Roth conversions easier, but are they right?

When you are deciding whether to convert your IRA/401(k) to a Roth seek the advice of an objective financial professional. With the increasing tax environment we need to assess the value of a conversion now. It may be right for some and not for others.

Scrabble Series Roth IRA Ver2
Scrabble Series Roth IRA Ver2 (Photo credit:

So when might a Roth conversion make sense?Appleby said the following are some of the cases in which Roth conversions may make sense:

  • The IRA owner wants to leave a tax-free inheritance to his beneficiaries, and does not care how much it costs him to pay the taxes now, even if it would cost more if he pays the taxes instead of his beneficiaries paying the taxes.
  • The results of comprehensive Roth conversion analysis shows that a Roth conversion will very likely make good tax/financial sense.
  • The IRA owner is at the lower end of the tax-rate scale now, and will very likely be in a much higher tax-rate scale as his income increases including during retirement.
  • The IRA owner has enough deductions and tax credits to offset the tax bill that would be due on the Roth conversion.

There is no cookie cutter solution to the question, should I c3onvert my IRA/401(k) to a Roth? Each individual has unique circumstances and should the objective advice of an independent fiduciary.

Please comment or call to discuss how this affects you and your family.

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Roth 401(K) Conversions For All Thanks To Fiscal Cliff Deal

Plan sponsors need to review their 401(k) plan to determine that the plan is appropriate. There is also an imperative need to educate their employees on any tax changes. Plan sponsors fiduciary responsibilities and risks will be taking center stage for some time.

Scrabble Series Roth IRA Ver1
Scrabble Series Roth IRA Ver1 (Photo credit:

The new rules become effective Jan. 1, 2013, but you can transfer amounts contributed to pre-tax accounts in 2012 and earlier. So say you had made pre-tax 401(k) contributions over the years before your employer started offering the Roth 401(k) option. You could convert the pre-tax contributions and any earnings and any employer match, so that your whole account is Rothified. Going forward you could then make contributions earmarked directly to the Roth 401(k) account.The strategy is much like converting a traditional pre-tax IRA to a Roth IRA, a move savvy taxpayers make who think it’s worth paying taxes now—at historically low rates—rather than later. You pay income tax on the amount you convert. The Roth grows tax free and eventual distributions are tax free. A Roth conversion makes sense if you expect your tax rate to be the same or higher in retirement and won’t need the funds for a decade or more. It’s also an attractive way to leave an income-tax-free inheritance to your kids or grandkids.

“It’s a huge opportunity for younger workers who have the cash on hand to pay the conversion tax,” says Urwitz. For employees who have larger pretax balances, they can convert part of the 401(k) at a time. The longer the money has to grow, the more likely it is that the conversion will be worthwhile.

Plan participants should check with their employer to determine whether the Roth option is available. The next step would be to seek the advice of a financial professional. Preferably an independent fiduciary. If your employer provides such advice take advantage of it, if not seek outside guidance.

Please comment or call to discuss how this affects you and your financial future.

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Watch Out: Your 401(k) Is Being Targeted

The drama created by the federal government has led many Americans to believed that the federal government cannot be trusted with their financial future. This includes your retirement accounts. We should become more accountable for our own future. This does not include using our retirement accounts like a casino. We should develop a prudent strategy and remain disciplined to that strategy. In most cases this requires the guidance of an investor coach.

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A Petition to Protect the 401(k)

All of these rumblings have led the American Society of Pension Professionals and Actuaries to launch the “Save My 401(k)” online petition, which it also calls “Protect My Piggy.” (I’m no Beltway pundit, but I don’t think using the word “piggy” will be endearing to deficit hawks in D.C.) The website for the grassroots campaign lets you email your concern to your members of Congress.

“We understand Congress needs to reduce the debt and raise revenue, but raiding the tax incentives for 401(k) plans will put American workers’ retirement security at risk,” says Brian Graff, the society’s executive director and chief executive.

2 Tips for Retirement Savers

With retirement plans a likely target, I have two pieces of advice:

1. Invest as much as you can next year in your 401(k) or similar employer-sponsored plan if you have one. If you can invest in an IRA, do it; the contribution limit for traditional and Roth IRAs in 2013 will be $5,500; $6,500 if you are 50 or older.

2. If you work for an employer with a 401(k) plan that offers advice, pay attention to it.Writing in the Schwab Talk Blog, Catherine Golladay says that a study of employees in plans served by Charles Schwab found that those who follow its 401(k) investment advice save more, are better diversified and are better equipped to handle inevitable fluctuations in the market. Planning for your eventual retirement is tough, so I say: Why not benefit from smart insights from professionals, when they’re there for the taking?

