New IRA Laws Help Pre-Retirees and Seniors

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Nationally-Recognized Financial Advisory Firm Says Pension Protection Act of 2006 Provides New Financial Planning Opportunities

That way, the whole account can continue to grow tax deferred

The Pension Protection Act of 2006 offers new financial planning opportunities says Susan S. Morse, CFA, CFP®, a Senior Advisor with Mosaic Financial Partners ( New items that will benefit pre-retirees include more flexibility in how terminating employees can roll over the money from their company's defined contribution plan, 401(k), 403(b) or 457 plan.


If you leave an employer where you have a tax sheltered annuity (such as a 403(b) at school districts and governments), you can roll both the pre-tax and after-tax amounts to an IRA. "That way, the whole account can continue to grow tax deferred," says Morse. "Also, the silly requirement that you must first roll your company account into a regular IRA and then into a Roth IRA has been dropped. Under the new rule, when you retire, you can roll your company account directly into a Roth IRA. Of course, you pay income tax and then the Roth grows tax free," she adds. This is effective January 1, 2008.

"The nonsensical prior rule that a non-spouse beneficiary of a company plan could not roll over the money has been dropped," says Morse. Here's an example. Dad worked for XYZ Company and he listed his son as beneficiary on his 401(k). If Dad dies, the son can now do a trustee-to-trustee transfer of Dad's account into an inherited IRA. Previously, only a spouse could move money from a deceased's 401(k) into an inherited IRA or their own IRA. The non-spouse beneficiary still cannot take possession of the money or else it will be taxed (i.e., there is no 60-day rollover provision here).

There's more good news, according to Morse. "Let's say Dad died in 2003 and the son was subject to the 5-year rule which required that the IRA be emptied (and taxed) by 2008. Now, the son can just do the rollover in 2007 (the rule is effective January 1, 2007) and take advantage of the new rule even though Dad died years earlier," he says.


If you're charitably inclined, a big new change is that now you can give IRA funds or retirement funds to charity during your lifetime. "Since each dollar in a retirement plan is only worth 65 cents (after an assumed 35 cent tax)," says Morse, "it always made sense to give retirement funds rather than non-retirement funds to charity. However, prior tax law said that if you wanted to give a lifetime gift of your IRA funds, you needed to include the distribution from your IRA on your tax return and then show a charitable deduction. For limitation reasons, this was not always favorable."

Now, you can distribute up to $100,000 directly to a public charity and not show it on your tax return, provided you are also past age 70½ (this does not apply to transfers to foundations, donor advised accounts or charitable remainder trusts - only outright gifts to public charities). "This is really a rule for seniors because you must be age 70½ to use it," Morse says. "It helps people, typically seniors, who have the following issues/limitations: people who could not previously make full immediate use of the charitable deduction because of the 50% of AGI limitation; those who paid tax on Social Security income; those who had a limit on their itemized deductions; and people who do not itemize deductions."

"The best news is that these transfers to charity count toward your required minimum distributions at age 70½," says Morse. One more benefit: these transfers to charity are exempt from the normal 'pro-rata' rule. Therefore, if the taxpayer has after-tax funds in their IRA, the transfers to charity are only from pre-tax funds and will not affect basis in the IRA. Be aware, however, that while this rule is immediately effective, it is set to expire at the end of 2007.


"This a powerful tax strategy when rolling over retirement plans that hold employer stock," Morse says. You must meet certain requirements, but those that do can distribute shares of employer stock, in kind, from their retirement plans and pay ordinary income taxes on the original basis of the stock in the year of distribution. The original tax basis is the value of the stock on the day of contribution to the plan. The difference between the fair-market value of the stock on the date of distribution less the original tax basis on the date of contribution to the plan is the net unrealized appreciation, or NUA. The NUA is not taxed until the shares are sold outside of the plan. At the time of sale, this NUA is taxed at long-term capital gains rates, regardless of how long the stock is held post-distribution.

Consider the difference in taxes: "If you had 2,500 shares of employer stock worth $100 per share in a qualified stock bonus plan and the original basis of the stock (average cost per share) is determined by the employer to be $15 per share, then your stock is worth $250,000 with a tax basis of $37,500. This is not unusual for employees who have spent 20 years or more with the same company. If the requirements are met, you could distribute the full $250,000 of stock, in kind, from the plan and pay ordinary income taxes on just the $37,500 of original basis in the year of distribution. The remaining $212,500 of appreciation will not be taxed until you choose to sell the stock, and then it will be taxed at the maximum capital gains rate of 15%, instead of ordinary income rates. This long-term capital gains treatment is available even if you sell the stock the next day. Compare this to liquidating the stock while it is still in the plan and rolling over the entire balance to an IRA. The full $250,000 would be taxed as ordinary income when it is distributed from the IRA. The tax bill for this scenario would be $70,000 assuming a 28% federal bracket and no state income tax, vs. just $42,375 if the NUA approach is taken. That's a $27,625 tax savings," Morse says.


Finally, starting in 2010, the $100,000 MAGI limitation on Roth conversions is repealed. Therefore, people with over $100,000 income will be able to do a Roth conversion and also spread the tax over at least two tax years. This can be a useful tool for those wanting to use an IRA as tax-free legacy for children and grandchildren," says Morse.


Mosaic Financial Partners currently has offices in San Francisco and Lafayette. Founder and President Norman M. Boone and East Bay Managing Director Linda S. Lubitz have been cited as two of "America's Best Financial Advisors" by Worth magazine. Boone has been included on the list every year since its inception in 1994 and Lubitz has been included eleven of those years. They are also among those recognized as "Best Financial Advisors for Doctors" by Medical Economics magazine. Co-authors of the best selling industry book, Creating an Investment Policy Statement - Guidelines and Templates, they are active on a national and regional level within the Financial Planning Association. They are frequently quoted in both industry trade publications and consumer-oriented financial press.

Susan S. Morse, CFA, CFP® is a Senior Advisor at Mosaic Financial Partners, Inc. ( a wealth management firm with offices in San Francisco and Lafayette. Susan is actively involved with the CFA Society of San Francisco, particularly with its Financial Literacy Program in the high schools, the Financial Planning Association and the Financial Women's Association in San Francisco. She currently serves on the Board of Directors of the Bank of San Francisco and the Olympic Club in San Francisco.

Kevin Gahagan, CFP®, CIMC, a principal who works in the San Francisco office, is equally active and respected within the profession. An instructor at UC Berkeley, he educates other financial planners who are enrolled in the CFP® program. Gahagan is also former president and chair of the East Bay Financial Planning Association (FPA), and serves on the board of directors for both the American Association of Individual Investors (AAII) and the Estate Planning Council of Diablo Valley.

For more information, contact Norman M. Boone at Mosaic Financial Partners, Inc. Phone 415.788.1952 or visit

NOTE: When you need an expert to speak on complicated financial topics in an easy-to-understand and lively way, please call the nationally-recognized advisors at Mosaic Financial Partners.


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