2011 IRA contributions still accepted

Reminder:

It's not too late to make IRA contributions for 2011, but please be aware that it must be deposited to your account on or before April 17, 2012.

2011/2012 Maximum IRA Contributions:
Under Age 50: $5,000.00
Age 50+: $6,000.00

Roth IRA Conversions

"The primary attraction of a Roth IRA is the absence of future income taxes. Account holders contribute after-tax money, which grows tax-free until withdrawal." Excerpt from Dan Danford MBA, CRSP of Family Investment Center’s article in Medical Economics Magazine.

In this article titled Roth IRA Conversions, Opportunity or Trap, Dan discusses how changing a traditional IRA to a Roth is easier than ever, but may not be right for everyone. To read this article, click here.

Question of the day: Roth IRA withdrawal rules

We get questions from blog readers and followers on Twitter (@family_finances), and we're always happy to answer. Today's question is answered by Elaine Coder, Director of Client Services for the Family Investment Center. If you have a question for us, please post it in the comments section or e-mail robynsekula@sbcglobal.net.

QUESTION: I have a Roth IRA, and I have a few questions. Does a Roth IRA have the same withdrawal restrictions as a traditional IRA? I’d like to know because I have a Roth IRA, but do not have a sizable emergency fund yet, and I’m wondering if I could take money out of a Roth IRA should some sort of emergency come up before retirement.

ANSWER FROM ELAINE CODER: An advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements.

Because Roth IRA contributions are not tax-deferrable, withdrawals are generally tax-free, but not always. Direct contributions to a Roth IRA may be withdrawn tax free at any time.

The earnings from your principle contributions can not be withdrawn until you reach the age of 59 1/2 without paying a 10% early withdrawal penalty. There is also a provision on being able to withdraw your earnings after 59 1/2 called the 5 year rule. You can only withdraw your earnings from your Roth IRA at 59 1/2 and have them count as qualified distributions if your Roth IRA has been open for for at least 5 years. Example, if you opened your account at 57, you would need to wait until you were 62 to withdraw any earnings on your principle.

Money in a Roth IRA due to conversion from a traditional IRA may be withdrawn up to the total of the converted amount without penalty, as long as the 5 year rule has been met.

The order of distributions is setup in order to help you avoid paying fees or penalties. Your contributions (tax and penalty free) come out first. Next come conversion or rollover amounts followed by earnings on your contributions, which could be assessed penalties if not a qualified distribution.

There are exceptions to the 10% penalty. If you need to take a distribution from your Roth IRA for a non-qualifying reason you can avoid the 10% early withdrawal penalty but will pay income tax. Some of the exceptions are:

* If you have un-reimbursed medical expenses that exceed 7.5% of your adjusted gross income.
* You are paying medical insurance premiums after losing your job.
* Education expenses
* Qualified disaster recovery assistance distribution

It is best to have a sufficient emergency savings (6-12 months of annual expenses) trying to avoid tapping retirement funds. The point of a retirement account is to have the money going in, growing tax free using the power of compound interest, withdrawing the money defeats the whole process.

Some Roth IRA rules for withdrawls

By Robyn Davis Sekula

Last year, my husband and I opened up Roth IRAs - one for each of us. It's a great way to save for retirement, as you don't pay taxes on the earnings when you take it out decades later once you're retired. Traditional IRAs tax the earnings, which can be substantial.

I was glad to run across this post today by Peter Anderson which explains some of the Roth IRA rules for withdrawls. Since we don't have substantial emergency savings yet, I've wondered if could treat the Roth IRA as an emergency fund. And by that I mean only in the case of extreme emergencies, such as one of us becoming permanently disabled, losing a job, getting cancer, etc.

As it turns out, yes, you can take money out of it early, according to his post. But of course, that's not the point of a Roth IRA, and you should avoid it unless you're absolutely desperate. Ideally, you should have emergency savings set aside separate and apart from your Roth IRA. (We're working on that.)

I thought this provided some great rules, so I'm posting a link to it here:

http://bit.ly/9WbHHX

Question of the day: real estate or Roth IRAs?

We maintain an active presence on Twitter @family_finances, giving out a financial tip every day, and also taking questions from our followers. On Monday, we received a question from @therealbrandon1 who asked, "Curious what ur thoughts r...real estate vs roth ira?" Dan Danford's answer is below.

This is a question of apples and oranges. A Roth IRA is a type of account that can be invested multiple ways. Real estate is a broad investment option, much like stocks or bonds. Some real estate requires active management - rental properties, say, or construction - while others is more passive. The passive variety can be packaged into securities such as REITS or unit trusts. Actually, those securities could be purchased in a Roth or other IRA just like stocks, bonds, or mutual funds. Active real estate investors know that leverage (borrowing money to buy properties) is one of the appealing aspects of ownership. IRAs are prohibited from borrowing, so that's one reason why active real estate isn't a strong choice for IRA investing.

