Financial Abundance

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  The retirement funds also receive tax deferred growth until the funds are withdrawn.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.

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Typically, financial advisors and tax consultants advise their clients to defer all income possible into future years to avoid paying taxes on earnings for as long as possible.  However, 2010 should be looked at as a “tax waterfall” year, in which this advice may get turned on its head.  Let’s examine why you might consider having as much income as possible taxed in 2010.

The press has been full of the fact that the “Bush tax cuts” will expire at the end of 2010.  We have been led to believe that this event will only effect the wealthy, currently being defined as couples earning over $250,000 per year.  While I could make the case that working couples with total income of $250K per year are not always “wealthy”, let’s explore how the expiration of these tax cuts will affect all tax payers, rich and poor alike.

In 2011, when the tax cuts passed in 2001 expire, everyone’s taxes will increase.  What is not commonly known is that, on a percentage basis, the largest increases will be on taxpayers who earn the least.  Here’s why:

In 2010 a couple with taxable earnings of only $25,000 per year pays 10% taxes on the first $16,750 and then 15% on each additional dollar that they earn, up to $68,000.  The total 2010 federal tax bill on $25,000 of taxable income is approximately $2,900.

Since 2011 tax brackets have yet to be published, we will assume no inflation, leaving the 2011 tax brackets the same as in 2010.  In 2011, the 10% tax bracket disappears.  The couple earning $25,000 now pays 15% taxes on every taxable dollar that they earn.  When their tax bill comes due, instead of owing $2,900 to the federal government, they will owe $3,750.  This represents a 30% increase in federal taxes owed.

Now let’s look at a “wealthy” couple, with taxable earnings of $250,000 per year.  In 2010, they are in the 33% marginal tax bracket with a federal tax bill of approximately $60,300.  In 2011, if this couple again has $250K in taxable income, they are now in the 36% marginal tax bracket, with a federal tax bill of approximately $66,600.   The additional $6,300 represents a 10% increase in federal taxes owed..

When the 2001 tax cuts expire, every tax payer will be negatively impacted.   Tax payers with the least income will be hit with the greatest percentage federal tax increase.   Regardless of what the politicians say, the expiration of the 2001 tax cuts will hurt every tax payer, not just the wealthy.

The 2011 tax impact will be even more onerous for Americans who have saved and invested their income. Currently, if you are lucky enough to have long term investments that have increased in value, the government receives a maximum of 15% of your (capital) gain when you sell the investment.   In 2011, the taxes on investment gains will increase by at least 33%, as the long term capital tax rate rises to (at least) 20%.

If you are receiving stock dividends, you currently pay a maximum of 15% federal tax on all of your qualified dividends.  In 2011, these same dividends will be taxed at your ordinary income tax rate, which could be as high as 39.6%.  Thus your dividends will receive tax increases that could be a great as 164% of their current rate.

These tax increases require no action by congress.  Our politicians are also considering numerous new tax increases.  One increase being considered is a European style Value Added Tax (VAT), similar to a sales tax but on a national scale.  However, without any legislative action, the expiration of the 2001 tax cuts will result in a significant tax increase on every tax-paying American.

2010 will be a very important year to pay close attention to your taxes.  If you are planning on retiring, selling a vacation home or any other activity that might have significant tax consequences, visit with you financial and/or tax advisor early in 2010.  Together, you can determine the lowest cost approach, on an after tax basis, to the important decisions that you face in 2010.

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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.

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While it is important to execute year-end tax saving strategies to minimize your taxes in 2009, your greatest opportunity for tax savings comes from advanced tax planning before the start of 2010.  There are several areas where advanced planning will provide a significant amount of tax savings in the year ahead.  Here are just a few:

Purchasing a home – Congress has extended the $8,000 refundable tax credit to anyone who closes a “first home” by the end of June 2010.  This “first home” credit applies also to anyone who has not owned a house for the past three years.  If you have a home that you have owned for at least five years, you are eligible for a refundable tax credit of $6,500, as long as your new home costs less than $800,000.  To qualify for either option, income cannot exceed $225,000 for joint tax filers.

A refundable tax credit provides for a full tax refund of either $8,000 or $6,500, even if the taxes that you owe are less than the refund amount.  As an example, suppose that you owe taxes of $5,000 and are receiving a refundable credit of $8,000.  With a refundable tax credit, you pay no taxes at year end and the treasury will send you a check for $3,000.

If you have not owned a home in three or more years or are thinking about moving after living in your home for at least five years, these subsidies can help you buy a new home.  Just be sure to sign a purchase agreement by April 30 and that closing occurs by June 30.

Health Savings Accounts – If you choose a qualified High Deductible Health Plan (HDHP) for your family’s health insurance in 2010, you will be able to make a tax deductible contribution of $5,950 to your Health Savings Account.  Not only are these funds immediately deductible against 2010 income, when you use these funds for future health care, no taxes are due on these funds or their income.

HSAs combine an immediate tax deduction (like an IRA) with the advantage of never paying taxes on these funds (like a Roth IRA), when the HSA funds are used for health care services.  On an after tax basis, HDHP insurance plans, combined with fully funded HSAs are often the most cost effective approach to providing health insurance.

Sales Tax Deduction – For the past few years, Congress has allowed for taxpayers to choose between deducting their state and local income taxes or their annual sales taxes. In states such as Colorado, most people deduct the income taxes.  However, if you are retired or having a low income year, it may be more advantageous to deduct state and local sales taxes instead of income taxes.

My approach is to have a large jar in the pantry into which my wife and I put every receipt with at least $1 in sales taxes.  At the end of the year, you might be surprised to find out how much you pay in sales taxes.  As an example, if you buy $80,000 in taxable items, you pay $6,800 with Colorado’s 8.5% sales tax,.  With Colorado’s 4.64% income tax rate, $145,000 of taxable income is required for the same $6,800 deduction.

IRS provided sales tax tables vastly understate actual sales tax payments.  For the sales tax alternative to succeed, you must save your sales tax receipts.  However, a little effort at the end of the year could save hundreds of dollars in federal income taxes.

Other tax savings approaches include maximizing your retirement plan savings, properly funding your flexible spending account (FSA), gifting strategies, etc.  To get more detail on these and other tax strategies, check out my book, Financial Abundance Guide, which is now available free on my website.

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One of my Seven Steps to Financial Abundance is “minimize your taxes.”  As 2009 draws to a close, there are several ‘to do” list items that can help assure that your 2009 federal and state taxes will be as low as possible. Let’s look at ten actions that could lower your 2009 taxes, if they are performed by December 31.

1.    New Car Purchase – If you were unable to take advantage of “cash for clunkers,” but are still planning on a new car purchase, do it now.  If you buy a new vehicle by December 31st, you can deduct state and local sales taxes from your 2009 federal tax return, regardless of whether you itemize or not.  This deduction applies to the first $49,500 of a new car price and phases out for couples earning over $250,000.
2.    Capital Loss Deduction – Determine if you have realized any 2009 capital gains in your taxable investment accounts.  If so, assuming that the taxable accounts have assets that are valued at less than their purchase price, sell enough of these capital loss assets to have a net realized capital loss of $3,000 in 2009.  This $3,000 capital loss will offset other 2009 income.
3.    401(k) and 403(b) Plans – Maximize your 401(k) and 403(b) contributions before year end.  In 2009, the maximum tax deductible contribution for each plan is $16,500.  If you are over age 50, you may make a “catch up” contribution of $5,500 for a total of $22,000.  If it is too late to increase your allocations for 2009, be sure to sign up for the maximum reduction that you can afford in 2010.
4.    Roth IRA Conversions – If your modified Adjusted Gross Income (AGI) for 2009 is less than $100,000, you may convert IRA holdings into a Roth IRA.  While the AGI limitation will disappear in 2010, if your 2009 income is lower than normal, it may be wise to convert some IRA funds before the end of 2009.
5.    IRA Charitable Contributions – For those over age 70½, 2009 is the last year in which you can make direct charitable donations of up to $100,000 from your IRA.  If you withdrew this money and then gave it to a charity, your AGI would increase, which could trigger future Medicare premium increases.
6.    Charitable Gifts –If you are inclined to help those less fortunate than yourself, charitable giving will help reduce your taxes.  Any tangible items that you donate must be in at least “good” condition.   Keep a detailed list of the items, their condition and the thrift store value of each item.
7.    Set up a Donor Advised Fund – If your charitable gifts are in cash, consider establishing a Donor Advised Fund.  You can donate long-term appreciated capital assets to the Donor Advised Fund and receive a deduction for the full value of the asset.  Not only will you receive a charitable tax deduction, you will never pay taxes on your capital gains.
8.    Defer Income – The self-employed and some small business owners can elect to invoice customers in January, so they don’t have to include this income in 2009.  However, this may only be wise if you will be in the same or lower tax bracket in 2010.
9.    Adjust Medical Deductions – Since medical deductions are limited to expenses exceeding 7½ % of income, if you have already had high 2009 medical expenses, get any tests, eyeglasses, prescriptions or dental work that you may require during 2009.  If your 2009 medical expenses are low, hold off on these expenses (if possible) until 2010.
10.    Prepay mortgages and state income taxes – If your mortgage payment is due January 1, paying it by December 31 will allow you to deduct the interest in 2009.  Prepaying your state income tax by December 31 will also allow the amount paid to be deducted in 2009.

There are other methods of reducing your 2009 taxes, such as IRA and HSA contributions, that do not require action by December 31.  However, the actions listed above must be done by December 31 if you wish them to apply to your 2009 taxes.

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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.

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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.

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As your children (or grandchildren) head back to school, you may be wondering how you will ever afford their college education.  A four year education in a public university costs approximately $55,000 and a degree from a private university costs $132,000. 

In 15 years, these costs are estimated to rise to $316,000 for four years at a private university and $133,000 for a public university.  Since educational expenses are not tax deductible, with a combined state and federal tax bracket of 35%, the required before tax income to pay for these expenses is $486,000 for a private college and $205,000 for a public college.

Let’s look at two approaches to college savings where Uncle Sam can help pay these huge expenditures.

529 College Savings Plans – 520 College Savings Plans allow for a parent, grandparent or other family member to set up a plan for each child.  An individual may provide up to $13K annually or a couple can fund up to $26K annually for each child’s plan, using the annual gift tax exclusion.  A unique aspect of the 529 plan is the ability to pre-fund up to five years ($130K for a couple or $65K for an individual) when the plan is established.  

The investment growth in a 529 plan is not  taxed.  As long as the funds are eventually withdrawn for higher education expenses, associated with a college or graduate school, the 529 investment and its growth can be withdrawn tax free.

As an example, assume your daughter is just entering 1^st grade.  Wishing to help pay for their granddaughter’s education, your parents put $100K into a 529 savings plan, with their granddaughter named as the beneficiary.  Assuming an 8% annual return on the 529 plan, when your daughter enters college, the 529 plan will have $252K available for college expenses.  If your combined federal and state tax bracket is 35%, the tax free withdrawal of 529 funds could save as much as $53K in income taxes.

529 plans offer great flexibility to the person who funds the plan.  In the example above, if the granddaughter decides to go to a public university and does not require the full amount remaining in her plan, the grandparents can change the beneficiary to another grandchild, who could then use the remaining 529 funds for their higher education.  The grandparents can even provide the remaining funds to grandnieces or grandnephews.

With a 529 plan, you must choose your investments from the investment options offered by the plan administrator.  However, the plan owner (funder) can change investment options once every 12 months.  If a better plan becomes available, you can even transfer the fund assets to a different plan as often as once per year. 

Coverdell Education Saving Accounts – Another way to fund educational expenses is through the Coverdell ESA.  Contributions to a Coverdell ESA can be made for any child, under the age of 18.  The maximum funding per child, regardless of the funding source, is $2,000 per year.  Thus, a family with five children can put aside a maximum of $10K per year into the Coverdell ESAs.

Similar to the 529 plans, all growth and income in a Coverdell ESA is never taxed, as long as the funds are withdrawn for qualified educational expenses.  Unlike the 529 College Savings plan, the Coverdell ESA funds can also be used for K-12 educational expenses.   Also, Coverdell ESAs can only be fully funded by individuals with annual income below $95K and couples with income below $190K.

If there are funds remaining in an ESA account, the Coverdell ESA funder may transfer funds from that ESA account into another ESA account as long as both account holders are under age 30.

If funds are not used for qualified educational expenses Coverdell ESAs and 529 plans have severe tax consequences.  In both cases, the income is taxed as ordinary income plus a 10% penalty amount is applied to the income.   However, the flexibility to transfer funds to other family members and the significant tax savings make both plans attractive to any family that is facing the significant costs of higher education.  

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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.  

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