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When It Comes to Retirement Accounts, It Pays to Pay Attention and to Pay a Pro

September 24, 2000|LIZ PULLIAM WESTON

Q I want to know why, as a reader of two major newspapers, I managed not to know enough to make a simple, five-minute transaction that would have saved me a $20,000 tax penalty and the loss of my individual retirement account. I converted my IRA to a Roth IRA in 1998, not realizing that my income was too high to qualify for such a conversion. By the time I realized my mistake, it was past the Dec. 31, 1999, deadline to undo it. We had to pay the tax penalties and I was forced to liquidate the entire account. We did get a notice from the IRS, but it came during the holiday season and we put it aside, not realizing its importance. On one hand, I feel like an idiot; on the other, I believe what happened was unfair.

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A I'd go with that first feeling.

Congress created Roth IRAs in 1997 as a way for people to save money that would not be taxed in retirement. People whose incomes were under certain limits ($160,000 for married couples, $110,000 for singles) were allowed to make a nondeductible contribution of up to $2,000 a year to a Roth IRA.

Lawmakers also allowed people whose incomes were under $100,000, married or single, to convert traditional IRAs to Roth IRAs. People who converted their traditional IRAs paid income taxes, but not penalties, on the amounts they transferred to a Roth IRA.

A Roth conversion is indeed a complex transaction. That is why newspapers and personal finance magazines were filled with stories about who should and shouldn't convert, and how to go about converting if you were eligible. The Los Angeles Times alone had dozens of stories about Roth conversions during 1998 and 1999, including 34 that specifically included the $100,000 income limitation. One of the stories, which appeared in March 1999, talked about the fact that many people were discovering their incomes were too high and were undoing their conversions. We also had three mentions of the Dec. 31, 1999, deadline.

The IRS itself tried to tell you about your mistake, to no avail. You've learned the hard way that it never pays to ignore an IRS notice.

Another lesson you might have learned is that you should never touch a retirement account until you get professional (that is, paid) tax advice on the transaction. A knowledgeable tax preparer could have saved you an enormous amount of grief and expense. Retirement accounts, and their tax-deferred status, are too valuable to throw away through a dumb mistake.

An Expensive Investment Vehicle

Q Ever since I read one of your recent columns, I've been worrying that my husband and I should not be putting almost $1,000 a month into a variable universal life insurance policy. I am not an investment novice and was under the impression that this is a good product for future tax-free retirement income. I am not interested in the life insurance benefit. The main caveat from our financial planner is that, because the product has relatively high fees, it takes a while before the investment potential accumulates. After a certain point of buildup within the policy, the benefit of tax-free compounding and eventually the ability to avoid taxes altogether by withdrawing tax-free income overcome the cost. Is this right?

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A Your planner's caveat is correct--the expenses associated with such a policy mean it's a long-term investment. But why invest in life insurance if you aren't interested in the death benefit?

Cash-value life insurance such as variable universal life makes sense only if you need insurance anyway, can afford the premiums to buy enough coverage and have exhausted all your other avenues for saving money tax-deferred. If you don't need the coverage, there are many less expensive ways to invest.

Trustee Choice a Vital Detail

Q Your advice was perfect to the grown children whose deceased father's trust was being administered by their stepmother--apparently none too well. My firm specializes in trust and estate litigation, and the scenario described in the question could not be more classic. Too often, the estate-planning attorney treats the designation of successor trustees as almost an afterthought, not bothering to educate the client about the risks, responsibilities and consequences. Sometimes it's the children who may end up battling each other; often it's the children versus the stepparent. And in almost all these cases, no one is being intentionally dishonest; the problem is lack of competence to be a trustee combined with bad legal advice.

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A Judging from my mail, a lot of people are confused about whom they should name to take over their affairs after death. There is no easy solution, and sometimes even the most considered choice doesn't work out. Naming two co-trustees, however, may prevent one unethical or uninformed person from making a mess of things.

Fortunately, there are several sources consumers can turn to for information about choosing a successor trustee. Michael T. Palermo, a lawyer and financial planner, has created the "Crash Course in Wills and Trusts" online at http://www.mtpalermo.com. The book "Plan Your Estate," by Denis Clifford and Cora Jordan (Nolo.com, 2000), also has good information.

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Liz Pulliam Weston is a personal finance writer for The Times. Questions can be sent to liz.pulliam@latimes.com or to Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets she cannot respond personally to queries. For past Money Talk questions and answers, visit http://www.latimes.com/moneytalk.

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