Paying some taxes now could save you later

Your Money

April 08, 2007|By Janet Kidd Stewart | Janet Kidd Stewart,Chicago Tribune

Iwill be retiring with — I will be retiring with- in the next few months, and I am confused about how to deal with my retirement accounts. When I stop working, must I convert my existing 403(b) accounts into IRA accounts? Can I simply stop contributing and allow them to remain dormant until I need to withdraw the money? If I have to convert, will this have an impact on my desire to convert existing IRA accounts to Roth IRAs in 2010?

- A reader in Arlington Heights, Ill.

If you have less than $5,000 stashed in your account, your employer could force you out of the plan.

But if you have more than that tucked away, you should be able to leave the money where it is until you have to begin taking required minimum distributions at age 70 1/2 or until 2010, the first year savers can convert traditional individual retirement accounts into Roth IRAs regardless of income restrictions.

Whether that is the best option depends on the quality of your plan and your other assets, said Robert Oliver of Oliver Financial Planning in Ann Arbor, Mich.

Employers with 403(b) plans typically are educational or nonprofit institutions. Depending on the organization, the plans can have attractive investment options at low costs. Another advantage: Participants can take loans out on the money, which can't be done with IRAs, Oliver said.

Although tax-deferred earnings growth has been the key selling point for retirement plans and IRAs, more financial advisers are recommending a strategy of diversifying the tax structure of a portfolio, with an emphasis on paying a chunk of taxes now to get them out of the way. Their rationale is that while it's impossible to predict the future tax climate, many analysts expect rates to increase.

The idea would be to take a portion of your 403(b) and pay the taxes on it as you convert it to a Roth IRA, which then grows and is distributed tax free.

In your situation, Oliver said, it might make sense to convert the entire account to a Roth. With a little planning, you could be in a lower tax bracket by 2010, given your pending retirement, and if you haven't started collecting Social Security, for example.

Another option to investigate: If your 403(b) includes contributions from before 1987, that money can be left untouched until you are 75, providing more years of tax-deferred growth before required minimum distributions kick in.

My husband and I recently retired. We both had flex health accounts at work but are now collecting Social Security and have Medicare. My husband does some outside consulting and has a stream of income from it. Medicare doesn't cover all of our medical expenses, such as dental. Is there any flex-type account that we can set up to pay these additional medical expenses with pretax dollars? I understand that the health savings accounts are tied to health insurance policies and high deductibles, so that obviously doesn't work. Is there anything that works for retirees still earning some income?

- Mary Baim, Chicago

Sounds like you may be feeling the pinch common to many couples who earn some income after retiring and beginning to collect Social Security. Post-retirement work can reduce Social Security benefits and can throw you into a higher tax bracket.

Meanwhile, health care costs continue to soar. Flexible spending accounts allow workers to save pretax dollars through an employer and use the money for qualified health care expenses. By definition, these are workplace plans and self-employed workers can't participate.

I checked with your husband's employer, and they do allow certain part-time employees to participate in flexible spending accounts. So check to see if he qualifies. Failing that, do all you can to reduce your tax bite in other ways, including maximizing deductions elsewhere, said Ed Slott, an accountant and author of Your Complete Retirement Planning Road Map: The Leave-Nothing-to-Chance, Worry-Free, All-Systems-Go Guide. That includes judiciously harvesting stock losses and recording business-related expenses attributable to his part-time income, he said.

Have a retirement question? Write to, or via mail at Your Money, Chicago Tribune, Room 400, 435 N. Michigan Ave., Chicago, IL 60611. If your letter is selected, we may include you and your question in a future column.

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