Here are some retirement saving tax tips that should help you keep more of that money for yourself:

If You Plan on Converting to a Roth IRA,  Do It This Year

If you are planning to convert any of your pre-tax investments to a Roth IRA, this is a great year for it.  Why?   Because taxes will likely increase on most income tax brackets next year, making that rollover more costly.

Don’t Take Early Distributions

The IRS conducted a study in 2003 which revealed that nearly 5 million taxpayers took money out of retirement accounts before they were 59 ½ years old. The retirement account penalties for withdrawing money early were about $3.4 billion!  In addition to paying income taxes on your distribution, you are also smacked with a 10% penalty when withdrawing before the eligible distribution age.

If you use retirement savings plan specifies a minimum age to withdraw money, do not withdraw it before you are the appropriate age. If you feel there is a possibility of having to withdraw money prior to retirement, keep more than one retirement savings; one that allows withdrawals anytime, and another which does not.

When Changing Jobs, Take a Rollover Instead of a Distribution

When you change jobs, it’s in your best interest to roll your funds directly to the new employer’s retirement plan or your own IRA plan.  If you choose a distribution instead of a rollover,  you’ll lose 20% because the of the 20% IRA Withholding tax law. This rule applies to a 401k or 403b plans and not to a SEP IRA. Sometimes, it is smart to roll a 401k to a SIMPLE or traditional IRA because you will not only avoid paying taxes on the distribution, but will also have unlimited investment choices (compared the the few options most 401(k) plans offer).

You Can Designate Your Children as Your Beneficiaries

Many people commonly put their spouses on their retirement accounts as their beneficiary. If you have an IRA, you can designate children and/or grandchildren as beneficiaries, which allows the money to be stretched out over the child’s project life span. The child can take IRA pay outs over their lifetime if they choose. This means the money earns decades more tax-deferred or tax-free growth than it would have if the surviving spouse was named the beneficiary. Realize that naming your children as beneficiaries requires the corresponding spouse needs to sign a waiver; otherwise he or she is automatically the beneficiary.

You should consult a professional for setting up an IRA trust for minor children to make sure you avoid any money traps.

In Most Cases Don’t Take a Lump Sum When You Retire

In most cases, when you’ve finally said goodbye to the world of employment, do not take a lump sum or you’ll have an insanely high tax bill and the money will no longer grow tax free. Instead, you may consider moving your retirement funds from an employer-sponsored plan into an IRA to allow you to maintain tax-deferred status while taking distributions (that are subject to only ordinary income taxes at 59 1/2). There is a loophole in Section 72(t) where you can take equitable distributions from an IRA before 59 1/2 (but after 55) and avoid the 10% early withdrawal penalty (this loophole has other provisions to be aware of). It is highly recommended that you consult with a financial planner or tax professional who specializes in retirement plan distributions as the Internal Revenue Service’s code is complex and making the right decision depends upon your financial needs and situation.

photo credit: Pug50

This is a guest post by TaxDebtHelp.com, a website that provides advice and guidance for taxpayers with tax debts and other major State and IRS tax problems.

It seems that brokerages and employers are increasingly competing for those retirement funds. According to the Investment Company Institute, more than 50 million employees and retirees hold $3 trillion in 401(k) plans, which means that brokerage firms and mutual fund companies are clamoring for the business. TD Ameritrade and E*Trade are offering up to $500 to buy rollover business.

At the same time, employers who have been historically non-committal about keeping retirees in their plans have begun offering low-cost index and exchange-traded funds, target-date retirement funds and annuities as a carrot to hang on to 401(k) participants.

So…should you roll your 401(k) to an IRA or not?

Advantages of rolling a 401(k) to an IRA

More investment choices

The very best 401(k) plans have limited investment options whereas an IRA gives you access to nearly unlimited investment options.

Flexibility

With an IRA, you can withdraw money whenever you need it, but not necessarily with a typical 401(k). Some limit the frequency of withdrawals; others set all or nothing restrictions.

Simplicity

Many workers leave a string of 401(k) investments behind as they switch jobs over their career. Rolling all into a single IRA greatly simplifies the retirement savings; making it easier to monitor investments, plan allocations and rebalance.