One proposal is to limit 401(k) deductions, including employer contributions is $20,000 or 20% of gross pay whichever is less. Employees should put away as much as possible in 2013.

Please comment or call to discuss other alternatives.

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4 reasons not to roll over an old 401(k)

Any move you make should be with the advice of a financial professional. Objective advice is very difficult to find today, therefore you should seek an independent fiduciary adviser. This will lead to solutions that are in your best interest and not the best interest of the broker.

Roth IRA
Roth IRA (Photo credit: Philip Taylor PT)

1. You plan to retire between ages 55 and 59.5

As you’ve probably read before, taking money out of a traditional IRA prior to age 59-and-a-half results in a 10% penalty, unless you meet one of several exceptions.

What many investors don’t know is that with a 401(k), the 10% penalty on distributions does not apply if you are at least age 55 (rather than 59.5) at the end of the calendar year in which you left your employer.

So, if you’re planning to retire prior to age 59.5, keeping money in your old 401(k) is an easy way to get penalty-free access to some cash for the years between ages 55 and 59.5. Then, after you reach age 59.5, you can roll what’s left of the 401(k) into an IRA if it makes sense to do so.

2. You’re planning a Roth conversion

If you have a traditional IRA that includes nondeductible contributions and you are planning to do a Roth conversion in the near future (a “back-door Roth,” for example), holding off on a 401(k) rollover is likely to be beneficial.

When you do a Roth IRA conversion, the percentage of the conversion that is not taxable is calculated as your net nondeductible contributions, divided by the sum of:

— All of your traditional IRA balances (and SEP and SIMPLE IRA balances) as of the end of the year of conversion,

— Any Roth IRA conversions you made throughout the year, and

— Any other distributions you took from your IRA throughout the year.

Rolling a pre-tax 401(k) into an IRA increases the first item on that list, thereby reducing the portion of a conversion that would be nontaxable. In other words, rolling over a pretax 401(k) into an IRA in the same year that you do a Roth conversion will increase the portion of the conversion that is taxable as income.

3. Your old 401(k) has better investment options

In some cases — particularly if your previous employer was a large organization — you may actually have better investment options in your old retirement plan than you would in an IRA.

For example, if your ex-employer’s retirement plan includes the “Institutional” share class of Vanguard mutual funds, the expense ratios on those funds are typically about 1/3 lower than the cost of the ETF or “Admiral” share classes that you would have access to in an IRA.

Or, if you worked for the federal government and had access to its Thrift Savings Plan (TSP), no fund available to retail investors is going to be less expensive than the 0.025% expense ratio you’re paying on the TSP funds.

4. You have employer stock in your 401(k)

If you have appreciated employer stock in your old 401(k), you might want to roll that stock into a taxable brokerage account rather than into an IRA in order to take advantage of the “net unrealized appreciation” rules.

Here’s why: If you roll the stock into an IRA, all of it will be taxable as ordinary income when you eventually withdraw from the IRA.

But if you roll the stock into a taxable account, only your cost basis (the amount you paid for the shares) will count as a taxable distribution. Any net unrealized appreciation (the amount by which the stock has increased in value while in your 401(k) account) will be taxed as a long-term capital gain rather than ordinary income.

It’s important to understand, however, that if you’re under age 55 when you roll the employer stock into a taxable account, the 10% penalty will apply to your basis in the stock, because it will count as an early distribution.

If you’re considering taking advantage of this particular tax break, I would suggest consulting with a tax professional to make sure you follow the necessary rules.

Whenever you are deciding what to do with your 401(k) at an old employer seek the advice of a independent fiduciary. Many brokers will recommend rollover, not because it is in your best interest. Brokers will recommend a rollover to earn a commission.

Please comment or call to discuss how this affects you and your financial future.

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IRS raising limits on retirement contributions for 2013

Now is the time to maximize the contributions to your retirement accounts. The government is encouraging the conversion of qualified accounts to Roth accounts. Unless Americans become more responsible for their own retirement the government will take this over as well. Many are criticizing the over spending of the government, however perhaps we should look at the spending habits of all Americans. Individuals need a balanced budget and a saving strategy for the future.

Retirement (Photo credit: Wikipedia)

With many Americans worried about potential tax increases coming next year if the “fiscal cliff” remains unresolved, the extra boost in potential savings could be coming at a good time, said Garth Scrivner, a certified financial planner with StanCorp Investment Advisers in Albuquerque.“It’s kind of nice with the potential increases in taxes next year to have the ability to defer a bit more money,” Scrivner said. “We’re encouraging people at the end of the year to take an inventory of tax changes that are happening next year and, to the extent that they can, maximize the 401(k) limits.”

For those over 50 years old, the additional “catch-up” amount allowed will remain the same at $5,500, meaning the overall limit for such workers will be rising to $23,000 from $22,500.

In addition to raising the contribution limits, the IRS has also expanded how many people are eligible to contribute to Roth IRAs. For married couples, the upper income limit will rise to $188,000 from $183,000. For singles, the limit will increase to $127,000 from $125,000. (All amounts are adjusted gross income.)

Monthly Social Security benefits are also set to rise 1.7 percent, another move meant to keep up with inflation.

There are two other tweaks to look out for: The IRS is raising the limit on tax-free gifts to $14,000 from $13,000. And Americans living abroad will be able to exclude up to $97,600 in foreign earned income starting next year, a modest increase from the current $95,100.

The higher contribution limits toward retirement plans come as many Americans look for ways to juice their returns after seeing their portfolios battered in recent years.

Investors have enjoyed a pretty strong year in 2012, with the Standard & Poor’s 500-stock index rising about 13 percent. Despite concerns about the fiscal cliff, some analysts see signs that next year could include even more stock gains, driven by an improving housing market and rising consumer confidence.

But many workers saving for retirement still have a lot of ground to make up.

More than half of working households run the risk of being unable to maintain their standard of living when they retire, according to a report released in October by the Center for Retirement Research at Boston College.

By building a globally diversified portfolio and remaining disciplined, investors can reach their long term financial goals without anxiety. Many Americans are not saving for retirement because they do not know how to invest. Plan sponsors can eliminate this concern by automatically enrolling employees in a age appropriate portfolio.

Please comment or call to discuss how this affects you and your family.

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Roth 401(k)s vs. Traditional 401(k)s

By now, most Americans understand that at the very least, they should be participating in their employer’s defined contribution plan, most commonly offered in the form of a 401(k). But some companies offer two forms of these plans: the traditional 401(k) and the Roth 401(k). You thought deciding how much to allocate to your plan and then researching and electing the investment funds to support it was confusing enough, but here you are, faced with yet another option for safeguarding some retirement funds. Let’s break it down just a bit more.

What’s the difference?
The primary difference between a traditional and a Roth 401(k) is simple but significant. With a traditional 401(k) plan, your contributions grow tax free, and you pay taxes on the withdrawals; Roth 401(k)s, on the other hand, work in precisely the opposite way, as you pay taxes on your contributions but not on your withdrawals.

Additionally, Roth 401(k)s tend to be seen as more of an estate planning tool, since they do not necessitate that you to take required minimum withdrawals (RMDs) once you reach age 70 ½, as you must do with traditional 401(k)s. This allows you to leave your funds untouched for as long as you want after retirement, letting your investment grow tax free all the while.

Which is right for you?
This is a conversation best held with your financial advisor, as you must determine whether the back-end payoff of a Roth 401(k) outweighs the benefits of traditional tax deferral on the front end, but generally speaking, it depends largely on where you are in life and into which tax bracket you fall.

If you’re relatively young with an eye toward saving for retirement and you don’t earn a great deal of money, a Roth 401(k) may be worth exploring, as the upfront tax-savings benefits wouldn’t be as significant to you as a tax-free payout in retirement. Conversely, if you’re an established earner in a higher tax bracket, getting up-front tax-advantaged treatment is probably best, making the traditional 401(k) your most likely option. This is especially true for individuals who expect to be in a significantly lower tax bracket when they retire.

You can even double-dip.
If your employer does offer both types of 401(k) plan, you can split your contributions between the two if you so choose, as long as your  combined annual contributions do not exceed 2012’s annual limit of $17,000. If you’re 55 or older, that limit jumps to $22,500.

With so many options, there is a 401(k) plan, or a combination of the two, that is ideal for your current situation. But before you make your decisions, be sure to weigh these considerations carefully, especially if you don’t speak with a financial advisor regularly.

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If Roth 401(k) were a human being, he would be going through an existential crisis.

Part of every retirement plan discussion should include the use of the Roth 401(k). Not everyone would benefit from this component but it should be considered when planning your retirement.

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“[The] lack of savings by our population is going to be one of the biggest crises our country will face,” says Mark Ratay, financial adviser with The Ratay Group and Corporate Retirement Director of Morgan Stanley Smith Barney in Lisle, Illinois. “But when you go out there and start talking to the masses, all but the most sophisticated investors don’t get it. They’re already confused about saving in a 401(k). So, when you get into the Roth topic, you’re throwing one more thing up in the air to confuse them,” he says.

