Here is the 2010 contribution limit data, courtesy of the IRS:

2010 401(k)/403(b) Contribution Limits :

After many expressed concern that the 2010 401(k) contribution limits would be decreased, the IRS has announced that they will remain the same as 2009: $16,500 plus a $5,500 catch-up contribution if you are 50 or over, for a total of $22,000.

For all of the exciting details, consult this IRS press release and this IRS 401(k) Resource Guide.

2010 IRA Contribution Limits:

If you are under 50 years of age at the end of 2009, the maximum contribution that you can make to a traditional or Roth IRA is the smaller of $5,000 or the amount of your taxable compensation for 2009. This limit can be split between a traditional and a Roth IRA but the combined limit is $5,000. The maximum contribution to a Roth IRA and the maximum deductible contribution to a traditional IRA may be reduced depending upon your modified adjusted gross income (modified AGI).

If you are 50 years of age or older before 2010, the maximum contribution that can be made to a traditional or Roth IRA is the smaller of $6,000 or the amount of your taxable compensation for 2009. This limit can be split between a traditional and a Roth IRA but the combined limit is $6,000. The maximum contribution to a Roth IRA and the maximum deductible contribution to a traditional IRA may be reduced depending upon your modified AGI.

To determine if and how much of your traditional IRA contributions will be deductible in 2010 based on your income and marital status, use this IRS table if you have a retirement plan at work, and this IRS table if you do not. Roth IRA contributions, of course, are not tax deductible.

2010 HSA Contribution Limits:

Health Savings Account (HSA) participants can contribute up to $3,050 for an individual and $6,150 for a family plan. Participants 55 and older can contribute an extra $1,000, or $4,050 for an individual account and $7,150 for a family account.  These contributions are 100% tax deductible from gross income. The limits apply to the combination of employee and employer contributions to the account.

Being able to sock away $7150 annually tax-free, and being able to withdraw it (and earnings) in retirement tax-free is a fantastic deal. I sure hope Obamacare doesn’t change this.

Minimum annual deductibles for HSAs in 2010 are $1,200 for self-only coverage and $2,400 for family coverage.

Annual out-of-pocket expenses (deductibles, co-payments and other amounts, but not premiums) cannot exceed $5,950 for individual coverage and $11,900 for family coverage.

Don’t forget that you have until you file your 2009 federal income tax return to complete your 2009 IRA and 401(k) contributions!

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Under present law, only taxpayers with a modified adjusted gross income less than $100,000 may convert from a traditional IRA to a Roth IRA.  Under the new law,  regardless of income, contributions can be made to a traditional IRA in 2009 (and prior years) and then rolled over into a Roth IRA in 2010.

The remaining question is whether executing a Roth IRA conversion is the right move for you. That’s where a conversion calculator can help. Here are some online Roth conversion calculators that I have learned about:

RothRetirement.com was one of the first to publish a complete website about Roth conversions, including a conversion analysis calculator. The output from the calculator can be confusing, which may be intentional.

Fidelity Investments has introduced its version of a conversion evaluator but you will have to sign up to use it.

Dinkytown is well-known for offering a multitude of different financial calculators, including a very simple Roth conversion calculator with an easy to understand graphical output.

SmartMoney Magazine has an online site including an electronic worksheet for Roth IRA conversions. I like that the output includes a definite “yes” or “no” recommendation.

Vanguard Investments also has a conversion calculator but it seems not to know about the rule change for 2010.

The TIAA-CREF Roth IRA conversion calculator is unremarkable and does not appear as comprehensive as some of the others.

The Bank of America conversion calculator is the most interactive because it uses sliders for input with the results instantly displayed on the same page.

Overall, of the online Roth IRA conversion calculators that I have tried, I like the RothRetirement.com and SmartMoney versions the best.

What are your plans for a IRA conversion in 2010?

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A required minimum distribution is the smallest annual amount that must be withdrawn from an IRA or 401(k) beginning in the year that the account owner reaches age 70½. The 2008 law waives required minimum distributions (RMD) for 2009 for IRAs and 401(k)s). It also allows certain amounts distributed as 2009 required minimum distributions to be rolled over into an IRA or another retirement plan.

When the law was first passed, an account owner who had already received an RMD was allowed 60 days after receiving the money to put it back into the retirement account. The IRA has now extended that deadline until the later of November 30, 2009 or 60 days from the time you withdraw the money. This is good news for retirees to be sure.

1. You are allowed to return only one IRA withdrawal back into the account within a 365 day period. This means that if you received regular distributions every month, you can return only one of those withdrawals. However, if you received the RMD in a lump sum, you can put it all back into the account.

2. If any taxes were withheld from your RMD, that money needs to be returned also. If it is not, the amount withheld for taxes will be considered a distribution and will be taxed as ordinary income.

3. Since you didn’t have to take an RMD in 2009, that leaves more IRA money available for possible conversion to a Roth IRA.  Although you will pay taxes when you make the switch, you can take tax-free withdrawals after five years. The Roth conversion also means no more required minimum distributions and a potential a tax-free inheritance for your heirs. If you want to make the conversion in 2009, your adjusted gross income just needs to be below $100,000. That income limit is removed in 2010.

4. If you notified your IRA or 401(k) account service to stop RMD withdrawals in 2009, be sure to restart them in 2010 to avoid being penalized.

For more information on the RMD payback extension, you can read IRS Notice 2009-82.

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401(k) Plan Hardship Withdrawals

How do these retirement plan leaks occur? The most common scenario is a hardship withdrawal. These early withdrawals are permitted in some circumstances, such as to cover un-reimbursed medical expenses, to purchase a principal residence,  to pay certain education expenses, for payments necessary to prevent eviction or foreclosure, funeral expenses, and certain expenses for the repair of damage to your principal residence.

An “early withdrawal” is one that occurs before the plan participant reaches age 59 and 1/2.

However, a hardship withdrawal from a 401(k) account can still trigger a 10% penalty plus taxes owed, unless you are:

• Totally disabled
• Your unpaid medical expenses exceed 7.5 percent of your adjusted gross income.
• You are required by court order to give the money to a divorced spouse, a child, or a dependent.
• You leave your job due to layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.

According to a recent GAO Report, an early withdrawal or complete retirement plan cash-out of this nature at job separation is terribly damaging to your retirement future:

Participants who voluntarily cashed out their entire 401(k) account balance at job separation experienced the largest reductions in the amount of retirement savings that accumulate over their working careers,” the report noted.

For example, a participant who cashed out his entire 401(k) at age 35 would forfeit more than $183,000 in savings by his 65th birthday, according to the report. Cashing out later in a career, when there is less time to recover from losses, leaves an even bigger wealth gap.

I couldn’t have said it better myself.

One aspect of a 401(k) hardship withdrawal that many folks don’t consider is that the person making the withdrawal is prohibited from making more contributions to his or her 401k account for six months after the withdrawal. This prohibition also includes employer contributions.

I think that anyone over the age of 50 who proposes to cash out or take a hardship withdrawal from a retirement account should receive mandatory counseling from a financial advisor.

IRA Hardship Withdrawals

The rules for hardship withdrawals from an IRA are somewhat different. Also, traditional and Roth IRAs have different rules.

An IRA owner can make no-penalty hardship withdrawals for:

• Excessive un-reimbursed medical expenses.
• Payment of medical insurance premiums while unemployed.
• Total and permanent disability.
• Distribution of account assets to a beneficiary after you die.
• Certain qualified educational expenses.
• First time home purchases (maximum of $10,000 per purchaser)

If this is a conventional IRA, you still must pay taxes on the withdrawals.

Finally, the IRS will allow early withdrawals from an IRA without penalty based on the “substantially equal periodic payment rule.” Using this method, you must distribute the entire IRA balance using equal payments spread over your life expectancy.

The bottom line is that baby boomers should consider an early hardship withdrawal from a retirement account only as an absolute last resort.

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The Roth IRA conversion strategy is clearly near the top of the list for retirement tax management.

There are numerous online resources for comparing and assessing Roth eligibility.

Recently, CNN/Money has published a very good slide presentation called “Retire Without Taxes.” This article carefully walks the reader through how to use the Roth IRA to minimize your retirement tax burden.

One of the important points addressed in the presentation is whether Congress could change the rules and start taxing Roth withdrawals made by wealthier retirees. The answer is probably not. However, Congress could do equivalent damage to our retirement tax burdens by either taxing consumption or bumping marginal tax rates for retirees having higher net worth. This type of tax punishment of baby boomers who have actually saved for their retirement is a frightening scenario.

There is one statement that I disagree with in the CNN/Money Roth presentation. The author states that the Roth is only savings plan that gives us the opportunity for tax-free withdrawals in retirement. Actually, there is another plan, and it can be even better than a Roth. If you have a Health Savings Account (HSA), you can use your HSA as a super-Roth investment vehicle. I say “super” Roth because if you use it properly, you won’t pay taxes going in or out of the plan!

Anyway, I recommend careful consideration of the Roth IRA conversion strategy in the next few months because the window won’t be open long. Indeed, if Congress or the White House get nervous about massive amounts being converted early on, they might conspire to close that window early.

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RMD Rules

Although the requirement for minimum distributions has been waived for 2009, they will return in 2010. If you are a baby boomer, even that is too soon to worry about because the RMD rules apply only after you hit 70 1/2 years of age. Nevertheless, I think it helps to look ahead so that you can incorporate this knowledge into your retirement income planning.

