Financial Abundance

For golfers, a mulligan is a “do-over,” typically of your drive on the first hole.  However, even the most avid golfer may not know that a mulligan is also available for your Social Security benefits.

If you are already collecting Social Security benefits or years away from collecting your benefits, knowledge of the Social Security “do-over” could provide for significant future financial benefits.  Let’s look at how this “do-over” works.

For a single taxpayer, the “do-over” option is fairly easy to understand.  For this article, we will assume a Full Retirement Age (FRA) of 66.  We also assume that other financial resources are available, so that Social Security benefits are not required before age 70.  We also assume that there is no inflation adjustment to the benefits

Between age 62 and your FRA you should begin collecting Social Security benefits in the first year in which you do not meet or exceed the “earnings test”.  In 2010, annual earned income in of more than $14,160 exceeds the “earnings test”, which reduces benefits by one dollar for every two dollars earned above this amount.  If the “earnings test” is always exceeded, begin taking your Social Security benefits at your FRA, when the “earnings test” is no longer applied.

Depending upon when Social Security benefits begin, you will receive between 75 percent and 100 percent of your “full” Social Security benefits until you reached age 70.  It is recommended that all of the Social Security benefits received be saved and put into very safe investments such as CDs.   At age 70, if you are in good health and expecting to live at least 10 or more years, you would revisit the Social Security offices to execute your “mulligan.”

The “mulligan” allows you to revisit the social security administration and repay all of the Social Security income that you have received.  Only the amount of income received must be repaid.   The interest or investment gain from these benefits is yours to keep.

When Social Security benefits are re-filed at age 70, the monthly benefit increases to 132% of the FRA amount for the rest of your life.  If you are in poor health at age 70, you would not pay back any Social Security benefits and would continue to collect the current amount for the rest of your life.

To maximize the “mulligan” approach, keep track of your taxes every year in which you take social security benefits before age 70.  Run an alternate tax return scenario showing what taxes would have been without receiving any Social Security benefits.  When you turn 70 and repay the benefits, file a tax Form 1341.  This provides a tax credit for the amount of additional taxes paid in the years before turning age 70.

If you are married, the “mulligan” option exists for each spouse.  If one spouse has significantly higher Social Security benefits than the other spouse, it is especially important for the higher earning spouse to consider this option.  Not only will the higher earning spouse receive 132% of FRA benefits for the rest of their lives, if this spouse predeceases the lower earning spouse, the survivor can claim the increased benefit for the rest of their lives.  This approach assures that 132% of the FRA amount of the higher earning spouse will be available for both spouses lifetimes.

As there are so many benefit options available for  couples, consult your local Social Security office or a financial planner, who is well versed on the complexities of Social Security, to determine the best approach for you and your spouse.

There are few “mulligans” in our financial lives with no downside.  If you are age 62 or older and your earnings do not exceed the “earnings test,” consider beginning Social Security benefits now.  If you are at your Full Retirement Age and have not begun taking Social Security, why not?  Based on your health and expected longevity at age 70, you can determine whether to maintain your current payments or to repay the payments made and switch to significantly higher payments for the rest of your (and possibly your spouse’s) life.

• » Comments (0)

A recent Wall Street Journal article stated that, with unemployment hovering at 10 percent, approximately 20-23 percent of all US workers are now self-employed.  If you have self-employment income or own a small company, it is important to be aware of the tax saving options available through retirement plans.

We will consider four retirement plan options available for the self-employed and small business owner.  Each of the plans provides immediate tax savings on the retirement funds contributed.  The retirement funds also receive tax deferred growth until the funds are withdrawn.

The simplest retirement plan is the IRA.  If you have no company retirement plan and are under age 70 ½ , you may contribute up to $5,000 ($6,000 if you are over age 50) annually to a traditional IRA.  If your taxable income is below $166,000, your spouse may contribute the same amount, if they have no company retirement plan.  This contribution may occur even if your spouse receives no income.  There are no requirements to file any company paperwork with an IRA.  As long as your earned income exceeds your IRA contributions, you may continue IRA contributions until age 70 ½ .

