Mar 14

Note – this ‘letter’ is to my mother-in-law, whom I sometimes just call ‘mom,’ even though she’s fine with my using her first name. She’s a widow, and in her 80’s.

Dear Mom,
It’s no burden for me to do your taxes, in fact, I enjoy the process. After you and dad (who passed away almost 8 years ago) told me what you were paying for your tax guy, I thought I could save you that money to spend on something else. The fact that the tax guy wasn’t really a financial planner also gave me the opportunity to offer some advice that would help save on your tax bill each year.

I just looked at the folder of paper to start doing this year’s return. Wow. A lot more than we really need. Here’s why – you don’t itemize. To take any deduction for medical expenses, you need to be out of pocket more than 7.5% of your adjusted gross income. Even though your bills feel like they were in the thousands, the amount you had for copayments didn’t even add up to $1000. Your standard deduction is $7400. Your Condo property tax and interest (you own your unit, but there’s a master mortgage on the property) along with your donations aren’t anywhere near this. A few years ago, when you had one really large donation we used a Qualified Charitable Distribution from your IRA. Since you were going to make that donation anyway, by using money from your Required Minimum Distribution (RMD), it made that distribution tax free. I thought that was pretty cool, but this year it was pages of small donations, so we agreed to pass on the QCD trick.

All in all, there are a handful of numbers to enter. Your pension, dad’s pension you still receive, social security, and the transactions from your brokerage accounts. What makes it even easier is that TurboTax (disclaimer, right here, for FTC, this is an unpaid mention) will pull the yearend data from your Schwab (FTC – ditto) account, so I don’t even type those numbers in.

The other thing I do for you is to convert a bit of you IRA each year to your Roth account. This way you pay 15% on the money, and it keeps growing tax free. If we didn’t do this, your RMDs would keep increasing each year and you might be pushed into the 25% bracket. You’re not even spending your RMD, and the girls and I keep telling you that you should spend more on yourself. But, if you need to withdraw more than your RMD and should start to hit the 25% bracket, you can use the Roth money. If I did two thing right for you, it was this – a balance of stocks and CDs so you were buying in at the bottom, and rebalancing at the tops. You have more now than you did 10 years ago, even after withdrawals. And keeping your tax rate right at 15%. This is one strategy that’s perfect for someone in your situation, just enough income to let you convert a bit each year to top off that bracket.

I hope you understand a bit better why I don’t need all that other stuff every year, but I’m pretty sure it will all be there next year when I look at your 2013 return. And I’ll explain again, ‘you don’t itemize!’

written by Joe \\ tags: , , , ,

Mar 27

Today is a special day in the world of Personal Financial Blogging. As my regular readers know, I’ve expressed mixed feelings about the Roth IRA. When I read articles telling me that a couple converted a million dollars to Roth, slamming themselves into the top bracket (35%, and possibly higher, through the effect of AMT) and then financing the tax due, I realized that some sanity was in order. Level headed discussion about how to best benefit from this type of retirement and not go too far in the other direction. I realized that far more discussion was in the future than I’d want to write in one place as I’m trying to maintain a variety of topics here. So, I planned to launch RothMania, a new blog dedicated solely to the Roth IRA and Roth 401(k) and how they can help you reduce your lifetime tax bill.

Today is the launch of the new RothMania site. Coincident to this, Jeff Rose of Good Financial Cents has coordinated The Roth IRA Movement a day in which Personal Financial Bloggers are all writing articles on the Roth.

At RothMania, to celebrate the occasion I’ll be giving away copies of Ed Slott’s The Retirement Savings Time Bomb. All you need to do to be eligible is ask your question regarding the Roth IRA.

If you are new the Roth, Let me start getting you up to speed. The Traditional IRA typically is funded with pre-tax money. If you are in the 25% marginal bracket, this means you are out of pocket $3750 in order to put away $5000 into your IRA. It grows tax-deferred, but is then taxed on withdrawal. The assumption is that you will be in a lower bracket at retirement and therefore save money. That said, the Roth IRA is the mirror image of this. A Roth lets you deposit money you’ve already paid tax on, but then the growth and eventual withdrawals are not taxed again.

That simple, Joe? Uh, hardly. You see, both flavors of IRA have Phaseouts, where for the traditional, you may not be permitted to deduct the IRA deposit from your income, and for the Roth, where you can’t deposit at all. Then there are the choices that come with being able to convert the traditional IRA to Roth, and the tax implications of these conversions. In the end, there’s no “one size fits all,” but there is a best strategy for each individual situation, and that’s what needs to be determined on a case by case basis. Let’s look at a short few examples of the IRA no-brainer, the times it’s not tough to decide what’s right.

  • You are just above the AGI limit ($112K MFJ, $68K Single) for a Traditional IRA deduction. Time to make that Roth deposit.
  • A dependent child has low income, and would otherwise have no tax due. She can deposit up to the lesser of $5000 or her total income to a Roth, and jump start her retirement savings.
  • A retiree, single, with a 2012 taxable income of $25,000. She can convert from Traditional IRA to Roth enough to get her taxable income up to $35,350. This would tax the difference of $10,350 at 15%, and avoid the potential of having ever increasing RMDs put her into the 25% bracket.

written by Joe \\ tags: , ,

Mar 11

I’m surprised that Social Security isn’t a more widely discussed topic than it seems to be. All kinds of investing advice, retirement planning with 401(k) or IRAs, but not as much focus on Social Security. Maybe I’m just not looking hard enough? Either way, it my pleasure to start this week’s roundup with 7 Secrets Social Security Won’t Tell You, an article by Maggie at Square Pennies. One of the ways i judge whether an article is worth a mention is to decide if I learned something new from it. In this case, I learned quite a bit. For example, I didn’t know that one needs to be married for 10 years to collect a benefit on the spouses earnings if they divorce. Nice job, Maggie, and a worthwhile read.