If you don’t take your minimum IRA withdrawals when required, there is a 50% federal tax penalty on the difference between the amount you actually withdrew and the amount that you should have withdrawn. Moreover, you will need to withdraw the required minimum and pay tax due on the taxable amount of that withdrawal. You can determine the taxable amount of your RMD by using IRS Form 8606.

The RMD must generally be withdrawn by December 31 of each year. This can be in a lump sum or in installments during the year.

If it is your first RMD year, you can delay withdrawing until April 1 of the year after the year you turn age 70½. If you use that delay, you will end up taking two minimum distributions during that calendar year. This could put you in a higher tax bracket for that year, so be careful.

Of course, the RMD rules do not apply to a Roth IRA because you have already paid the taxes that are owed.

Estimating Your RMD Amounts in Retirement

The RMD amount is calculated applying an IRS life expectancy factor to your account balance at the end of the year. The life expectancy factor can be found in IRS Publication 8606.  Thus, to calculate your RMD you: (1) Find your age in the table; (2) Find the corresponding life expectancy factor; and (3) Divide your IRA balance as of the end of the previous year by the life expectancy factor.

Vanguard provides a helpful online calculator for estimating required minimum distributions from an IRA when you retire. It can be used to estimate the withdrawal amount and the account balance, based on your age, your spouse’s age if applicable, starting balance, projected rate of return, and beneficiary type.

If you have more than one retirement plan (such as multiple IRAs or a 401(k), you have to separately calculate the RMD for each plan. You are allowed to add the RMD amounts of all IRAs and then withdraw the total RMD amount from any one (or more than one) of your IRAs. These rules also apply to 403(b) accounts.

Final Thoughts on RMD Planning

In my opinion, it is not too early for baby boomers to think about how they will be funding their retirement all the way through. This means being careful about taxes and knowing which retirement accounts should be used for withdrawals and different points in time. If you have an IRA or other plan, I would start studying the required minimum distribution rules now.

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Judgment Creditors and Retirement Accounts

In this issue, I am not referring so much to mortgage lenders and credit card companies. They need to be paid. I am speaking more about the unexpected creditor, such as someone who comes after you for an overwhelming and uninsured medical expense or lawsuit judgment. The concern is greatest if such a judgment forces you into bankruptcy.

The first issue that comes to mind is protection of retirement assets of one spouse from the creditors of the other spouse. This will depend in large part on how the asset is owned. 401(k) and IRA accounts are not jointly owned but they do have beneficiaries. Generally, a creditor of a non-owner spouse has no rights to pursue that asset except if the owner spouse dies while the account is still in place. Then it gets more complicated.

Federal and State Protection of Retirement Assets

Funds held in 401(k) plans are shielded from all creditors by the federal Employee Retirement Income Security Act (ERISA). No federal or state court creditor can touch 401(k) money except for claims made by a spouse or by the IRS. 

Funds held in an IRA are not protected by ERISA. However, the 2005 bankruptcy reform legislation provides protection for up to $1 million in IRA funds that you contributed, including Roth IRAs. This makes it even more important to keep good records of your IRA contributions.

SEP, Simple IRAs, Keogh, and solo 401(k) plans are completely exempt (with no upper limit) from bankruptcy proceedings, as are IRAs that are rolled over from a 401(k) or other qualified retirement plan.

Outside of federal protection, the ability of creditors to go after IRA funds in or outside of bankruptcy is determined by state law. Some states  (New York, New Jersey and Connecticut for example) will protect all IRA funds while other states will cap that protection at $100k or $500k.

Still other states – California being a prominent example – protect only those IRA and other retirement assets that are “reasonably necessary” to support the owner of the funds and dependents. This is a flexible test that depends on the owner’s income, age, and other assets.

Final Thoughts on Creditors and Retirement Accounts

Anyone who works in a field that is high risk for uninsured attacks by judgment creditors needs to be careful about how retirement assets are held. For example, rolling over a 401(k) account to an IRA may not be the best idea in some states, because of possible loss of protection from creditors.

Similar concerns can arise if a retiree is offered a choice of receiving a pension benefit in a lump sum.

Bottom line: Get some legal advice from a lawyer in your state about protecting retirement assets before you make a financial planning decision that is irrevocable.

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Also, even if you specify in your will how your retirement plan benefits are to be distributed, your will cannot override a beneficiary designation in the plan documents themselves. 

So what retirement plan documents should baby boomers be reviewing?

Primary beneficiary designations on qualified defined contribution plans.

These include 401(k), 403(b), SEP, and similar plans. (Note that a spouse must generally provide written consent if you attempt to remove him/her as primary beneficiary on a qualified defined contribution plan.)

Primary beneficiary designations in qualified defined benefit (pension) plans.

Again, you will generally have to obtain spousal consent to name someone other than your spouse.