The easiest company retirement plan, for a self employed individual, is the SEP IRA.  Your annual contribution to a SEP IRA is limited to the lesser of 25 percent of your W2 compensation or $49,000 annually.  SEP IRA contributions are tax deductible for the employer and excluded from the employee’s income.  These plans are immediately vested and must apply equally to all employees over age 20, who have been employed for at least three of the past five years.

For high-income, self-employed individuals, a SEP IRA is often the best choice for a company retirement plan.  If your income is below $50,000 or if you expect to have employees, the SEP IRA may not be your best option, as a SEP IRA requires that you provide the same percentage salary contribution for all of your qualified employees.

If your self-employment income is less than $50,000 or if you have employees, the SIMPLE-IRA is worth consideration.  SIMPLE stands for Savings Incentive Match Plan for Employees.  While these plans allow for up to 100 employees, most SIMPLE-IRA plans are used in smaller companies, including single employee companies.

With a SIMPLE-IRA you may contribute $11,500 ($14,000 if age 50 or over) annually.  Additionally, the company pays an employee matching amount of up to 3% for each employee that makes a SIMPLE IRA contribution.  If you are over age 50 and make $100,000 per year, your total contribution could be $17,000.  A SIMPLE-IRA requires that your company submits a (simple) application to the custodial firm.  Employees typically have the same investment options as they would with an IRA or a SEP IRA.

If you are self-employed and earn $100,000 per year or more, you can maximize your tax deferred contributions to with a Solo 401(k) retirement plan.  Solo 401(k) plans are typically established through mutual fund companies, insurance companies and discount brokerage houses.  These plans will have a set up fee, an annual administration fee, and other fees associated with investments and trading.

With a Solo 401(k) plan, you may contribute $16,500 of your W2 income ($22,000 if age 50 or older) plus twenty percent of your net corporate profits, up to a maximum of $49,000 ($54,500 if over age 50).  As an example, if you are over age 50 and your company produces annual income of $120,000, you may contribute $22,000 plus twenty percent of your net income, for a total of approximately $40,000 in contributions, to a Solo 401(k) plan.

For the self-employed or small business owner, there is no “on size fits all” solution to retirement plans.  The best plan will depend upon your annual income as well as the amount of tax deferred savings you desire to contribute each year.  If it is unclear which plan will be the best for you, feel free to contact me or call your financial advisor to determine which retirement plan best fits your requirements.  Regardless of which plan you choose, it is important to start saving now for your retirement, to help insure that you will have financial abundance throughout your retirement.

• » Comments (0)

In recent newsletters, I have explained why it is often wise to convert traditional IRA account assets to a Roth IRA.  However, for many people this was not allowed.  In 2010, the $100,000 income ceiling has been removed, allowing everyone to convert IRA funds to a Roth IRA.  2010 also provides the added benefit of being able to spread the income taxes owed on the conversion over two tax years.

What many people are unaware of is that the IRS also offers an “insurance policy” on your Roth conversions.  This insurance can be especially important if you pay taxes on a large amount of converted funds that then proceed to fall dramatically in value, as did the stock market in 2008  This IRS “insurance policy”  is called “Recharacterization.”

Recharacterization allows you undo an IRA to Roth IRA conversion.  If you make the IRA to Roth IRA conversion in January of 2010, you will typically have until October 15, 2011 to undo this conversion through a recharacterization.   Over this 21 month period, if your converted funds fall substantially in value, you would have been better off leaving these funds in the IRA and converting them at their lower value  Recharacterization is the IRS “insurance policy” that allows this.

