Posts Tagged ‘Roth IRA’

To Convert or Not Convert - Looking Beyond the Roth IRA Conversion Calculator

Tuesday, November 3rd, 2009

Jane M. Young, CFP, EA

As I mentioned in the previous article on Roth IRAs, with a Roth IRA you pay income tax now and not upon distribution. With a traditional IRA you defer taxes today and pay income taxes upon deferral. When you convert a Traditional IRA to a Roth IRA you must pay regular income taxes on the amount that is converted. The advisability of converting to a Roth depends on the length of time you have until you take distributions, your tax rate today and your anticipated tax rate upon retirement and your projected return on your investments.

When you run your numbers through one of the numerous calculators available on the internet you may or may not see a big savings in doing a Roth Conversion. However, there are several other factors that may tilt the scale toward converting some of your money to a Roth.

• Income tax rates are currently very low and there is a general consensus that they will increase considerably by the time you start taking distributions. With a Roth conversion you pay the tax now at the lower rates and take tax free distributions when the tax rates are higher.

• The stock market is still down about 25% from where it was in August of 2008. There is a lot of cash sitting on the sidelines waiting to be invested once consumer confidence is restored. You can pay taxes on money in your traditional IRA while the share prices are low and take a tax free distribution from your Roth down the road when the market has rebounded.

• You may have a sizable portion of your portfolio in tax deferred retirement accounts on which you will have to take required minimum distributions (RMD). This could put you into a much higher tax bracket. By converting some of your traditional IRA into a Roth you can get some tax diversification on your portfolio. This will lower your RMD– because there is no RMD on a Roth IRA. Diversifying your portfolio between a traditional IRA and a Roth IRA enables you to take your distributions from the most appropriate pot of money in any given year.

For more information on Roth IRAs and the new tax laws for 2010 please review the articles previously posted under Roth IRAs.

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What You Should Be Doing Now!

Thursday, August 13th, 2009

Jane M. Young CFP, EA

1. Start by re-evaluating your monthly expenses to determine how much money you need for necessary expenses. Then determine how much you have remaining after you cover these expenses.

2. During difficult economic times, like the present, most people should maintain an emergency fund of at least 6 months of expenses. If you have an exceptionally secure job you may be able to drop it down to 3 months. Always be sure to sure to maintain an adequate emergency fund.

3. Once your emergency fund is established pay off any high interest credit cards.

4. Put aside money for special one time expenses such as a new roof, a new car or a down payment on a house. If you don’t own your own home give some serious consideration to saving up to buy one. Decide how much you want to save on a monthly basis and start a systematic savings plan.

5. Now you can start investing! Determine how much you can afford to invest on a monthly basis. Most people should start by investing in their company retirement plan up to the level that the company will match. If you can afford to invest beyond the level of your company match, invest up to the maximum allowed in a Roth IRA. This should be done on a monthly basis to take advantage of dollar cost averaging - investing the same amount every month. The 2009 contribution limit for a Roth IRA is $5,000 if you are under 50 and $6000 if you are over 50. There is an income limit on your eligibility to contribute to a Roth IRA based on your adjusted gross income. For 2009, your eligibility to contribute begins to phase-out at $166,000, if you are married filing jointly and $105,000 if you are single.

If you still have money to invest after maximizing your Roth IRA, resume contributing to your company retirement plan up to the maximum amount. The maximum contribution limit for a 401k in 2009 is $16,500 if you are under 50 and $22,000 if you are over 50.

Invest your money in a diversified set of mutual funds. Establish an asset allocation consistent with your timeframe and risk tolerance. For most individuals this will vary from 50% to 80% in stock mutual funds, with the balance in fixed income investments. The market is still priced very low and it is a great time to buy stock mutual funds. However, the market will be very volatile over the next 6 – 9 months. Dollar cost averaging into your retirement plans will help you take advantage of this volatility.

This is very general advice and everyone’s situation is unique. Treat this advice as a general guideline and adapt it to your own situation or consult a Certified Financial Planner for guidance.

