Better to convert annuity

August 17, 2008|By Janet Kidd Stewart

My wife and I recently retired on small government pensions and have moderate Social Security benefits from nongovernmental employment work history. We both have untapped 403(b) annuities and have heard that we should convert them to IRAs, then gradually convert the IRAs into Roth IRAs. What are the tax effects of such a conversion, and what is the optimum way for us to do this?

- J.P.

Because your other sources of income are fixed pensions, you are right to consider getting rid of the annuity to diversify the types of investments in your portfolio, said Mark Balasa, a financial adviser with Balasa, Dinverno & Foltz LLC in Itasca, Ill.

"Unless they are in the rare 403(b) that has low-cost investment options, they should probably get out," Balasa said. "Besides costs, your options are the whole world in an individual retirement account versus the limited choices in the 403(b). Third, you can typically get more sophisticated with beneficiary designations in an IRA than you can with a 403(b)." Assuming your modified adjusted gross income is below the conversion threshold of $100,000, you can make the conversion directly to a Roth without stopping at a traditional IRA first.

But that's where proper tax planning comes in, Balasa said.

"The older you are, the less advantageous the conversion becomes because the math works against you later in life," he said, referring to the income tax you will pay now and how much, or how little, time you have to reap the rewards of tax-free compounding in the Roth IRA.

Your idea about gradually converting to a Roth could make sense if you convert just enough each year to allow you to stay in the same tax bracket, he said.

A key question: Do you plan to spend this money or pass it on to heirs? Where conversions make the most sense is when the Roth IRA will pass to heirs, and they can spread withdrawals over several decades, he said.

"But my hunch is these people need to live on this, and so you can make an argument for converting some of it now, particularly if you believe tax rates are going higher in the future," he said.

It's no slam-dunk, though. Balasa suggested having a professional run some scenarios through spreadsheet models to see how a combined strategy might perform.

Can you offer more details concerning Social Security benefits for divorced spouses, including eligibility, how to apply and whether it is something that is usually negotiated during the divorce?

- C.S.

Information on collecting Social Security benefits on the work record of a former spouse, if they are higher than your own, is offered at the Social Security Administration Web site at www.socialsecurity.gov. (On the Questions pulldown, click on Benefits, then in the search box enter "divorce spouse.")

You can apply online for these benefits at https://secure.ssa.gov/apps6z/ISBA/main.html if you are at least 61 years and 9 months old and expect to begin collecting benefits within four months of the filing. They are not part of the divorce negotiation process; former spouses qualify for them without affecting the worker's benefits, an SSA spokeswoman said.

To be eligible, the marriage must have lasted 10 years or more, you must be at least 62 and unmarried. Your former spouse must be entitled to benefits, meaning he or she is eligible to receive them and has applied for them. If they have not, you must be eligible for benefits and divorced at least two years before receiving benefits under their work record.

As with other decisions about Social Security, don't race to collect until you've examined all your options. Delaying these benefits until full retirement age will mean a higher monthly benefit, to the maximum amount of 50 percent of the benefit the worker would receive at full retirement age, the spokeswoman said.

The administration's Web site says its representatives may be able to provide benefit estimates by calling 800-772-1213.

Have a retirement question? Write to yourmoney@tribune.com, or via mail at Your Money, Chicago Tribune, Room 400, 435 N. Michigan Ave., Chicago 60611.

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