JoeTaxpayer

I must admit, this only recently came to my attention. The fair tax (not to be confused with the “flat tax”) is a system that does away with income taxes completely, instead it taxes consumption at a 30% rate. Lower income households are “pre-bated” their projected sales taxes, so in effect, they would pay no tax at all.

Many questions occur to me as I ponder such a system. I’ve saved mostly in a pre-tax 401(k). Seems this system with let me access that money at retirement with no further taxes due until it’s spent, same as others would pay with money they’ve already paid taxes on. And therein lies the rub. How are these two sources of funds (one’s savings already taxed vs money in pretax accounts) differentiated? I feel sorry for the retiree who spent the last few years converting all his retirement money from a pre-tax IRA to a Roth IRA, now to only find a 30% sales tax waiting at the other end.

On the other hand, there’s a certain appeal to knowing that those in the underground economy, who are paying no taxes at all, will be drawn in to the system if only when they go to their local grocery store. I’m not sold either way, a lot more discussion is needed on this topic.

Joe

written by JOE \\ tags: 401(k), fair tax, income, income tax, IRA, money, Retirement, roth ira, saving, Savings, Taxes

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

I recently fielded this multi-part question;

First, is conversion from a traditional IRA to Roth IRA still OK when over 70 and taking RMDs (required minimum distributions)?

Ok? It’s fantastic!! I will first tell you that I believe that Roth’s value while working is slightly exaggerated. Your scenario above is ideal. I have an 80+ yr old client who is in the 15% bracket. Each year we convert just enough to ‘top off’ that bracket so the next hundred dollars would have been taxed at 25%.

Second, does the “conversion” count as part of RMD?

No, the conversion must take place after you calculate the RMD. Our RMD is based on 12/31/07 year end balance. We can do the Roth conversion any time during the year, but that RMD is fixed.

Third, is it possible to transfer stock directly from Traditional IRA to Roth IRA — using current valuation on day of transfer as the basis for amount of conversion?

Yes - you can convert stock, the broker will report that value based on the day of conversion. There is no wash sale selling in one IRA and buying in another, anyway.

Joe

written by JOE \\ tags: IRA, irs, required minimum distribution, roth conversion, roth ira, tax, traditional ira

Most blogs you may read are starting to offer an RSS feed, a way of reading the blog through a reader. I use Feedburner and in the left sidebar offer links so you may access my blog through Google or Yahoo’s RSS feature. Few non-bloggers use this feature, and May 1st has been declared RSS Awareness Day.

So, if you are enjoying my blog, or any other blogs you read on a regular basis, consider become a “reader” through an RSS feed.

Joe

written by JOE \\ tags: Finance, IRA, money, Retirement, roth ira, RSS Awareness Day, RSS reader, tax rates, Taxes

There’s a recurring question regarding whether one should rollover a 401(k) from a previous employer to an IRA account (or to the new employer’s 401(k)) or leave it in the original account. One new variable that comes into play is the ability to convert one’s IRA to a Roth IRA, regardless of income, in 2010. How are the two related? When one converts from a regular IRA to a Roth, taxes (at your marginal rate) are due on a prorated basis on the pretax money within the IRA. For example, if you have a $100,000 balance, $20,000 of which is post tax deposits, 80% of any money converted is subject to tax. Now, this presents an interesting opportunity. Most 401(k) accounts will permit IRA money to be rolled back into the 401(k) regardless of the source. So in this example, you might consider rolling the $80,000 in pre tax money into the 401(k) before doing the conversion on the $20,000 post tax money. This two step will avoid any and all tax on that conversion. If you have a 401(k) account, you might consider leaving it for now, and converting it to an IRA only after that Roth conversion is made in 2010.