Here is how recharacterization works:

Let’s assume that you convert $100,000 from your traditional IRA to a Roth IRA in January 2010.  If your marginal tax bracket is 25%, you will be required to pay $25,000 in additional taxes for this conversion.  If the market goes up, the $100,000 grows tax free and you (or your heirs) are never required to pay taxes on this growth.

But what if the market declines, leaving the converted $100,000 with a value of only $50,000 in September, 2011.  You have now paid $25,000 in taxes on an investment that is now worth $50,000.  At this point, your effective tax rate is 50%.  If this happens, you should use the IRS provided “insurance policy” called recharacterization.

Before October 15, 2011, you may put the $50,000 remaining in your Roth IRA back into your traditional IRA account.  You must also file an amended tax return showing this recharacterization.  If done properly, your amended tax return will provide for a refund of the $25,000, in 2010 taxes that was accessed for the Roth conversion.

31 days after you have completed a recharacterization you can once again convert the remaining $50,000 in IRA funds to a Roth IRA.  If you are still in the 25% tax bracket, your tax bill is $12,500 for this new conversion.  If the market skyrockets and the $50,000 grows to $100,000, you will have paid only a 12.5% tax rate on the conversion, based on the new market value.

IRA to Roth IRA conversions have many benefits, as long as you have the financial resources to pay the taxes owed, without having to use IRA funds.  However, the conversion and recharacterization rules are somewhat complex.  If you are exploring a Roth conversion in 2010, be sure to talk to your financial adviser or CPA about the benefits and drawbacks of an IRA to Roth conversion.  After considering all of the facts, if you decide on an IRA to Roth IRA conversion, be sure to re-analyze this decision in September 2011, to see if you should take advantage of the recharacterization insurance policy.

• » Comments (0)

Is it better to contribute to a traditional, deductible IRA or to a Roth IRA?  As with most personal finance questions, the answer is “it depends.” Let’s look at some guidelines to help you decide.

With a traditional IRA, contributions can only be made if you are under 70½ years old and you and/or your spouse have earned income. The maximum contribution is the lesser of $5,000 ($6,000 if over age 50) or the total amount that you and/or your spouse earned.  If you have a qualified retirement plan, the full amount can only be contributed if your Modified Adjusted Gross Income (MAGI) is no more than $55,000 as a single tax payer or $89,000 as a joint filer.

With a Roth IRA, your Adjusted Gross Income (AGI) must be less than $105,000 as a single filer or $166,000 as a joint tax filer plus you and/or your spouse must have earned income.  Like a traditional IRA, the maximum contribution is the lesser of $5,000 ($6,000 if you are over age 50) or the total amount that you and/or your spouse earned. If deductible IRA contributions are made, the amount that can be contributed to a Roth IRA is further reduced by the amount contributed to a deductible IRA.

The decision on which IRA to use is sometimes obvious:

1. A single filer with an AGI over $105,000 or a joint filer with an AGI over $166,000 who is not covered by a retirement plan can only fund an IRA.
2. If covered by a company retirement plan with a MAGI of over $89,000 but less than $166,000 as a joint filer or over $55,000 but less than $105,000 as a single filer, only a Roth IRA can be fully funded.
3. If you reach 70 ½ and have earned income, only a Roth IRA can be funded.
4. When saving to buy a first home, only with a Roth IRA can up to $10,000 of growth and income plus all contributions be withdrawn, tax and penalty free.

The following are more subtle advantages of Roth IRA plans:

1. For those under 40, the tax free growth combined with the tax free withdrawal of the funds (after age 59½), typically make the Roth IRA a better investment.
2. If funds are required before reaching age 59½, a Roth IRA allows the withdrawal of all contributions, with no taxes or penalty on this withdrawal.
3. For older individuals, a Roth IRA is an excellent way to pass funds to younger generations. The younger recipient may allow these funds to continue to grow tax free by withdrawing inherited Roth funds tax free over their lifetime

When none of the above apply, the decision of funding a Roth IRA or a traditional, deductible IRA must be made by analyzing your current tax bracket, what you believe will be your future (retirement years) tax bracket and whether you expect to consume the retirement funds or pass them to future generations.  If you need help making this decision, consult with your financial planner or tax adviser.

