You can only contribute to a Roth IRA if you have earned income, so one wonders what counts as earned income? Does Social Security count? What about rental income? How about interest from bank accounts or capital gains from the sale of stock? Actually, none of those count as earned income. Earned income is, in general, that income which you receive as a result of working. Whether that’s reported on a W-2, reported on a Schedule C (where business income is reported), or on a Schedule F (that’s for farming), it has to be earned. In addition to those things that appear on those two schedules and a W-2, union strike benefits, alimony, and long-term disability benefits received prior to minimum retirement age also count as earned income.

In a few short months it’ll be 2008 and with a new year comes new retirement account contribution limits.

For Individual Retirement Accounts (including Roth and Traditional IRAs), the contribution limit for 2008 is $5,000 if you are 49 and below. If you are 50 and above, you can contribute an additional $1,000 as a catch-up contribution. As for 2009 and beyond, those increases are indexed to inflation.

For 401(k) and 403(b), the contribution limit for 2008 will remain $15,500 (the same as 2007) for those 49 and below. If you are 50 and above, the limit will again remain at $20,500 (the same as 2007). The limits for 2009 and beyond are again indexed to inflation.

Enjoy!

If you’re currently not eligible to contribute to a Roth IRA because you’re being phased out, you should consider starting a Traditional IRA so that you can convert it to a Roth IRA in 2010, when income restrictions for those eligible to convert are lifted. Right now, if you earn more than $100,000, you are not eligible to convert any of your Traditional IRA into a Roth IRA. When President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005, it lifted the restriction and so starting in 2010, you can convert. Those Traditional IRAs that are converted in 2010, you can spread the tax payment out across 2011 and 2012.

So, the plan would thus be to contribute to the Traditional IRA, deduct it from your taxes, then wait until 2010 when you can convert the sum over to a Roth IRA. If you currently are participating in your employer’s 401K, then your Traditional IRA contributions may not be tax deductible so you won’t even have to pay the tax when you convert.

Please check with a tax professional before making decisions regarding this as I may have my facts wrong or my interpretation is inaccurate.

It’s only August so you have plenty of time to do some look ahead planning but have you ever considered using a 0% balance transfer from a credit card to fund your Roth IRA? Well, if you have, rest assured that you aren’t alone but there are a few things you should be very much aware of. There are some good reasons to do this and some bad reasons why you shouldn’t and I will outline all them below.

Good Reason: You Expect A Tax Refund
If you are expecting to get a tax refund and you don’t currently have the funds to contribute to your Roth IRA, a 0% balance transfer for 12 months is a great way to get some money right now. Getting the funds now means that you can contribute to your Roth and then when you get your tax refund a few weeks after you file your taxes, you can pay off the credit card debt. Since the interest rate will be 0%, you pay nothing extra to get this money a few weeks earlier. Or, since it is August, you can file your taxes as soon as possible (sometime in February after you get your W-2’s) so you get your rebate earlier than April 15th.

Bad Reason: You Carry The Debt Past Promotion
Let’s say you get the one year offer and you contribute it to your Roth IRA but then you also go on a spending spree with the “extra money” and you don’t pay off the credit card debt before the promotional period ends. Or, say you get a smaller than expected tax refund check or you run into some hardship later on. Those are all reasons why a 0% balance transfer for this purposes would not be for you, if you can’t pay it off within the time period alloted for the promotional offer, DO NOT APPLY FOR THE OFFER. A Roth IRA is valuable but you shouldn’t take on credit card debt to fund it. Since it is August, start some saving now so you aren’t in this position in six months.

In general, since it is so early, I would not recommend doing it because you should instead implement a savings plan so you are funding it with savings instead of debt. If you are reading this article and it’s February or March, then be sure to get a card that has a 0% balance transfer offer such as the Citi Professional Cash card or the Citi Platinum Select card.

If you are working and your spouse is not, you are permitted to contribute to your spouse’s Roth IRA as long as you still satisfy the rules for the Roth IRA. Even though the IRA is for the individual, you are still allowed to contribute to the Roth IRA as long as your income doesn’t exceed the phaseout limits and it’s large enough that you can fund the Roth in the first place. This question was recently posed to Walter Updegrave and his response delved more into the rules of the Roth than most people probably wanted, but the answer is still the same.

Essentially as long as you earn less than $156,000 and more than $8,000, then you can contribute to the Roth IRA of both of you. If it’s greater than $156,000 and less than $166,000, then you have to calculate what your Roth IRA contribute phased out limit is. If it’s over $166,000, then you’re out of luck.

The rules for a Traditional IRA are a little more complicated because the limits depend in part on whether your employer offers a retirement plan. He offers up this calculator to help you calculate your limits.

While question 3 of 4 is titled “Are you grabbing every tax break you can?“, it’s really just asking you whether you’re contributing to a Roth IRA. A Roth IRA is a retirement account that grows tax-free, your contributions are post-tax dollars but your earnings and disbursement are never taxed. This differs with a 401k in that the 401k is tax deferred, you don’t pay taxes on your contributions but you pay them on earnings and disbursements. They’re two different but both excellent ways to save for retirement. Roth IRA Explained is a great mini-site that explains how Roth IRAs work.

