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!

If you have a Traditional IRA or 401(k), you are required by tax rule to start taking required minimum distributions (most of the major brokerages have tools to help you manage this) by April 1st of the year after you turn 70 1/2. One of lesser known benefits of a Roth IRA is that there is so such similar requirement to take required minimum distributions. You are in total control when it comes to RMDs and Roth IRAs.

Granted, you can begin taking distributions at 59 1/2 on 401(k)s, so by the time you reach 70 1/2 you may need those distributions. However, it’s always nice to know that you can take out your funds on your terms, especially since the government won’t have let you touch it without penalty (outside some generally negative situations, first home excluded).

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My post on Naming Beneficiaries on Retirement Plans was selected as an Editor’s Choice at the Money Hacks Carnival #17 - Music of the ’80s hosted at Mrs. Nespy’s World. Thanks!

If you’re considering converting your Traditional IRA to a Roth IRA, remember that you will need to pay taxes on the conversion amount and you may be subject to an underpayment penalty because of it (if you fail to file estimated tax payments).

The federal tax law regarding underpayment is straightforward. If you pay more taxes this year than you owed last year, you’re in the clear. If you don’t but are within 90% of your tax liability, you are also in the clear. State tax law will differ and you’ll have to check with your state (for example, Maryland’s law is that you have to pay more than 110% than last year or be within 90%).

So, if you make a conversion, be sure to begin paying estimated tax payments with a 1040ES so you aren’t subject to a penalty. As always, consult with a tax professional before you make any important decisions.

Snowflaking, or micropayments, is a clever idea but when it comes to paying off debt but when you are talking about contributing towards retirement, you have to keep several things in mind.

First, the rules of a Roth IRA, which will be easiest to snowflake into, state that you are only permitted to contribute earned income. If you don’t have a full time job and are relying on small irregular income such as filling out surveys or performing odd jobs, you won’t be able to contribute that to a Roth IRA unless you claim it as income. While you should always claim that as income, oftentimes people don’t and so you could find yourself in a quandary if you don’t claim it as income but still contribute into a Roth IRA.

If you have a full time job and the take home pay exceeds the $5,000 limit, you have nothing to worry. If you don’t declare that income, you have enough regular income to contribute so the snowflaking still works. If you don’t have W-2 or other earned income, you could run into problems.

Second, keep track of your contributions. If you are irregularly contributing to your Roth IRA, it may contribute too much in a year. If you do and have to make withdrawals, it can become a pain to roll back the contributions (you have to calculate how much of the annual appreciation is the result of your over-contribution and then pay taxes on it).

If you keep those two concerns in mind, everything should be dandy!

I had a reader Wallace send in this question:

What is the law regarding premature IRA CD withdrawals by senior citizens without penalty?

Wallace,
The law regarding premature IRA withdrawals depends on the type of IRA you have. If you have a Roth IRA, you can withdraw your principal without penalty as long as it’s been in the account for five years.

If it’s a Traditional IRA, you pay a 10% penalty in addition to your marginal tax rate if you are under the age of 59 1/2.

There are a few exceptions to the 10% early withdrawal penalty that may apply to your situation:

• You are permanently or totally disabled,
• You are unemployed and are paying for health insurance premiums,
• You are paying for college expenses for yourself or a dependent,
• You are paying for medical expenses exceeding 7.5% of your AGI,
• Or the IRS has levied your retirement assets to pay off your tax debt.

If you fit any of those categories, you avoid the 10% penalty but you still have to pay your income tax on those funds.

Please consult with a tax professional before making any decisions, rules are constantly changing and this information may be out of date.

Given the recent Supreme Court ruling that upheld the tax advantaged status of investments such as municipal bonds, you may be tempted to begin investing in these instruments. If you do, don’t invest in them through a 401K or an IRA (either Roth or Traditional). You want to take full advantage of their tax advantaged status by investing in them in a fully taxable brokerage account.

The benefit of municipal bonds is that they are exempt from federal, state and local income taxes if they meet certain qualifications. If you live in Maryland and purchase a Maryland municipal bond, then those earnings are exempt from federal, state, and local income taxes - thus pushing up its yield (because you’d be paying taxes on the earnings of any other investment).

If you invest in those types of securities in a 401K, you lose the tax exempt status because you ultimately pay taxes on distributions in the 401K (the same for a Traditional IRA). If you invested in a Roth IRA, you are still exempt but all appreciation in a Roth IRA is exempt from taxes. You are essentially no longer getting the same advantage and thus not maximizing your yield.

If you have children (or if you are a child under the age of 18 and reading personal finance blogs, kudos to you!), you might be thinking about what you could do to help give them a jump start on their retirement savings. Roth IRA contribution rules say nothing about age so anyone of any age, as long as they meet the other criteria, is eligible to contribute into a Roth IRA. So, your child is permitted to contribute as long as they have earned income and his or her adjusted gross income falls under the income ceilings and phaseouts.

What is earned income? Basically, if they get a W-2 or report income on a Schedule C, then they qualify.

Catching up is hard to do, unless you’re talking retirement savings and you have the power of the US Government behind you. The contribution limits for various retirement accounts are increased if you are over the age of 50 and you can use them to your advantage if you didn’t contribute as much in your younger days. Below is a table listing the contribution limits for each account as well as the catch-up amount for the 2008 tax year.

So, if you’ve considered increasing your contributions to either account, know that you have a little extra breathing room if you want to contribute more and “catch 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!

Snowflaking is a play on words off Dave Ramsey’s Snowball psychologically-driven debt busting technique and it refers to putting small amounts towards your debt, snowflakes, to help eradicate debt. One of the ideas of snowflaking is that you can find small alternative sources of income and then push it towards your debt but you could really put it towards anything. You’re snowflaking when you drop your loose change in the piggy bank, so why not apply this towards retirement?

Snowflaking won’t work for things like a 401(k) since it will be a payroll deduction, but you could use it to fund your IRA, Roth or Traditional. I recommend using the piggy bank approach, putting small amounts of money into your piggy bank and then making one deposit each month, hopefully in addition to your monthly Roth IRA contribution. If you’ve maxed out your retirement fund, that’s wonderful and you can skip this. If you don’t max out your contributions to your Roth IRA each year, consider using snowflaking to help get you even closer. Remember, the 2008 Roth IRA contribution limit is $5,000 if you’re under 50 and $6,000 if you’re over (it’s the catch-up provision).