, if you own property in more than one state or in a foreign country, or have heirs that live overseas. Further, probate takes time, and your property generally won’t be distributed until the process is completed. A small family allowance is sometimes paid, but it may be insufficient to provide for a family’s ongoing needs. Transferring property through a living trust provides for a quicker, almost immediate transfer of property to those who need it. Probate can also interfere with the management of property like a closely held business or stock portfolio. Although your executor is responsible for managing the property until probate is completed, he or she may not have the expertise or authority to make significant management decisions, and the property may lose value. Transferring the property with a living trust can result in a smoother transition in management. Finally, avoiding probate may be desirable if you’re concerned about privacy. Probated documents (e.g., will, inventory) become a matter of public record. Generally, a trust document does not. Note: Although a living trust transfers property like a will, you should still also have a will because the trust will be unable to accomplish certain things that only a will can, such as naming an executor or a guardian for minor children. Note: There are other ways to avoid the probate process besides creating a living trust, such as titling property jointly. Note: Living trusts do not generally minimize estate taxes or protect property from future creditors or ex-spouses.

Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources.

Prepared by Forefield Inc. Copyright 2010.

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With the lure of tax-free distributions, Roth IRAs have become popular retirement savings vehicles since their introduction in 1998. But if you’re a high-income taxpayer, chances are you haven’t been able to participate in the Roth revolution. Well, new rules apply in 2010 that may change all that.

What are the general rules for funding Roth IRAs?

There are three ways to fund a Roth IRA–you can contribute directly, you can convert all or part of a traditional IRA to a Roth IRA, or you can roll funds over from an eligible employer retirement plan (more on this third method later).

In general, you can contribute up to $5,000 to an IRA (traditional, Roth, or a combination of both) in 2010. If you’re age 50 or older, you can contribute up to $6,000 in 2010. (Note, though, that your contributions can’t exceed your earned income for the year.)

But your ability to contribute directly to a Roth IRA depends on your income level (“modified adjusted gross income,” or MAGI), as shown in the chart below:

If your federal filing status is:	Your 2010 Roth IRA contribution is reduced if your MAGI is:	You can’t contribute to a Roth IRA for 2010 if your MAGI is:
Single or head of household	More than $105,000 but less than $120,000	$120,000 or more
Married filing jointly or qualifying widow(er)	More than $167,000 but less than $177,000	$177,000 or more
Married filing separately	More than $0 but less than $10,000	$10,000 or more

What’s changed?

Prior to 2010, you couldn’t convert a traditional IRA to a Roth IRA (or roll over non-Roth funds from an employer plan to a Roth IRA) if your MAGI exceeded $100,000 or you were married and filed separate federal income tax returns.

In 2006, however, President Bush signed the Tax Increase Prevention and Reconciliation Act (TIPRA) into law. TIPRA repealed the $100,000 income limit and marital status restriction, beginning in 2010. What this means is that, regardless of your filing status or how much you earn, you can now convert a traditional IRA to a Roth IRA. (There’s one exception–you generally can’t convert an inherited IRA to a Roth. Special rules apply to spouse beneficiaries.)

And don’t forget your SEP IRAs and SIMPLE IRAs. They can also be converted to Roth IRAs (for SIMPLE IRAs, you’ll need to participate in the plan for two years before you convert). You’ll need to set up a new SEP/SIMPLE IRA to receive any additional plan contributions after you convert.

What hasn’t changed?

TIPRA did not repeal the income limits that may prevent you from making annual Roth contributions. But if your income exceeds these limits, and you want to make annual Roth contributions, there’s an easy workaround. You can make nondeductible contributions to a traditional IRA as long as you have earned income at least equal to the contribution, and you haven’t yet reached age 70½. You can simply make your annual contribution first to a traditional IRA, and then take advantage of the new liberal conversion rules and convert that traditional IRA to a Roth. There are no limits to the number of Roth conversions you can make. (You’ll need to aggregate all of your traditional IRAs when you calculate the taxable portion of the conversion–more on that below.)

Calculating the conversion tax

When you convert a traditional IRA to a Roth IRA, you’re taxed as if you received a distribution with one important difference–the 10% early distribution tax doesn’t apply, even if you’re under age 59½. (The IRS may recapture this penalty tax, however, if you make a nonqualified withdrawal from your Roth IRA within 5 years of your conversion.)

