This decision – heck, any decision – has been much anticipated so that people could do their end-of-the-year planning.  The good news is that it also comes with some direction about the estate tax so we can all move forward with estate tax planning as well.

What should you do?

You have probably been talking to your accountant about this contingency, and now you need to act.  If this means shifting income from this year to next, taking more expenses this year, converting an IRA to a Roth, etc., you now need to make all that happen before the end of the year.   (As if you didn’t have enough to do already.)

Finding the right retirement income sources

What about the government?  Will Social Security income go away?  Hard to say.  Social Security income is a huge political football that no one wants to drop or be accused of ending.  As workers (a large electorate), we pay into the system and would like to see money out of the system.  Yet, the Social Security statement itself discloses that it predicts to pay on 78% of benefits in 2037 (http://www.ssa.gov/mystatement/currentstatement.pdf).  Even my clients in their late 50s don’t think they’ll get a dime of Social Security.  Here’s my take:  If it’s there, I want my clients to get their share and have that share be taxed as little as possible.  That takes some planning now.

What about employers?  Will employer pensions ever come back into vogue?  Unlikely.  They’re expensive and complicated to manage.  Employers faced with rising costs (medical insurance being high on that list) are looking to give retirement income benefits as cheaply as possible.  In years past that has meant the 401k, which for most highly compensated employees and business owners is inadequate.  The 401k was never intended to be the sole retirement benefit. It was designed to supplement the pension offered.  Even if my clients fund a 401k, we have to find alternate investment vehicles.

What about personal savings?  No one feels they’re saving enough.  That might be true.  Only to make it worse, no one feels like they made any money with their investments in the last 10 years.  There are many solutions here besides winning the lottery (and, by the way, if this is your solution, remember that you have to play to win – it’s always about the follow-through).  One of the tricks, I believe, is to find retirement income sources that provide tax-free income.  No, not the Roth IRA which most Bay Area families don’t quality to fund, and even if they did, they’d only be able to put away $5K.  Business owners (especially of C corporations), in particular, have potentially one of the best strategies to make this happen.  The other trick is to find non-stock market related investments.

The government might create a universal retirement funding plan.  You might win the lottery.  Or, you might just explore some of your personal savings options.

Redefining financial security and other out-of-date financial terms

As many of you know, I don’t approach financial planning from a traditional prospective because we don’t live in a traditional world.  Please consider adopting the following definitions:

“Financial security”:  The ability to weather any financial storm and to take advantage of any financial opportunities.  Notice this has nothing to do with whether you own your home outright.  If you cannot pay your bills if you’re out of work for a year, if you cannot help out your family when they are out of work for a year, when you can’t buy things that are on sale (e.g., income taxes right now when you convert your traditional IRA to a Roth or purchasing investment property), you are not in a financially secure place.  Get your safety net in place, which includes reserve accounts and insurances.  Then go pay off your house.

“Retirement”:  The ability to work for no money and still support one’s health and well-being.  Notice this has nothing to do with whether you own your home outright.  People are living longer and want to contribute to society with their gifts and energy into late adulthood.   They want to try new things.  If you have your house paid off, but no other sources of income to help you make ends meet, you cannot work for no money and pursue those late adulthood activities.  Go get your retirement income accounts in place and then go pay off your house.

“Debt-free”:  When your assets (after liquidation, taxes and penalties) exceed your debts.  Notice this has nothing to do with owning your home outright.  Once you have accumulated assets and can wake up one morning and say, “Hey, you know, today I think I will pay off my house and all my debts,” you are debt-free.  Just because you can do this doesn’t mean that you should.  In many cases, it makes sense to take debt even into retirement.  Go get your assets working for you, use debt intelligently and safely, and someday go pay off your house.  If that’s what you want to do.

There’s an Alternative Worth Considering

Roth IRAs have two big downsides:  (1) you can’t access the money without penalty until you’re 59 and a half or have special circumstances; (2) the income limits for contributing to a Roth remain intact ($120K for single filers, $177K for married couples in 2010); and (3) the amount you’re able to contribute is low ($5K; $6K with catch-up).  We get this one-time shot at converting to a Roth, but for many of us, we’ll never be able to contribute another dime to that account.

But what if you could?  What if you could put 10 or 20 percent of your income (an amount that might actually get you through retirement) into an account that would grow tax-free, would allow you access the cash tax-free for any reason at all at pretty much any time, would never require you to take a required minimum distribution, and would transfer to your heirs income tax-free?   Would you do it?  You’d sure like to know about it, right?  It exists.  It’s out there.  It’s likely available to you.

Here’s another issue:  If your IRA accounts are a small portion of your overall net worth, it actually might make a lot of sense to leave it alone and let it grow.  If it’s one of the few places that you’ll withdraw taxable income in retirement, you may be financially better off leaving it in its Traditional IRA form.  Take the tax savings and invest it.

To Roth or Not To Roth

There’s much to consider in deciding whether to convert an IRA:

• Do you think you’ll be in a higher tax bracket in retirement?
• Can you pay the taxes owed as a result of the conversion out-of-pocket?
• If not, will you suffer a 10% penalty for paying the taxes by withdrawing the money from the Traditional IRA?
• Should you pay those taxes in 2010 or spread them out over tax years 2011 and 2012?
• And more….

Do:  Talk to your accountant and financial advisor.  Find your IRA statements and your 401(k) statements from previous employers.  You’ll want to make this conversion early in 2010 (as close to January 4^th as possible), so that you have lots of time to see that account perform.  If it doesn’t produce positive returns, you might want to “recharacterize” it back to a Traditional IRA.

Don’t:  Forget that there’s a tax liability incurred by making the conversion. Talk to your financial professionals about how you’ll handle that liability.  Keep in mind that 2011 and 2012 might bring higher tax rates, making an election to pay that liability in 2010 preferable.

And remember:  The removal of the income limit for conversions is permanent.  You don’t have to make a decision this year.  But the opportunity to spread the tax liability over two years is temporary.  You should also note that the income limitations on contributing to a Roth remain.

This might be a great opportunity for you.  Or maybe there’s a better way to spend that tax money.