Getting Your Financial Ducks In A Row Rotating Header Image

Roth IRA

myRA? What’s the point?

Image courtesy of stockimages at FreeDigitalPhotos.net

Image courtesy of stockimages at FreeDigitalPhotos.net

After the President’s state of the union announcement of the new myRA account, my first reaction was: Did we need this?  What’s so “out of reach” about a regular Roth IRA?  And if there was a great hue and cry for this, why hasn’t the marketplace provided it already?

After all, there are custodians who will provide a no-fee Roth IRA with no account minimum already (TD Ameritrade comes to mind). Plus, there are plenty of ways to get a bond-like return with no costs or account minimums as well.

All that I can find that is different about the myRA accounts is that the bond investment (same as the TSP “G” fund) has downside protection – meaning that the funds in the myRA account will never reduce in value, only grow or stay the same.

As with any gift (and downside protection is indeed a valuable gift), there is a cost associated with it.  Think about it: bonds fluctuate in value day in and day out, year in and year out.  If the value of the bonds decreases, somehow the investor’s dollar has to remain constant.  The only way to do that is to have other funds available to hedge the value fluctuations, and someone has to provide those funds.  Since these myRA accounts have no fees associated with them, the investor isn’t paying for the hedge. I KNOW! How about all taxpayers foot the bill?!

One other difference with the myRA is that the intent is to have this available via widespread employers – at no cost to the employer – via payroll deduction.  First of all, there is cost associated with making changes to payroll.  Adding in a new deposit destination doesn’t just happen automatically, someone has to take action to set it up – and that costs money.

Other than those two facts, all of the remaining features that I’ve been able to read about are exactly the same as a Roth IRA – contributions are not tax deductible, withdrawals at retirement age are tax free, withdrawal of contributions can be done without tax or penalty at any time, and the account can be rolled over into a Roth IRA at any time (myRAs must be rolled over when the balance grows to $15,000, or a maximum of 30 years from initial investment).

From my perspective the myRA is only going to complicate matters more than they already are.  Folks who had the desire to save money in a Roth IRA were already figuring out how to do it on their own.  Having this additional option is (I believe) destined to the same result as the Coverdell ESA – great idea, but there are too many alternatives already in place with 99 44/100ths percent of the same features.

Far be it for me to disparage attempts to help people save more.  I spend a lot of time encouraging folks to do just that, all the time.  I suspect that the myRA will likely do not much more than just confuse folks who know someone named Myra (I knew a Myra when I was a kid, she was our pastor’s wife and she taught my sister to play the piano).  She was a very nice lady and an excellent piano teacher, but if she did anything to promote retirement savings, it was lost on me.

2014 IRA MAGI Limits – Married Filing Separately

Separated Strawberry

Separated Strawberry (Photo credit: bthomso)

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on that page to determine eligibility.

For a Traditional IRA (Filing Status Married Filing Separately):

If you are not covered by a retirement plan at your job and your spouse is not covered by a retirement plan, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at your job and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 55% for every dollar (or 65% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

If you are not covered by a retirement plan but your spouse is, and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

Finally, if you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status of Married Filing Separately):

If your MAGI is less than $10,000, your contribution to a Roth IRA is reduced ratably by every dollar, rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $10,000 or more, you can not contribute to a Roth IRA.

Enhanced by Zemanta

2014 MAGI Limits for IRAs – Married Filing Jointly or Qualifying Widow(er)

rendered universal joint animation. Español: M...

rendered universal joint animation. (Photo credit: Wikipedia)

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on that page to determine eligibility.

For a Traditional IRA (Filing Status Married Filing Jointly or Qualifying Widow(er)):

If you are not covered by a retirement plan at your job and your spouse is not covered by a retirement plan, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at work, and your MAGI is $96,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $96,000 but less than $116,000, you are entitled to a partial deduction, reduced by 27.5% for every dollar over the lower limit (or 32.5% if over age 50), and rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $116,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

If you are not covered by a retirement plan at your job, but your spouse IS covered by a retirement plan, and your MAGI is less than $181,000, you can deduct the full amount of your IRA contributions.

