Traditional IRA vs Roth IRA: When an Account Owner Should Hold Off on a Conversion

Upon divorce, retirement accounts that existed during marriage are frequently divided through a Domestic Relations Order. After a Domestic Relations Order is signed by the parties, submitted to the court for signature, and filed as an official order of the court, it is then sent to the Plan Administrator for approval. Once the Plan Administrator approves the Domestic Relations Order, it then becomes a Qualified Domestic Relations Order, which is frequently referred to as a “QDRO.” The retirement account is then split, at which time both parties will own their portion of the retirement account as separate property. If the retirement account is a Traditional IRA, the split of the account upon divorce puts a lot of people who are not familiar with retirement accounts in an interesting situation because they have the option to convert their Traditional IRA to a Roth IRA.

The full or partial conversion of a Traditional IRA to a Roth IRA was first allowed by congress in 2010. This financial decision became increasingly popular over the years because many IRA owners wanted to reap the many benefits that come with having a Roth IRA rather than a Traditional IRA. In fact, there have been more than one million conversions and more than $75 billion in Traditional IRA funds that have been converted to Roth IRA funds since that time. Some of the many benefits of converting a Traditional IRA to a Roth IRA include moving the retirement funds into an account that provides tax-free growth, offers tax-free withdrawals, and the person who owns the account is not required to take payouts at a particular age. Additionally, Roth IRAs also yield income that does not raise reported income in a way that reduces other tax breaks, raises Medicare premiums, or increases the levy on net investment income. Traditional IRAs, on the other hand, also provide tax-free growth, but the withdrawals are usually taxed at ordinary income rates at the time of the withdrawal. Moreover, an account owner of a Traditional IRA who is 70½ years or older is required to take payouts that will deplete the account over time.

After a divorce, converting the Traditional IRA a person received in a divorce to a Roth IRA is a popular financial decision for many people. However, even though this is frequently a smart decision to make, it may not always be the best decision. There are multiple scenarios where converting to a Roth IRA is not necessarily in the account owner’s best financial interest. The following are some questions you may want to ask yourself to help you decide if you should convert your Traditional IRA to a Roth IRA:

Is your tax rate going down?
Generally speaking, it would not make sense to convert all or part of your Traditional IRA to a Roth IRA if your tax rate will be lower when you make the withdrawals. For example, if your federal tax rate is low one year because you are a student working part time, this would be a great time to convert because you will pay taxes on your conversion based on your current tax rate. However, if you are well into your career making substantial income and your federal tax rate is on the higher side, you may not want to convert that year because you will pay taxes on your converted funds at that higher tax rate. It is usually best to convert your IRA funds in years where your tax rate is lower, so you do not have to pay more money in taxes.

Do you have enough money in your checking or savings account to pay the taxes on the converted money?
If you do not have enough “outside funds” to pay the taxes on your converted money, you should probably hold off on fully or partially converting your Traditional IRA to a Roth IRA. The reason for this, is that paying the taxes with money from the IRA shrinks the account value, which results in a reduction in the amount that can grow tax free. Consequently, it is best to hold off on the conversion until you have the outside cash to pay the taxes.

Will you need the funds from the Traditional IRA soon?
Much of the benefit of a Roth IRA comes from leaving the account untouched and allowing the funds to grow for years. If you anticipate that you will need to take payouts from your IRA sooner rather than later, then converting the funds to a Roth IRA may not be the best financial option for you. It would be best to leave the Traditional IRA as is, so you do not lose money on the conversion.

Will converting your Traditional IRA to a Roth IRA substantially increase your income and affect a financial aid award?
Retirement accounts are frequently excluded when institutions are determining financial aid awards. However, income from a conversion would not be excluded. If the income you receive from converting your Traditional IRA to a Roth IRA will prevent you from qualifying for a financial aid award for yourself or your child, you should consider holding off on your conversion until you already receive the financial aid you need.

