By Darlynn Morgan, Orange County Estate Tax Lawyer

The talk this year about changes in the availability of Roth IRAs has raised questions from many people eligible for the benefits of these individual retirement accounts.

One of the hottest topics of discussion is the advantages of a traditional IRA versus a Roth IRA, and whether or not you have to convert your traditional IRA to make it a “stretch” IRA.

First of all, the answer is no, you don’t have to convert your traditional IRA to make it a “stretch” IRA.

A “stretch” IRA is not a particular type of IRA.  It’s merely a strategy used to stretch out or prolong the tax advantages of an IRA (most commonly a traditional IRA or a Roth IRA).

Before Congress passed the Taxpayer Relief Act of 1997 and created Roth IRAs, the term “stretch” IRA was used to describe the financial strategy used by a spouse, child or grandchild to draw out distributions (and tax deferrals) when they inherited a pretax traditional IRA.  The longer the beneficiary expected to live, the smaller each payout had to be to “stretch” the advantages.

With a traditional IRA the money is taxed as you take it out of the IRA.  By stretching out the IRA, you have extra time, and this could be decades, to compound tax-deferred interest.  That’s one of the things that makes an IRA a good investment opportunity.

Now that Roth IRAs are available to taxpayers at all income levels (beginning this year), there are more ways to stretch out a Roth IRA as well.

This is what you need to know to take full advantage of the tax savings:

If you have a traditional IRA, you have to start taking withdrawals by April 1^st of the year after you turn 70 and a half.  To calculate your required minimum distribution, just take the account balance on December 31^st of the previous year and divide it by the number of years left in your life expectancy (you can get this number from the Internal Revenue Service’s “Uniform Lifetime” table). You pay taxes on what you take out in each withdrawal.

Now, this is what confuses people with regard to a Roth IRA.  In converting to a Roth IRA from a traditional IRA, you move money to the Roth IRA and must pay ordinary income taxes on whatever amount you move.  However, you don’t have to take annual minimum payments and all future growth in the IRA is tax free, and so are any future withdrawals.  That leaves more money for your heirs to stretch out unless you have to take money out for your own living expenses.

By converting from a traditional to a Roth IRA, you can leave a larger IRA for your heirs and it will be tax-free rather than tax-deferred.  That’s why the Roth IRA is such a big deal.

One more thing to think about when considering an IRA is your choice of beneficiary.  You have to indicate your choice on the beneficiary designation form when you open the account.  Don’t worry.  You can amend it later if you need to.  Money in your IRA is distributed according to this form, NOT your will.

If you leave the IRA to someone other than your spouse, they have to take required minimum distributions, regardless of the type of IRA.  A  Roth conversion eliminates this requirement for you, but not for your heirs.  These requirements are slightly more lenient for your spouse than for a non-spouse heir.

And one more word of caution.  Never name your estate as the beneficiary of your IRA.  If you do, under the worst possible combination of circumstances, the money may have to be withdrawn within five years of your death.  If you have a traditional IRA, the income tax has to be paid as the money comes out.  Always name contingent beneficiaries just in case your first choice dies before you do.  Otherwise, the funds go to your estate by default.

If you currently have an IRA and want to know more about converting it or want to make sure that you’ve set it up properly for estate planning purposes, call me, your neighborhood Orange County estate tax lawyer to schedule your Family Wealth Planning Session today.  We can identify what needs to be done to ensure that you have the right documentation to make your wishes known and followed.  Our Family Wealth Planning Session is normally $750, but this month I’ve made space for the next two people who mention this article to have a complete planning session with me at no charge.  Call (949) 260-1400 today and mention this article.

From the desk of Darlynn Morgan, Orange County Estate Tax Lawyer

George Steinbrenner, the fiery owner of the New York Yankees, passed away on July 13. Mr. Steinbrenner became one of the most recognizable professional sports owners in America after having paid around 10 million dollars for ownership of the Yankees in 1973. While often controversial, Mr. Steinbrenner was also hugely successful and made the Yankees worth anywhere from 1.5 to 4 billion.

Several sources have claimed that the heirs of George Steinbrenner’s estate would have to pay in the neighborhood of 500 million in the estate or “death” tax. But because of lapse in the estate law anyone who dies in this calendar year will not have to pay the estate tax.

Steinbrenner’s heirs will receive his entire estate – tax free.

George Steinbrenner is not the only billionaire to avoid the estate tax this year. Texas billionaire Dan L. Duncan also died this year, leaving his 9 billion dollar estate to his heirs without being taxed. Both these two men avoided the estate tax, but the lapse in the law that made this possible will be corrected by January 1, 2011 if the Congress does not elect to extend it.

In 2001 President Bush put in this lapse as part of his tax cuts. Democrats were unable to come to an agreement after promising to fix the glitch, so the lapse went into affect on the 1^st of this year. The lapse in the estate tax will end on January 1, 2011 and will actually rise to 55%, which is higher than 2009 max which was 45%.

Congress is discussing repealing the tax break for 2010, which could be retroactive and the family of George Steinbrenner, and others, would then be required to repay the amount they would have paid if the lapse never existed.  Ouch!

While Congress can potentially prolong the estate tax break into next year, that is highly unlikely. The estate tax impacts individuals who are worth over 1 million dollars, but that can include, bank accounts, retirement accounts, mutual funds, and other assets. It adds up faster than you think!

That means if something happens to you in 2011 your family could lose up to 55% of your assets to taxes.

If you don’t plan to die in 2010 but also don’t want to hand 55% of your assets over to the government, there are alternatives available to you. Proper estate planning can save your family thousands.  By working with an experienced Orange County estate tax lawyer you are taking a big step toward protecting your family. That is why I invite 10 families per month to come in for a Family Wealth Planning session at no-charge (normally $750).  Make your appointment today so you can be sure that your assets stay in your family and not given over to the government.