Easier to handle required minimum distributions (RMDs) at age 70 ½

With traditional IRAs (there is no RMD for Roth IRAs), the RMD is based on the total amount in all your IRAs with the RMD distribution coming from any account or combination of accounts. With 401(k)s at age 70 ½, you must calculate each RMD separately and take the money from that account.

Some estate planning advantages

Heirs can normally take tax-deferred distributions from an IRA over their lifetimes; most 401(k) plans force heirs to take assets after the account holder dies. Note that the beneficiary has the option of rolling the 401(k) into an IRA, but this is a tricky process and is better done by the account holder while living.

Reasons for sticking with your 401(k)

Relaxed penalty rules for early distribution

If you retire or get laid off between ages 55 and 59 ½, you are able to take penalty free distributions from a 401(k) while you would be penalized 10% for withdrawing funds from an IRA.

Protection from creditors

The 401(k) funds can’t be touched by creditors in a bankruptcy or by plaintiffs in a civil lawsuit. IRA funds, however, have limited protection and differ from state to state.

Delayed RMD for workers over 70½

As long as you are still working at age 70½ , no required minimum distribution is taken from your 401(k). With an IRA, the RMD is a must whether you continue to work or not.

Possibility of rolling an inherited plan to a Roth IRA

New rules allow nonspouse beneficiaries to roll a 401(k) to a Roth IRA, something that cannot be done with an inherited traditional IRA.

Comfort

Some retirees are used to their 401(k) plans and are not comfortable with starting out fresh with the management of an IRA.

How about the costs?

Deciphering the management expense of your 401(k) or IRA can be a challenge. With your 401(k), you will need to find the expense ratio of each fund. How do you do this? Try the fund’s Web site or the plan’s Web site. According to Kiplinger’s Retirement Report, an expense ratio of 1% or less is reasonable. You shouldn’t have trouble finding funds in your IRA with comparable expense ratios. A new tool, by BrightScope, a San Diego firm, has tabulated the administration costs, investment fees, returns and quality of investments for 45,000 companies. Visit www.brightscope.com, enter the company name, and you will get a score of between 1 (worst) and 100 (best). Give this tool a try…it is really that simple.

Conclusion

Because of more choices, flexibility and simplicity of the IRA, most 401(k) holders should seriously consider rolling to the IRA. However, this decision is not a no-brainer. Think it through and understand what you are doing before deciding.

When leaving employment with a 401(k) provider, have you rolled your 401(k) to an IRA, rolled it to your new company’s plan, left it in your previous company’s plan, or cashed it out?   Why did you make the decision you made?  What recommendations would you give to others who are leaving a 401(k) employer?

photo credit: pfala

Savings are low risk funds that must be liquid (available) when you need them. The purpose of saving money is so you can have it for a specific purpose within a short time frame.

Investments, on the other hand, are for wealth building, and will not be needed for many years. Yes, investments do involve greater risk, but, investments also yield much greater returns when left alone long enough to ride out the turbulence of the stock market.

Examples of savings

Emergency Fund

When an emergency happens, the money is needed immediately. The emergency fund, therefore, should be in a very boring account, such as a Savings Account or Money Market Account. One could also consider an online high interest account, as long as the funds are easily accessible. Its purpose is not to make a bunch of money; it is there for emergencies.

Car Fund

You DO save up and pay cash for your cars, don’t you? This money should be saved, not invested. Why? Because you don’t want to take the risk of a market plunge just when you are ready to buy.

Anything else you will need to pay cash for

What are you saving for (notice the word “saving”)? A home improvement (or repair), a riding lawn mower or a new computer are all examples of saving: you will need a set amount on a set date.

College Funding (sort of)

Should college funding be an investment or saving? It depends on how soon Junior is going to be entering college. If college is 18 years away, the money should be invested (make sure you use an ESA or 529 plan to get all of the tax breaks). But what if college starts four years from now? You don’t want the risk of your investments tanking just when that first tuition payment comes due. The choice is yours, but I think you should be moving those funds to a less risky vehicle (maybe even a savings account) as the time of need approaches.

Examples of investments

Retirement

Yes, retirement is the big one and retirement funds should definitely be considered investments. However, like college funding, the retirement nest egg should be made safer as the time of need draws closer.