• » Comments (0)

In 2006, the Pension Protection Act was signed into law.  A key provision of that act was the elimination of the $100,000 earnings ceiling for an IRA to Roth IRA conversion.  Until now, only taxpayers with an Adjusted Gross Income (AGI) of $100,000 or less have been allowed to convert funds from their IRA accounts into a Roth IRA account.  However, thanks to this 2006 legislation, on January 1, 2010, anyone may transfer funds from an IRA account to a Roth IRA, regardless of income.

When IRA funds are converted to a Roth IRA, taxes must be paid on the amount of (pre-tax) IRA contributions that are converted.  However, another “gift” from the Pension Protection Act of 2006 is the ability to delay this tax liability on funds converted in 2010.

In 2010, if you convert $100,000 of taxable assets from your IRA to your Roth IRA, you may choose to pay taxes on an additional $100,000 of income for tax year 2010.  However, you also have the option of paying no additional income taxes on the converted amount in 2010.  Instead, you may pay income taxes on ½ ($50,000) of the income in tax year 2011 and on ½ in tax year 2012.

After 2010, you may continue to convert IRA funds to Roth IRA funds, regardless of income.  However, from 2011 on, taxes on the converted taxable amount must be paid in the tax year during which the conversion is made.

Are there any reasons to not use the three year option for a 2010 Roth conversion?   An obvious reason would be if you have very little income in 2010 and expect significantly more income in 2011 and 2012.  A less obvious reason may be the possibility of future federal income tax increases.

The current administration has proclaimed that it will raise taxes on the “rich,” which it defines as couples with incomes of $250k or more.  One way this will be accomplished is by allowing the current “tax cuts” to expire at the end of 2010.  When these tax cuts expire, income taxes on all income level will rise in 2011 and beyond.

Since 2010 is an election year, congress may not be anxious to pass additional tax increases in 2010.  However, with our enormous and increasing budget deficit, a tax increase in 2011 appears likely. Depending upon your expected income in 2010 – 2012, you could pay less in taxes on your IRA to Roth IRA conversion by declaring the full amount of income in 2010, especially if income taxes increase dramatically in 2011 and beyond.

If you are considering retirement in the near future, it may be beneficial to retire at the end of 2010.  This could allow you to convert a substantial amount of IRA savings into a Roth IRA.  With the three year option, the Roth conversions would be taxed in 2011 and 2012, when work related income has ceased.  This approach could minimize the amount of taxes owed on the Roth IRA conversion.

Do not do an IRA to Roth IRA conversions without having enough funds, outside of the IRA, to pay the taxes owed.  If the taxes are taken out of the IRA, advantages of a Roth conversion will be substantially lost.  When IRA funds are used to pay the taxes owed on the conversion: 1) taxes are paid on funds being used to pay taxes 2) If you are under 59 ½, a 10% penalty will be assessed on IRA funds that are used to pay taxes and 3) the tax deferred and tax free account funds are reduced in value by the amount of taxes and penalties paid.

2010 provides an opportunity for millions of new taxpayers to consider the advantages of converting IRA funds into a Roth IRA.  If you are unsure of whether this conversion would be beneficial, talk to your financial planner or tax account and ask them to help you make this determination.

• » Comments (0)

Does your company have a “use it or lose it” policy with respect to your vacation or sick leave?  If so, the IRS has recently issued new guidelines that can help you save more for retirement when you are unable to use all of your allotted annual leave.

In September, the IRS released Revenue Rulings 2009-31 and 2009-32 to clarify steps that employers can take which would allow employees to contribute unused vacation and sick leave to 401(k) and other qualified retirement accounts.  These IRS rulings describe how employers can permit employees to convert the value of their unused leave into contributions to tax-qualified retirement plans.

