New York Times Analyzes Roth IRAs

The Tuesday, July 21st edition of The New York Times had an article titled “Converting an IRA Into a Roth? How’s Your Crystal Ball?”. Naturally, this got our attention. Jim Lange was at the forefront of the Roth movement when he wrote the first peer-reviewed article on Roth IRAs for The Tax Adviser in 1998. Since then, Roth IRAs and Roth IRA conversions have been Jim’s passion.

For many taxpayers, Roth IRAs have not been on their radar because of the income limitations. Currently, if your household’s adjusted gross income is over $100,000, you don’t qualify for a Roth conversion. However, a big change is about to take place. Starting January 1, 2010, all taxpayers will be eligible for a Roth IRA conversion regardless of income. If you are unfamiliar with Roth IRAs, here’s how they work. With a traditional IRA, you take a tax deduction now and pay income taxes when you withdraw the money. With a Roth IRA, you pay the taxes up front and then your money continues to grow income tax-free for the rest of your life and, perhaps, even the lives of your children and grandchildren.

As we get closer to the tax-law change in 2010, not only is interest in Roth IRAs heating up, but so is speculation that the rules may change down the road. The New York Times article suggests that in the worst case senario, the federal government might try to tax the earnings on a Roth IRA after all. Or, perhaps, the feds might impose a penalty tax on excessive balances. This argument is especially hot right now considering the massive and growing federal budget deficit.

Others believe that Roth IRAs will remain the same, but all other accounts would change to be like them. That means contributions to traditional IRAs would no longer be tax-deductible and pretax savings in 401(k)s and similiar plans would also stop.

Does that mean that you shouldn’t consider a Roth IRA conversion? Not at all. As The New York Times also mentions, many advisors believe that Roth IRAs will not only remain the same, but will become even more valuable if income tax rates increase.

If you’ve ever been to one of Jim Lange’s Roth IRA workshops, he answers the question about a possible tax-law change governing Roth IRAs by pointing out that Roth IRAs are part of The Internal Revenue Code (as opposed to Social Security taxes – which were never part of The Internal Revenue Code). If this law were suddenly changed and taxes imposed at withdrawal, Jim has said in his workshop that this would be “a violation of due process, a violation of the constitution, and you would have a very well-financed revolution”.

Listen to the July 15th edition of The Lange Money Hour which featured one of America’s top IRA experts, Natalie Choate, and you’ll find that Jim and Natalie both agree with two other points made in The New York Times’ article. First of all, if you don’t have the money to pay for the taxes on a Roth IRA conversion outside of your retirement plan, you should probably not convert.

Secondly, it’s not a good idea to do a 100% conversion. As Natalie put it, “don’t put all your money on one horse”. It’s not a good idea to ignore the Roth IRA, and it’s also not a good idea to have all of your money in a Roth IRA. Diversification is key.

Jim Lange and the rest of our team are still very excitied about the possibilities ahead with Roth IRAs and Roth IRA conversions. If you’re wondering what to do, we recommend a professional analysis of your situation. It’s possible that a series of small conversions would work best for you. The professional staff here has been doing thorough Roth IRA projections for years. You don’t have to wait until 2010 to get started – for help, call the office at 800-387-1129.

Michael Jackson’s Estate

Posted on July 14, 2009 by James Lange in 401(k), IRAs, Roth IRA Conversions.

The circus surrounding Michael Jackson’s death and estate will, no doubt, continue for months, possibly years. No matter what you may think of Michael Jackson personally, we can all learn some lessons from the way that Michael set up his affairs.

For starters, Michael took the time to consider the matter of guardianship for his children. Some believe that his choice is unwise – naming his 79 year-old mother, Katherine, as guardian and 65 year-old singer Diana Ross as contingent guardian. The important thing to remember is that Michael obviously gave this considerable thought and wanted to make sure that his wishes were known. It’s very important that all parents of minors do the same thing and take the responsible step of putting their wishes in their will.

Michael’s will was relatively straightforward — have a look for yourself – http://www.docstoc.com/docs/8016703/Michael-Jacksons-Will. The will is a pour-over will which basically says that all money or property that has not already been transferred into a trust should be transferred into a trust at the time of death. For medium or large estates, a pour-over will with a family trust is an excellent way to avoid probate and to maintain some privacy since details of a trust are, in most states, not a matter of public record.