Starting a business

If you have a long range plan to start up a business (say 10 to 20 years from now), you should be investing to achieve the nest egg needed.

Breaking it down

The difference between investing and savings is really quite simple. If you are going to need the money in the near future, save it. If you aren’t going to touch the money for a longer time frame, invest it. The trick is defining this time frame. Financial guru Dave Ramsey uses five years as his criteria. His rationale is that the stock market has historically made money in 93% of the five year rolling time frames and in 100% of the rolling ten year periods. Most of us are aware that the recent recession changed those percentages, and I heard Dave Ramsey recently say that the stock market has made money in 100% of all rolling fifteen (no longer ten) year periods. However, as far as I know, Dave still uses the five year criteria to distinguish saving from investing.

What do I think about the five year guideline?

I am OK with it. If I know I will need to tap the money in five years or less, I consider it savings. Our emergency fund and car fund are both in Money Market Savings Accounts. On the other hand, if I am not planning to touch the money for longer than five years, I invest it. Our traditional and Roth IRA’s are examples of our investments.

I also have a sort of hybrid investment fund. I am currently involved in flipping a house. This is clearly an investment, with money tied up in the house. However, when we sell the house, I plan to keep this money quite liquid and available (like a savings account) so I can be poised to buy another flip house. I say hybrid, because I would at that time have an investment that I am treating like savings.

How about you? Do you have a clear guideline to distinguish saving from investing? What is that guideline?

photo credit: Ken Wilcox.

The House We Will Be Flipping

When our son Jonathan approached us with the prospect of flipping a house, I listened. As part of his duties with his current employer, Jonathan has earned his boss some decent income by overseeing the purchase and resale of two houses in our community.

In this post and upcoming posts, I plan to chronicle the process, the strategy and the results of our current house flipping experience. I probably won’t reveal any dollar amounts until all is done, and even then I will wait and see. But this is a new adventure for me, so come along.

Our House Flipping Discussion

Jonathan, “I have a proposal for you to think about. I know about an estate auction that includes a house on North Acre Lane in Jonesboro. I am not in a position to do it alone. Are you interested in partnering with me to try to flip this house?”

Me, “Sure, I am interested, but your mom and I will need to talk this over before I can give you an answer.   This is interesting timing because Janice and I have recently been talking about some real estate investments.    I’ll have to get back with you.”

Jonathan, “Sounds good to me.”

I then spoke to Janice, who was immediately interested. I might mention that Janice, our design expert, is an integral part of this team. She is visually artistic, with the ability to “see” how the project will look before we start. She is also good at checking and comparing prices. Janice did the design (including scale drawings complete with wiring, lighting, appliances, etc.) of the remodeling in both Jonathan’s most recent house and our current house.

Figuring our Bid

Jonathan set up a meeting for the auctioneer to let us into the house. We measured, looked, talked, looked and talked some more. This house is a single level, 1100 SF with three bedrooms, single bath, kitchen and living room (see photo above). Built in the 1950s, it is solid but dated. We agreed that we could do cosmetic work to most of the house (new flooring and replace the dark paneling with drywall), but the bath and kitchen need upgrading. We plan to replace the kitchen cabinets, add a dishwasher, remove most of the wall between the kitchen and living room and add an island to the kitchen. The bathroom layout is awkward, with the toilet in a corner near the hot water heater, so we plan to move the toilet, replace the fiberglass tub/shower with a new tub, add a shower, and install twin pedestal bathroom sinks.

Janice went to work making the drawings and checking prices. The three of us then met for several hours to tabulate our remodeling budget and figure our bid. Jonathan’s market price research matched the number I had come up with by the seat of my pants. We took 70% of our anticipated sale price, then subtracted our remodeling budget to arrive at our bid price. We agreed that we would not bid over that price under any circumstances.

The Auction

This was new to me, but not to Jonathan. Knowing that the house would be auctioned first (before the rest of the estate), I arrived an hour early just to get a feel for the process. Because this was an estate auction, I shouldn’t have been surprised by the crowd, but I was. I had to park a block away.

