ditional IRA to a Roth IRA this year
triggered a surtax of thousands of
dollars where the surtax otherwise
would have been avoided completely. Remember, the 3.8% is in
addition to the regular income tax
the conversion normally generates.
EXAMPLE: IRA WITHDRAWALS
A single filer had $1 million in a traditional IRA at the end of last year.
Jane will be 75 this year, so according to the IRS Uniform Lifetime
Table, she has a life expectancy of
22. 9 years. Besides the required
minimum distribution from the
woman’s IRA, she has $180,000 of
other income, $80,000 of which is
net investment income.
the patient protection and
affordable care act will trigger a
surtax on some investment
income.
3.8%
or at least increase, deductible contri-
butions or salary deferrals to 401(k)s,
SEPs, IRAs and other retirement
accounts. Salary deferrals to 401(k)s
and similar plans are excluded from
gross income, and contributions to
retirement accounts are above-the-line
deductions, which reduce adjusted
gross income (and therefore modified
income tax.
There are occasions when IRA distributions can cause other net
investment income to be hit with the surtax.
She would be required to take at
least $43,668 from her IRA this year
($1 million divided by 22. 9 years).
Such a withdrawal would increase
her 2013 modified adjusted gross
income from $180,000 ($20,000
less than the single-filer threshold)
to $223,668.
That puts her past the threshold for single filers; $23,668 (her
net investment income exceeding
$200,000) will be subject to the
3.8% surtax. Like all clients with
sizable required minimum distributions, she could run into this
problem year after year, since she
is forced to withdraw ever greater
percentages of her IRA account as a
required minimum distribution.
How can you help clients minimize the surtax bite? One way would
be to suggest that clients maximize,
Business owners and very high-income professionals may want to
consider defined-benefit plans that,
in some cases, allow extremely large
deductible contributions.
The higher the deductible contributions that clients make to lower
their reported adjusted gross income,
the less exposure they will have to the
3.8% surtax. Of course, building up
retirement funds at an accelerated rate
isn’t a bad benefit on its own.
CONVERT B Y YEAR-END
Whether they are still working or
have already retired, clients with
high incomes who execute Roth IRA
conversions or take required mini-
mum distributions from traditional
IRAs starting this year might owe
the 3.8% surtax as well as ordinary
won’t increase a client’s modified
adjusted gross income and cause
other investment income to become
subject to the surtax.
CLIEN T RELuCTANCE
Of course, clients may be reluctant to
pay tax sooner than they must. Converting, say, a $400,000 traditional
IRA to a Roth IRA could produce a
$140,000 tax obligation at a 35% rate
or more.
Ideally, the tax on a Roth IRA conversion will be paid from non-IRA
funds, leaving more to compound,
potentially tax-free, inside the Roth
account. If a client draws down his
taxable portfolio to pay this tax, that
will leave fewer taxable investment
assets and perhaps less investment
income in the future; this will also
reduce exposure to this surtax.
