Roth IRA Basics
Jul/090
Here are some of the basics of Roth IRAs.
Income thresholds for Roth IRA. To be eligible to contribute to a Roth, you must have taxable income. Next, you must have a modified adjusted gross income (MAGI) (modified specifically for purposes of determining your Roth eligibility) that is under a certain threshold.
The MAGI thresholds in 2009 are as follows:
• If you’re married filing jointly, $176,000 with a phase out beginning at $166,000.
• If you’re single or married, filing separately, and you did not live with your spouse at all during the year, $120,000, with a phase out beginning at $105,000.
• If you’re married, filing separated, and you did live with your spouse for at least part of the year, $10,000, with a phase out beginning at $0.
Your modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your return modified as follows:
Plus:
1. Traditional IRA Deduction,
2. Student loan interest deduction,
3. Tuition and fees deduction,
4. Domestic production activities deduction,
5. Foreign earned income exclusion,
6. Foreign housing exclusion or deduction,
7. Exclusion of qualified bond interest shown; and,
8. Exclusion of employer-provided adoption benefits.
Subtract:
1. Roth IRA conversions,
2. Roth IRA rollovers from qualified retirement plans; and,
3. Minimum required distributions from IRAs
How much can you contributeto a Roth IRA? If you are eligible to contribute to a Roth IRA prior to the phase out limits, the maximum contribution is $5,000 or your taxable compensation, whichever is higher. If you are over 50 years old, the limit rises to $6,000. The extra $1,000 is considered a catch-up contribution. If you’re also contributing to a traditional IRA, however, the total of your IRA contributions (traditional + Roth) is still limited to either $5,000 or your taxable compensation.
Some other exceptions also apply: People who worked for employers who went bankrupt in previous years are, in some cases, allowed to make additional “catch-up” contributions. This is a limited exemption to employees of bankrupt companies that had a 401k plan that match contributions at a rate of at least 50% in company stock. The company or an employee also had to have been part of an indictment as part of the bankruptcy. Employees of airlines who went bankrupt may be permitted to make special contributions from airline payments.
Some types of income are ineligible for Roth contributions. There are some types of income ineligible for contributions to a Roth IRA. You can’t use capital gains, dividend income, interest income, and income from rental properties to contribute to a Roth IRA. (If you have other income, that won’t matter, but if you happen to make most of your money from investments, this could be an obstacle to establishing a Roth IRA.)
Unlimited Roth Conversions Coming in 2010. I hope this outline of requirements helps you to understand your likely eligibility for a Roth IRA. Remember, too, even if you’re not eligible to contribute to a Roth in 2009, you will be eligible to convert a traditional IRA to a Roth in 2010 if you want to. So, I’d recommend making a non-deductible contribution to a traditional IRA for the 2009 tax year and converting it to a Roth IRA in 2010.
If you have any question about Roth IRAs, please feel free to email or call me.
Derek Pilecki
Gator Capital Management
(813) 282-7870
derek.pilecki@gatorcapital.com
IRA Tips
Jul/091
These days, many of us feel retirement is getting further away. That’s all the more reason to review your retirement plan, evaluate your current IRA, and make adjustments if necessary. Too many people establish IRAs with a one-time contribution, without giving any more thought to their retirement plan.
Review you investment choices – With the market downdraft of late 2008, many people aren’t opening their brokerage statements. This is natural because the emotional pain of financial losses is something we want to avoid. However, the best thing to do is open the statement look at the current portfolio and make changes. It is likely that you are overweight bonds compared to your planned stock/bond weighting. It is a good time to rebalance your portfolio by moving some money out of bonds and into stocks.
Diversify your investments - One rule of thumb for a moderate risk portfolio is to invest the same percentage as your age in bonds and the rest in stocks. If you are 50 years old, put 50% in bonds and 50% in stocks. If you are 30 years old, put 30% in bonds and 70% in stocks. It is important to rebalance back to these ratios periodically. Rebalancing tends to reduce risk and smooth performance over the longer-term because when you rebalance, you tend to buy stocks after they decline and sell them after they have risen.
Should I put money in an IRA or a 401k - If you don’t have an IRA at all and are relying solely on a 401k for retirement, consider the advantages of diversifying your retirement savings by adding an IRA. Unlike 401ks, an IRA allows you to access your money before retirement if necessary—yes, there are penalties. But if all your retirement savings are in a 401k and you suddenly have a catastrophic loss, your 401k won’t give you the flexibility you’ll need.
Make sure you take advantage of employer matching - Does that mean you should stop contributing to an employer retirement plan and put all your money into an IRA? Probably not. If your employer provides any matching contributions, you should make sure before anything else that you’re taking full advantage of the matching. (Remember, employer matching is free money, but it earns interest just like the contributions you make yourself—so it’s the most valuable way of building your retirement savings). But if you’re currently contributing more than necessary to get the matching (or if you could afford to contribute more than that), the excess should probably be going into an IRA, which will give you more investment options, better returns, and more flexibility.