What does all this mean for you? Upon divorce, if you and your spouse obtain a QDRO and split a Traditional IRA in two, you should examine your option to convert your Traditional IRA to a Roth IRA. If you are fairly young, do not have substantial income, and expect your tax rate to be much higher when you are older, then converting your Traditional IRA to a Roth IRA may be the best choice for you. However, if you are older, earn quite a bit of income, and your tax rate is on the higher side, then maintaining your Traditional IRA as is may be the best option for you. If you are unsure or have questions, you should reach out to your CPA or financial planner to determine what would be best for your financial position and your future. There is no doubt that this decision should not be taken lightly, and you should ensure you make an informed decision.

New Decision Means Changes for PERS Recipients

On October 18, 2018, the Nevada Supreme Court published Public Employees’ Retirement System of Nevada v. Nevada Policy Research Institute, Inc., which will mean big changes for those who are part of the Nevada Public Employees’ Retirement System (“PERS”).
The Nevada Policy Research Institute, Inc. (“NPRI”) made a public records request to PERS to obtain payment records for retired government employees for the year 2014. NPRI planned to post this information, including the names of the retirees, on their website for public viewing.
PERS had given NPRI the same information in 2013 but refused to disclose it for 2014. PERS claimed it had no duty to create a new document for NPRI, as PERS’ own data did not contain retiree names, which had forced them to create a new list with names for NPRI.
In response, NPRI revised their records request to only retiree names, years of service, the gross pension benefit amount, their year of retirement, and their last employer. PERS, however, still refused to release that information, so NPRI filed a petition in the district court for the information.
In the district court case, NPRI argued that the information they sought was not confidential because it was a public record. There was an evidentiary hearing (essentially, a bench trial) in the district court, and the district court found that the information was not confidential, and that any risks associated with its disclosure did not overcome the public’s interest in access to the records. The district court also found that PERS had a duty to create the document with the requested information and ordered PERS to release the requested information to NPRI. PERS then appealed the decision to the Nevada Supreme Court.
PERS argued that the information sought was confidential, and that the risks in making this information public outweighed the public interest in the record. PERS also argued that it was improper to force it to create a new document to respond to NPRI’s request per the Nevada Supreme Court’s previous decisions on the matter.
In response, NPRI argued that the information requested was, in fact, a public record because the information is stored on a governmental computer. NPRI cited a previous decision, Las Vegas Metropolitan Police Department v. Blackjack Bonding, Inc., which involved NRS 239.010 – the statute that dictations that governmental agencies must make nonconfidential public records within their legal custody available to the public.
In Blackack Bonding, a bonding company made a public records request to the Las Vegas Metropolitan Police Department (“LVMPD”), for call records from the Clark County Detention Center (“CCDC”), specifically seeking call records for calls between bail bond agents and CCDC inmates. LVMPD denied the request, claiming it did not have the records because a private telecommunications provider provided the telephone services for CCDC.
The Nevada Supreme Court stated that the records did fall under the Nevada Public Records Act (NRS 239.010) which states:
[A]ll public books and public records of a governmental entity, the contents of which are not otherwise declared by law to be confidential, must be open at all times during office hours to inspection by any person, and may be fully copied or an abstract or memorandum may be prepared from those public books and public records.
The Nevada Supreme Court concluded in Blackjack Bonding that the records were public and had to be disclosed (as long as the inmates’ names and numbers were redacted).
In PERS v. NPRI, the Court noted that the Nevada Public Records Act was originally put into place to “foster democratic principles” and “promote government transparency and accountability by facilitating public access to information regarding government activities.” Due to the importance of this goal, the Act’s provisions are to be “liberally construed to maximize the public’s right of access” to information.
There is a presumption in favor of the disclosure of information in such circumstances. The governmental entity seeking to withhold the records is the one with the burden of overcoming the presumption by showing, by a preponderance of the evidence, that the information requested in confidential. In order to be confidential, a statute must state the information is confidential or that the interest in nondisclosure clearly outweighs the public’s interest in access to the information.
The Court concluded that the information requested by NPRI was limited in scope and “helps promote government transparency and accountability by allowing the public access to information that could reveal, for example, if an individual is abusing retirement benefits,” and, thus, was not confidential pursuant to statute.
The Court then addressed whether the request improperly required that PERS create a new record. It stated that PERS was correct in its assertion that a public agency does not have a duty to create a new record in response to a public records request but disagreed that NPRI’s request required that.
The Court cited to decisions from other states that distinguished between requests that simply required an agency to search its electronic database and requests that required an agency to compile a document or report about the information contained in the database. The Court held that the Act does not require an agency to compile a document or report about the information, but that it does require an agency to “search its database to identify, retrieve, and produce responsive records for inspection[.]”
Finally, PERS argued that satisfying the request would cost staff time and money. This argument was also negated because the statute allows for PERS to charge NPRI for the cost of providing copies of the records.
The Court concluded that PERS would need to produce the requested records. The case was remanded to the district court, however, to determine whether PERS could fulfill the document request, as the record indicated that the PERS database is “not static” and that PERS “may not be able to obtain the information as it existed when NPRI requested it in 2014.”
Four Nevada Supreme Court Justices signed off on the majority opinion for PERS v. NPRI. Three other Justices, however, issued a dissenting opinion. The dissenting Justices argued that the decision would force PERS to create records “so long as a court determines that the agency has the technology to readily compile the requested information” against the Court’s previous decision. They argued that the information requested by NPRI “goes far beyond” simply requiring PERS to search its electronic database, and also that the database itself is confidential (though not all of the information contained in it is necessarily confidential).
This decision has major ramifications for PERS employees and retirees. The public will now, presumably, be able to locate a retiree by name and obtain information about how long they held their PERS-qualified position, how much they get each month for their pension, when they retired, and the name of their last employer.