But I do think real estate can be one component of retirement investing. Many of the world's great fortunes were made in real estate. The two big factors to consider are liquidity and leverage. Liquidity simply means that it's tough to monetize your real estate investments when you need money. You must sell or borrow against them, and neither option is fast or assured. Leverage is what makes real estate so potentially profitable, but it's a double-edged sword. That same leverage makes it risky, and banks foreclose on real estate every single day. It's a high-risk, high reward business. For most people, owning their home is the only exposure they need to this sector of investing.

Frugal by nature

By Robyn Davis Sekula

In the past few years, my income has increased. In fact, it’s more than tripled. It’s been terrific. But I have spent so many years not making all that much that I’ve developed some thrifty habits. And even now that I’m making much better money, I’m not willing to let go of most of my frugal ways.

Why? Mainly because I enjoy getting a bargain. Plus, I believe that most items in the world are overpriced. Children’s clothing is among the things on the top of my list. Since my first daughter was born, and I wasn’t making much money, I picked up most of her clothes at yard sales. I then passed those on to my twin daughters a few years later. To this day, they still wear hand-me-downs. It doesn’t make one bit of difference in their lives. I find that coats, sweaters and fancy dresses are among the most overpriced and the most under-used by children. I regularly pick these up in almost new condition and pass them along to my children. Or I buy new clothes at the end of one season and use them a year later. But I never, ever pay full price for any clothing. It’s just about never worth it.

Books and toys are also just as good used as they are new, for the most part. I buy books for myself, my husband and my children second-hand. They read just the same and can be less than half the price of new. They’re essential in my home for all five of us.

However, one of my frugal habits has gone by the wayside. Now that I need to dress professionally, I do not buy second hand clothes for myself or Greg. Adults are hard on clothes. We keep them for a long time and wear them for years. I’ve gotten picky about my clothes. I buy quality items, usually from Land’s End, Talbots (actually an outlet they have in Lexington, Ky.) and Coldwater Creek, which is a wonderful catalog company. The clothes wear well and stay with me for a long time. Also, fit matters, and you simply can’t try on clothes at Goodwill or yard sales. I do buy the occasional item at a yard sale, but not often, and only if it’s very cheap. If so, and it doesn’t fit, I donate it to Goodwill and move on.

I’ve also given up the routine eating out that tends to drive the lives of those with small children. Now, Greg and I go to nice restaurants and hire a babysitter. It’s an expensive evening out, but extremely valuable to us. We spend money now on things that mean something.

So where does our money go? This year, I made $25,000 extra over last year’s income. I made a point not to blow it. I paid off our van, which had $10,000 in debt, and put away $5,000 each for us in Roth IRAs. I also doubled our payments to our second mortgage, and at the end of the year, doubled the amount we’re putting away for the kids’ college funds and through Greg’s 403 (b) at his work. I’ve also built up savings. We did splurge on a new TV, but not much else.

The point is this. I simply LIKE being thrifty. After 15 years of working in professional jobs where I made sometimes as little as $15,000, I have gotten into frugal habits that stay with me. I now can afford some things of quality, and I buy those things when I need them. I probably won’t ever start shopping at Gymboree for all of my kids’ clothes. Yes, they sell great stuff, but good gracious, $50 for a kids’ dress is nuts. It pains me to pay that and know that it will be stained and outgrown in a matter of a few weeks. What I really love about being frugal, too, is that I’m going to pass these habits on to my kids. They are having a happy childhood, thank you very much, doing simple things like baking cookies and playing dressup, and reading books with us. It’s all they need.

I don’t really like expensive jewelry (too flashy) and cut flowers just die. Want to get to my heart? Buy me an iTunes gift card. Nothing means more to me than permission to buy music.

We dumped cable TV this year because we realized we really don’t watch $60-some worth of TV each month. Instead, we have Netflix, and their wonderful Roku watch-instant player.

The best thing you can do for your family’s budget is find the things that you’re spending on that really don’t matter to you. Do you read the magazines that come into your home? Do you actually watch much TV? How often do you take out that boat? Where is the fat in your budget, and what happens if you trim it?

I’d love to hear your own stories of frugality. Post in the comments section.