Jonathan arrived fifteen minutes before the auction began. We learned that a 5% buyer’s fee would be added to the bid, so we adjusted our maximum bid accordingly.  The auctioneer patiently explained the bidding rules in a very normal voice and then launched the bidding with typical auctioneer hyper-jibberish.  Others were bidding, but Jonathan refrained,  causing me to squirm. “What”, I wondered, “if the auctioneer ends this auction before we ever bid?” I elbowed him, but he smiled and told me not to worry. When the price got within about $10,000 of our maximum bid, Jonathan bid. Several others backed out and suddenly it was us and one other bidder. Our opponent deliberated considerably when it was his turn; Jonathan simply bid when it was our turn. Finally, the other bidder dropped out. We were the winners – at $2,000 less than our maximum bid.

“Jonathan!” I exclaimed. “I thought you were going to let someone else get it before without bidding! Why did you wait?”

“Dad, I knew that the auctioneer wouldn’t end the auction without the ‘Going once! Going twice! Sold!’ routine. So I waited just to keep the other bidders on their toes.”

We paid the earnest money, signed the papers and were on our way to becoming a flip house owner.

As we wait to close on the house, here are my thoughts: good and not so good:

The good

We should make some money.

We realize that most remodeling projects end up costing more than budgeted, but we built considerable margin in our budget to allow for contingencies. We also figured the market price lower than what we think it should bring. One more bonus: the house, inside the city limits, has a HUGE back yard that is accessible from another street.  The house proper sits on a city lot of 0.27 acres and the “back yard” has a separate survey of 0.67 acres.  We could therefore sell the back lot separately from the house and perhaps maximize our investment.  Because we did not figure this possibility into our bid, we are optimistic that it will give us some added cushion.

Doing a project with my son.

Jonathan has a real desire to buy and flip houses. This partnership should help him on the path of realizing his dreams while cultivating some great together time.

The not so good

My summer is booked.

Jonathan works a day job, so we plan to work a few hours nearly every evening to put the project on a fast track.

Doing a project with my son.

What if it doesn’t go as planned? What if we work really hard and then have trouble selling the house? What if we don’t agree on a sales price when those negotiations start? What if we have misunderstandings about each other’s responsibilities? Doing a project with my son could be a great thing, and I am confident it will be.  But, being the realist I am, I also realize that  it could backfire.

Readers: Please share your thoughts. This is my first house flip, so I want you to be brutally honest. What have I done right so far? What could I have done better? Any tips (or questions) as we move forward? Thank you!

photo credit: Kevin Krejci

Assuming you are investing for future retirement, you should seriously consider the Roth IRA (Individual Retirement Agreement). I am already a huge fan of the Roth, but as the national debt increases with federal bailouts and stimulus packages, the Roth IRA is looking better all of the time.

Let me explain. With the traditional IRA, you get to deduct the contribution for the tax year it was made, but you will pay taxes when you start drawing the money out for retirement. The Roth IRA, on the other hand, is purchased after you have paid your taxes and is therefore tax free when withdrawn. When deciding which one is best for you, conventional wisdom is that if you believe you will be in a lower tax bracket when you retire, you are better off with the traditional IRA. Why? Because you were able to claim a tax deduction at a higher percentage, but pay those taxes later at a lower percentage.

But I ask: do you seriously believe that the tax structure when you retire will be essentially the same as it is today? Is it possible that even if your retirement income is less than your working income, your tax rate could be higher than it is today?

Why The Roth IRA is a Good Choice

Our current national debt is $10 trillion and climbing by the second. My longhand math (calculators don’t have that many zeroes) indicates that we owe $30,000 for every man, woman and child in America. To compound the problem, the Social Security Trust Fund is scheduled for depletion in about 30 years unless “something” is done. That “something” will have to be raising taxes or lowering benefits. As I see it, Congress has four possible choices:

1. We could spend less than we make. A great choice, but nowhere on the radar.
2. We could print more money, but doing so will raise inflation rates, maybe to hyperinflation. Not a good choice.
3. We could sell more Treasury Bonds, but our national debt is making these bonds more and more risky. Besides, neither families or nations can borrow their way out of debt.
4. We can raise taxes. Again, not a good choice, but, in my mind, one that will happen.

Our future tax structure is very uncertain because of our national crash course with debt. Are higher income taxes a certainty? No, but in my thinking a very high probability. Although I am already retirement age, I invest in a Roth IRA every month. I just feel better about paying my taxes today, knowing that they are fully paid today and will never be impacted by future tax increases. That, for me, is a very good feeling.

Update: Consumer Boomer did an excellent job recapping all the Roth IRA limits.  Be sure to check it out.

photo credit: stuartpilbrow

You have come to the conclusion that you and you alone are responsible for your retirement. Good for you. You have decided to use an IRA (Individual Retirement Arrangement) as the vehicle to accomplish your goals. Good for you again. Now you are struggling with whether you should use the Traditional or the Roth IRA. Hopefully, this article will help you with this decision.

First some quick definitions on the rules of the Traditional IRA Account and Roth IRA Account:

While both plans are considered tax advantaged, they differ in how the taxes are handled. A Traditional IRA gives the contributor an IRS deduction for his annual contribution to the plan, but the retiree is required to pay income taxes when he accesses the money. With a Roth IRA, the contributor gets no tax deduction at the time of the contribution but pays no taxes when drawing the money out.

Because of these different tax treatments, conventional wisdom is that if you think you will be in a lower tax bracket upon retirement, you should choose the traditional IRA. Why? Because you would have received a deduction at a higher rate when contributing and paid the taxes back at a lower rate when receiving the money.

Roth IRA Vs. Traditional IRA Examined

To prove this point, let’s compare two people who make exactly the same salary and are both in a 20% tax bracket. Jill chooses to contribute $300 a month to a Roth IRA. Jack chooses to contribute an equitable amount to a Traditional IRA. This equitable amount will be $375 a month. How did I get $375? Because Jack is using a Traditional IRA, he will claim a 20% deduction of his contribution, which is $75. $375 – $75 = $300, which is Jill’s contribution. Are you with me so far? Another way to view this is that both make the same salary and, with this illustration, both will receive the same net pay after their contributions.

Assuming that both continue their contributions for 30 years and are able to get a 10% annual rate of return for the 30 year period, Jill would have a nest egg of $678,146 while Jack’s nest egg would be $847,683. Who did better? It depends on the tax rate Jack would have to pay when drawing his money down from his traditional IRA. If that tax rate is still 20%, we have a tie because $847,683 less 20% taxes equals $678,146…the exact same amount of Jill’s nest egg. Obviously, if Jack could get by paying less than 20% upon retirement, the traditional was the better plan; if he pays more than 20%, the Roth would have been the better choice.

So how does this example help you with your decision?

photo credit: m0bile

If you KNOW that you will be in a higher bracket, you should go with the Roth. If you KNOW that you will be in a lower tax bracket upon retirement, you should probably consider the Traditional. I said “probably” because there are other advantages of the Roth that could sway you that direction even if you do end up in a lower bracket. What are these differences?

• Contributions to a Roth can be withdrawn tax free at any time. The Traditional would require you to not only pay the taxes but also a penalty. Note: you shouldn’t tap your retirement savings for any reason except for an extreme emergency. But should that extreme emergency happen, the Roth is clearly advantageous. The Roth IRA withdrawal rules can be tricky, so make sure you understand all the consequences.

• You can withdraw up to $10,000 in earnings tax free from your Roth in order to acquire a principal residence for a first time buyer. Again, not something I recommend, but this is an option with the Roth and not the Traditional.

• Unlike the Traditional, the Roth does not require minimum distributions at age 70 1/2. Why? Your Uncle Sam has given tax deductions for that Traditional IRA nest egg and, if you haven’t started paying him back by age 70 1/2, he will force you to. Because any withdrawals from the Roth are tax free, your Uncle has no incentive to force you to take them.

• The Roth covers you for future tax increases. With our National Debt spiralling upward, tax rates are more likely to increase than decrease by the time you retire. With the Roth, you have already paid your taxes, so future increases will not affect you.

These are not the only differences between the plans, and you would do well to talk to a Certified Financial Planner or Estate Planning professional for further details and how they apply to your situation. What do I think? I think that you should always choose the Roth unless you are absolutely certain that your tax rate will be lower when you retire.