If you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $181,000 but less than $191,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% if over age 50), and rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

Finally, if you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $191,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status of Married Filing Jointly or Qualifying Widow(er)):

If your MAGI is less than $181,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $181,000 and $191,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $191,000 or more, you cannot contribute to a Roth IRA.

Enhanced by Zemanta

2014 MAGI Limits – Single or Head of Household

David Lee Roth IRA ruins my perfect shot

David Lee Roth IRA ruins my perfect shot (Photo credit: nickfarr)

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately who did not live with his or her spouse during the tax year, is considered Single and will use the information on this page to determine eligibility.

For a Traditional IRA (Filing Status Single or Head of Household):

If you are not covered by a retirement plan at your job, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at work, if your MAGI is $60,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $60,000 but less than $70,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% if over age 50), and rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $70,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status Single or Head of Household):

If your MAGI is less than $114,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $114,000 and $129,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, rounded up to the nearest $10. If the amount works out to less than $200, you are allowed to contribute at least $200. If your MAGI is $129,000 or more, you cannot contribute to a Roth IRA.

Enhanced by Zemanta

How the 3.8% Surtax Could Influence Roth Conversions

Note: This is a dust-off of an article written in April 2010 that dealt with the special two-year taxation of Roth Conversions that was available in that year.  An astute reader noted that the original was a bit dusty and not applicable to today’s decision-making (thanks S!). Income tax

One of the provisions of the Affordable Care Act is a new tax – a surtax on investment income over certain amounts.  This surtax has come into play this year, for tax returns filed in 2014 on 2013 income.  The income amounts are, admittedly, rather high, but nonetheless will likely impact a lot of folks.  What you may not realize is that, due to the application of this surtax, Roth IRA conversion strategies that you may have had in play may be impacted.  Depending upon your overall income, you may have to pay the surtax on some or all of your conversion amount. On the other hand, by converting, in the future you could avoid surtax, and likely reduce the bracket that you have to pay from for all income.

The New 3.8% Surtax

Here’s how the new 3.8% surtax is applied:  a tax will be imposed for each taxable year, equal to 3.8% of the lesser of 1) net investment income; or 2) the excess of Modified Adjusted Gross Income over the threshold amount. So, in order to understand what this means, we need to define a few things.

Net Investment Income – this is the total of all interest, dividends, annuities, rents, royalties, income from passive activities, and net capital gains from disposition of capital property not held in an active trade or business.  The IRS has specifically excluded the following from Net Investment Income:

  • Income (including self-employment income)
  • Distributions from IRAs or other qualified plans
  • Gain on the sale of an active interest in an S Corporation or partnership
  • Items that are otherwise excluded from income, such as interest from tax-exempt bonds

Modified Adjusted Gross Income – for the purpose of the surtax, this is simply your Adjusted Gross Income (Form 1040 line 37) plus the net amount related to the foreign earned income exclusion.

NOTE:  THIS IS NOT THE SAME AS THE MAGI THAT YOU USE TO DETERMINE YOUR ELIGIBILITY FOR VARIOUS IRA DEDUCTIONS OR CONTRIBUTIONS.  You can find that calculation by reading “Determining Your MAGI”.  Don’t confuse the two, as they are completely different calculations – thanks, IRS!  To keep the confusion at a minimum, I will explicitly refer to this Modified Adjusted Gross Income as Modified AGI within this surtax context.

Thresholds – the thresholds for applying the surtax are as follows:

  • $250,000 for filing status of Married Filing Jointly
  • $125,000 for filing status of Married Filing Separately
  • $200,000 for filing status of Single or Head of Household (yes, Virginia, it is more tax efficient to be single)

Examples

Now that we know the definitions, let’s look at a couple of examples to see how the surtax would be applied:

Example 1. Joe and Mary, a married couple filing jointly, have net investment income of $50,000 and pension income of $125,000.  They are also strategically converting distributions from their IRA to Roth annually in the amount of $100,000, which brings their Modified AGI to $275,000.  So in 2013 Joe and Mary will be subject to the surtax on the lesser of their net investment income ($50,000) or the amount of their Modified AGI over the threshold ($275,000 minus $250,000 equals $25,000).

