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Three Retirement Loopholes That Are Likely to Close Soon

July 9, 2015

Financial advisors have been able to find various workarounds to maximize retirement benefits. But these loopholes are likely to close, Liz Weston writes at Reuters — in part because they’ve grown so popular.

Recent tax-related bills aim to stop wealthy families from shielding retirement assets from the tax man, according to Weston. Chief among them is the back-door Roth IRA conversion, employed by individuals whose incomes are higher than the threshold for allocating after-tax money directly into a Roth. This loophole allows funding a traditional IRA with a non-deductible contribution and subsequent conversion of the IRA into a Roth IRA. While taxes are normally levied in a Roth conversion, they are likely to be minimal if there are no other funds in an IRA, Weston writes. Back-door conversions are on the chopping block: President Barack Obama’s budget proposal for 2016 aims to restrict Roth conversions to pretax money only.

But thanks to the current legislative standstill, any ban is unlikely until the next administration. Even then, the tax changes probably won’t affect accounts already converted, one financial planner tells Reuters, so the opportunity to exploit this particular strategy remains open.

But lawmakers may be able to kill the so-called stretch IRA, which allows those who inherit an IRA to receive payouts over their lifetimes. If the IRA is converted to a Roth, withdrawals from which are not normally taxed, this can provide tax-free income. Legislators from both parties don’t like the idea of retirement funds being used to fund inheritances and have proposed tax-related bills that would force beneficiaries other than spouses to withdraw the Roth within five years, according to Reuters.

Obama’s budget may also take aim at strategies that manipulate the timing of Social Security payments.

Retirement experts tell Reuters that this may include the “claim now, claim more later” method, which allows a spouse in a dual-earner couple to collect a spousal benefit at 66 years of age and then collect from his or her own benefits starting at age 70, when the spousal benefit maxes out — a strategy that can net a couple tens of thousands of dollars in extra Social Security benefits.

Then there is the “file and suspend” strategy, which can be used with the previous method or on its own and permits a spouse to apply for Social Security upon reaching full retirement age and suspend the application immediately, allowing his or her own benefit to grow while the other spouse claims a spousal benefit. But one economist tells Reuters that any changes to these strategies will likely be phased in, so people now approaching retirement are not likely to be affected.

By Alex Padalka
  • To read the Reuters article cited in this story, click here.