My Retirement Blog

If you earn over a certain amount, the Roth IRA option isn’t available to you, you’re left to go after the Traditional IRA. If you participate in a 401(k), you can’t even deduct the contributions to a Traditional IRA. So, why would anyone ever contribute to a non-deductible Traditional IRA? If you did, you’d be paying taxes on the contributions and taxes on the disbursements when you retire… that’s double taxing and that’s foolish! However, there is one reason why you would want to do this. Conversion!

Right now, only those who earned fewer than $100,000 a year can convert a Traditional IRA to a Roth IRA. However, the Tax Increase Prevention and Reconciliation Act of 2005, signed in May 2006, introduced a conversion loophole in 2010 that removed that $100,000 rule. In 2010, anyone is permitted to convert from a Traditional IRA to a Roth IRA. What this also means is that it gives those above the Roth IRA income phaseout to have a back-door method of contributing to their Roth IRA.

When you convert a Traditional IRA to a Roth IRA, you pay taxes on the sum because you were able to deduct the contributions. If you made contributions to a non-deductible Traditional IRA, you already paid the tax so you can make the conversion absolutely free. That’s the only reason I can see for contributing to a non-deductible Traditional IRA… as long as they don’t close the loophole.

I’ve rolled over two 401(k)’s into a Rollover IRA at Vanguard and both times the process was absolutely painless. If you’re thinking about taking advantage of Vanguard’s low fee index funds, and other mutual funds, then I think that rolling over a 401(k) is a great way to do it. The process is pretty easy and similar to rolling over to anywhere else.

First, you’ll need to open an account at Vanguard.com, specifically you’ll want this page because it focuses on moving money to Vanguard. If you run into any trouble, you can always call up their retirement specialists at 800-414-1742 and get to a human being in a few minutes. After you follow those instructions, you’ll need to contact your current 401(k) custodian (brokerage firm) to let them know you intend to perform a trustee-to-trustee rollover.

The name you want the check made out to is Vanguard FTC and then have the check mailed either to you, where you will forward it to Vanguard, or directly to Vanguard. The information that is provided to you from Vanguard’s online form should tell you where everything should be sent.

If you already have a Rollover IRA at Vanguard, simply do everything as you did before and include a letter that instructs them on how to divide up the funds. The letter is simple, just write that you want a certain dollar amount or percentage in which funds and you’re all done.

As easy as it should always be. (I don’t know if any other brokerage is easier or harder, I just know that Vanguard’s never been a problem)

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The 150th Carnival of Personal Finance is up!

If you’re a stay at home mom or dad, you can make a deductible IRA contribution (or non-deductible if you opt for a Roth) of up to $5,000 for 2008 if you file a joint return and your working partner/spouse has enough earned income to cover the contribution. That’s right, even if you don’t personally earn the income, if you file a joint return than you can contribute to what is known as a spousal IRA.

The rules regarding the Spousal IRA are the same as any other IRA. Your contribution is capped at $5,000 a year, $6,000 if you are older than 50, and you must have the earned income to do it. For example, if you and your spouse want to both contribute the maximum towards your IRAs, your combined earned income must be greater than $10,000 ($5k each). For the purposes of a Roth IRA, the contribution phaseout schedules still apply.

Deductibility Phaseout Rules

The rules start to get a little tricky when you’re talking about deductible IRA contributions and qualified retirement plans (like 401ks). If neither one has a qualified retirement plan, you’re in the clear and can deduct up to $10,000 of contributions. If both participate in a qualified retirement plan, then the phaseout is from $85k to $105k in earned income for deductibility purposes. That means that if your combined AGI is over $105k, then you cannot deduct your Traditional IRA contributions.

If only one participates, then it gets tricky. The deductibility phaseouts for the one participating is the $85k to $105k one listed above. The non-participating spouse instead uses the $159k to $169k phaseout period. For example, if a couple only has one participating member and earns $120k, then the participating spouse can’t deduct contributions but the non-participating spouse can.

