Anyone saving for retirement should be paying attention to the small-business bill president Obama signed last month.
In addition to mandating tax changes and other incentives for business owners, it extends three benefits to workers saving for retirement.
Two new rules allow participants in workplace retirement plans to transfer money into a Roth account without penalty. The third allows savers to more easily convert money into an annuity.
The focus on Roth accounts is important for tax planning, because workers with 401(k) accounts put aside a portion of their pretax income from each paycheck. Then in retirement, the accountholder pays taxes when the money is withdrawn. With a Roth account, money is put in the account after taxes are paid, but withdrawn in retirement tax-free.
The ability to draw money from both taxable and nontaxable accounts allows a retiree to better control tax liability.
Roth rollover
The small business act allows workers to roll over some of their 401(k) account into a Roth within their retirement plan. The worker must pay the taxes due but won’t face a penalty. Formerly, rolling over a 401(k) into a Roth IRA before age 59 1/2 resulted in taxation plus a 10 percent penalty.
The IRS also is allowing individuals to pay taxes from a Roth conversion, if done in 2010, to be spread out through 2012. Another provision adds the Roth option to government 457 retirement plans in 2011. Current law allows Roth accounts in 401(k) plans and their nonprofit equivalent, the 403(b), but not the retirement plan for government workers.
IRS guidance is available at http://tinyurl.com/29mocn5.
Annuities
The third change involves allowing annuity owners to take out part of the money and convert it to a new annuity.
An annuity is an insurance company product. You turn over a sum of money; the insurer invests it and guarantees a set monthly payment.
The annuity industry had been pushing for the change because it would offer more flexibility in the way the investment may be used, said Drew Denning, at Principal Financial Group in Des Moines.
Many retirees are reluctant to commit their life savings to an annuity contract out of fear they may need money for unforeseen expenses.
“A more gradual conversion or partial purchase is more appropriate for most individuals,’’ Denning said.
Many advisers recommend that retirees annuitize at least enough of their savings to pay for basic necessities such as housing, food, and transportation. This gives them flexibility to spend the remainder of their retirement funds as needed.
David Pitt writes for the Associated Press.