From an employee morale viewpoint, a “use it or lose it” policy may not be in a company’s best interests.  While the intention behind the policy is to insure that employees take their allotted time off, it is often difficult to do this every year.  This is especially true of valuable, longer term employees who have accumulated several weeks of annual paid leave.

The repercussions of a “use it or lose it” policy is that valuable employees are often “forced” to take time off near the end of the calendar year, a time when most companies need every available employee to meet their year-end goals.  The new IRS rulings allow companies to offer an alternative that benefits both the employee and employer.

The new IRS rulings apply to qualified retirement plans, including 401(k)s, Keoghs, profit-sharing plans and SIMPLE IRAs.  The rules can apply to unused vacation, sick leave or personal days that accrue either annually or when an employee leaves a job.

The rulings allow the employee to contribute the entire amount of their unused leave to the company’s retirement plan, unless the employee has already exceeded the annual plan contribution limit.  For 401(k) plans, the 2009 contribution limit is $16,500, or $22,000 for those over age 50.  For a SIMPLE IRA, the 2009 contribution limit is $11,500 or $14,000 for those over age 50.

Companies can opt to pay workers for unused leave only if is deposited into their qualified retirement plan.  This provides a positive alternative to the “use it or lose it” approach.  Instead of being forced to take time off in the critical end of year time frame, employees have the option of saving their unused leave in their retirement plan.

Employers that don’t currently pay workers for unused leave may want to consider this approach.  Putting unused leave into an employee’s retirement account compensates valuable workers and encourages retirement savings with no increase in base pay.

Another benefit of adding this alternative is that neither the employer nor the employee will pay FICA taxes on the contribution, since the payment is to a qualified retirement plan.  An employer who offers this benefit must offer it to all plan participants.  However, the employer is not required to offer it every year. The employer can also prorate or limit the amount of leave for which they will pay.

If you own a company that has a 401(k) or SIMPLE IRA retirement plan, you may want to consider modifying your plan to allow for unused paid leave to be put into the qualified retirement plan.  As a business owner in trying economic times, you are likely very concerned about keeping company morale high.  You are also aware of the correlation between high employee morale and high employee productivity.  Providing a method for your employees to retain their earned leave time plus save for retirement could be a major morale booster for your company

If you are an employee of a company that has both a qualified retirement plan and a “use it or lose it” vacation policy, talk to your company management or personnel department about these recent IRS rulings.  They may not be aware of how the new IRS rulings can provide a new alternative to “us it or lose it.”

Our nation must begin to save more for our long term health and security.  Hopefully, many companies will take advantage of this opportunity to help employees save more for retirement.

• » Comments (0)

I am often asked, “What should I do with a 401(k) or 403(b) retirement plan that I had with a former employer?”  Most former employees are allowed to keep their funds in the former employer’s plan or “roll over” their former plan assets into a new employer’s 401(k) plan.  However, for many people, the best option may be to roll over the retirement plan funds into an IRA.

Let’s look at some of the areas where having an Individual Retirement Account may be advantageous to continuing with your former employer’s retirement plan

Diversification – When you roll over your retirement plan assets to an IRA account with a discount broker such as Schwab, Fidelity or TD Ameritrade, your investment options become virtually unlimited.  For a small trading fee (typically under $10 per trade), you can have a well diversified portfolio consisting of Exchange Traded Funds (ETFs) and mutual funds.  Some retirement plans have such limited choices that providing adequate diversification is virtually impossible.  TIAA-CREF is an example of a large sponsor of retirement plans with such limited investment choices that it is difficult to produce a well diversified portfolio.

If your 401(k) has a good selection of mutual funds from Vanguard or Fidelity, you can roll your IRA over to a mutual fund account with Vanguard or Fidelity.  Not only will the funds in your 401(k) be available, the entire family of funds will be at your fingertips.