In this case, the amount of the Modified AGI over the threshold is the lesser amount, and so Joe and Mary will have to pay the surtax on $25,000, or $950 in surtax.

Example 2. Les, a single taxpayer, also has net investment income of $50,000, and pension and other income of $155,000.  Les also is converting amounts each year from his IRA to Roth, in the amount of $50,000 annually.  Les’s Modified AGI, combining of all of this income, is $255,000, which is over the threshold.  Applying the calculation, Les will owe the surtax on $50,000 – which is the lesser of his two amounts (Modified AGI of $255,000 minus $200,000 threshold equals $55,000, which is greater than his net investment income of $50,000).  The surtax will be $1,900.

How a Roth IRA Conversion Strategy Could Be Impacted

You’ve undoubtedly heard about Roth IRA conversions – where you move money from a traditional IRA or 401(k) plan to a Roth IRA, paying income tax on the pre-tax amount moved.  This overall concept should be considered by all folks who have IRAs, especially folks with higher incomes.  This is especially true if future (taxable) distributions from traditional IRAs will have an impact on your tax bracket – and potentially cause the surtax to be applied.

When the money is moved to a Roth IRA, there are no future Required Minimum Distributions (RMDs) from the Roth IRA account during your lifetime, whereas if the money is in a traditional IRA when you reach age 70½ you will be forced to withdraw funds (via RMDs) from your IRA and pay tax on it in that year.  Plus, any amount that you withdraw from the Roth IRA in the future will not be taxed, and therefore will not impact the calculations for the surtax.

In Example 1 above, the only reason the surtax was applied at all was because of the IRA distribution for conversion.  If Joe and Mary had completed the conversion of the $500,000 in IRAs to Roth IRA in prior years, they would have paid tax on the conversion in each year of conversion.  This would mean that for 2013 they would not have Modified AGI above the threshold, so they would not owe the surtax.

If they waited until 2013 to do a total conversion, they’d have Modified AGI of $675,000 – with a pretty hefty income tax and surcharge applied.  However, if they adjusted their conversion amounts to only $75,000 for 2013 their Modified AGI would be exactly $250,000, so they wouldn’t owe the surtax.  Keeping up at the rate of $75,000 per year, they’d have their IRAs converted to Roth within the coming 7 years, eliminating RMDs from their future income – but since they wouldn’t be subject to the surtax from future RMDs, they might opt to discontinue Roth Conversions at this stage and opt to take future RMDs at a much smaller pace.  This could result in lower overall taxes for the couple.

In Example 2, Les was already going to be subject to the surtax even without the IRA distribution.  If we assume that Les also had $500,000 in his IRA account, converting that amount to a Roth IRA would result in a Modified AGI of $705,000, again with a hefty tax bill and surtax.  Unlike the Example 1 couple, Les can’t make an adjustment to his Roth Conversion amounts to eliminate the surtax.  But he might want to continue with his conversion activity nonetheless in order to eventually eliminate the additional amounts being withdrawn via RMDs.  Like most Roth Conversions, a decision must be made as to whether or not you believe future taxes will be more or less than the current rates.

Conclusion

While the surtax on its own should not be a reason to enact a Roth IRA conversion strategy, one of the tenets that we’ve talked about in the past that can cause the conversion to work in your favor is a future increase in tax rates.   If you believe that future taxes are likely to be higher (and let’s face it, who doesn’t believe this?) then any amounts that you can afford to convert should be considered now.  The surtax just gives you more reason to consider it.

Photo by alancleaver_2000

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
%d bloggers like this: