If you convert a Traditional IRA into a Roth IRA this year, remember that the balance you convert will be considered income and so you may be penalized for underpaying your taxes. There are several safe harbor conditions that would save you from the underpayment penalty (for example, if you did not owe taxes last year, then you would not be subject to the underpayment penalty this year) so check with a tax professional to ensure you are adequately paying your taxes to avoid this penalty.

There is no safe harbor simply because the underpayment was the result of a Roth IRA conversion so be sure to review it.

Here’s a gem of a recommendation from Kiplinger: If you converted a Traditional IRA to a Roth IRA this year and lost value on your investments, you can undo the conversion and then reconvert to save on taxes.

The process is called “recharacterization.” If you ask the IRA sponsor to recharacterize your conversion and put your money back into a traditional IRA, then you don’t need to report the original conversion to the IRS. Then you can convert the traditional IRA to a Roth later and pay taxes on the smaller balance.

The process is called recharacterization and you have to start it within six months after the due date of your return. So, if you convert it this year (2008), you have six months after April 15th, which is October 15th, to change your mind and undo it. Call up your brokerage and ask them how to recharacterize your Roth IRA back into a Traditional IRA.

Now, there are some gotchas:

• You will still be subject to the $100,000 rule, which expires in 2010, on this new conversion.
• You will not be able to convert it back to a Roth IRA immediately. You must wait until the year after the first conversion or 30 days after recharacterizing. So if you converted it last year (2007), you can’t convert until the calendar says 2009.

You can save yourself a lot of money if your investments lost value in the Roth after the conversion!

Marshall Loeb’s Daily Money Tip near the end of July was a list of three retirement gotchas you need to be aware of so they don’t catch you unawares when you retire. The first gotcha is an obvious one but the other two are less so.

Underestimating Your Budget. This refers to underestimating how much you’ll spend in retirement. The rule of thumb is that you’ll need 70-80% of your pre-retirement income to cover your expenses. However, given all the extra time you have, you might find yourself spending more. This is why it’s important to be realistic about your budget as well as keeping on top of it. If you plan for 70%, keep your spending within 70%!

Not Budgeting Benefits. When you retire, you often don’t get to keep your benefits such as medical, dental, and vision coverage. Those insurances can be very expensive so it’s important that you put them into your budget.

Divesting Takes Time. Lastly, you don’t get all your money immediately (nor may you want to) so be sure to plan your disbursements accordingly. You’ll learn that waiting until full retirement age will maximize your Social Security benefit payments so you’ll want to structure your disbursements to maximize that.

Get better prepared for retirement [MarketWatch]

With the recent high profile bank “failures,” they’re really just liquidity crises that forced the FDIC and Fed to intervene, you might be wondering if your investments are safe. In a nutshell, your investments are protected by the Securities Investor Protection Corporation (SIPC) up to $500,000. The coverage is such that you get what you would’ve lost, not money. So if you had shares of stock, you’d get the same number of shares in that same company or mutual fund.

What Is Protected?

Cash and securities are covered with some exceptions. Commodity futures contracts and currency, that is foreign currency, aren’t covered. Investment contracts, like limited partnerships, and fixed annuities that aren’t registered with the SEC under the Securities Act of 1933 are not covered. If you’re just in stocks and mutual funds, you’ll be OK.

What Happens In Failure?

What will happen is what often happens when banks fail, your assets are simply transferred to another brokerage or dealer and it has no effect to you. In the worst case, the brokerage you’re working with has bad records and you have to file a claim to retrieve your assets.

Sometimes brokerages will buy additional insurance to supplement SIPC. For example, TradeKing has up to $25M of protection in addition to the SIPC coverage: “Through its clearing firm, TradeKing provides an additional $25 million of coverage per client (including $900,000 for claims of cash) through a third-party insurance company with an aggregate clearing firm limit of $100 million to pay amounts in addition to those returned in a SIPC liquidation. This brings the total protection per client to $25.5 million with a limitation of $1 million on claims for cash balances for each client (as defined by SIPC rules). This coverage does not include transactions or trading losses or declines in the value of securities.”

A recent study by the Americans for Secure Retirement foudn that 3 out of 5 middle-class Americans will outlive their retirement savings because they will fail to reduce their expenses in retirement. It’s a scary study but it makes sense, people think they will spend less in retirement but often don’t. You might pay less in taxes, less in work related travel, but you go on more vacations and spend money on new leisure activities that you didn’t have time for.