Roth IRA

Or you can contribute it all to a Roth IRA, which are after-tax dollars, and then deductibility is not an issue. The phaseouts for the Roth IRA for 2008 are $159k to $169k, meaning if you earn more than $169k then you cannot contribute to a Roth IRA.

Whew!

April 15th is right around the corner and many of you will be making your 2007 IRA contributions right now, that’s great news. Putting money away into a Roth or Traditional IRA is one of the best ways you can save for your retirement, so kudos to you for doing it.

Many brokerages and mutual fund firms are now allowing online ACH transactions and through the menu system you can identify which year the contribution is for. For those who still mail in checks, it’s crucial that you identify the year, which is as simple as putting “2007 IRA Contribution” in the Memo line.

What happens if you forget and your 2007 contribution is listed as a 2008 contribution? What if the brokerage misses the line and puts it into 2008? Not a problem, simply write them a letter and have them “re-characterize” the contribution from a 2008 to a 2007 contribution and you will be okay.

Always double check to see if the brokerage characterized it correctly, you don’t want to discover it next April!

As we mentioned last Friday, there are two positive ways you can withdraw funds from an IRA without the 10% penalty. The first is for eligible educational expenses, the second, which we will discuss now, is for the purchase of your first home.

The government has always been a friend of the prospective homeowner (private mortgage insurance, property tax, and mortgage interest are income tax deductible) and this benefit has been around for a while. The regarding the withdrawal of funds from an IRA is that you can use up to $10,000 in IRA funds, $20k if you’re married but must be $10k per IRA and your spouse must be a first time homebuyer too, towards the purchase of a home.

Definition of a First Time Homebuyer
As long as you haven’t owned a principal residence anytime in the last two years, you count. If you have but your spouse, child, grandchild or parent hasn’t been then you can give them the $10k from your fund!

120 Day Time Limit
Another gotcha to watch out for is that you have to use the IRA money towards “qualified acquisition costs” within 120 days. A qualified acquisition cost includes buying, building or rebuilding, settlement, financing, or other closing costs.

Whether or not it is a smart move to raid your retirement fund is a different question.

There are two positive ways you can withdraw funds from an IRA without penalty, the first is for the purchase of your first home and the second one, which we will discuss right now, is for qualified education related expenses. The rules regarding penalty-free withdrawals for education are actually quite simple:

• The student has to be eligible. An eligible student can be you, your spouse, your child, foster child, or a descendant of them.
• Ensure that the eligible student attends an eligible institution, approved by the IRS. Any college, university, vocational school or post-secondary facility that meets federal student aid program requirements will be eligible. Whether the program is public, private or a nonprofit is irrelevant as long as its an accredited institution.
• Ensure that the funds are used to pay for tuition, fees, books, supplies, or any required equipment (such as lab equipement). If the student is more than half-time, room and board are also legitimate.

For more information, read Chapter 9 of IRS Publication 970: Tax Benefits for Education.

Some mutual funds are very tax efficient. They realize very little in the way of realized capital gains, they pay out very little in dividends, and they have protocols in place to reduce how much buying and selling occurs so those events don’t happen. Some mutual funds, on the other hand, are not very tax efficient and throw off lots, relatively, in realized capital gains, dividends, etc. For those mutual funds that are not efficient but perform well, you can make a home for them in an IRA because the earnings are tax free (temporarily).

Whenever a fund realizes capital gains, dividends, interest, etc; it has to pay out that amount to shareholders if it exceeds the fund’s expense ratio. If the mutual fund has to pay this out, then you’re going to be taxed for it, which is not ideal. Ideally you want the fund to increase in value but not throw off these payments because you want the fund to just keep getting bigger. Kiplingers has a list of four mutual funds that are tax inefficient but otherwise great performers:

• T. Rowe Price Global Stock (PRGSX)
• Pimco StocksPlus D (PSPDX)
• Merger (MERFX)
• Calamos Market Neutral Income A (CVSIX)

So, if you know of a solid fund with weak tax efficiency, don’t dismiss it… consider putting it into your IRA.