Have you considered borrowing some money to fund your retirement? I’m talking about borrowing some money, perhaps via a 0% balance transfer from a credit card, so that you can contribute more towards either a 401K or an IRA. You might be thinking that borrowing money in order to invest it is a risky proposition, and it is, but if you’re only borrowing it for a short period of time and because you want to get the money now so you can contribute it before April 17th (in the example of an IRA), I think that the risk may be OK. Just be sure to remember that any benefits are almost 100% negated if you begin to carry that balance at a typical credit rate.

So, the scenario I’m painting is this… it’s March and practically near the deadline to contribute to an IRA but you don’t have enough cash to open up an IRA without being hit with low balance fees. Or it could be that you have an IRA but you’re a thousand dollars short of hitting the limit and you’d really like to max it out. Either way, you’ll have enough by the end of the April or May to fully fund it so you decide to get a 0% balance transfer or borrow some money from family in order to fully contribute to the IRA for 2006. I think in that specific scenario, it’s okay (I’d hit up family before the credit cards) as long as you believe you’re disciplined enough to pay off the debt. If you start to pay interest on it, you’ve already lost.

I think that in any other situation, you should avoid borrowing money in order to fund your retirement. The risks versus the rewards just don’t make sense.

Taxes change, just like investments do, and in order to be prepared for whatever comes through the chambers of Congress, you have to diversify your tax profile. Simplistically, this just means that you need to have good mix of investments that are both tax-deferred and tax-free. For example, a Roth IRA is a tax-free investment vehicle. You put in dollars that are already taxed and your earnings and principal are tax-free when you withdraw them. A Traditional IRA is a tax-deferred investment vehicle. You put in dollars pre-tax and your earnings and principal grow tax free but they are taxed when you withdraw them. What happens if we do away with income tax and instead raise sales tax (a value added tax) across the board?

See, now your Roth IRA comes out of your fund tax free but is then “taxed” when you start buying things. You are essentially double taxed - once on the contribution side and then once when you spend it after withdrawing it. Now let’s say that the income tax is re-evaluated and it is doubled to help pay for nationalized health care… now you’re basically screwed on your tax deferred investments because you’re paying more taxes (and you win on your tax-free investments).

So, the next time you go to plot out your retirement portfolios, remember to not only diversify your investments but also remember to diversify your tax profile!

The Roth 401k was made permanent with the passing of the Pension Protection Act of 2006 last year, though it has been around since 2001, and it does for 401k plans what the Roth IRA did for Traditional IRA plans - it created a vehicle for folks to save after-tax dollars and allow it to grow tax free. With a Roth IRA, you contribute after-tax dollars and the earnings and dividends and everything grow tax free - when you begin taking withdrawals from the Roth IRA near retirement, you will not pay any income taxes on them because you’ve already paid for it. With the Roth 401k, you basically operate under the same premise.

There are some huge differences between Roth IRAs and Roth 401ks:

• The Roth 401k has no income limit! Whereas contribution amounts phase out starting at 99k (for 2007) for Roth IRAs, there is no such limit for Roth 401ks.
• Since the Roth 401k is a 401k plan, it’s subject to those limits - $15,500 for 2007. So, you can contribute a total of $15,500 to a regular 401k and a Roth 401k total.
• Roth 401k’s follow the early withdrawal rules of 401k’s, so there are penalties and such. For example, with a Roth IRA, you can withdraw your contributions at any time with no penalty, but not so with Roth 401k’s. You will be penalized if you withdraw your Roth 401k contributions before retirement age.

Lastly, if and when you do leave your job and contemplate rolling over your Roth 401k, it would go to a Roth IRA - just as how a regular 401k rolls into a regular IRA.

Remember back when you were a child and your parents said you couldn’t do something and it made you really really want to do it? Well, that’s how many people approach the Roth IRA because after you start making more than $95,000 the amount you can contribute to a Roth decreases. Once you earn more than $110,000 per year, you can no longer contribute $4,000 (in 2006-7) towards your Roth.

Well, just because you can’t do something is no real reason why you should do it when you can, let me go into the reasons why you should do it.

Diversification

By diversification, I mean diversification from a tax perspective. Most employees will have the option of participating in a tax-deferred retirement plan, a 401k or 403b or something like that, where you can contribute and deduct the contributions from your income. Since we won’t know what the tax rates will be when you retire, you want to have a portion of your retirement assets free from tax - that’s where the Roth IRA comes in.

Earnings Grow Tax Free
When you contribute to a Traditional IRA, you get to start with a bigger amount but that amount is taxed when you withdraw it from the account. With the Roth IRA, it “costs” more to contribute that $4,000, because you are using money that has already been subject to income tax, but all of the earnings are tax free.