How to Get the Most Out of Your Retirement

Here is a shocking statistic: Nearly half of all American families have no retirement savings at all. This is astounding, considering many of these people do not want to work when they are of retirement age. The big question is WHY? Why are there so many people who do not save for retirement, but do want to retire? Many Americans believe they will just be able to live off social security, but social security was never intended to be the sole source of income. It is only supposed to be a supplement.

It is crucial that everyone begin to save for retirement today. Not tomorrow. Not next week, or next month. Today, because otherwise they will continue to put off saving for retirement until it is too late. Here are five steps you can take to set yourself up for the best possible retirement:

1. Get Advice

Whether you get your advice from a financial advisor, a parent, a mentor, a friend, or the internet, you absolutely must get advice. There are people who spend literally years researching and studying to be able to become financial advisors. Ask around to find someone who can help you. Ask your friends or colleagues if they recommend anyone. If not, think of the most financially savvy person you know, and ask that person. You would be surprised at how willing people are to help others who want to help themselves.

As a last resort, or if you truly are an excellent researcher, resort to our great friend, Google. The number of financial institutions that provide completely free financial advice on the internet is mind-blowing. Simply Googling “how to save for retirement” or “the best retirement account for [insert whatever you are – elderly, college student, executive, etc.]” and you will be shocked at the number of articles and completely free advice that populates onto your screen. If you still do not know what to do, go talk to someone who works at your bank.

2. Create and Stick to a Financial Plan

This step cannot be stressed enough. It is essential to your financial future that you come up with a plan. This will allow you to create an end goal, as well as mini-goals throughout your working years. Additionally, the most benefit is gained from compounding interest. If you have never heard of this term, follow Step 1 above.

A fantastic tool for you to use as you formulate your financial plan is to utilize a retirement calculator. This will help you come up with the amount you will need at retirement, and the amount you must save monthly or yearly to reach that goal. Again, Google is the perfect resource for this, as you can google “free retirement calculator” and numerous options will pop up. Additionally, most banks provide free retirement calculators on their websites.

Once you have formulated a financial plan, it is best if you put it in writing, rather than just keep the information in your head. You may want to place the plan, which should include some goals, somewhere easy to access so you can review it regularly. Decide on how often you would like to review your financial plan, and then stick to your schedule. You might want to look at the plan quarterly, bi-annually, or annually to assess your progress, or maybe you have the personality that would like to review your plan every month. Whatever you decide, stick to your plan.

3. Max Out Contributions

This step is frequently skipped by people. Many people are too afraid that they will need the money, so they decide to only save a very small amount from their earnings. This is more common in lower-income households. This is a huge mistake. What often ends up happening, is that the “money that might be needed” just ends up getting spent. You are far better off coming up with a monthly budget that includes a maxed-out amount that will be dedicated to retirement, and then forcing yourself to stick to your budget. If you need to have a reserve savings account, then do that for emergencies. If you max out your contributions, you are maximizing the amount you will have at retirement. If you dislike working now, imagine how you will feel in 30 or 40 years. The last thing you will want when you are older is to need to work just so you can survive.

Additionally, you should undoubtedly make the most of your employer match, if any. A lot of employers provide retirement contributions as a benefit of employment. If your employer does this, and say matches up to 5% of your salary, then you should contribute 5% of your salary to your retirement at a bare minimum. If you can afford to contribute more, then you should, as that is how you will get the most benefit out of the compound growth of your account. The beauty of a 401k is that it miraculously allows you to reap the benefit of compound growth tax-free. You contribute pretax money to the 401k, which lowers your income taxes. The amount in your 401k then grows tax-free. Who could possibly complain about that?

4. Avoid Loans and Distributions

This step is also frequently skipped by people. What good is it to put money into an account that grows tax-free and is intended for retirement, if you are just going to take the money out now? If you take a loan against your account or take distributions, then the amount of money that would otherwise grow tax-free is reduced, thus decreasing the amount that could be available to you at retirement if you just left the account alone. Similarly, you should have your distributions reinvested into your retirement account. There is no reason to take this money when you can instead just reinvest it into your future. It is important to break the cycle of immediate gratification, and instead look at your life from a long-term perspective.

5. Start Saving

All this information is useless unless you actually start saving for retirement. Start today. You can begin getting advice after you finish this article. As you get advice, create your financial plan. Write it down. There is no shame in revising your plan as you acquire new information, but you must create and then stick your financial plan. Next, max out your contributions and take advantage of your employer’s contributions, if any. This is free money that you miss out on if you do not invest at least the percentage of your salary they will match. Last, now that your plan is in effect, avoid taking loans or distributions from your retirement account. As you save for retirement, compound interest will be your best friend. Let your best friend grow and you will reap the benefits when you are of retirement age and you do not want to work anymore.

Your 401(k): Some Considerations Before Removing Money

As a group, Americans are not particularly good at saving money. The national savings rate has hovered between 3 and 5% for the past 25 years, a far cry from the world’s better savers. Coincidentally, 3% is also the default percentage for many workers when they initially enroll in their company’s 401(k) plan. Although more people are enrolling in optional retirement savings plans, the average amount in 401(k) plans has changed little in the past ten years, staying around the $100,000 mark.

“Compound interest is the most powerful force in the universe,” is a quote often attributed to Albert Einstein, by all accounts a reasonably bright guy. While it seems unlikely that Dr. Einstein said that, the sentiment is correct. Time and compounding market returns are your retirement account’s best friends. While it is possible to take money out of your 401(k) before you retire, this is not a decision to be made lightly. However, for many Americans, their 401(k) represents a significant portion of their personal wealth, and certain circumstances may dictate that tapping into that asset is the best, or only, financial choice.

Most 401(k) plans allow pre-retirement access to funds by way of loans and withdrawals. Generally speaking, if you must take money out, a loan is the better option. With a 401(k) loan you are, in essence, borrowing money from yourself. You are generally allowed to borrow up to 50% (with a maximum of $50,000) and have five years to repay the loan. The loan is repaid back to the plan with interest. While that interest rate is likely lower than the rate of return the funds would have earned had they remained invested, it’s at least something, and you are able to return the entire principal balance back into your retirement account. This is a big deal. If you take a withdrawal, you will not be able to return that amount later, and you may even be restricted from making contributions for a period.

In addition, the amount you withdraw will be treated as taxable income. The plan administrator will withhold 20% of the amount for income taxes, and if you are under the age of 59 ½ you will also trigger a 10% penalty.

Your plan may allow a “hardship distribution.” Keep in mind that plans are not required to offer this option. The IRS defines a hardship as an unforeseeable emergency, with a distribution permitted “on account of an immediate and heavy financial need of the employee, and the amount must be necessary to satisfy the financial need.” This distribution will be taxed as income and may even be subject to a penalty.

If you must take money from your 401(k), use a loan instead of a withdrawal to avoid taxes and penalties. Here are a few situations that might warrant tapping into your retirement account.
You may be faced with an emergency and not have any other source of cash. (If you do have an emergency fund, use that first.) It is hard to say what might constitute an emergency for any individual. One example might be a need to pay the deductible on your high deductible health care plan.
You may have an urgent cash need, but your poor credit score makes you ineligible for a competitive interest rate on a loan. Most 401(k) loans charge 1 to 2% over the prime rate, which is currently 5%. A loan at 7% is likely better than the rate on an unsecured personal loan. Try not to borrow more than you need and consider what amount you will be comfortable paying back in the next five years. 401(k) loans do have the advantage of not being reported to credit agencies or triggering a credit search. And since you are repaying the loan to yourself, the “interest” you are paying is really just a transfer of funds from one pocket to another.

You might already be saddled with high interest debt that is hampering your long-term financial goals. If you are in pay down debt mode, then you are looking for the cheapest interest rate and the opportunity to get your debt down or paid off as quickly as possible. Be careful here – if you borrow from your retirement plan and fail to repay the loan, your finances will be in even worse shape.
If you plan on leaving your current job in the next five years, you may want to reconsider taking a 401(k) loan. Whether you leave voluntarily or not, you may have to repay the balance of the loan to avoid having that amount considered a taxable distribution. The new tax law extended the time to repay the balance of the loan from 60 days to October of the following year.
Just because you have borrowed from yourself, do not ignore your debt to income ratio. The classic rule of thumb is that no more than 36% of your gross monthly income should go toward servicing debt. You should treat your plan loan as you would any other extension of credit.

Your retirement plan will have its own rules for loans. They may limit the number of loans available, and the amount that is available for you to borrow. Your plan can also establish their own repayment schedules, which you will need to follow. Remember that the loan payments will come out of your paycheck, reducing your take home pay.
If you or your spouse take a loan from a 401(k), and you get divorced while the loan is still active, be sure that your Decree of Divorce properly accounts for the loan. A Qualified Domestic Relations Order (QDRO) will need to be prepared based on information taken from the Decree, in order to divide the asset. If this is incorrectly worded, you may get stuck with the entirety of the loan, or the account may be divided in a manner which treats the loan as an asset not a liability. Make sure you have an attorney with experience in QDRO preparation draft the QDRO to ensure that your intentions are accurately reflected.

Should Married Couples Maintain Joint or Separate Accounts In Preparing for Retirement?

Some married couples prefer to keep their finances separate during their working years. For example, one in five married keep separate bank accounts, and a third maintain their own credit cards. These couples often discover that this arrangement works less well once they move into retirement.

It is highly unlikely that both spouses will have equal retirement incomes or expenses, but they may have different ideas about what spending looks like once they stop working. Retiring couples should consider how their respective income sources, likely health care costs, insurance needs, and proposed discretionary spending will affect how they manage their finances.

The tax treatment of each spouses’ income may make it advantageous to draw from one income source over another. If one spouse has access to after-tax funds, from a Roth IRA, for example, it might be better to draw down that account first, and let the other’s traditional IRA continue to grow tax-deferred. Couples may want to coordinate when each will begin collecting Social Security benefits as well.

If one or both spouses was previously divorced, they may have been awarded a portion of their former spouse’s retirement. A Qualified Domestic Relations Order (or QDRO) may have been necessary to divide that asset. If this situation applies to you, and you are not sure that a QDRO was prepared, it probably wasn’t, and you should consult an attorney who specializes in QDROs right away.

Out of pocket health care costs are likely to increase for both parties over time, but not always equally. A retiring couple should determine the amount of their Medicare and any private health care premiums, estimate out of pocket costs, and discuss how these expenses will be paid.

Keeping separate finances may make life insurance or long-term care insurance more important for some. One spouse may be unable to bear the financial burden when the other has increased expenses, or is no longer contributing. Couples should take this “survivor-income stress test” and consider how the death of one spouse would affect the ability of the other to pay expenses.

Many people look forward to travelling more during their retirement, but however a couple chooses to spend their increased free time, how the expenses are to be divided should not be overlooked. The discussion on this issue, as well as the others noted above, is best had before retirement, not after.