Getting Your Financial Ducks In A Row Rotating Header Image

roth ira

Retirement Plan Contribution Limits for 2014

United Way tax prep volunteers help hard-worki...

United Way tax prep volunteers help hard-working families avoid tax prep fees (Photo credit: United Way of Greater Cincinnati)

The IRS recently published the new contribution limits for various retirement plans for 2014.  These limits are indexed to inflation, and as such sometimes they do not increase much year over year, and sometimes they don’t increase at all. This year we saw virtually no increases for most all contribution amounts, but as usual the income limits increased for most types of account.

IRAs

The annual contribution limit for IRAs (both traditional and Roth) remains at $5,500 for 2014.  The “catch up” contribution amount, for folks age 50 or over, also remains at $1,000.

The income limits for traditional (deductible) IRAs increased slightly from last year: for singles covered by a retirement plan, your Adjusted Gross Income (AGI) must be less than $60,000 for a full deduction; phased deduction is allowed up to an AGI of $70,000.  This is an increase of $1,000 over the limits for last year.  For married folks filing jointly who are covered by a retirement plan by his or her employer, the AGI limit is increased to $96,000, phased out at $116,000, which is also a $1,000 increase over last year’s limits.  For married folks filing jointly who are not covered by a workplace retirement plan but are married to someone who is covered, the AGI limit for deduction is $181,000, phased out at $191,000; this is an increase of $3,000 over 2013’s limits.

The income limits for Roth IRA contributions also increased: single folks with an AGI less than $114,000 can make a full contribution, and this is phased out up to an AGI of $129,000, an increase of $2,000 at each end of the range.  For married folks filing jointly, the AGI limits are $181,000 to $191,000 for Roth contributions, up by $3,000 over 2013.

401(k), 403(b), 457 and SARSEP plans

For the traditional employer-based retirement plans, the amount of deferred income allowed has remained the same as well. For 2014, employees are allowed to defer up to $17,500 with a catch up amount of $5,500 for those over age 50 (all figures unchanged from 2013).  If you happen to work for a governmental agency that offers a 457 plan in addition to a 401(k) or 403(b) plan, you can double up and defer as much as $35,000 plus catch-ups, for a total of $46,000.

The limits for contributions to Roth 401(k) and Roth 403(b) are the same as traditional plans – the limit is for all plans of that type in total.  You are allowed to contribute up to the limit for either a Roth plan or a traditional plan, or a combination of the two.

SIMPLE

Savings Incentive Match Plans for Employees (SIMPLE) deferral limit also remains unchanged at $12,000 for 2014.  The catch up amount remains the same as 2013 at $2,500, for folks at or older than age 50.

Saver’s Credit

The income limits for receiving the Saver’s Credit for contributing to a retirement plan increased for 2014.  The AGI limit for married filing jointly increased from $59,000 to $60,000; for singles the new limit is $30,000 (up from $29,500); and for heads of household, the AGI limit is $45,000, an increase from $44,250.  The saver’s credit rewards low and moderate income taxpayers who are working hard and need more help saving for retirement.  The table below provides more details on how the saver’s credit works (Form 8880 is not updated yet for 2014, so the figures for the 50% and 20% limits will likely change):

Filing Status/Adjusted Gross Income for 2014
Amount of Credit Married Filing Jointly Head of Household Single/Others
50% of first $2,000 deferred $0 to $35,500 $0 to $26,625 $0 to $17,750
20% of first $2,000 deferred $35,501 to $38,500 $26,626 to $28,875 $17,751 to $19,250
10% of first $2,000 deferred $38,501 to $60,000 $28,876 to $45,000 $19,251 to $30,000
Enhanced by Zemanta

Why Diversify?

Diversity

Diversity (Photo credit: Wikipedia)

Remember Enron? I think we all do. Enron was once a powerhouse company that saw its empire crumble and took the wealth of many of its employees with it. Why was that the case? Many of Enron’s employees had their 401(k) retirement savings in Enron stock. This was the classic example of having all of your eggs in one basket and zero diversification.

Let’s say that the employees had half of their retirement in Enron stock and half in a mutual fund. Enron tanks but their mutual fund stays afloat. This means that they lost, but only lost half of their retirement, all else being equal.

Imagine if they had only a quarter of their retirement in Enron and the remaining 75% in three separate mutual funds. Enron’s demise is only responsible for a fourth of their retirement evaporating. This could go on and on.

The point is that when you choose to diversify you’re spreading your risk among a number of different companies. That way if one goes belly-up you’re not left with nothing.