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Roth IRAs - Part II - The Major Differences Between a Roth IRA and a Traditional IRA

Saturday, July 25th, 2009

Jane M. Young, CFP, EA

The primary difference between a Traditional IRA and a Roth IRA is when you pay income tax. A traditional IRA and a traditional retirement plan are funded with pre-tax dollars and you pay taxes on your withdrawals. A Roth IRA is funded with after tax dollars and you don’t pay taxes on your withdrawals. The decision to buy a Roth or a Traditional IRA is largely based on your current and future tax rates, your investment timeframe and your investment goals. The Roth IRA is usually the more advantageous of the two options but it depends on your individual situation.

Traditional IRA: (tax me later)

• Funded with pre-tax dollars therefore it provides a current tax deduction
• Earnings are tax deferred
• Distributions taxed at regular income tax rates, penalty if withdrawn before 59 1/2
• Required minimum distributions must be taken beginning at age 70 1/2
• Income limit on contributions begins at, if participant is in a retirement plan, $89,000 MFJ and $55,000 if single.
• Annual contribution limit is $5000 if under 50 and $6000 if over 50
• Many IRAs are created as a result of a rollover from a company retirement plan such as a 401k – very similar in tax structure.

Roth IRA: (tax me now)

• Funded with after tax dollars, does not provide a current tax deduction
• Earnings tax exempt (after five years or 59 ½)
• Contributions can be withdrawn penalty and tax free
• Earnings can be withdrawn tax free after five years or 59 1/2
• No required minimum distribution
• Income limit on contribution begins at $166,000 MFJ and $105,000 if single
• Annual contribution limit is $5000 if under 50 and $6000 if over 50

Part III of this series will address the pros and cons of converting a Roth IRA to a Traditional IRA.

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Start Planning Now! Income Limits on Roth IRA Conversions to be Lifted in 2010 - Part 1

Friday, July 24th, 2009

Jane M. Young, CFP, EA

Beginning in January 2010 the income limit of $100,000 AGI (adjusted gross income) on converting a traditional IRA to a Roth IRA will be lifted. This is a huge opportunity for many who have been unable to contribute to a Roth or convert to a Roth due to income restrictions. Normally, when one converts a traditional IRA to a Roth IRA the amount converted is added to gross income in the year of conversion. However, for conversions made in 2010 the government is allowing you to spread out the payment of taxes over the 2011 and 2012 tax years.

Why should you care about this now, prior to 2010? There are several things you can do to prepare for this opportunity. This is a great time to fund your traditional IRA, non-deductible traditional IRA or your 401k plan, if you are planning to retire or change companies soon, in anticipation of converting it to a Roth in 2010. You will need cash to pay the taxes associated with converting to a Roth IRA, so you should be incorporating this additional need for liquidity into your financial planning today.

This is the first in a series of postings on Roth IRAs and Roth IRA conversions.

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Three Significant Changes to Your Retirement Plans in 2009 and 2010

Tuesday, June 16th, 2009

Jane M. Young, CFP, EA

1. No required minimum distribution in 2009 for IRA, 401k, 403b, 457b, 401k and profit sharing plans. This does not apply to annuitized defined benefit plans.

2. If you are older than 70 ½, in 2009 you can make charitable gifts from your IRA without the payment being included in your adjusted gross income. The distribution must be a “qualified charitable distribution”, which means it must be made directly from the IRA owner to the charitable institution. This is especially beneficial if you claim a standard deduction and were unable to deduct charitable contributions by itemizing.

3. Beginning in 2010 individuals earning over $100,000 in modified adjusted gross income will be able to convert traditional IRAs to Roth IRAs. Modified adjusted gross income is the bottom line on the first page of the 1040 tax form. Income from a conversion in 2010 may be reported equally over 2011 and 2012.

While there are many benefits to converting from a traditional IRA to a Roth IRA the conversion will increase your adjusted gross income (AGI) which can have some unintended consequences. An increase in AGI may impact the taxability of your social security, phase-outs on itemized deductions, education and your tax bracket.

I will write more about Roth IRA conversions in a future blog.

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