If you’ve made only nondeductible (after-tax) contributions to your traditional IRA, then only the earnings, and not your own contributions, will be subject to tax at the time you convert the IRA to a Roth. But if you’ve made both deductible and nondeductible IRA contributions to your traditional IRA, and you don’t plan on converting the entire amount, things can get complicated.

That’s because under IRS rules, you can’t just convert the nondeductible contributions to a Roth and avoid paying tax at conversion. Instead, the amount you convert is deemed to consist of a pro-rata portion of the taxable and nontaxable dollars in the IRA.

For example, assume that your traditional IRA contains $350,000 of taxable (deductible) contributions, $100,000 of taxable earnings, and $50,000 of nontaxable (nondeductible) contributions. You can’t convert only the $50,000 nondeductible (nontaxable) contributions to a Roth, and have a tax-free conversion. Instead, you’ll need to prorate the taxable and nontaxable portions of the account. So in the example above, 90% ($450,000/$500,000) of each distribution from the IRA in 2010 (including any conversion) will be taxable, and 10% will be nontaxable.

You can’t escape this result by using separate IRAs. Under IRS rules, you must aggregate all of your traditional IRAs (including SEPs and SIMPLEs) when you calculate the taxable income resulting from a distribution from (or conversion of) any of the IRAs.

Special deferral rule for 2010 conversions only

But even if you have to pay tax at conversion, TIPRA contains more good news–if you make a conversion in 2010, you can take advantage of a special deferral rule that applies only to 2010 conversions. You can report half the income from the conversion on your 2011 tax return and the other half on your 2012 return. Or you can instead elect to report all of the income from the conversion on your 2010 tax return.

For example, if your only traditional IRA contains $250,000 of taxable dollars (your deductible contributions and earnings) and you convert the entire amount to a Roth IRA in 2010, you can report half of the resulting income ($125,000) on your 2011 federal tax return, and the other half ($125,000) on your 2012 return. Or you can instead report the entire $250,000 on your 2010 tax return.

Should you use the special 2010 deferral rule? The answer depends in part on your tax rate in 2010 versus what you think your tax rates will be in 2011 and 2012. Keep in mind that tax rates are scheduled to increase in 2011, if the Bush tax cuts are allowed to expire. The top tax rate will increase to 39.6% in 2011, up from 35% in 2010.

And speaking of employer retirement plans…

You can also roll over non-Roth funds from an employer plan (like a 401(k)) to a Roth IRA. Prior to 2010, the income limits and marital status restrictions also applied to employer plan rollovers to Roth IRAs (commonly referred to as conversions). As with traditional IRA conversions, these restrictions have been removed beginning in 2010, and now anyone can roll over funds from an employer plan to a Roth, regardless of income level or marital status.

Like traditional IRA conversions, the amount you convert will be subject to income tax in the year of conversion (except for any after-tax contributions you’ve made). But the good news is that the special deferral rule discussed earlier also applies to amounts you roll over from an employer plan to a Roth IRA in 2010. You can report half of the conversion income on your 2011 tax return, and the other half on your 2012 return, or you can instead elect to report all of the income on your 2010 tax return. And even non-spouse beneficiaries can roll over inherited employer plan funds to a Roth IRA, as long as it’s done in a direct (not 60-day) rollover.

Is a Roth conversion right for you?

The answer to this question depends on many factors, including your current and projected future income tax rates, the length of time you can leave the funds in the Roth IRA without taking withdrawals, your state’s tax laws, and how you’ll pay the income taxes due at the time of the conversion.

And don’t forget–if you make a Roth conversion and it turns out not to be advantageous (for example, the value of your investments declines substantially), IRS rules allow you to “undo” the conversion. You generally have until your tax return due date (including extensions) to undo, or “recharacterize,” your conversion. For most taxpayers, this means you have until October 15, 2011, to undo a 2010 Roth conversion.

A financial professional can help you decide whether a Roth conversion is right for you, and whether you should take advantage of the special deferral rule for 2010 conversions.

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Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources.

Prepared by Forefield Inc. Copyright 2010.

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