Sorting out the details of Michael’s financial situation will take quite some time. One of the reasons is that much of Michael’s estate was not liquid. The value placed on his main asset, a 50 percent interest in the Sony/ATV music catalog, has been reported to be worth anywhere from $500 million to $1.5 billion. In addition, the estate is burdened by personal debt in the neighborhood of $500 million.

One lesson to be learned from this example is that if you have assets that are hard to value and not terribly liquid, you should consider life insurance. If set up correctly, the life insurance proceeds would be tax-free and could be used to pay debts of the estate and taxes on the estate.

Finally, a piece of advice in the event that you leave behind a 401(k) plan. While little is known about Michael Jackson’s estate planning, let’s assume that he got good advice and had set up a 401(k) plan. If the 401(k) plan was left to Michael’s children, they could make a Roth IRA conversion of that plan in 2010. They would pay income tax on the plan now, but all future growth of the plan would be income tax-free. Considering the ages of Michael’s children, the difference would be measured in millions of dollars over their lifetime.

One interesting side note – if Michael had put his money into an IRA instead of a 401(k), his children would not have the option of making a Roth IRA conversion of the inherited IRA. The ability of heirs to make a Roth IRA conversion is just one of the potential benefits of keeping your money in an existing 401(k) plan instead of doing a rollover to an IRA.

These lessons taken from Michael Jackson’s estate just scratch the surface. There is much to be learned in the way Michael dealt with his estate while alive and we have put together a more in-depth article which you can access through our homepage by clicking on articles. We will also be including this piece in our next newsletter. If you aren’t receiving our newsletter, it’s easy to sign-up. Go to the homepage of this website and click on e-newsletter sign-up on the left-hand side.

New Alternative to LTC Insurance

Posted on July 6, 2009 by James Lange in Educational Resources, Life Insurance and tagged LTC insurance.

If you’re one of the millions of baby boomers approaching your golden years, you’ve probably given consideration to the purchase of LTC (long-term care) insurance. You may also be concerned that you’d be throwing your money away. It’s possible that you could pay a lot in premiums and never need the coverage.

Jim Lange has always felt that if a husband and wife had enough money to provide for both of their potential long-term care expenses, they were really just insuring their estate. In that case, Jim would typically advise that life insurance was a more certain bet.

Now there’s an alternative to LTC insurance and that was the topic on the July 1st edition of The Lange Money Hour: Where Smart Money Talks. Guest Tom Hall of Capitas Financial/Pittsburgh Brokerage explained the ins-and-outs of a relatively new hybrid product that is essentially a life insurance policy with a long-term care rider.

It works like this — if you need long-term care, the insurance company will pay for your care. The amount the insurance company pays you will be subtracted from your death benefit. If you never need long-term care, your life insurance death benefit will remain the same.

All of this is acheived with a single premium that is significantly lower in cost than separate LTC and life insurance policies. Plus, if you do need to tap into the long-term care coverage, you will be withdrawing the money income tax-free. In this way, this hybrid policy becomes an effective estate planning tool. You avoid the possibility of dipping into your retirement plans and paying taxes upon withdrawal.

Tom Hall pointed out that, just like any other policy, you can be turned down for this hybrid product. However, it also works the other way. Some people who don’t qualify for LTC coverage may qualify for life insurance with an LTC rider.

By the way, if you currently have a life insurance policy, you can’t just call your agent and add an LTC rider. An entirely new policy needs to be put in place.

We’d also like to thank the listener who emailed the question asking what happens to your premiums if your insurance company goes bankrupt. We’re glad she asked because it gave Tom the chance to explain that in Pennsylvania, if your insurance company fails, you are protected for up to $300,000.

Of course, this hybrid product isn’t for everyone — in some cases, straight LTC coverage might still be the better idea. Each case needs to be evaluated on its own. As always, the Lange team is happy to provide you with a thorough analysis — just contact the office toll-free at 800-387-1129.

Tax Issues With Job Loss

Posted on June 25, 2009 by James Lange in Roth IRA Conversions and tagged James Lange, unemployment compensation.