At Money Rates, I read Is inflation making a comeback? I wonder about any premature sightings of inflation. Inflation is measured by rising prices, of course, but its true momentum has to be demand driven. In other words, “too much money chasing too few goods” as classic definition is what I subscribe to.
The rise in oil prices is actually deflationary, as it throttles other activity. Less vacation travel, less pleasure driving, etc. In fact, Walmart statistics show that rising gas costs reduce their store activity. A drop in gas prices to sub-$3 levels could actually be the catalyst for improving consumer confidence that actually does spur more spending and demand driven inflation.

My Money Design asks Is 2 Percent the New Safe Retirement Withdrawal Rate? If so, we are all in some serious financial trouble. Most of us who actually do a bit of planning have used 4% as the safe withdrawal rate when determining our “number.” That number is tough to reach and doubling it means retirement is even further off.

Miranda answers the important question Can You Still Do a Roth IRA Conversion in 2012? And I won’t ruin the punchline, you’ll have to head over and read her article for yourself. The use of IRAs and Roth can help you save quite a bit on your total lifetime taxes, great to understand these accounts.

Ginger at Girls Just Wanna Have Funds (Ha! I love that blog name) wrote 3 Reasons Why Your Home Is A Crappy Investment. I think she got it right, and more so, summarized it in a brief article. I think it would take a book of analysis, 295 pages at least, to come to the same conclusion. Save the $24.95 and read this article.

In the oddest post I read this week, Shawanda Greene discusses the License to…Steal? It’s a strange series of how people rationalize that stealing is okay in certain situations. Me, I’d rather earn every cent, but to each his own. An interesting insight into what others are thinking as they steal.

After looking at all the restrictions there are on the use of your home and property. Kevin at Out of Your Rut asks Do You Ever REALLY Own Your Home? His point is well taken, there are many things you can’t do due to zoning issues, and you still have property tax to pay. In many cases, the property tax alone is over $10,000 per year. So in a sense, sure I own it, but it’s still not ‘free and clear,’ it will always be an expense.

Today’s roundup title come from the fact that in the US, we move the clocks forward an hour during the night (2am to be precise). We lose an hour of sleep, they say, but not me, I’ll sleep an hour later. We do gain an hour of light at night but give it up in the morning. By the way, it’s daylight saving time, not “savings” even though everyone seems to say that.

written by Joe \\ tags: , , ,

Oct 12

Sometime last year you converted some funds from your pretax IRA account to a Roth. Now, the market is down (The S&P index down about 5% year to date) and you are thinking that paying the tax on the higher value when you first converted isn’t the greatest idea.

Or, you make have realized when you filed your return that the extra taxable income put you into a higher tax bracket. Why pay 25% on that conversion when your regular rate is running at just 15%? In hindsight, it’s easy to look at your return’s ‘taxable income’ line and see where you fall. You can recharacterize just enough to keep you in your original bracket. Don’t forget, you had the option to spread the income over two years, 2011 and 2012 or to take it as income in 2010. If so, you need to look closely at how your 2011 income is doing along with how your investments in the Roth have fared.

It’s nearing the deadline, 6 months after that April 15th Tax Day, or October 17th as October 15th is a Saturday. The clock is ticking!

written by Joe \\ tags: , ,

Mar 23

I’ve written about Roth Mania and will stick to my premise, that conversion to Roth makes sense for some people, not all, and rarely a whole conversion of all of one’s IRA balance. Today, I’ll share the story of a woman whose taxes I do. She is retired, a widow, and has an IRA with an otherwise growing RMD (Required Minimum Distribution.) The RMD is based on the number of years the actuarial tables say you have left on this earth. As an example, at 70-1/2, your first RMD is 3.6% of your IRA balance, at 75, it’s 4.4%, and by 80, it creeps up to 5.3%. This doesn’t seem too bad, but in normal times, if the market is growing at even a modest 6-7%, the balance in the account is growing as well, and the dollar amount you must withdraw at 80 may be two or three times what you had to withdraw at 70. Years ago, when I first did this woman’s taxes, I observed that she was in the 15% bracket and had about $9,000 or so before she’d hit 25%. So, each year since then, we’ve done a dry run of her numbers, and converted just enough to put her in the 25% bracket. When the final numbers are in, we recharacterize so the taxable income line precisely matches the dollar amount where 15% ends and 25% begins. Got that?

A graph over the years might be cool, but I’ll just offer the tax table from Fairmark, (my thanks to Kaye Thomas for the ok to copy it) a publisher of financial books focusing on taxes and retirement accounts. You can see above, in 2010 any amount over $34,000 is taxed at 25% , but the prior dollar was taxed at just 15%. This strategy of “Topping off” her 15% each year will keep her RMD from growing and forcing her into the 25% bracket. Also, the Roth balances will pass to her heirs on her death, tax free (she’s well under any estate tax concerns) but they will need to take RMDs regardless of their age. Any thoughts on this strategy, I’d love to hear from you.


written by Joe \\ tags: , , , ,