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Archive for the ‘Roth IRA’ Category

For college-bound students, funding retirement has to be the farthest thing from their minds. Yet, with a little planning, parents may be able to kill two birds with one stone. Unfortunately, most parents of college-bound kids tend to overlook some obvious ways to lower the cost of college but wisely using the tax code and some retirement planning techniques can help.

It may be a low-priority item, but this strategy can help parents when it comes to planning how to pay for college. How?  By lowering the Expected Family Contribution (or EFC) of the family and sheltering assets in a retirement account, there is the potential for qualifying for more needs-based financial aid.

Roth IRA

Consider using a Roth IRA for any earnings that a student has from part-time work.  For students over 16 they can put away up to $5,000 each year (or up to their total earnings, whichever is less) from all those part-time or summer jobs. Students already in college can also use this same strategy.

A Roth IRA allows any wage earner regardless of age to put money away now and then later withdraw money without paying taxes on the earnings. When you contribute to a Roth IRA, there is no tax deduction as there is with a traditional Individual Retirement Account (IRA) but there are other advantages.

If a student earns money and the parents leave it commingled in one of their accounts, the balance will potentially be assessed at the student’s higher rate as an asset available for paying for school.  Parents may want to maintain control over funds and have the earnings put into an account in their name but this will show up as a parental asset subject to assessment by the financial aid formulas used by colleges.

On the other hand, funds in a Roth IRA are not counted and will not affect financial aid calculations.

Follow the Road Map

The key to this strategy is following the rules of the road. Any funds placed in the account as a contribution may be withdrawn at any time free of taxes or penalties.

For earnings that may accrue on the account balance, these may be subject to income taxes or penalties but there are exceptions.

Converted Assets

For amounts that were converted from another IRA and recharacterized as a Roth, there are special rules.  For amounts that meet the five-year holding test (from the date the account was first opened) then no income taxes or early withdrawal penalties apply. If a withdrawal is made within five years, then a 10% early withdrawal penalty applies unless it is for a special purpose.  One of the eight special purposes is withdrawals used for higher education expenses.

Withdrawals of Earnings

While income taxes will apply, no 10% early withdrawal penalties apply when the proceeds are used for one of eight special purposes including higher education expenses.

Distribution Rules

For distributions from a Roth IRA you need to note that Roth contributions are always considered to be the first amounts withdrawn.  These are not taxable.  Then any amounts that were converted from other IRAs are considered to be withdrawn second and subject to the time line noted above.  Finally, earnings on the account are considered to be withdrawn last.

Ideal for the Self-Employed Parent

Consider employing your kid in your business and paying them instead of just giving them an allowance.  I write about this on a previous blog found here. This way you can lower the taxable profit from your business which may help you qualify for more financial aid.  And by diverting the wages earned into a Roth IRA as a contribution, your child will not have this asset exposed for the financial aid calculations.

Use It Now or Later

This strategy can be used for late-starters, those who haven’t saved enough for upcoming college bills.

But it can also work very well if you start early.  Since there is a five-year rule in place, open a Roth IRA account even while the child is in middle school and working part-time outside the home or in the family business.  Then by the time the child is ready to enter his third or fourth year of college, he may be able to withdraw some of the earnings to pay for costs without paying any penalties.

By using this strategy, parents can help their students learn to save and the funds can be available in a tax-efficient way during college to pay qualified education expenses.  Or they can skip the withdrawals while in college and use them later for graduate school or to help pay for their first home purchase.

Advantages of This Strategy:

  • Shelters assets from financial aid calculations
  • May help lower family Expected Family Contribution (EFC)
  • Instills value of saving early for goals
  • May help accumulate capital that can be used later for school with tax efficient withdrawals
  • May help save for future home purchase or better yet … retirement

 

For more tips, check out my free webinar offered monthly. For a current schedule visit the Clear View website.

 

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Lots of ink has been spilled discussing one of the most hyped retirement and tax strategies: Roth IRA conversions.  The prospect of future tax-free withdrawals is enticing.  But there are lots of issues that need to be considered whether it is right for you.

According to Google, there has been a surge in interest about Roth IRA conversions as it has become one of the top search terms this fall. (1)

This is hardly surprising considering that starting in 2010, all taxpayers, regardless of income, are eligible to convert tax-deferred retirement assets to a Roth IRA.

Prior to the change, the law prevented taxpayers with household incomes above $100,000 from converting assets to a Roth IRA.

Starting this year, tax code changes allow conversions of other tax-deferred retirement accounts regardless of income. This broadens the opportunity for those who did not have these choice before. It should be noted that there are still annual income limits in place for determining eligibility to contribute to a Roth IRA. (There are no limits to use a Roth 401k provision in your employer’s plan).

The majority of Americans believe their own taxes are going to increase.  Given government deficits and entitlements for an aging workforce, taxes may certainly be needed to cover these commitments.

As it stands, tax rates are scheduled to increase in 2011. Unless Congress acts to delay reversion to the prior tax rates, taxes on Roth IRA conversions will be higher after 2010.

A Roth IRA conversion offers an opportunity for future tax-free income.2

But does it make sense?

Does Roth Conversion Make Sense

Whether or not a Roth conversion makes sense really depends on an individual’s circumstances.

Money in all types of tax-deferred accounts like IRAs, 401ks and such are all jointly owned by the participant and Uncle Sam as silent partner.

Although the tax tail shouldn’t wag the dog, you should cut the best deal with the least impact on your personal tax situation.

It makes the most sense for those who expect to have more than enough assets and income for retirement and don’t want to be forced to take Required Minimum Distributions (RMDs) on IRA accounts.  It also makes sense for estate planning purposes as a way to build a multi-generational legacy of tax-deferred wealth accumulation.

And for most who believe that their marginal income tax rates in retirement will be higher whether because of tax policy or because of their own success with work and investments, then it may make sense to lock in the tax liability now.

It also makes sense for those who expect a low income year in 2010 because of retirement or unemployment for example.  Being in a lower tax bracket may reduce the tax bite on the converted funds.

While income and earnings may be withdrawn in retirement tax-free, an investor will still need to pay Uncle Sam now for that future privilege.

And all of this analysis assumes that Congress doesn’t change the rules down the road and even tax Roth accounts.  Consider the fact that during the 1980s, Congress changed the rules about taxing Social Security benefits.

Keeping that in mind, it still may make sense as a way to hedge against future tax policy to do a partial conversion of some of your tax-deferred retirement accounts especially if you have money from non-IRA accounts to tap.

If you use the funds from the tax-deferred account and you’re younger than 59 ½, you’ll be hit with an early withdrawal penalty and your investment will be starting from a lower base making the payback of the strategy more complicated.

Because the tax is assessed on the gains in the account, an ideal time to do this and minimize the tax impact is when account values are off their highs.  With the gains over the past year, this may make a conversion less attractive.

Another thing to consider is that by doing a conversion, your adjusted gross income will increase and potentially result in loss of COBRA subsidy or education credits which are subject to income phase outs.

You Can Change Your Mind Later

Unlike most things in life, you can get a “do over” called a recharacterization that converts everything back to the way it was. The assets would be converted back to tax-deferred status and you can file an amended tax return seeking a refund of the income taxes you paid on the conversion.

Roth IRA conversions offer the potential for tax-free income in retirement for taxpayers at all income levels. If you want more information about converting to a Roth IRA, call 617-398-7494 or email today.

It’s critical to review your individual situation before making a decision about moving important assets.
1) InvestmentNews, November 16, 2009
2) Rasmussen Reports, September 3, 2009

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“The safest way to double your money is to fold it over once and put it in your pocket.” Kin Hubbard

Investing takes time.  As humans our brains are more wired toward the flight-or-flight survival responses that got us to the top of the food chain.  So we are more prone to panic moves in one direction or another and this is not always in our best long-term interests.

So to retire richer requires a little work on understanding who we are and what we can do to improve our sustainable retirement odds.

There are lots of things in life that we cannot control.  And humans in general are easily driven to distraction. We are busy texting, emailing, surfing the web, and all other manner of techno-gadget interruptions from phone, computer and office equipment around us.

It’s no wonder that folks find it difficult to focus on long-term planning.  We hear a snippet of news on the radio or watch a talking head wildly flailing his arms about one stock or another and think that this is the ticket to investing success.

For those who remember physics class and one of Newton’s great discoveries, you can just as easily apply the rules of the physical world to human financial behavior:  A body at rest will tend to stay at rest; a body in motion will tend to stay in motion.

For most investors, inertia is the dominant theme that controls financial action or inaction.  Confronted with conflicting or incomplete information, most people will tend to procrastinate about making a commitment to one plan or another, one action or another.  Even once a course of action is adopted, we’re more likely than not to leave things on auto-pilot because of a lack of time or fear of making a wrong move.

To get us to move on anything, there has to be a lot of effort.  But once a tipping point is reached, people move but not always in the direction that may be in their best interests. Is it any wonder that most people end up being tossed between the two greatest motivators of action – and investing:  Greed and Fear.

So while someone cannot control the weather (unless you remember the old story line from the daytime soap General Hospital in the 1980s), the direction of a stock index or the value of a specific stock, we can all control our emotions.

Easier said than done?  You bet.  That’s why you need to approach investing for retirement or any financial goal with a process that helps take the emotional element out of it.  And you need to develop good habits about saving, debt and investment decisions.

What Does Rich Mean To You?

So you say you want to retire rich?  Sure, we all want to.  But what does “rich” look like to you.  There are surveys of folks who have $500,000 or $1million in investable assets describing themselves as middle class.  There are those I know who live quite comfortably on under $30,000 a year and would never describe themselves as poor.

Be Specific

First you should get a good picture of where you expect to be and what kind of life you envision.  Be clear about it.  Visualize it and then go find a picture you can hang up in a prominent place to remind you of your goal every day.  (That’s why I have pictures of my family on this blog reminding me of why I do everything I do).

Appeal to Your Competitive Streak

We are better motivated when we have tangible targets for either goals or competitors.  Ever ride a bike or run on the road and use the guy jogging in front of you as a target?  Same thing here.

So assuming you know what your retirement will look like, you’ll be able to put a number to it.  Now find out how you’re doing with a personal benchmark.  One way is to go to www.INGcompareme.com, a public website run by the financial giant ING which allows you to compare your financial status with others of similar age, income and assets.  Or try the calculators found at the bottom of the home page for www.ClearViewWealthAdvisors.com. This might help give you the motivation you need to save more if needed.

Use Checklists

They can save your life.  And even the lives of your passengers.  Just ask Captain Sully who credits his crew with good training and following a process that minimized the distractions from a highly emotional scene above the Hudson River.

The daily grind can be distracting.  Often we may be unable to see the big forest because of the trees standing in our path to retirement.

So try these tips:

Mid-thirties to early 40s:

  • Target a savings goal of 1.5 times your annual salary
    • Enroll in a company savings plan
    • Take full advantage of any 401k match that’s offered
    • Automatically increase your contributions by 5% to 10% each year (example: You set aside 4% this year; then next year set aside at least 4.5%)
    • If you max out what you can put aside in the company plan, consider adding a Roth IRA
    • Get your emergency reserves in place in readily available, FDIC-insured bank accounts, CDs or money markets
    • Invest for growth: Consider an allocation to equities equal to 128 minus your current age
    • Let your money travel: More growth is occurring in other parts of the world so don’t be stingy with your foreign stock or bond allocations.  Americans are woefully under-represented in overseas investing so try to look at a target of at least 20% up to 40% depending on your risk profile

Mid-Career (mid-forties to mid fifties)

  • Target a savings goal of 3 times your annual salary
    • Rebalance your portfolio periodically (consider at the very least doing so when you change your clocks)
    • Make any “catch-up” contributions by stashing away the maximum allowed for those over age 50
    • Consolidate your accounts from old IRAs, 401ks and savings to cut down on your investment costs and improve the coordination of your plan and allocation target

Nearing and In Retirement (Age 56 and beyond)

  • Target savings of six times your annual salary
    • Prune your stock holdings (about 40% of 401k investors had more than 80% in stocks according to Fidelity Investments)
    • Shift investments for income:  foreign and domestic hi-yield dividend paying stocks, some hi-yield bonds, some convertible bonds
    • Map out your retirement income plan – to sustain retirement cash flow you need to have a retirement income plan in place
    • Regularly review and rework the retirement income plan that incorporates any pensions, Social Security benefits and no more than 4% – 4.5% withdrawals from the investment portfolio stash accumulated
    • Have a Plan B ready:  Know your other options to supplement income from part-time work or consulting or tapping home equity through a reverse mortgage or receiving pensions available to qualifying Veterans.

Don’t be afraid to get a second opinion or help in crafting your plans form a qualified retirement professional.  You can find a CFP(R) professional by checking out the consumer portion of the Financial Planning Association website or by calling 617-398-7494 to arrange for a complimentary review with your personal money coach, Steve Stanganelli, CFP(R).

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I would suggest something that can be added to over time by you and other friends or relatives. In this category, that would include the following:

  • UGMA/UTMA accounts
  • 529 Savings Accounts
  • Zero-Coupon Bonds
  • EE Savings Bonds
  • Individual Corporate or US Treasury Bonds
  • Dividend Reinvestment Plan (DRiP)

1.) UGMA/UTMA accounts that can invest in a diversified fund(s) or use proceeds to buy shares of some large diversified companies – Warren Buffet’s Berkshire Hathaway would work here;

2.) 529 savings account with maybe a target date allocation (tied to when the child is 18 y.o.);

3.) Zero-coupon bond (target face amount could be equal to part of an expected year of college tuition expense for example);

4.) EE Savings Bonds (as mentioned before, the taxes are zero when used for education and you can always buy more of them in reasonable denominations);

5.) Specific company or US Government bonds would have maturities that are close to the time frames you noted.

6.) Participate in a company-sponsored dividend reinvestment program (DRiP) by buying a single share of stock.  When the company issues its dividends, the proceeds will be used to buy shares (even fractional shares) in the company.  Over time, this is a cost effective way to build a stock position.  And since most companies that offer such plans are ones with brand names that children may know, it’s a great way to help kids gain an interest in savings and investing.

On a separate note for longer range thinking, you may also want to consider contributing to a Roth IRA once the child gets older and starts earning his own money from odd jobs, paper routes or the local grocery. If the rules don’t change and the child has earned income, he can contribute some of his earnings (or parents can consider it as long as it doesn’t exceed the total earnings).

Roth IRA proceeds can be tapped to pay toward college or toward a house down payment and if not used can at least be great seed money for retirement. (Yes, the rules could change but something to keep on the radar screen for when the time comes).

Now consider that as a way for a gift to really have a long term impact.

CAUTION: Giving the funds to a child when they reach a certain age without any strings could backfire. That’s why others here have mentioned things like the 529 or a UGMA account. Short of paying for a trust at least these structures allow you to place some restrictions on the use of the funds for the benefit of the child or for education specifically in the case of a 529. So if opening up any type of mutual fund direct with a fund family or even a brokerage account to hold the stocks or bonds suggested, consider having it titled in one of these forms.

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