First off, I am a private investor who is retired from earnings employment. I am not an investment advisor, not a tax expert, nor am I a certified accountant or lawyer. Since I am no longer drawing employment earnings, I am not eligible to put additional money into my IRA. The IRA itself has happily grown for over thirty years. But for someone in my position, the IRA* is a looming tax obligation since every dollar coming out of an IRA account is taxable at ordinary income tax rates. So this modest proposal is a personal "diary entry" on my private blog which is totally non-commercial. This is only what I am thinking, and I am not recommending this to anyone else.
To give us some US income tax context, here is the US income tax table for 1980. Any taxable income over $60,000 was taxed at 54%, and any income over $215,000 was taxed at 70%! Putting as much money as possible away tax-free was truly a no-brainer in those years. Recall also that the top income tax rates had been 90% until President Kennedy's tax cut in the 1960's! The tax table for 2009 is entirely different. The top tax rate this year is 35% of taxable income over $372,951 or half of what the rate was in 1980.
This simple graph shows how tax rates changed: http://www.swivel.com/graphs/image/24335430
Summary: 1. A lot of the money put into IRAs of people now retired or retiring was put in when tax rates were much higher. 2. The US Congress could increase tax rates again to those levels and still be entirely within historic norms.
Guess what? What happens to taxes under the current White House and Congressional regime? The Bush tax cuts automatically will expire for 2010, and every democrat I've heard says the cuts will not be extended. That alone would send the highest bracket rate back to 39.6%. All the rob-the-rich rhetoric during the 2008 campaign and since then suggests that rates will go up much higher at the top end. There may a slight reprieve until it appears that the US economy has reached bottom, and that is precisely why I see this year and possibly part of next year as the last times to empty or greatly reduce the balances in IRAs. Most US Government revenues come from personal income taxes, and the government will need a lot more money just to pay the interest on all the astonishing total trillions of bonds needing to be sold this year to pay for all the rescues and pork. Summary: income tax rates were much higher when much of the early money was put into IRAs by current retirees. The rates are lower right now, but they are going up again.
There are some other factors in any decision to cash out a long term tax-deferred account. Besides the tax deduction for putting money into IRAs and 401ks, one expected, and sometimes got, large capital gains plus interest or dividends which could be re-invested tax-free. In the accumulation period of an IRA or 401k, before retirement, this was a very valuable feature. But when you retire you are less interested in gambling on uncertain capital gains. Also why would you want to take capital gains in a tax-deferred account and turn it into income taxable at ordinary income tax rates when you take it out in a few years? The uncertainty of capital gains (see 2000-2002 and 2007-2009) and the 35% tax on capital gains for money coming out of an IRA compared to 15% now in a taxable account are compelling reasons not to keep very much in capital gains-producing assets in retirement vehicles once you're retired. Summary: by the time of retirement the reasons for compounding capital gains and income are very much less important since you are then drawing down the assets and need to be more certain what they actually will be for budgeting your expenses and your life.
Once an IRA owner reaches age 70, the money has to start coming out as a percentage of the assets in it, and the annual mandatory withdrawal percent of assets increases every year. The IRS wants to be sure they get to tax it all before you die. So you risk getting pushed into higher tax brackets or Alternative Minimum Tax traps as the Required Minimum Distributions (RMD) increase every year. Investigate and see what these withdrawals are likely to be for you. (Note: this site is sometimes not available on weekends: http://www.hughchou.org/calc/irawith.cgi) Also there are other penalties or extra taxes for Social Security and higher Medicare premiums for those in higher tax brackets. There are very likely to be more of these penalties going forward. Summary: stay in as low a tax bracket as you can to avoid "wealth penalties" above and beyond income taxes.
Another possible, and frankly very scary, factor is whether the current world wide financial crisis could lead to nationalization of private pensions including IRAs. There was testimony to Congress last year on that very subject. Do a web search on it if you doubt me. We never expected nationalized banks in this country did we? But now we have them. Argentina recently nationalized private pensions, and it has happened in other countries many times. A government decides that you don't really need the money and they do. So they seize the assets in your fund and issue you "special" government bonds which aren't really so special for you at all. After all, your IRA was a "greedy tax dodge" in their rhetoric, so they feel justified in seizing it. This is most likely to happen when a government can no longer reliably sell its bonds in its own currency because the currency and the government are both no longer trustworthy. That hasn't happened yet in thr US, and perhaps it never will. But it could happen given the amazing amounts of government bonds and bills that will need to be sold to pay for all the new administration's plans for us. Summary: You are eventually going to pay all the tax anyway, probably at much higher rates, so why not pay it now and have the after tax money to invest privately instead of with Uncle Sam's "help"?
At the present time there also is a special feature available only in 2010 for converting regular IRAs to Roth IRAs. You still have to pay the same income tax on the money you convert to a Roth IRA, but everything in a Roth IRA accumulates tax-free, and whatever you take out of a Roth IRA is tax free, except for any new earnings made in the first five years of your Roth IRA. Normally there are very strict limits on how much you can convert based upon your tax bracket. You can read up on that if interested. But in 2010 there are no limits. Even if you have millions of dollars in an IRA in 2009, in 2010 you just pay the tax and convert it regardless of your tax bracket. Even better you can split-pay the tax due in 2010 and 2011. Bear in mind that this 2010 special ROTH IRA provision could be repealed by the present Congress, so keep your ears and eyes open as this year progresses.
Thus the reasons for emptying a regular IRA in 2009 and/or in 2010 are 1. you're retired or may soon be; 2. taxes will be going up so you will pay more tax on IRA withdrawals later if you wait; 3. you will avoid tax bracket upwards creep due to the always increasing IRS-mandated RMD's after age 70; 4. you want to avoid even the remote chance that private pensions could be nationalized; and 5. you want to take advantage of a one-time removal of limits on conversions to a Roth IRA and the two year tax payment option.
*More current retirees, especially those who must withdraw IRS-prescribed amounts each year, will have IRAs rather than 401ks. Most US federal rules seem to me to be the same for both types of tax-deferred retirement funds. To be consistent and clear I am going to refer only to IRAs which I know about.
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