Mutual funds are an excellent way to diversify among an asset class. For example, if you purchased a total stock market index fund you’d have nearly the entire US Stock Market in your portfolio which amounts to approximately 4,100 different stocks.

That’s great diversification but we can do better. The US equity market is only one area. We can diversify into domestic bonds, international stocks, international bonds, real estate, and so on. This is called diversifying among asset class. The point is that you want to spread your risk and diversify as much as possible so one market or asset class doesn’t ruin your entire portfolio.

A term we use often in the industry is correlation. This simply means how one particular security moves in relation to another. If I own two large cap growth funds they’re pretty closely correlated; meaning that if large cap companies fall both of these funds are going to fall very similarly.

If I own a large cap fund and a bond fund, then if large cap stocks fall, the bonds may rise or may stay the same or even fall slightly. This is because they are a different asset class and move differently than equities. Keep adding different assets to the mix and you have a potential portfolio that can withstand the dip and turns of the market.

Even the Oracle of Omaha, Warren Buffett diversifies. Granted he may have all of his eggs in one basket, Berkshire Hathaway, but own Berkshire Hathaway stock and you’ll get exposure to insurance, bricks, candy, cutlery and underwear to name a few. Admittedly, not many people have $175,000 to buy just one share of BRK stock, but the point is that even Mr. Buffett diversifies.

Diversify. It works.

Enhanced by Zemanta

Taking Distributions from Your IRA In Kind

Commemorative Diploma from 1901

When you take a distribution from your IRA, whether to put the funds in a taxable account or to convert it to a Roth IRA, you have the option of taking the distribution “in kind” or in cash.

In cash means that you sell the holding in the account or simply take distribution of cash that already exists in the account. This is the most common method of taking distributions, and it is definitely the simplest way to go about receiving and dealing with a distribution.  Cash is cash, it has only one value – therefore the tax owed on the distribution, whether a complete distribution or a conversion to a Roth account.

On the other hand, if you choose to use the “in kind” option, you might just save some tax on the overall transaction.  The reason this is true is due to the fact that the amount reported on your 1099-R for the distribution is the Fair Market Value (FMV) of the distribution.

Quite often, when you have holdings in your IRA that have very limited liquidity or marketability, the actual value on any given date could be discounted quite a bit from the eventual or Net Asset Value (NAV) of the holding.

For example, if you held shares in a limited partnership (LP) that makes investments in leveraged real estate, meaning that the real estate holdings are encumbered by mortgage loans, the value of the overall holding will first be reduced by the outstanding non-recourse (mortgage) loans against the assets.  Secondly, if the property is limited in its marketability (and what property isn’t these days?) there could be a reduction in the FMV for liquidity and marketability.

Let’s say that the LP owned several properties that amounted solely to vacant real estate that is to be eventually sold to developers.  The property was purchased several years ago with the idea that developers would quickly be willing to purchase and develop the tracts, as the area was growing quickly.  Then the property values dropped off drastically and development in the area dried up completely.

When you originally purchased the shares in the LP, you invested $100,000, and your shares are encumbered by an additional loan of $100,000 – so the original NAV of your holdings is $200,000.  Now that the property values have dropped off by 40%, your holdings effectively have a value of $120,000.  When a qualified appraiser reviews and values the property in the LP, the Fair Market Value (FMV) is set at exactly 60% of the original NAV.  In addition, the loan balance against your shares is now down to $90,000.

If you decide to convert your holdings of this LP to your Roth IRA in kind, here’s how the FMV would be calculated for tax purposes:  your FMV of the overall holdings of $120,000 (60% of the NAV) minus the encumbrance loan of $90,000, for a total value of $30,000.  So this is the amount that is reported on the 1099-R for the value of your holdings being converted.

Then (hopefully), after a year or so, fortune once again smiles on your LP, and developers come a’callin’.  Now they’re willing to pay full value plus a premium of 30% on the original values of the properties – for a total of $260,000 value on your shares.  So effectively you have a property that cost you a total of $100,000 initially, is now worth $170,000 (your $260,000 minus the $90,000 loan), and you only had to pay tax on $30,000 of the value – the rest is tax free!

Granted, this is an extreme set of circumstances that uses the tax laws to your advantage, but it represents an example that, with some adjustments, could be a real world happening.  If you happen to be investing in esoteric-type investments that might have wildy-fluctuating FMVs over time, this could be a good strategy to look into.  Just make sure you have a trusted advisor on your side who is familiar with this sort of activity – you don’t want to mess this one up, as the tax and penalty downsides can be substantial.

Enhanced by Zemanta
%d bloggers like this: