JoeTaxpayer

I recently read a post “Why I love Roth IRAs” in which the author ignores much of the math going in and coming out. Now, I love Roths myself, but only when used to take most advantage of the tax rates involved. Let me explain. From my feature article earlier this year titled “Can you save too much, pre-tax?” we see that a couple with $447,500 in their 401(k) or Traditional, Pre-Tax IRA, can take withdrawals and remain in the 0% bracket. This is due to the combination of standard deductions and exemptions. The next $401,250 will support withdrawals at the 10% rate.
If you have a defined benefit pension (a traditional pension) the numbers certainly will shift, and you need to take this income into account. Pensions are getting more scarce and those who frequently changed jobs are likely to have never vested into any one plan.
So, now I’ll ask, what percent of retirees are likely to have saved this sum, a total $848,750 from the numbers above? I cite an article from AARP titled 2004-05 Boomers which offers a forecast. One chart in this report offers that for those born in 1956-65, their mean (this means average, important distinction from median, middle) wealth is forecast to be $839K. But reading on, we find that after subtracting non-retirement wealth and present value of Social Security benefits, we are looking at a retirement account balance of just $140K. It turns out the 4th quintile (this is the second 20% from the top) is forecast to have $906K, this scales to about $151K in retirement accounts. Even the top quintile (top 20%) will average $2028K total wealth, with maybe $350K-$400K in retirement accounts. So it’s only the upper portion of that group (in addition to those with fat traditional pensions) that need to consider the Roth while working. For the rest of us, we will likely be in the 10% or if fortunate, the 15% bracket upon retiring.
I’ll close with this thought - each family has their own set of numbers. This is why if you write in to a web site or magazine and ask “Is Roth good for me?”, it’s impossible to answer without knowing many details. We know more the closer you are to retirement, but only have a series of clues the further away you are. Another blog “The Finance Buff” offers a view similar to mine. I remain surprised at how many wave the Roth flag without some level of analysis. For those who have access to a Roth 401(k) and Roth IRA, it would be a shame to load those up and find that they missed out on the tax savings that pretax savings could have provided.

Joe

written by JOE \\ tags: 401(k), Finance, income, IRA, Retirement, retirement account, roth ira, saving, Savings, Social Security, tax, tax rates, traditional pension, wealth

If you don’t own a rental property, this may not interest you. If you do, read on.

One of the rules of rental property is that you must take depreciation each year. To be clear, whether or not you “take” the depreciation on your Schedule E each year you must recapture all the required depreciation regardless. Until now, many who did not understand this wound up going back to their returns and amending them for the last three years, but losing the benefit of all the deprecation not taken.

I recently came across an article titled Allowed or Allowable which discusses new revelations that may help you recoup the money you’d have otherwise lost. The article suggests a change in accounting method, and IRS bulletin 2004-3 confirms the content of the article I cited.

As I stated in my introduction, this impacts few people, but those impacted have the chance to save quite a bit of money by reading the above.

Joe

written by JOE \\ tags: depreciation, irs, rental property

Last week, in “More Roth Magic”, I discussed how for people on the edge of a tax bracket, there are some moves that one can make to optimize their wealth (read that - minimize their taxes over time.) Now, as promised, let’s look at schedule A.

From Fairmark, we can see that in 2008, the standard deduction for a married couple filing jointly is $10,900. Let’s think about this. A couple earning $60,000 might live in a house worth $200K, and be paying on a mortgage balance of $150K or at 6%, about $9,000 per year interest. Maybe another $2000 or so goes to property tax. At tax time, their total itemized deductions may just exceed the standard deduction, if that. Now, with a bit of planning, they may be able to use the system to work toward their advantage. In year one, right at the end of the year, make one extra mortgage payment. Not a principle payment, but the next month’s payment. This way the bank will credit the account with having paid that interest in advance. Similarly, go to the tax assessor’s office and pay at least half next year’s property tax bill in advance. They should be happy to take your money and credit your account. Are you generous to your house of worship or other charities? Make your annual donations in January of this year and then again in December of the same year. Now you’ve stacked up your Schedule A deductions to their maximum. Next year, just 11 mortgage payments, no donations, maybe half a year’s property taxes, and you take the standard deduction. Just one way to beat the system, a bit. Let me know what you think.

JOE

written by JOE \\ tags: charity, property tax, schedule a, Taxes

For this, you must do a bit of homework to see if this advice can apply to you. Go to Fairmark and look at the tax rate schedule that applies to your filing status. You must also have a good idea what your taxable income will be, at least as the year draws to a close. If you fall near the top of your marginal rate, say $32,550 for a single, $65,100 joint, keep reading.

During the year, of course you should deposit enough to your 401(k) to capture your company match. But beyond that, make use of a pretax IRA if you are able to save more. At year end, if you are going to be just below the top of your tax bracket, make use of the Roth conversion to take some existing IRA money and convert to your Roth account.

For example, as I mention above, the 25% bracket begins for a couple, filing jointly, at $65,100. Remember, this is after exemptions, ($3500*number of family members) and any other deductions including itemized or the standard deduction of $10,900. So you see that one can gross as much as $100,000 or more and still be near the 15%/25% line.

Over the years, by straddling the top of the 15% bracket, but not paying 25%, you will save a lot of money on your taxes, and as you near retirement, the Roth accounts can be used if you retire before 59-1/2 to take withdrawals. Look at the Fairmark site to understand if this wil help you, and send a comment if you have any questions. Enjoy the weekend. Next week, we will talk about how to take advantage of Schedule A vs the Standard Deduction.

JOE

written by JOE \\ tags: Finance, Investing, Retirement, roth ira, saving

Making the rounds on the internet, a friend sent me this piece;

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.

So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until on e day, the owner threw them a curve. “Since you are all such good customers, he said, I’m going to reduce the cost of your daily beer by $20. Drinks for the ten now cost just $80.”

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share’? They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:

The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

‘I only got a dollar out of the $20,’declared the sixth man. He pointed to the tenth man,’ but he got $10!’

‘Yeah, that’s right,’ exclaimed the fifth man. ‘I only saved a dollar, too. It’s unfair that he got ten times more than I!’

‘That’s true!!’ shouted the seventh man. ‘Why should he get $10 back when I got only two? The wealthy get all the breaks!’

‘Wait a minute,’ yelled the first four men in unison. ‘We didn’t get anything at all. The system exploits the poor!’

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

For those who understand, no explanation is needed.
For those who do not understand, no explanation is possible.

It seems the original Author is not known.

JOE

written by JOE \\ tags: Finance, money, richishan, Taxes, wealth