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Roth IRA

Monday’s need-to-know money news

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Zemanta Related Posts ThumbnailToday’s top story: The tax mistake you cannot afford to make. Also in the news: The best time to shop for Christmas (seriously), how to keep your kids out of debt, and how to use your Roth IRA as an emergency fund.

The 1 Tax Mistake You Must Not Make
Making sure your figures match.

Best Time to Shop, Save for Christmas? Now
It’s practically right around the corner!

5 Tips for Keeping Your Kids (and Grandkids) Out of Debt
Teaching the value of money during Financial Literacy Month.

How To Use Your Roth IRA As An Emergency Fund
Not just for retirement.

Negotiate Your College Financial Aid to Get the Best Deal
If done right, the school of your choice could match your best offer.

5 LAST-MINUTE MONEY MOVES BEFORE 2014

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Tax return checkOkay, you’re on overload with all the last-minute shopping, cooking, preparing for guests and/or traveling. But try to squeeze in a few money tasks before year-end. Including:

Contribute to an IRA. You can put money into an IRA even if you have a retirement plan through work, but you may not be able to deduct the contribution if your income is over certain limits. If, on the other hand, your income is low, you could score a valuable tax credit for your retirement contributions. The problem of course is that it can be tough to come up with the maximum contribution of $5,500 ($6,500 for those 50 and over) at year end. Luckily, you have until tax day, April 15, 2014, to make your contribution for 2013. And consider setting up regular contributions to your IRA so you don’t have to scramble for the cash next year.

Make a (back door) Roth contribution. If you can’t deduct an IRA contribution, a better option is to contribute to a Roth IRA. Roth contributions aren’t deductible but withdrawals from the accounts are tax-free in retirement (unlike regular IRA withdrawals, which incur income taxes). If your income is too high to contribute to a Roth directly, you can contribute to a regular IRA and then convert it to a Roth. This works best if you don’t already have a fat IRA account, since your tax bill for the conversion will be based on the total you have saved in regular IRAs.

Use it or lose (most) of it. If you have money set aside in a flexible spending account at work for medical or child care expenses, you typically need to use it up by year end. There are some exceptions: the Treasury Department recently said plan participants can roll up to $500 of unused funds into the next year’s plans, and some employers extend the deadline from Dec. 31 to mid-March.

Accelerate and delay. If you don’t expect a big change in your tax circumstances, it can make sense to delay income into 2014 (by asking your boss to pay a bonus next year instead of this, for example) and to accelerate deductions by paying mortgage, property tax or medical bills for January in December.

Get generous. If you itemize your deductions, you can get a tax break for your charitable contributions. Again, rushing to get those in at the last minute isn’t ideal, so consider setting up regular contributions such as paycheck deductions or monthly payments to your favorite nonprofits. No extra cash? “Noncash” donations—such as clothes or household items—can earn you a deduction as well. They just have to be in good condition and given to a recognized charity.

 

How to start Roth IRAs for your kids

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Dear Liz: I would like to start a Roth account for each of my kids. (They’re in their 30s.) Is it better to start an account in my name with them as beneficiaries or to start the accounts in their names?

Answer: Roth IRAs can be a wonderful way to save, but they’re not custodial accounts. You won’t be able to control the accounts or prevent your adult children from spending any money you deposit.

If you still want to help, though, let your kids know you’ll contribute to any Roths they set up. They can open a Roth if they have earned income at least equal to the annual contribution and their incomes are below the Roth limits. The ability to contribute to a Roth phases out between $178,000 to $188,000 for married couples in 2013 and from $112,000 to $127,000 for singles.

Ideally, you’ll contribute to your own Roth first. The limit on contributions is $5,500 this year.

Missed deadline could limit inherited Roth IRA’s benefits

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Dear Liz: I inherited my brother’s Roth IRA about three years ago. I find it hard to get any information about non-spousal inherited Roths. Can you tell me more about this type of Roth IRA?

Answer: It may be unfortunate that you didn’t ask sooner.

When a spouse inherits a Roth IRA, he can roll it into his own Roth IRA, and it’s as if he or she was the owner of the inherited funds all along. There’s no minimum distribution requirement, so the money can continue to grow.

If you’re not a spouse, you have the option of transferring it into an account titled as an inherited Roth IRA. You also have the option of taking distributions over your lifetime — which means keeping the bulk of the money growing for you tax-free — but to do that you must begin taking required minimum distributions by Dec. 31 of the year after the year in which the owner died.

If you didn’t start these required distributions on time, you have to withdraw all the assets in the account by Dec. 31 of the fifth year after the year your brother died, said Mark Luscombe, principal analyst for CCH Tax & Accounting North America. You won’t have to pay taxes on this withdrawal, but it would have been better to let the money continue to grow tax-free in the account.

Don’t rush to pay taxes

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Dear Liz: I am a CPA and fairly knowledgeable about investing, but I have a question about my IRAs. I am 58 and my husband is in his mid-80s. We both are retired with federal pensions and no debt other than a mortgage. My plan is to start taking money annually from my traditional IRA in two or three years. I want to reduce the required minimum distribution I will need to start taking at age 701/2 and lessen the tax impact at that time. Should I put these annual withdrawals in my regular investment account or should I put them in the Roth IRA? My goal is to lessen the tax impact on my only child when he ultimately inherits this money. Does my plan make sense?

Answer: Your letter is proof that our tax code is too complex if it can stymie even a CPA. Still, it’s hard to imagine any scenario where you’d be better off accelerating withdrawals from an IRA and putting them in a taxable account.

A required minimum distribution “is merely a requirement to take the money out anyway,” said Certified Financial Planner Michael Kitces, an expert in taxation. “All you’re doing by taking money out early to ‘avoid’ an RMD [required minimum distribution] is voluntarily inflicting an even more severe and earlier RMD on yourself.”

In other words, you’d be giving up future tax-advantaged growth of your money for no good reason.

What might make sense, in some circumstances, is moving the money to a Roth. You can’t make contributions to a Roth if you’re not working, because Roths require contributions be made from “earned income.” What you can do is convert your traditional IRA to a Roth, either all at once or over time. You have to pay taxes on amounts you convert, but then the money can grow tax-free inside the Roth and doesn’t have to be withdrawn again during your lifetime, since Roths don’t have required minimum distributions. Whether you should convert depends on a number of factors, including your current and future tax rates and those of your child.

“In other words, if your tax rate is 25% and your child’s is 15%, just let them inherit the [traditional IRA] account and pay the lower tax burden,” said Kitces, who has blogged about the Roth vs. traditional IRA decision at http://www.kitces.com. “In reverse, though, if the parents’ tax rate is lower … then yes, it’s absolutely better to convert at the parents’ rates than the child’s. In either scenario, the fundamental goal remains the same — get the money out when the tax rate is lowest.”

If you do decide to convert, remember that the conversion itself could put you in a higher tax bracket.

“It will be important not to convert so much that it drives up the tax rate to the point where it defeats the value in the first place,” Kitces said. “Which means the optimal strategy, if it’s to convert anything at all, will be to do partial Roth conversions to fill lower tax brackets but avoid being pushed into the upper ones.”