Despite the fact that there have recently been encouraging economic signs, the national unemployment rate continues to inch higher. At the end of April, the unemployment rate was 8.9%. By the end of May, it stood at 9.4% and in a June interview with Bloomberg News, President Barack Obama predicted that the country will soon see a 10% unemployment rate.

As shocking as it is to lose a job, it’s even worse when you suddenly realize that there are also tax consequeneces to deal with. Be aware that severance pay and unemployment compensation are taxable. Payments for accumulated vacation or sick time are also taxable. Make sure that enough taxes are withheld from these payments or arrange to make estimated payments.

There is one bright spot — you get a bit of a break this year thanks to the American Recovery and Reinvestment Act of 2009. This new law temporarily excludes up to $2,400 of unemployment compensation from a recipient’s gross income. Remember, this is for 2009 only and anything over $2,400 is fully taxable.

Sometimes unemployed individuals resort to withdrawing money from their IRAs and qualified retirement plans. This creates another tax issue and is not a course of action that we recommend. Generally speaking, if you withdraw money before you reach eligible age and don’t roll it into another plan within 60 days, that amount must be reported as taxable income. One exception allows an umemployed individual to take penalty-free distributions from an IRA to pay health insurance premiums. This exception does not apply to qualified plans. In addition to possible taxes, your IRA or qualified plan withdrawal may be subject to a 10% tax on the early distribution.

The other big question is whether or not expenses incurred while looking for a new job are tax deductible. Don’t rely on your peers for the answer to this question! Check with a tax professional or see IRS Publication 529, Miscellaneous Deductions. As a rule, you can deduct employment agency fees, resume preparation and travel expenses associated with job interviews.

The Lange team sincerely hopes that unemployment tax issues aren’t something you have to deal with this year. However, if you find yourself in this situation, you can get detailed information at www.irs.gov.

We also suggest that if you are facing unemployment, but have the means to make a Roth IRA conversion, you give it serious consideration. You would likely be in the lowest income-tax bracket of your life — the perfect time to make a Roth IRA conversion. As always, our office is available to help with Roth IRA conversion analysis.

Review of Retire Secure!

Posted on June 19, 2009 by James Lange in 401(k), Roth 401(k), Roth IRA, Roth IRA Conversions and tagged Estate Planning Magazine, James Lange, Nancy Shurtz, Retire Secure.

Big thanks to Nancy Shurtz, Senior Editor of the Media/Book Products Committee of the ABA’s Real Property, Trust and Estate Law Section for her in-depth review of the 2nd edition of Retire Secure! Pay Taxes Later. The entire office was thrilled when we received a copy of the June 2009 edition of Estate Planning Magazine and discovered that Nancy had rated the book highly recommended.

We appreciate that Nancy obviously took the time to thoroughly read the 2nd edition and even make a comparision to the first edition. She noted that one of the chief differences between the two editions is Jim Lange’s discussion of the family of Roth retirement vehicles which is weighed against traditional retirement vehicles.

If you have a copy of the book and want to take a look at the comparisons between a Roth 401(k) and a traditional 401(k), turn to Chapter 3 starting on page 49. One of our favorite chapters is Chapter 7 which explains Roth IRA conversions and the big tax law change coming up in 2010 that makes all taxpayers eligible for a Roth IRA conversion regardless of income (begin on page 127).

In her review, Nancy mentions that one of the strengths of the book is the proportion devoted to estate planning issues — including themes like charitable giving, beneficiary and survivorship issues and the role of trusts in estate planning. She wraps up by saying, “This book is a great read, full of illustrative (and entertaining) stories, but also full of practical advice”.

It’s always nice when your hard work is recognized and we’re thankful for Nancy’s attention. Nancy is also a chaired professor at the University of Oregon School of Law in Eugene and you can read her complete review on page 42 of this month’s Estate Planning Magazine.

Keep in mind that if you do not yet own a copy of the 2nd edition of Retire Secure! Pay Taxes Later: The Key to Making Your Money Last, you can return to the home page and click the Order Now button (you’ll be directed to the order page on amazon.com).

Making Work Pay Credit

Posted on June 11, 2009 by James Lange in Income Tax, IRS and tagged James Lange, Making Work Pay Credit.

For the past couple of months, you’ve probably noticed a little extra money in your paycheck. Those extra few dollars are thanks to the Making Work Pay Credit which was part of the American Recovery and Reinvestment Act of 2009 signed into law by President Obama in February.