Consider converting to a Roth IRA - If you’re already in a traditional IRA and you’re under the income limit for Roth IRAs, consider converting. In 2009, the income limit has been increased to $169,000 for married filing jointly or $116,000 for single. If you are under the income limits, it makes good sense to convert your traditional IRA account to a Roth. With a Roth, you’ll pay taxes on the contributions you make now, but you won’t be taxed on the dividends when you begin to take those out. And there won’t be any mandatory disbursements at age 70 ½ either. For most people, the Roth makes more sense.
Converting to a Roth IRA will affect your taxes - There are some tax adjustments that will impact your taxes the year that you convert, so make sure you understand how this change will affect you before converting. Beginning in 2010, the rules on converting other retirement accounts to Roth IRAs will be relaxed, so if you’re considering conversion, you might want to wait until 2010.
Don’t Open an IRA at a Bank – Bankers love IRA deposit accounts because they are sticky accounts that they can price very low. Don’t let your IRA get crummy interest rates from some banker. Plus you limit your investment options by having your IRA account at a bank. Instead, I like to advise clients to open an IRA account at a major discount brokerage firm such as Fidelity, Schwab or TD Ameritrade. If you want to put your IRA in a bank account for stability, each of these brokers has an option to move your money into a bank account within your IRA. Plus, they always pay competitive rates on their bank accounts.
Don’t invest in tax-free or tax-deferral investment in an IRA – The major benefit of an IRA is tax deferral, so you want to avoid investing in other tax saving investments such as municipal bonds or annuities within your IRA. Municipal bonds usually have lower absolute returns because of their tax-free status, but within an IRA, you get no benefit from the tax-free nature. Annuities qualify for tax-deferral because they are insurance contracts, but the insurance company charges a layer of fees for their services. It is better to invest directly in mutual funds within your IRA to avoid the insurance fee of an annuity.
Avoid investing in Master Limited Partnerships in your IRA – Master Limited Partnerships (MLPs) make your taxes much more complicated if you own them in your IRA. MLPs aren’t taxed at the partnership level. They are pass-through entities and their owners have to pay taxes. You might think you wouldn’t have to pay the taxes if you made the investment in an IRA, but the IRS will require your custodian to pay the UBTI at the corporate tax rate with funds from your IRA. Then, when you withdraw the money from your IRA, you’ll get taxed as usual. Plus, there is the potential administrative hassle of your IRA custodian overlooking paying the tax. Some make the argument that the potential of having to pay the UBTI is very low if you have less than $5 million because MLPs investing in pipelines usually report losses due to depreciation on the pipelines for tax purposes. On the other hand, several MLPs in the asset management sector do or may report substantial amounts of income such as Alliance Bernstein, Blackstone and Fortress Investment. To be safe, I’d keep MLP investments in a taxable account and out of an IRA.
Try to make the maximum contribution each year - Whether you’re contributing to a traditional or Roth IRA (or both), you should come as close to the contribution limit as you can afford to. The limit in 2009 is $5,000, or for those over 50, $6,000. If you have more than one IRA account, this limit applies to the combined total of all your IRA contributions for the year.
Maximum contribution are tough on young adults but worth it in the long run - While $5,000 annually can seem like a lot to young people who are just getting established, your goal should be to reach the limit as early in your career as possible, since the retirement savings you make when you’re young have the most time to compound before you retire. For those just beginning their working careers, the question might be “How much can I afford to contribute?” but as soon as possible, you should be asking “How much do I need to contribute to my retirement savings in order to retire when I want to and do the things I want to in retirement?”
Under some circumstances, extra contributions are allowed - Have you worked for an employer in the past who went into bankruptcy? If you were contributing to a 401k with that employer, under a certain set of circumstances, you may be eligible to make a higher annual level of contribution to your IRA account—and if you can, you should definitely take advantage of these catch-up contributions.
Keep track of deadline dates for IRA contributions - If you’re looking for the tax savings that contributions to a traditional IRA offer, you should keep in mind that contributions for a given year can be made from January 1 of that year to tax filing day (so in 2009, you can make IRA contributions between January 1, 2009 and April 15, 2010, in order to exclude contributed amounts from your 2009 tax return). If you do decide to make a contribution in that pre-tax day window from January to April 15 for the previous year, be sure to mark the tax year for which the contribution is being made on the check you write—otherwise it will be assumed to be a contribution for the year in which it was made.
Review your beneficiaries - If you’ve been contributing to an IRA for a while, it’s a good idea to check on the beneficiary you named when you opened the account. Since IRAs can be inherited, you want to make sure that the right names are listed. Ideally, of course, you’ll be the one enjoying your retirement savings, but just in case, an occasional review is a good idea. Also make sure that you’ve recorded the location of your IRA accounts and the names of their beneficiaries along with other instructions for those who will execute your wishes in case of your death.
Make sure to start taking minimum distributions - If your 70 ½ birthday is in sight and you hold a traditional IRA, remember that you’re required to begin taking minimum distributions no later than April 1 of the calendar year following the year in which you turn 70 ½. If you miss the deadline, you’ll get hit with tax penalties.
While IRAs do require some consistent attention over the years, they are one of the best ways to accumulate the funds you’ll want for a comfortable retirement. Now more than ever, it’s time to get planning. If you have any questions or want help with your IRA, please call or email me.
Derek Pilecki
Gator Capital Management
derek.pilecki@gatorcapital.com
(813) 282-7870
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