Fees – Fees are a significant contributor to the success or failure of an investment portfolio.  Every employer must disclose the retirement plan’s annual fees to the plan participants.  If your 401(k) plan is with a large employer, the 401(k) fees are likely fairly low.   If your employer is a small to medium sized companies, annual fees could be over 1%.  Combining this fee with the typical 1%+ annual operating cost for mutual funds in the plan, your plan’s total annual fees could be as high as 2-3%. 

At most discount brokerages, a well diversified, index-based ETF portfolio can be developed for approximately $100 in trading costs. Most index-based ETFs have annual operating costs of 0.25% or less.  Thus, the IRA option could have total annual fees that are over 2% less than the total fees of many 401(k) plans.

Investment Management – Larger employers often provide 401(k) investment advice to their employees.  However, when you leave the employer, you may find that this advice is no longer available.  Smaller employers typically offer both limited investment options and limited investment advice, with no advice available for past employees.

Fee only asset management is available to provide investment management advice to investors that have neither the time nor interest to manage their own portfolio.  Annual fees for fee only asset management may be as little as 0.75% of the assets under management.  If your asset management firm uses indexed based ETFs, the total annual costs of both management and fund operating expenses may be just 1% or less.  With this approach, you can have individualized professional investment management advice with total fees that are less than ½ of many 401(k) plans.

If you have well diversified investment options, a low cost retirement plan and the time and interest to personally manage your plan, there may be no need to roll it over to an IRA.  However, if diversification, fees or the investment management advice supplied by your former employer’s plan are not adequate, you will likely find that the IRA roll over option is the better approach.  

• » Comments (0)

Let’s explore some little known tips on Social Security benefits that could provide thousands of additional retirement dollars to you or your parents. 

Did you know that If two spouses are 64 years old, there is a 40% probability that at least one spouse will live to be over 90 and an 80% probability that at least on spouse will live past age 82?  If both spouses are in good physical shape, these percentages go even higher.

Let’s assume that both spouses are 66, their full retirement age (FRA). If one spouse has earned more than double the Social Security benefit of the other spouse, the lower earning spouse may claim a Social Security benefits that is 50% of the higher earning spouse’s benefit. 

When the higher earning spouse waits until age 70 to begin taking benefits, the combined lifetime Social Security benefits may be significantly greater.  At age 70, the higher earning spouse will receive 132% of the benefit they would receive at age 66 plus four years of cost of living adjustments (COLA).  For the lower earning spouse to begin receiving benefits, the higher earner can “file and suspend” their Social Security benefits until they reach age 70.  At the FRA age of 66, the lower earner will receive 50% of the higher earner’s full FRA benefits. 

If the higher earning spouse dies first, the survivor can claim the full Social Security benefit of their spouse.  Thus, for the rest of the survivor’s life, they will get 132% of their spouse’s FRA Social Security benefits, plus annual cost of living (COLA) increases.  Let’s look at how the “file and suspend” strategy can increase the total Social Security benefits over the two lifetimes.

Assume that the higher earning spouse will receive $2500/ month at their FRA age of 66.  Let’s also assume that one spouse will die at age 80 and the other will live to age 90.  Remember, there is at least a 40% probability of one souse living past age 90.

With a 3% annual inflation rate, if both spouses begin taking Social Security benefits at age 66, their total income with the previous assumptions will be approximately $1,373K.  If the higher earning spouse files and suspends payments until age 70, the total income that the couple would receive over the same period is approximately $1,577K. 

By the higher earner waiting until age 70 to begin receiving benefits, the couple’s combined income is increased by $184K, with the surviving spouse receiving $171K more over their final 10 years of life.  Obviously, this scenario provides the highest possibility of working if both spouses are in good health at age 66. 

While the above approach may not be suitable for you, it demonstrates the importance of understanding the complex rules of Social Security.  It is important to know the rules so you can decide how to maximize your Social Security benefits. 

What if you have already begun taking Social Security and now realize that you should have waited.  If you are under age 70, Social Security provides a “do over” capability.  Next month, we will explain this “mulligan” approach in more detail.

When you are ready to start your Social Security planning, I recommend that you read Getting Started in a Financially Secure Retirement, written by my friend and colleague, Henry (“Bud”) Hebeler.  If you still need help in deciding your Social Security strategy, give me a call and I will be happy to provide complimentary Social Security planning support.  Proper Social Security planning is an important piece of maintaining an abundant retirement.

• » Comments (0)

There is a simple, easy to use tax reduction tool, currently available to 90% of all US taxpayers.  In 2010, this tool will be available to everyone.  Unfortunately, only 19% of all taxpayers currently take advantage of it.  Do you know what it is?

If you guessed the Roth IRA, you’re correct.  Like a traditional IRA, a Roth IRA is a personal savings account in which funds grow tax free.  Unlike a traditional IRA, when Roth IRA funds are withdrawn, in a qualified withdrawal, no taxes are due on either the funds or their investment growth. 

With the growing federal deficit, it is probably safe to assume that your tax bracket in retirement will be close to your present tax bracket.  If so, the Roth IRA will always yield a higher after tax return than a traditional IRA.  This holds true even when if you invest the tax savings from your traditional IRA contribution.    

Another advantage of a Roth IRA is that there are no mandatory distribution requirements.  With a traditional IRA or a 401(k) plan, you must begin taking withdrawals and paying taxes on the withdrawn funds at age 70 ½, even if you do not need these funds.

Because there are no mandatory withdrawal requirements with a Roth IRA, they can be an excellent estate planning tool.  If you do not need your Roth IRA funds during retirement, the Roth IRA funds can be passed to your heirs.  The inherited Roth IRA funds remain income tax free when withdrawn by your heirs.  An inherited Roth can have a mandatory distribution schedule that is based on the expected lifetime of the heir.  This allows most of the Roth IRA funds to continue to grow tax free throughout a second lifetime. 

If you earn less than $105,000 as an individual tax filer or less than $166,000 as a joint filer, you can annually contribute up to $5,000 ($6,000 if age 50 or over) to a Roth IRA, even if you are covered by a qualified company retirement plan. 

Many financial advisors recommend that you put the maximum amount possible into a tax deferred retirement account, such as a 401(k) or 403(b).  However, it is often wiser to put the maximum amount that your company will match in the tax deferred retirement account and put the next $5,000 ($6,000 if age 50 or over) of retirement savings into a Roth IRA. This approach will maximize your after tax retirement funds and maximize your withdrawal options during retirement.

Converting tax deferred funds from a traditional IRA or 401(k) to a Roth IRA is often wise, especially if you may not need all of your tax deferred funds during retirement.  Currently, if your annual income (AGI) exceeds $100,000, this type of conversion is not permitted.  However, this income limitation for a Roth IRA conversion will soon disappear.  

Starting in 2010, everyone will be able to do a Roth IRA conversion, regardless of income level.  With a Roth IRA conversion, you must pay current taxes on the amount converted.  Once these funds are converted, you never pay income taxes on these funds and their investment gains again. 

There is an additional incentive to convert funds to a Roth IRA in 2010.  Taxes owed on funds converted in 2010 can be spread over two tax years.  In 2011 and beyond, 100% of the conversion taxes must be paid in the year of the conversion.

A Roth IRA conversion should only be considered if you have adequate additional savings to pay the taxes due without using the converted funds.   If you will need any of the converted funds within five years, do not convert these funds.  Funds withdrawn within five years will likely be considered a non-qualified distribution, requiring the payment of a 10% penalty on any funds withdrawn.

With the enormous expansion of government debt, it seems likely that income and capital gain tax rates will soon rise.  Whether you are eligible now, or must wait until 2010, the benefits of having a Roth IRA should be considered as part of your personal financial plan.  

• » Comments (0)