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.

Recently a reader asked:

I would like to know the breaking points for annual income that affects the percentage of social security that is taxable. example…low income only 15% is taxable.

Social Security is normally not taxable unless you earn over a certain amount. This lower amount is called the base amount and depends on your filing status. Single and Head of Household filers have a base of $25,000. Married Filing Jointly has a base of $32,000. If your provisional income (all worldwide income, including tax-exempt income, plus half of Social Security benefits) is lower than the base, you are not taxed on your benefits.

The next tier is at $34,000 for Single and HoH and $44,000 for MFJ. If you earn between the base and the next tier’s limit, then your 50% of your benefits are taxed.

If you earn more than the second tier, then 85% of your Social Security benefits are taxed.

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.

The follow rules regarding dependents was accurate for the 2007-filing year, you should review any updated dollar limits as the IRS publishes them and, as always, consult with a tax professional before making any decisions.

When it comes to dependents, the rules are fairly straightforward. It’s important for you to figure this out because it has a significant effect on your taxes, which in turn has an effect on your retirement decisions. Dependents come in two forms, the first is a qualifying child and the second is a qualifying relative.

Qualifying Child Dependents

A qualifying child dependent must satisfy these rules:

• A son, daughter, step son, step daughter, eligible foster child, sibling or their descendent has to live with you for more than six months out of the year. This rules makes it so that no two people can claim the same dependents.
• The child has to be under 19 or a full time student under 24. This rule is waived if the child is permanently disabled.
• Child has to provide less than half of his or her own financial support.

Qualifying Relative

A qualifying relative has to follow these rules:

• There is no age limit.
• The relative must be of an approved relationship status, such as a parent or sibling.
• The relative must have gross income less than $3,400 per year and the claimant must provide at least half of the relative’s overall financial support.

That’s it! Simple enough right?

When it comes to taxes, it makes a big deal how long you’ve held your investments. If you’ve held your investments for over a year before selling, you are taxed at the long term capital gains tax. If you’ve held them for less than a year before selling, you’re taxed at the short term capital gains tax. The two tax rates are very very different.

To calculate how much your tax is, you first have to figure out which tax bracket you’re in. Here are the 2008 tax brackets.

Short Term Capital Gains Tax

This is easy, your gains are taxed at your tax rate as ordinary income.

Long Term Capital Gains Tax

If you are in the 10% and 15% tax brackets, you pay 0% in long term capital gains tax. If you are in the 25%, 28%, 33% or 35% tax brackets, you will pay 15% on your long term capital gains.

By waiting a full year, you can save quite a bit on capital gains taxes… but don’t let tax considerations by your main reason for buying or selling stocks. You’ll get yourself in deep trouble that way.

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The Carnival of Personal Finance is now available at Mpolanomy, my TradeKing review was included.

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.

It’s April 14th, tomorrow is tax filing day, have you made all your contributions for 2007? Now’s your last chance!

IRA Contributions

You have until April 15th of the following year to make contributions for that tax year, so you have until April 15th, 2008 to make your contributions to a 2007 IRA. If you have online account access and a linked bank account, you can still hop online to make your contribution right now. If you have online account access but haven’t linked a bank account, you may not have enough time to go through the verification process, but you are not out of luck. If you mail a check and it’s postmarked before April 15th, you can still get the contribution characterized as a 2007 contribution.

Retirement Savings Tax Credit

You’ll have to file a 1040 or 1040A, or go with an online service like TurboTax that will handle it all for you, but you may qualify for a retirement savings tax credit. The tax credit works on a schedule based on income, with the ceiling being $26,001. If you earn more than $26,001 as a single filer or $52,001 as a married filing jointly then you can skip this paragraph. For everyone else, you can get a credit of up to 50% of your retirement contributions. For single filers, the 50% credit rate is for incomes of less than $15,500, 20% is between that and $17,000, 10% for those earning less than $26,000, and then nothing for anyone over.

Another point to know is that in the case of IRAs, only half of the maximum contribution can be counted towards calculating your credit. So for 2007, the max contribution was $4,000 but only $2,000 figures towards the credit, leaving a maximum credit of $1,000 for single filers.

Almost every recognized retirement account contribution counts from IRAs to 401(k)s to SIMPLES, SEP, 403(b), etc. For additional help, check out Form 8880 Credit for Qualified Retirement Savings Contributions or just use TurboTax.

New year means new brackets and limits and all that great jazz!

This year the total amount you can contribute to your 401(k) or 403(b) will not increase (remains $15,500) but IRA contributors will be able to put $5,000 towards their retirement (more if you’re in the catch-up category).

There are a few other 2008 increases indexed to inflation that have been discussed over at Blueprint for Financial Prosperity in the review of 2008 federal income tax brackets post so I won’t be repeating them here.

There are a lot of retirement options out there, so many that your head probably spins whenever someone talks about 401(k)’s, 403(b)’s, Roth IRAs, or Traditional IRAs… the list goes on. One topic that most people don’t talk about is saving part of your nest egg in a regular taxable brokerage or mutual fund account. They don’t talk about it because you get immediate tax benefits for contributing to a 401(k) (you can deduct your contributions from your income) and because you get deferred tax benefits for Roth IRAs (your distributions are tax free in retirement), but a regular taxable brokerage account should be a part of your retirement planning for X key reasons.

Tax Diversification

You shouldn’t put all of your eggs in one basket and that basket shouldn’t say “tax deferred.” 401(k)’s give you immediate tax benefits in return for taxing your disbursements. It’s nice because you pay less taxes now in return for paying more taxes, on a larger asset base, in the future. The only risk you have is in whether your tax rate increases substantially. If you are saving on 25% in taxes today but forced to pay 50% in taxes in 40 years, it’s less clear how good of a decision you’ve made. This is why it’s important to diversify your retirement account tax exposure. You can do this by going with a Roth IRA or, if you’ve exhausted that route, opening up a taxable brokerage account.

Flexibility & Access to Funds

When you contribute to a 401(k), the only way to get the funds is either borrowing against the 401(k) or withdrawing from the 401(k) and taking a 10% penalty (on top of the taxes). With a taxable brokerage account, you have the flexibility to access the funds whenever you need it! Give yourself the flexibility to access your funds, or at least part of your funds, and you won’t have to cripple your retirement by borrowing or withdrawing from a 401(k).

Tax Benefits

When you invest with a 401(k), everything is taxed at the short term capital gains rate when you begin taking disbursements in retirement. With a brokerage account, you can take advantage of the long term capital gains tax rate if you hold the investment for longer than a year. In a 401(k), everything that comes out of the account is taxed at your tax rate, regardless of how long you’ve held the underlying asset! Does the benefit of an immediate tax break outweigh the fact that all of your appreciation is taxed at the short term rate? That is for you to decide.

I’m not advocating that you select a 401(k) or a taxable brokerage account, I’m merely suggesting that a taxable brokerage account has value in a retirement plan. All three accounts (401k, Roth IRA, and taxable brokerage account) have their place in a solid retirement plan.

This final tip in Forbes’ ten rules for building wealth starts dabbling in tax implications and how income and capital gains taxes will affect you investment decisions. The two tips they gives:

1. Be aware of whether your sale will be a short term or long term capital gain. A short term capital gain will be taxed at your income tax bracket whereas a long term capital gain will be taxed at a mere 15% - regardless of your income tax bracket.
2. Sell losers before the end of the year and they can offset winners. “…It can be a good move to sell losers in your portfolio to take advantage of the annual $3,000 capital-loss deduction limit and offset any capital gains on your winning picks.”

Source: Fortune