If you were to compare the recent stockmarket to the weather, most likely youwould describe it as rainy and gloomy. Itseems the sun is afraid to come out frombehind the gray clouds. Fortunately, yourmother was right when she told you everycloud has a silver lining. In this case, eventhough that silver lining is more difficultto find, it is there. The dismal performanceof the stock market over the past 2years has created a once-in-a-lifetimeopportunity for certain savvy investors.
YOUR LOSS, YOUR GAIN
Many investors who do not qualify tomake deductible IRA contributions makenondeductible IRA contributions instead.The primary advantage of choosingnondeductible IRA contributions is thetax-deferred growth of their investmentaccounts. With the broad market down29% and the technology-laden Nasdaqdown almost 68%, many of these nondeductibleIRA accounts have losses. If this isthe case for you, then you may want toconsider converting your nondeductibleIRA to a Roth IRA.
Normally a conversion of this naturewould result in ordinary income taxesdepending on the gains, but if you havelosses (courtesy of the recent market)there will be no taxes due. By convertingto a Roth IRA, future distributions will betax-free. However, if you hold on to yournondeductible IRA until retirement, theprofit portion of all distributions will besubject to ordinary income taxes.
For example, let's say you invest$10,000 in both a nondeductible IRA anda Roth IRA and both accounts grow to$100,000. If you were to cash in bothaccounts, you would owe income taxes onthe $90,000 gain in your nondeductibleIRA, but owe no taxes on your Roth IRA.
Another advantage of the Roth IRA isthat you are never required to take distributions.With a nondeductible IRA,you are required to begin taking distributionsshortly after you turn age 70 1/2.Many people, however, end up notneeding money from all of their IRAaccounts. The Roth IRA allows you tocontinue to grow your investment tax-freeas long as you live. After you'regone, your heirs inherit your Rothaccount, and they can take distributionsfree of income taxes as well. Toqualify for a conversion to a Roth IRA,your adjusted gross income must notexceed $100,000. You also do not qualifyif you are married and file separately.
OPPORTUNITY NUMBER TWO
The other great opportunity affordedto investors during this gray market is thechance to let go of variable annuities. Avariable annuity is a product that investorsrarely seek out. Instead, it is a product thatis usually sold to them. Over the years,annuities have received criticism becauseof their high expense charges, limitedinvestment choices, and the fact that theyconvert what may have been long-termcapital gains into ordinary income. Butthey do have advantages, which includethe tax deferral of income and the abilityto annuitize the investment account toprovide a life-long income.
Sometimes an investor regrets purchasingan annuity but keeps it because theyfeel trapped—for good reason. Cancelingresults in ordinary income taxes on anygains, plus a 10% federal penalty for withdrawalsprior to age 59 1/2.
However, if you have losses in a personalvariable annuity, surrendering thepolicy will not trigger the 10% federalpenalty. And losses may be deducted onyour income tax return as ordinary incomelosses. If you are looking for an opportunityto get out from under your annuity,now may be the perfect opportunity.
Stewart H. Welch III, founder of
the Welch Group, has been
rated one of the nation's top
financial advisors by Money,
Worth, and Medical Economics.
He welcomes questions or
comments from readers at 800-709-7100 or
www.welchgroup.com. Reprinted with permission
from the Birmingham Post Herald.