Saturday, August 29, 2009

Money Tips - Roth IRA Edition

It has been a while since I have added to the Money Tips library here at BadskiBlog and I really need to get better at keeping it updated. Not only could some of the advice or links help some people, but it also serves as my own little reference library to keep me down the right path financially. Back when I was playing Jr and eventually college hockey we always hit the summers hard for off season training. However, it wasn't complex drills and systems. It was always "back to basics" time. Its the little things that matter and make you better, and I think it is a great lesson to live in your financial life as well. Do the basics, like living the BadskiBlog definition of being rich, better day in and day out and you will attain your goals. In this post I wanted to take the opportunity to provide some guidance on one of the best retirement investing vehicles out there (especially if you are young); the Roth IRA. I keep the difference between the Roth and the Traditional IRA straight by saying the Roth is taxed in and free out. Which basically means that you contribute with after tax income on the way in, but the gains you build over the years are not taxed when you begin to withdraw the money (meeting all the prescribed criteria). If you have time on your side and don't have a dire need to lower your current tax bracket, which is probably most people under 35, then you should max this out every year. Here are two articles that not only give great insight into the benefits of the Roth IRA, but some special circumstances that you can use to make the most out of the investment vehicle.

The first article that I found on CNN Money can be read in its entirety here. This article starts out talking about specifics of the IRA and the general guidelines and stipulations surrounding it as an investing option. However, the article goes on to say that with retirement planning the wild card has always been the changing tax laws. But there is hope.

The uncertain tax outlook can be paralyzing. "The whole idea of not knowing how much money you really have saved because you don't know how much you're going to have to pay in taxes makes it impossible to plan," says Keith Maliniak, a 60-year-old physician in Harrisburg, Pa.

But even if you don't know how high your rates will be, there are steps you can take to insulate your retirement stake from the vagaries of the tax code. Luckily, you have a weapon in the war on taxes: the Roth IRA.

The author then goes on to say that we are at near historic low tax rates and that they will likely rise in years to come. This makes it one of the prime times in history to do a Roth IRA conversion.

If your income is below the IRS limits, you can contribute up to $5,000 a year to a Roth ($6,000 if you are over 50). Some companies have begun to offer Roth 401(k)s, which have no income limits. But for the most part, high earners have to settle for converting existing IRAs and paying the tax bill. As part of the deal, if you convert in 2010 you can stretch the tax payments out over three years, easing the pain.

The questions of whether — and how much — to convert are complicated and there's no one-size-fits-all answer. When you convert, the money in the IRA is added to your taxable income. This could bump you up into a higher tax bracket: "If you earn $120,000 a year and want to convert $200,000 of IRA money, that will throw you from the 28% tax bracket to the 36% bracket for that particular year," says Leonard.

That said, advisers suggest that the combination of the stock market slump and the likelihood of future tax increases makes today an ideal moment to convert traditional IRAs to Roths. "First, we're at historic low income tax rates," says James Lange, a CPA and lawyer and the author of Retire Secure. "Second, if you believe stocks go up over time, and that we're at a low point, this is probably one of the best times in history to convert."

In general, conversion may make most sense for younger people who are in lower tax brackets and have smaller IRA balances. That's because their tax hit will be lighter and they'll have a long time for the assets to grow tax-free before they need to make withdrawals.

But there are situations in which even high earners and older people may want to convert. Lange offers this example. "Let's say you used to have income of $150,000, and you got laid off and you're only going to have income of $60,000 this year," he says. "You're hoping to get a job and be back where you were next year. Then you should make the conversion this year because you'll be in a much lower tax bracket."

For some folks, the appeal of leaving tax-free accounts to heirs may be reason enough to move to a Roth. That's what persuaded Carroll Harris, a 68-year-old Southport, N.C., resident, to begin converting his traditional IRAs in 2008; he plans to do more conversions in 2009, 2010, and 2011 to spread out his tax payments. "I'd rather bite the bullet and pay the tax now," says Harris, who worked for 30 years in the international transportation business. "It's going to be a tremendous asset for my children and their children down the road because it will sit there and build for 30 or 40 years for them tax-free!"

One thing the experts agree on: Don't convert unless you can pay your taxes out of other cash — using assets from your IRA to pay the taxes is a losing proposition. "If you're paying the tax from the account itself, you're lengthening the break-even period because you have a lesser amount of money in the account growing tax-free," says Fisher.

There is some really good stuff in there to think about no matter what age you are or what your current financial situation is. Retirement planning applies to all of us and the Roth is one of your better options to reach your retirement goals in my opinion.

The next article is a bit more somber, but being in the military I thought I should share it with others to spread the word. I found this article on Jeff Rose's Good Financial Cents blog, which is a kickass financial planner blog out of Illinois. It can get a little bit more technical than I tend to get but it has awesome advice and it very detailed. His post is on the "Hero IRA" or the Heroes Earnings Assistance and Relief Tax Act other wise called the Heroes or Heart Act. You can read the full post here. In essence it is a law where you take the SGLI life insurance benefit from a service member who has passed away in combat, and place it into a Roth tax free. This is similar to the conversion above, however you would not be responsible to pay taxes on the entire amount. That is an unbelievable tax break. Obviously I hope that NO ONE ever has to use this option, however we are at war and maybe this information will help someone who is already suffering from the loss of a loved one.
Having served overseas in Iraq, this should have caught my attention earlier. It wasn’t until I recently lost a brother in arms that I happened on a little blurb in the IRS publication 590 on the SGLI. If you are not in the military or have a family member in the military, it probably wouldn’t mean anything to you. SGLI stands for Servicemen’s Group Life Insurance. It’s the life insurance that the government provides to all our military members. When I first got in the military the most you were allowed to get insured for was $250,000. Right about the time I was deployed, the government increased that amount to $400,000. The cost is minimal; $0.65 per $1000 of life insurance. While serving overseas, it’s a no-brainer.

Basically, the surviving beneficiary of a lost soldier soldier serving overseas is allowed to rollover the full amount into a Roth IRA. As you know, I’m a huge fan of the Roth IRA and this provides a tremendous opportunity to put an enormous chunk into for tax free growth. Remember, the full SGLI amount is $400,000 and that amount could be completely rolled into the Roth. To illustrate how that might impact someone, look at this calculation:

Let’s assume a 25 year old widow were to invest the full $400,000 and average 8% return over a 25 year period, she will have accumulated $2,739,390.08. She won’t be able to get it all yet. (She’ll have to wait until 59 1/2 for that). But she will have access to the original $400,000 since it’s treated as a “rollover contribution” and as you know or may not know, you always have access to your contributions in a Roth IRA. Another aspect is that if there are surviving children, they will inherit the money tax free. Another great aspect of the Roth that often goes overlooked.

If there are any other topics you want to hear more about on Money Tips just leave a comment. If I don't know about it (which is very possible) I will find someone who does to do a guest post.

1 comment:

converting ira to roth ira said...

Now there’s a talk going on about people converting their IRAs into Roth Individual Retirement Account. Roth Ira is the best for the people who are on the right side of age, because the Roth IRA allows for tax waiver. You can always compare between the pros and cons of a Roth IRA account and a normal IRA account and then decide upon it.