Source: Kiplingers

After writing the article on required minimum distributions, I checked with some popular retirement brokerages and saw that many of them handle required minimum distributions quite gracefully.

At Vanguard, they will:

* Calculate your RMD. Each January, we’ll notify you by mail of the amount you must distribute by year-end.
* Distribute your RMD, if you wish. We can automatically transfer your money to a Vanguard® nonretirement account or deposit it at your bank.
* Keep you posted. You’ll receive statements by mail, and you can track your progress online at any time.

Fidelity (a PDF about their “Personal Withdrawal Service”) also offers similar services but it’s a little harder to get at since it’s written into a PDF document and not with high level bullet points like Vanguard’s.

RMDs are a very well understood item in retirement when it comes to IRAs so if your current brokerage doesn’t handle it, I’d recommend finding another one.

The government requires that by April 1 following the year in which you turn 70.5, you are required to being taking minimum withdrawals from your IRAs, excluding the Roth IRA. The amount you are required to withdraw is based on a calculation (use this calculator) and that value is an annual number.

The example calculation is based on a $100,000 account balance and an 8% rate of return (based on a 27.5 year remaining life expectancy) and it requires that you take a minimum $3,649.64 withdrawal each year. The calculator is based on the published rules as of April 2002 and the calculator was last updated January 2006.

If you don’t take the required minimum withdrawals, then you are penalized 50% on the amount you were short by. So let’s say you were required to withdraw $5,000 and you only withdraw $1,000, then you actually owe a penalty of $2,000! So, be sure to take the minimum withdrawal or you’ll face a penalty but you can do whatever you want with it, including reinvesting it into the market (even into your Roth IRA if you meet the restrictions).

You’ve probably heard of the Roth IRA and the Traditional IRA, but did you know there are eleven varieties of IRAs? Yeah… there are a combined total of eleven types of IRAs and most of them are variations of the traditional or Roth IRA. For your reading pleasure, the eleven IRA types (and their descriptions) are:

1. First off, an Individual Retirement Account is a traditional or Roth that is set up with a financial institution like a bank, brokerage, or mutual fund. You can invest in stocks, bonds, MM, CDs, etc.
2. Next is the Individual Retirement Annuity which is a traditional or Roth that is set up with a life insurance company when you purchase an annuity.
3. An Employer and Employee Association Trust Account, common also known as a group IRA, is a traditional IRA that is setup by your employer, union or some other employee group.
4. A SEP-IRA, or Simplified Employee Pension IRA, is a traditional IRA that is set up by an employer for a company’s employees. The rules with a SEP are that the employer can contribute up to 25% of an employee’s compensation or $45,000, whichever is lower.
5. A SIMPLE IRA, or Savings Incentive Match Plan for Employees IRA, is another traditional IRA. How a SIMPLE works is that an employee can contribute up to $10,000 or 100% of their compensation, whichever is lower, and the employer will match up to 3%.
6. A Spousal IRA is a traditional or Roth that is funded by a person’s spouse if they earn less than $2,000 that year. The couple must file a joint tax return and the maximum is shared across both accounts.
7. A Rollover IRA, also called a Conduit IRA, is a traditional IRA that has been “rolled over” from a 401k, 403b, or some other similar account. There are no limits to the rollover.
8. An Inherited IRA is a traditional or a Roth acquired by a beneficiary, that isn’t a spouse, of a deceased IRA owner. There are some special rules with this and I recommend you read up on them if you’re in this situation.
9. An Education IRA (EIRA) is an IRA set up so that the funds will go towards the beneficiery’s education. The contributions are not tax deductible, so like a Roth, but all deposits and earnings are tax free if they are used for higher education.
10. Lastly there is the Traditional IRA…
11. And the Roth IRA.

There you go… eleven types of IRAs.