Posted on July 20, 2015 in

3 Retirement Loopholes That Are Likely to Close

The government has a knack for catching on to the most popular loopholes.
There are plenty of tips and tricks to maximizing your retirement benefits, and more than a few are considered “loopholes” that taxpayers have been able to use to circumvent the letter of the law in order to pay less to the government. But as often happens when too many people make use of such shortcuts, the government may move to close three retirement loopholes that have become
increasingly popular as financial advisers have learned how to exploit kinks in the law.

1. Back-door Roth IRA conversions
The U.S. Congress created this particular loophole by lifting income restrictions from conversions from a traditional Individual Retirement Account (IRA) to a Roth IRA, but not listing these
restrictions from the contributions to the accounts.

People whose incomes are too high to put after-tax money directly into a Roth, where the growth is tax-free, can instead fund a traditional IRA with a nondeductible contribution and shortly
thereafter convert the IRA to a Roth. Taxes are typically due in a Roth conversion, but this
technique will not trigger much, if any, tax bill if the contributor does not have other money in an IRA.

President Obama’s 2016 budget proposal suggests that future Roth conversions be limited to
pre-tax money only, effectively killing most back-door Roths. Congressional gridlock, though, means action is not likely until the next administration takes over. Any tax change would be
retroactive, which means the window for doing back-door Roths is likely to remain open for awhile.

2. The Stretch IRA
People who inherit an IRA have the option of taking distributions over their lifetimes. Wealthy families that convert IRAs to Roths can potentially provide tax-free income to their heirs for
decades, since Roth withdrawals are typically not taxed.

That bothers lawmakers across the political spectrum who think retirement funds should be for retirement – not a bonanza for inheritors. Most recent tax-related bills have included a provision to kill the stretch IRA and replace it with a law requiring beneficiaries other than spouses to
withdraw the money within five years. Anyone contemplating a Roth conversion for the benefit of heirs should evaluate whether the strategy makes sense if those heirs have to withdraw the money within five years.

3. “Aggressive” strategies for Social Security
Obama’s budget also proposed to eliminate “aggressive” Social Security claiming strategies, which it said allow upper-income beneficiaries to manipulate the timing of collection of Social Security benefits in order to maximize delayed retirement credits. Obama did not specify which strategies, but retirement experts said he is likely referring to the “file and suspend” and “claim now, claim more later” techniques.

Someone who reaches full retirement age also has the option of applying for Social Security and then immediately suspending the application so that the benefit continues to grow, while allowing a spouse to claim a spousal benefit.

People close to retirement need not worry. A change would have to be phased in so not to take something away that has already been given.

Source: Reuters, Liz Weston, June 30, 2015