Limitations on who may convert traditional retirement accounts to the Roth no longer exist. This is great because you’re better off with your retirement funds in Roth accounts than any other form of retirement account. This is because:

• Withdrawals from a Roth are not subject to taxation. Withdrawals from other types of retirement accounts are taxed as ordinary income.
• There are no withdrawal requirements for monies held inside a Roth. So if you want to leave your money in your account beyond the age of 70½, you can — and it will continue to grow tax-free.
• If your heirs inherit your Roth, their withdrawals are also tax-free.

These are serious advantages. The proverbial fly in the ointment, of course, is that money and/or investments moved from traditional retirement accounts, i.e., traditional IRA, SEP IRA or Simple 401(k), to a Roth is subject to taxation. This is because, as you will recall, you funded the accounts with pretax dollars.1 Roth accounts work the opposite way: Contributions are made with after-tax dollars2 and withdrawals are tax-free. Withdrawals from other types of retirement accounts are taxed in the year of withdrawal as ordinary income.

So the benefits of having your money in a Roth are considerable, but moving funds from traditional accounts to the Roth will trigger a tax bill. Maybe you have tax losses that can be used to offset all or a portion of the conversion gain? Also, to help cushion the tax blow is a federal tax law that will allow you to spread your gain over the three years — 2010, 2011 and 2012 — as long as you make the conversion in 2010. If you wait until 2011 or thereafter, you’ll have to pay the tax on any conversion gain in the year of conversion.

Should everyone convert? No. In some cases, the tax hit may be too large. Talk to your financial advisor about your particular situation. Whether to convert your retirement account(s)3 to a Roth is not the same for everyone, but you’ll likely want to convert if some of the following apply to you:

• You have operating losses in your business. Unused losses from 2008 or 2009 or expected losses for 2010 or 2011. You can use them to offset Roth conversion gains and thereby reduce or eliminate the associated tax bill.
• You have cash outside your retirement account(s) you can use to pay the conversion tax (so you don’t have to pay a 10 percent early-withdrawal penalty).
• You won’t need to use the converted funds within the next five years or before you’re 59½ (Roth rules).
• You expect to have “decent” income during your retirement years (and therefore will be in one of the higher tax brackets).
• You think there’s a greater likelihood that overall income tax rates will be higher in the future, as opposed to lower.

Talk to your financial advisor today. The year is coming to a close and your ability to spread your conversion tax bill — if you have one — over two additional tax years will end on January 1, 2011.

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Footnotes:

1. If you have made after-tax contributions, they — and investment gains on these contributions — are not subject to taxation when moved to a Roth.
2. Most contributions are made with pretax dollars, but after-tax contributions can be made, too.
3. Note: Funds held in 401(k) and Solo 401(k) accounts (at least funds in these account types that did not originate from profit share contributions) cannot be moved to a Roth outside of a “distributable event” such as discontinuation of the plan, severance of employment, retirement or reaching age 59½.

You have net operating losses.

If you have operating losses in your business — unused losses from 2008 or 2009 or expected losses for 2010 or 2011 — you can use them to offset Roth conversion gains and thereby reduce or eliminate the associated tax bill. You’ll still want your financial advisor to conduct a thorough analysis, but odds are it will make sense to convert.

Even if you don’t have losses, you’ll almost certainly want to convert before year-end if the following apply to you:

1. You have cash outside your retirement account(s) you can use to pay the conversion tax (so you don’t have to pay a 10% early-withdrawal penalty).
2. You won’t need to use the converted funds within the next five years or before you’re 59 ½ (Roth rules).
3. You expect to have “decent” income during your retirement years (and therefore will be in one of the higher tax brackets).
4. You think there’s a greater likelihood that overall income tax rates will be higher in the future, as opposed to lower.

If the above apply to you, definitely talk to your financial advisor about the wisdom of converting your traditional retirement accounts1 to a Roth before year-end (2010).

All this is predicated on a very simple and indisputable fact: You’re better off with your retirement funds in Roth accounts than any other form of retirement account. This is because:

• Withdrawals from a Roth are not subject to taxation. Withdrawals from other types of retirement accounts are taxed as ordinary income.
• There are no withdrawal requirements for monies held inside a Roth. So if you want to leave your money in your account beyond the age of 70 ½, you can — and it will continue to grow tax-free.
• If your heirs inherit your Roth, their withdrawals are also tax-free.

These are serious advantages. The proverbial fly in the ointment, of course, is that money and/or investments moved from traditional retirement accounts, i.e., traditional IRA, SEP IRA or Simple 401(k), to a Roth is subject to taxation. This is because, as you will recall, you funded the accounts with pretax dollars.² Roth accounts work the opposite way: Contributions are made with after-tax dollars³ and withdrawals are tax-free. Withdrawals from other types of retirement accounts are taxed in the year of withdrawal as ordinary income.

So the benefits of having your money in a Roth are considerable, but moving funds from traditional accounts to the Roth will trigger a tax bill. Which tactic makes the most sense for you depends on your particular situation. The core decision criteria are listed above.

If you convert this year (2010), you can allocate any taxes due to the 2010 and 2012 tax years. Talk to your financial advisors today.

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¹ Funds held in 401(k) and Solo 401(k) accounts (at least funds in these account types that did not originate from profit share contributions) cannot be moved to a Roth outside of a “distributable event” such as discontinuation of the plan, severance of employment, retirement, or reaching age 59½.

² If you have made after-tax contributions, they — and investment gains on these contributions — are not subject to taxation when moved to a Roth.

³ Most contributions are made with pretax dollars but after-tax contributions can be made, too.²

1. Attract, reward and retain quality employees.
2. Reduce taxes.
3. Maximize benefits that accrue to you, the owner.

Recent changes in tax laws and innovations by Web-based plan administrators have substantially reduced cost and complexity, and increased allowable contributions and flexibility of retirement savings plans for small businesses. SEP and SIMPLE plans cost nothing to set up and have no annual maintenance expense. Even the more complex plans such as profit sharing and defined benefits/401(k) plans should cost small businesses no more than $2,000 to set up and administer annually (and the IRS will give you a tax credit of up to $500 per year for the first three years of your plan).

There’s a Great Plan for Your Business

Three types of retirement savings plans are available to small businesses: Simplified Employer Pension (SEP), SIMPLE IRA and Qualified Plans. Each includes the following:

• Available to any business with fewer than 100 employees (even a one-person business).
• Businesses may expense, or deduct, contributions made to retirement accounts of employees (including you) in the year they were contributed.
• Contributions are not taxed as income to employees (i.e., contributions are made pretax).
• Owners of the business may participate in the plan as long as they are employees or have earned income (as defined by the IRS) from the business. This means that virtually any type of business – sole proprietorship, LLC, S-Corp., C-Corp., Partnership, etc. – can take advantage of these plans.

Plan Type 1 of 3: Simplified Employer Pension (SEP)

The SEP is a simplified method by which an employer can offer a plan and contribute to the retirement accounts of employees. It allows the employer to deposit contributions directly into traditional IRA accounts of employees, which eliminates the need to manage and invest the monies for employees and deal with the more complicated and costly requirements of other plans.

Eligibility: Every employee 21 years of age or older who has worked for the company for three of the past five years and earned more than $500 in the current year must be included in the plan and receive employer payments.

Contribution Requirements and Limits: Each year, the employer can decide what percentage of salary he or she wishes to contribute to each employee’s account, but it must be the same percentage for each employee. The minimum amount is zero. The maximum amount is 25 percent of annual salary, to a maximum of $45,000 (2007).

Vesting: Contributions are 100 percent vested when earned, i.e., monies contributed to accounts of employees are immediately theirs to keep, forever.

Matching: Employees cannot contribute a portion of their own salary, so there is no matching component. But employees may set up a separate IRA and contribute their own monies to it.

Other: Any business may set up a SEP. Employers may have a SEP in addition to a qualified plan such as a profit sharing and/or 401(k) plan.

Plan Type 2 of 3: Savings Incentive Match Plan for Employees (SIMPLE IRA)

A SIMPLE IRA is similar to a SEP. It’s simple and inexpensive to set up and maintain, and contributions are made directly to IRA accounts of employees. It differs from a SEP in two primary ways:

1. Employees may allocate a portion of their salary, commonly referred to as a “salary reduction contribution,” to be deposited in the IRA.
2. Employers make contributions only as matches to employee contributions.

Eligibility: Any employee who is reasonably expected to receive $5,000 in the current calendar year, and who has received $5,000 or more during the two prior years, may participate. Employers may choose a less stringent employee qualification standard, but not a more stringent one.

Contribution Requirements, Limits and Matching: Employees may contribute up to 100 percent of their pay up to an annual maximum of $10,500 if under 50 years of age in 2007. Employees over 50 years of age may contribute up to $13,000 in 2007. The employer is generally required to match employee salary reduction payments, dollar for dollar, up to the lesser of 3 percent of compensation (up to a 2007 salary maximum of $225,000) or $6,750 (2007). But employers may lower their matching contribution to less then 3 percent (but not less than 1 percent) in any two years of a rolling five-year period.

Vesting: None (i.e., funds are immediately vested).

Other: Any business can set up a SIMPLE IRA plan. Employers cannot have any other plan in addition to a SIMPLE IRA. Salary reduction contributions are subject to Social Security, Medicare, and unemployment (FUTA) taxes. Matching contributions are not. If your company has a 401(k) plan, you can adopt the less-expensive and easier-to-administer SIMPLE IRA account structure if you meet the employer size limits (under 100 employees). But your “SIMPLE 401(k)” still will be a qualified plan and must meet the other requirements of qualified plans (see below).

Plan Type 3 of 3: Qualified Plans

Qualified plans, also called H.R. 10 plans, or Keogh plans when covering self-employed individuals, are more complex and costly but offer increased flexibility in plan design and higher contribution limits. There are two types of qualified plans – Defined Contribution and Defined Benefit.

Defined Contribution (DC) Plan: Allows the employer to contribute to employee retirement accounts amounts up to 100 percent of salary, up to $45,000 (2007) per employee. There are two types of DC plans:

Profit-Sharing Plan: This is a plan for sharing your business profits with your employees. A preset contribution plan is not required as long as contributions are “regular and substantial.” But distribution of contributions must be made to employees on a pre-established formula. Employee forfeitures that occur due to vesting schedules can be re-allocated to employees based on the preset allocation plan or be used by the employer toward future contributions.

In addition, employers can include a 401(k) component in their profit-sharing plan. This allows employees to elect to make salary-reduction contributions. The 2007 limit on elective deferrals is 100 percent of salary up to $15,500 if the employee is under 50 years of age; $20,500 if over 50. Salary reduction contributions are subject to Social Security, Medicare, and unemployment (FUTA) taxes. Matching contributions are not.

Money Purchase Pension Plan: Contributions are fixed and not based on company profits. For example, you may contribute annually to each employee’s account an amount equal to 10 percent of his or her yearly salary. Employees can’t make salary-reduction contributions

Defined Benefit (DB) Plan: Contributions are based on what is needed to provide established, determinable benefits to plan participants. Actuarial assumptions and computations are required to figure these contributions, so an expert in this specialized area must be used on an ongoing basis.

Employee forfeitures, which result from employees leaving before being fully vested, cannot be distributed to employee accounts. But the employer can use the forfeited funds to meet future contribution requirements. Annual contributions of up to $180,000 are allowed in 2007. Employees cannot elect to make salary-reduction contributions.

Employers who have set up any of the above Qualified Plans may craft their own employee eligibility requirements so long as they do not discriminate between employees and owners. As such, Qualified Plans allow employers to exclude more employees than do SEP or SIMPLE IRA plans.

Other: Setup costs for a Qualified Plan are generally higher, and extensive documentation is required. Most companies adopt master or prototype plans made available by plan providers and pre-approved by the IRS.

Note About 401(k)Plans: A 401(k) plan is an elective component of a Qualified Plan. It is simply a provision that allows the employee to elect to instruct the employer to make salary-reduction payments to the employee’s retirement account. Employers may elect to match employee contributions but are not obligated to do so.

Note About SARSEP: A SARSEP is a SEP set up before 1997 and includes a salary reduction arrangement. SARSEPs are no longer available, but plans established prior to 1997 still are allowed to continue.

The only reason that a retirement investment plan may not be appropriate for you and your business at this time is if your business is struggling just to survive. But when profit and cash flow allow, you’ll want to establish a good benefits plan to better equip you to attract and retain talent, reduce your tax bill, and more fully take advantage of the perquisites of business owners – one of which is valuable and generous government programs that allow you to sock away big pretax dollars for your retirement.

Question:

Answer: The first question to answer is what the $100,000 already saved will be worth in 10 years. To determine this, we use the following equation:

F10=F0 (1+i)10

Where F0 = $100,000

i = 7%

F10 = Value of $100,000 in 10 years

So F10 = F0 (1+i)10

= $100,000 (1.07)10

= $100,000 x 1.967

= $196,700

Note: 1.967 can be obtained by doing the math, or by simply using a present-value table. See present-value factor table provided adjacent to this article. Locate the intersection of 10 years (periods) and 0.07 rate of interest, and you will find 1.967. Multiply this by F0 and the result is $196,700.

So we can expect the currently saved $100,000 to be $196,700 when Tom reaches 60. His bogey is $1,500,000, so he needs to know how much money he has to stash away in each of the next 10 years to make up the $1,203,300 shortfall ($1,500,000 minus $196,700).

Let’s label the $1,203,300 bogey R.

R = $1,203,300

Let’s label the interest rate i.

i = 7%

Let’s label the required annual contribution P.

P = ?

The number of years available we’ll label n.

n = 10

So here’s the formula:

P = (R * i) / [ (1+i) n - 1]

Solving for P:

P = ($1,203,300 * .07)

(1 + .07)10 – 1

= $84,231/(1.0710 – 1)

= $84,231/(1.967 – 1)

= $84,231/0.967

= $87,105.

So for Tom to reach his goal of $1,500,000 in savings in 10 years, he has to invest $87,105 per year and earn an annual rate of return of at least 7%. The problem is that 7% after-tax rate of return is rarely achievable without taking a lot of risk – not recommended with retirement funds. But if the funds are in retirement accounts, then they are tax sheltered, and pretax return is the same as after-tax return. Pretax return of 7% is much more easily achieved. So he needs to get all this money into tax-sheltered retirement accounts. Assuming the $100,000 is already in such an account, all he has to do is place his annual savings into the same.

Is this possible? Take a look at the chart on page 13. Do you see the annual contribution limits for various retirement plan types? The only plan that will allow an annual contribution as high as $87,000 is the defined contribution plan. Talk to your financial advisor about putting one in place.

Future value interest factor of $1 per period at i% for n periods, FVIF(i,n).

4%     5%     6%     7%     8%     9%     10%

1 1.040 1.050 1.060 1.070 1.080 1.090 1.100

2 1.082 1.103 1.124 1.145 1.166 1.188 1.210

3 1.125 1.158 1.191 1.225 1.260 1.295 1.331

4 1.170 1.216 1.262 1.311 1.360 1.412 1.464

5 1.217 1.276 1.338 1.403 1.469 1.539 1.611

6 1.265 1.340 1.419 1.501 1.587 1.677 1.772

7 1.316 1.407 1.504 1.606 1.714 1.828 1.949

8 1.369 1.477 1.594 1.718 1.851 1.993 2.144

9 1.423 1.551 1.689 1.838 1.999 2.172 2.358

10 1.480 1.629 1.791 1.967 2.159 2.367 2.594

11 1.539 1.710 1.898 2.105 2.332 2.580 2.853

12 1.601 1.796 2.012 2.252 2.518 2.813 3.138

13 1.665 1.886 2.133 2.410 2.720 3.066 3.452

14 1.732 1.980 2.261 2.579 2.937 3.342 3.798

15 1.801 2.079 2.397 2.759 3.172 3.642 4.177

16 1.873 2.183 2.540 2.952 3.426 3.970 4.595

17 1.948 2.292 2.693 3.159 3.700 4.328 5.054

18 2.026 2.407 2.854 3.380 3.996 4.717 5.560

19 2.107 2.527 3.026 3.617 4.316 5.142 6.116

20 2.191 2.653 3.207 3.870 4.661 5.604 6.728

25 2.666 3.386 4.292 5.427 6.848 8.623 10.835

30 3.243 4.322 5.744 7.612 10.063 13.268 17.449

35 3.946 5.516 7.686 10.677 14.785 20.414 28.102

40 4.801 7.040 10.286 14.974 21.725 31.409 45.259

50 7.107 11.467 18.420 29.457 46.902 74.358 117.391