“Of all the issues that are out there, I’m not sure I would have this at the top of my list, since there are so many variables with Roth. We all know that [participants] are not saving enough, and the issue of lifetime income from a 401(k) account is taking up a good amount of education time,” says Sean Deviney, Financial Planner, Provenance Wealth Advisors in Fort Lauderdale, Florida, agreeing with Ratay’s sentiment.

“I do think the Roth is a great option, but it isn’t a ‘problem’; it just hasn’t been adopted as quickly as the industry thought it would be,” he says, adding that the Roth 401(k) option is more of a tax planning tool, not necessarily a better alternative than the traditional 401(k).

At the very least, advisers say, plan sponsors should have the Roth option in their 401(k)s.

The Roth 401(k) is a great option for part of your retirement savings, however it should be discussed with your tax professional. The biggest challenge is and should be increasing savings rate for all American workers.

Please comment or call to discuss how to improve the savings rate for your company employees.

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Been There, Done That. Now What?

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Plan design is a very important component to allowing you plan to attract and retain top talent. This talent will be crucial in small to mid sized companies to remain competitive.

Paying Now or Paying LaterWhat we said: As with self-directed brokerage accounts, the Roth conversion window (and its affiliated tax acceleration) seems most likely to appeal to the highly compensated minority. The impetus for the conversion itself is not only the timing window, but also the (still) looming sunset of the Bush Administration’s tax cuts. Of course, the real issue may be a shift in assumptions about taxes; what if they won’t be dependably lower in retirement?

Where we are: Perhaps the most surprising trend to emerge from this year’s PLANSPONSOR Defined Contribution Survey was a huge increase in the offering of Roth 401(k)s, an option that “plan sponsors have long been reluctant to push since their pay-it-now concept on taxes seems at odds with the traditional tax-deferral mantra, and their benefits are often seen as skewed toward more highly compensated workers.” This year’s survey found that 38.2% of all plans now offer the option, compared with just 20.2% a year ago, and that increase was broad-based across market segments. Of course, just try finding someone today (who is not running for political office) who is expecting taxes to be lower in the future.

What’s ahead: As with self-directed brokerage accounts, the Roth conversion window (and its affiliated tax acceleration) seems most likely to appeal to the highly compensated minority. Many more plans are now offering the choice, but it remains to be seen if participants will respond in kind. I would guess not that many in the short term—but that, of course, could change.

Plan design is critical to many small businesses to realize a true employee benefit. One which will attract and retain talented employees.

Please comment or call to discuss how this could affect you and your company.

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The Value of Tax Deferral


History of top marginal income tax rates in th...
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Tax deferred account / qualified plan

Contributing your $3,000 to a 401(k) or other qualified plan, you have the whole amount to invest and investment earnings are tax free – but you have to pay tax when you withdraw it.  Leaving it in for, say, 20 years you would have $6,414 after paying your tax:  $3,000 x (1.06 ^ 20) x (1-.3333).

Taxable account

Contributing to a taxable account, you have $2,000 to invest after tax ($3,000 x (1-.3333)) and investment earnings are taxable so your effective investment return is 4% (6% x (1-.3333)).  But then you’re done paying taxes.  After 20 years you would have $4,382:  $2,000 x (1.04 ^ 20).

What if’s:  rising tax rates, capital gains, return, deferral period, Roth

In this simple example, the qualified plan clearly beats the taxable account.  But what if tax rates are higher at withdrawal?  For the $4,382 in the taxable account to beat the qualified plan, the tax rate would have to suddenly jump to 54.5% at withdrawal:  $3,000 x (1.06 ^ 20) x (1-.545) = $4,378.   Any tax increase that happens more gradually would be worse for the taxable account, with no effect on the qualified plan.

What about capital gains?  If the current 15% long term capital gains rate is sustainable and all your investments qualify, your effective return is 5.1% (6% x (1-.15)).  You still start with $2,000 to invest after tax, so after 20 years you would have $5,408:  $2,000 x (1.051 ^ 20).  That’s not bad, but it’s still less than the $6,414 you would have had from a qualified plan.

What about different investment returns and deferral periods?  We’ve used 6% return for 20 years in this simple example, but how does it change for other returns and time periods?  The short answer is that higher investment returns and longer deferral periods favor the qualified plan.  Lower returns and shorter time favor the taxable account.

What about a Roth IRA or 401(k)?  As it turns out, Roth and regular 401(k) results are identical if your marginal tax rates are equal at contribution and withdrawal.  Roth is better if your marginal rate at withdrawal is higher than at contribution time; otherwise a regular 401(k) is better.  And they both blow the taxable account out of the water.

These examples confirm the value of tax deferral in qualified retirement plans. As included in the examples the tax rate would have to increase to 54.5% at withdrawal to make tax deferral a bad deal. The Roth example is simple yet effective.

Please comment or call to discuss.

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