Joe

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

For my first post of this year I wrote an article titled, “Can you save too much, pre-tax?” This is a topic that comes up frequently as one decides whether to choose a Traditional (pre-tax) IRA vs a Roth IRA. I recently had some dialog with another blogger and it’s clear to me that the decision is not so clear cut. Ideally, one makes a deposit pre-tax and withdraws it at a lower rate some time later. But as Mark (the other blogger) reminds me, a Roth has many benefits that shouldn’t be ignored:

1. You can withdraw the original deposits at any time with no tax or penalty, as I suggested in my Roth magic post.
2. A Roth has no RMDs (required minimum distribution) requirement, which forces withdrawals when they may not be needed or wanted due to other considerations.
3. The accounts pass through one’s estate with less impact to estate tax as the funds are denser, and received by the beneficiary with no income tax upon withdrawal.

I think for any retiree there is likely an ideal mix, so they might draw funds from their pre-tax accounts (IRA and 401(k)) and use Roth withdrawals to avoid getting sent into the next bracket or be subject to the Social Security Tax Trap. The issue today is that we can’t know that mix two or three years out, let alone 20 or 30. What I do know, and I hope Mark agrees, is that this decision follows the shape of the Laffer Curve. I know with certainty that 100% of one’s savings in pre-tax accounts misses the benefits I share above. 100% in Roth accounts will miss the benefit of the zero bracket I discussed at length in my article cited and linked above. I don’t know the ideal mix, but I’d suggest this: The lower your savings rate, the more you’ll see the benefit of pre-tax savings, a diligent saver may be best served by leaning toward the Roth savings. A Wall Street Journal article titled “A Cool Million No Longer Buys You a Luxe Retirement” helps back up my position as it states that only the richest 2% of Americans have saved more than $1 million. One would need to be in this exclusive group to even begin worrying about higher taxes on the their retirement savings. I hope to get some feedback, as others’ opinions always help me to see a different side of the issue.

Joe

(update - are you feeling lucky? The Google search for “pretax vs post tax ira” (leave off the quotes) will lead right to this post. Could just be the choice of words? Or maybe I’m just lucky?)

written by JOE \\ tags: 401(k), Finance, marginal tax rate, money, Retirement, roth conversion, roth ira, Savings, Social Security, Taxes

The New York Times recently reported in a story titled “Top Court Allows Suit Over 401(k)” that the supreme court ruled on Wednesday allowing an individual to proceed with his lawsuit against his employer who administered the company’s 401(k). His claim was that they ignored his instructions to shift his investment mix and that he lost $150K due to his instructions being ignored. I received many emails asking about this ruling, asking if anyone can sue over the current losses. The suit was not about the losses of the market, but were specific to the fiduciary responsibility of a 401(k) sponsor to follow instructions of the participants. Most of us invested in stocks are down this year, but that’s not to suggest that any class actions suits will follow, we are just subject to the volatility of the current market.

JOE

written by JOE \\ tags: 401(k), Finance, money, Retirement, roth ira, 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

Starting in 2008, you are no longer required to first roll your 401(k) to an IRA to then convert it to a Roth IRA. You should still be in tune with the taxes that will be due upon conversion and do the math to see if converting makes sense. See Fairmark’s website to understand the tax bracket you fall into and at what rate the conversion will be taxed. The Roth conversion works best when you are in a lower bracket at conversion than you will be in upcoming years, or when the extra income from 4019k) or IRA withdrawals will force you into the Phantom Social Security Tax brackets.
JOE

written by JOE \\ tags: 401(k), Finance, Retirement, roth ira, Taxes

Last year (2007), the IRS permitted the company controlling a 401(k) to allow a non-spouse beneficiary to roll it over to a beneficiary IRA. Now that option is mandatory. If you are the non-spouse beneficiary of a 401(k) you may demand that it be rolled to a beneficiary IRA and you may then stretch out the withdrawals over your lifetime. This is an important option for those whom it impacts. Prior rules allowed a forced withdrawal within 5 years of the account holder passing on.
JOE

written by JOE \\ tags: 401(k), Finance, Retirement, roth ira, Taxes