Contingent beneficiary designations in qualified defined benefit and contribution plans.

A contingent beneficiary is named to cover circumstances where your primary beneficiary pre-deceases you or dies in a joint accident with you.   When boomers were younger, they would often designate minor children (or a trust for minor children) as a contingent beneficiary.  If the children are now grown up, you will probably want to change your contingent beneficiary, perhaps by naming your estate.  That way, your will can be used to determine where your retirement benefits will go upon your death.

Primary and contingent beneficiary designations for IRA balances.

The rules for rolling over an inherited IRA vary depending on whether the beneficiary is or is not a spouse.  The status of the beneficiary can also affect the application of required minimum distribution rules.  Thus, baby boomers should carefully consider their options when updating designations of IRA beneficiaries.  For more guidance on this issue, consult IRS Publication 590.  

Secondary/joint owners of bonds and CD’s set aside for retirement.

Most issuers of bonds and CD’s allow you to designate a secondary or joint owner of those financial instruments.  This is true for I-Bonds, for example.  If you have some of these assets in your retirement nest egg, you should review those designations to make sure they reflect your current family status.   Generally, there is no need to obtain the consent of any existing beneficiary to make these changes.

I like to review the beneficiary status for our retirement plans each year when I am working on our income tax returns.  This is a convenient reminder for me.  Perhaps that would make sense for you as well.

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IRA funding limits for 2009 have been set for various scenarios and you should consider all of them.

I find it helpful to use online calculators to: (a) help determine whether a taxpayer is eligible for a traditional, Roth, Roth-conversion, and/or non-deductible IRA; and (b) help compare the relative financial benefits of each different IRA type.  I have found two online IRA calculators that I like in particular.
First, Wells Fargo has an IRA Eligibility Calculator that is simple to use.  After entering your age, your spouse’s age, you adjusted gross income, your filing status, and whether you participate in a retirement plan at work, it displays a list of the IRA types and indicates whether you are eligible to fund each type.  The eligibility display also contains links to two additional calculators.  One calculator allows you to compare the after-tax benefits of a Roth vs. a traditional IRA.  The second calculator provides feedback on the financial benefits of doing a Roth-conversion, taking into account your marginal tax rate, expected return, and anticipated distribution period.

Morningstar also has an IRA Calculator in three different forms to help you make better decisions about funding or converting an IRA.  The three calculators determine the following:

• Eligibility contribution limits for a Roth or Traditional IRA
• Compare scenarios to find out which type of IRA is best for you
• Conversion – to find out whether it makes sense to convert a traditional IRA to a Roth IRA

Give these a try and let me know what you think.  Also, if you know of any other IRA calculators that you think work well, please tell us about it in a comment.

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First, analyze your options if your employer has stopped matching 401(k) contributions.
Second, determine if funding an IRA for 2008 and 2009 makes sense for you, even if you also participate in an employer-sponsored retirement plan.  As part of this, consider whether you would benefit from a conversion to a Roth IRA now (if eligible) or in 2010 when the income limits are removed.  If you converted in 2008, you should also analyze whether, based on stock market conditions, it would be better for you to re-characterize your converted Roth IRA back to a traditional IRA.

Third, understand the limits on what you can contribute and what your employer can contribute to your 401k retirement plan in 2009:

Maximum employee 401k contribution = $16,500 plus $5500 catch up contribution (if you are over 50) for a total of $22,000.

Maximum employer contribution is 25% of compensation, up to a maximum total employee + employer contribution of $49,000.  This maximum increases to $54,500 if you are over 50.

The employer 401k plan contribution can be any combination of matching funds and profit sharing contributions.  For you baby boomers who own a small business, anything over the safe harbor 401k contribution limit of $16,500 ($22,500 for over 50) may be subject to top-heavy plan analysis, so be sure to get some professional advice if you want to include additional company funds into your personal 401k account, over and above the safe harbor limit.

Fourth, consider whether any of your 2009 401(k) funding should be Roth 401k contributions, if your employer’s plan permits that.

Fifth, understand the limits on what you can contribute to your traditional, Roth, or non-deductible IRA in 2009:

Maximum contribution to an individual IRA = $5,000 plus $1,000 catch-up contribution for a total of $6,000.

Sixth, if you have a Health Savings Account, consider whether you want to use your HSA as a tax-free retirement investment.  For 2009, the HSA contribution limits are:

$3,000 for individual coverage

$5,950 for family coverage

Plus a $1,000 catch-up contribution if you are 55 or older.

Seventh, don’t forget that you have until you file your 2008 income tax return to make your 2008 contributions to an IRA.  Similarly, your employer can make additional 401k contributions to your account up until the time it files its corporate tax return.

For many boomers, there are a lot of issues to consider in making decisions on funding one or more retirement plans.  Be careful, be smart, and don’t procrastinate.

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