How do you prevent this? First, create a budget and stick to it. The rule of thumb is always to spend only 4% of your retirement savings each year. If you have a million dollars squirreled away, that’s $40,000 a year. Another rule of thumb works in the reverse and focuses on spending. You should estimate that your expenses in retirement will be about 70-90% that of your pre-retirement spending and save accordingly. This also means that when you do retire, you must spend only the amount you budgeted for in the first place!

Most Americans will outlive savings. [Marketplace]

I recently started playing golf, I have a huge blister on my right thumb from gripping it too hard, but I’m starting to get that itch. Golf is hard but it’s extremely rewarding and it’s easy to see why retirees would enjoy the sport, especially if you have plenty of time to practice and hone your skills. Even if you’re not a golf fanatic, the spots listed are still fine spots to retire because golf courses are often designed and installed in idyllic locations anyway.

Here are the top ten, in no particular order:

• Auburn, Ala.
• Bonita Springs, Fla.
• Charlotte, N.C.
• Georgetown, Texas
• Lemont, Ill.
• Mount Pleasant, S.C.
• Portland, Ore.
• Rancho Mirage, Calif.
• St. George, Utah
• Sun City, Ariz.

10 Great Retirement Spots for Golf Nuts [US News & World Report]

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My Retirement Blog’s post on how you shouldn’t gamble your safety net was included in this weeks’ Carnival of Personal Finance.

If you’re like me, you recently saw your retirement accounts take a pretty sizable hit. In fact, since October of last year, the markets have been down 20%. 20% puts it into bear market territory and something that probably makes you shudder to think about it (I know I do). You might be tempted to change directions, pull out of what you’ve invested in so far and going with something riskier to make up the losses. Please don’t.

Your retirement nest egg is your retirement safety net. You can gamble away your taxable investments, you can put your emergency fund into a hot new tech startup (I wouldn’t), and you can take your Latte Factor and blow it on the ponies - just don’t mess with your retirement accounts. Let them stay the course and you’ll be rewarded in the long run.

To put our current difficulties in perspective, consider that since the 1920s, the S&P 500 has returned a historic 11% year over year. That’s through numerous bear markets, including the recession in the 1980s and the tech bust the few years after 2001.

If you can’t stomach it and want to pull out, pull out. Just don’t gamble it on a potential shooting star.

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My Retirement Blog was included in this week’s Carnival of Personal Finance at Greener Pastures.

If you are retired and living on a fixed income, it’s very important for you to manage your expenses so that they don’t exceed your income. This underscores the importance of budgeting because you have a smaller room for error. A classic budgeting strategy is to establish a baseline by recording everything you spend (using a paper notebook is a cheap and effective way to accomplish this) for a few months. In a few months, you should be able to establish the fixed portion of your budget - how much you spend on food, rent/mortgage, car expenses, etc. After a few months, you don’t have to track everything down to the penny but it still helps to keep some sort of budget.

If you find that your budget is close to your income, you can try reducing how much you spend or taking on a part time job for supplemental income (or just for something to do). It’s becoming very popular for retirees to be paid for volunteering. Paid volunteerism, even if it’s a token salary, puts value on the work the retiree performs - it makes organizations take the volunteer more seriously even if they are only paid a small amount.

You can start receiving Social Security payments as soon as you turn 62 but you pay a penalty for taking payment so early. If you wait until full retirement age, which varies with the year of your birth, you maximize the total amount you can get from the Social Security program. If you begin taking it at 62, your benefit could be as low as 25% less than if you waited until full retirement age.

If you started taking payments early, before your full retirement age, there’s a way to reset the clock. It’s called the Social Security redo and the subject of a segment on Marketplace Money last Friday. Essentially all you do is repay all the money you’ve received so far and the clock will be reset.

Not bad!

I have no idea why 401(k) participation wasn’t automatic in the first place and why it took the Pension Protection Act of 2006 to make it possible. The benefits of the law are already being seen as Nationwide Financial Services reported that 96% of employees are now saving for their retirement versus 74% in 2006. While the cynics will say that defined contribution plans like the 401(k) take the burden of retirement off employers, I saw we need to face the realities of the day. The reality is that defined benefit plans like pensions carry their own set of risks, ask anyone who had a Delta pension. I’d rather we face reality rather than fight it for the sake of pointing fingers.

The findings come as Americans face a shortfall in funding their retirements. The average balance in a 401(k) account was $61,346 at the end of 2006, according to the Washington-based Employee Benefit Research Institute. The savings will matter more in the future, as the number of companies offering traditional pension plans has declined by two-thirds over the past 20 years, according to the Retirement Security Project, a Washington-based group that advocates policies to help Americans become financially secure.

[Washington Post]