Roth IRAs may be an option

On Mondays, we answer a question from a reader in this space. If you have a question, please post it in the comments section or e-mail it to robynsekula@sbcglobal.net

QUESTION: I’d like to make a ROTH IRA contribution for me and for my husband - $5,000 each in 2009. However, my husband’s income is about $60,000 and mine will probably be at least $100,000. I’m self-employed. I understand from what I’ve read about Roth IRAs that if your Modified Adjusted Gross Income is $166,000 you can’t make the contribution. If our income comes in at or right above $166,000, does that mean that we won’t qualify? What’s modified adjusted gross income anyway?


ANSWER FROM DAN DANFORD: This may sound like a simple question, but really, it's not. The Modified Adjusted Gross Income is a complex number that depends on many factors, and I don't know enough about your personal situation to tell if you'll be disqualified or not, especially since your income is near the borderline. Here's a link to solid information to read more about it: http://www.fairmark.com/rothira/modagi.htm

Despite the income limitations, Roth IRAs are worth taking the time to do the calculations to ensure that you qualify. Roth IRA accounts differ from traditional IRAs because there's no tax deduction for the annual contributions. In other words, it's money that has already been taxed. The desirable Roth benefit is that you won't pay taxes on the annual portfolio growth or withdrawals in retirement. There are a number of constraints - including family income and early withdrawal privileges - which alter the ability and attractiveness for using Roths.

I'm not going to address the exact Roth tax rules here. You'll need to talk that over with your tax advisor who knows your exact situation including income and adjustments. But some general guidelines might be helpful. First, the younger you are, the more attractive a Roth. Income and tax rates aren't high, so the tax you pay isn't prohibitive. A traditional IRA deduction isn't as meaningful for you. Second, the period for tax-deferred compounding is longer, so that's appealing, too. Third, the older you are, the more likely you are to have existing traditional IRA accounts. Why complicate life with another tier of monthly paperwork?

I'm a fan of Roth IRA accounts in the right circumstances, and your family could be a perfect fit. You've got high income and 401(k) or traditional IRA tax deductions could be more appealing. Also, I'd usually suggest a compounding table to view the actual difference between Roth compounding and traditional compounding, given your age and years until retirement. It's true that you'll pay taxes on withdrawals with the traditional, but most of our clients defer those withdrawals for a very long time anyway. Not sure how much difference the Roth makes for many people.

Overall, I'd suggest you discuss with your tax advisor and keep one eye towards convenience and simplicity. I see too many people with a dozen scattered accounts which include Roth, traditional, old 401(k)s, and an occasional orphaned Tax Sheltered Annuity. Stick to a good long-term plan, and weigh both current and future tax breaks.

Your best plan for 2009 may be to wait until as late as you can in 2009 when you'll know, as a self-employed person, what your gross income will be. Ask your tax advisor to help you figure out your MAGI and see if you'll qualify. Hold on to the Roth IRA money until then, and make the contribution in December if you qualify. If you aren't working with an advisor, you need to be. With your income, you can make some significant progress towards long-term goals if you have professional help. This is an opportunity you don't want to squander.

Should I convert a regular IRA to a Roth?

On Mondays, we post a question from a reader and answer from Dan Danford in this space. We welcome your personal finance questions, too! Please post in the comments or e-mail to robynsekula@sbcglobal.net.

QUESTION: I’m looking at converting a regular IRA to a Roth. I’m 45, and the IRA has about $36,000 in it. How would I do that? Should I do that?

ANSWER: Roth IRAs will get a lot of attention in coming months because Congress changed the rules to make a conversion easier for some folks. Like I say, there will be a lot written as we go forward, and I'll let the experts add voluminous details to this discussion.

To convert a Roth requires that the taxes be paid now. So, with a $36,000 IRA, the conversion itself will create a $36,000 taxable event this year. You'll owe federal and state taxes on that amount. Depending on the rest of your family income, taxes could be computed at a fairly stiff rate. Most experts suggest that you pay the tax with other money (your savings account, maybe) so that you can roll the entire $36,000 into the new Roth. Forever after, that money will grow tax-free, and you'll not pay taxes on distributions in retirement, either. That part is pretty appealing, for sure.

I can't answer your question without further information. The theory is that taxes today may be lower than they will be in the future, so you'll pay at a lower rate. That may be true, but it's always dicey to predict the future. A lot could happen between now and your eventual retirement. And, if you make the conversion today, it will all happen at today's marginal tax rate. Without a conversion, you could stagger withdrawals to minimize taxes in any particular year. In other words, you might control the tax bite through a thoughtful withdrawal scheme. In fact, those distributions (and taxes) could be staggered over your beneficiary's life expectancy. That's even more to think about.

Look, this is not likely to be a life-changing issue with your $36,000 IRA. I'd not be in any hurry to convert until all the experts weigh in. Personally, I rarely rush to pay taxes anyway, so my inclination would be to leave things as they are. But that could change as we learn more in the future.