While you’re no doubt grateful for the extra cash, you may be wondering exactly how this works. The Making Work Pay Credit is administered through a reduction in wage withholding and provides up to $400 per individual worker and $800 per working married couple. However, this credit phases out for individuals whose modified adjusted gross income (MAGI) exceeds $75,000 or $150,000 in the case of married couples filing jointly.

The amount of credit you receive will be reported on your 2009 income tax return, but it’s not taxable and you won’t have to pay it back if you received the correct amount. If, for some reason, you do not have taxes withheld this year, you can claim a lump sum credit on your 2009 return.

Since these changes will be made automatically through your withholding, most taxpayers can sit back and relax and enjoy the additional spending money. However, there are potential problems for some taxpayers and we don’t want you to be caught off-guard.

For instance, if you are claimed as a dependent on someone else’s return, you do not qualify for the Making Work Pay Credit. College students, in particular, need to be aware of this restriction. These taxpayers will have to return any credit paid to them — either through a payment to the IRS or through a reduced refund.

Married couples who both work should also be very careful about “over withholding”. This can happen if each spouse’s employer makes the adjustment, but the couple’s combined income hits the phase out amount. If this is the case, make adjustments now so that you don’t have a problem next April. Either adjust your form W-4 or set money aside.

It’s also important to note that only individuals with earned income qualify for the Making Work Pay Credit. If you do not have earned income, you are not eligible for the credit.

To be sure that you don’t have any unpleasant surprises when you’re filing your 2009 tax return, it’s a good idea to take a look at your withholdings now. The few minutes it will take to do this could save you headaches down the road. Then, if you’re still concerned, make adjustments now or talk to your tax professional.

One more suggestion from the Lange team — if you are in a position to save rather than spend the credit, you may want to consider using that money towards covering the taxes on a Roth IRA conversion. Let’s take the example of a married couple in the 15% tax bracket. They qualify for both the Make Work Pay Credit and a Roth IRA conversion. Assuming they have IRAs, they could do a $5,000 Roth IRA conversion and use the $800 tax credit to pay the $750 of federal income taxes due on the conversion (with $50 left to treat themselves to dinner).

Beneficiary Designations in a Second Marriage

Posted on June 5, 2009 by James Lange in Educational Resources, IRAs, QTIP Trusts and tagged James Lange.

Estate planning can be tricky to begin with — toss in a second spouse and children from different marriages and relationships and it becomes even more difficult.

Recently, Jim Lange came across an article in the Pittsburgh Post-Gazette that dealt with the estate planning challenges caused by divorce and remarriage. The example that was used was that after 15 years of a second marriage, a husband was getting ready to retire with $1 million in his IRA. His second wife was shocked to learn that she had no ownership rights to the account.

One of the proposed solutions listed in the article was a tool called a QTIP trust (qualified terminable interest property trust). In this case, a QTIP trust would be listed as the beneficiary of the husband’s IRA and would then provide an income stream for the surviving spouse while protecting a portion of the assets for the children.

Jim thinks that this is the wrong approach and offered his solution in a letter to the editor. Jim’s first point is that naming a QTIP trust as the beneficiary of an IRA accelerates income and taxes to the detriment of both the surviving spouse and the children. The surviving spouse is left with only an income stream and the kids don’t inherit anything until the second spouse dies. He’s also concerned about the fees generated by the QTIP trust solution — attorneys have to be paid to draft the trust and annual CPA and trustee fees have to be paid after the first death.

Instead, Jim prefers to leave a certain percentage of the IRA to the surviving spouse and give the rest to the children of prior marriages. It’s a simple solution that provides more money for the heirs and less for the IRS.

Coincidentally, the topic of the June 3rd edition of our radio show, The Lange Money Hour, was trusts — so, we started the show with a discussion about the Post-Gazette article. A special thank-you to a guest who agreed to join us on short notice — Tom Crowley, Senior Wealth Planner and VP at PNC Wealth Management. While Tom agreed with Jim about the tax consequences of naming a QTIP trust as beneficiary of an IRA, he pointed out that in his practice, some clients are willing to sacrifice more money in taxes in order to gain greater control over the distribution of the funds.

During the rest of the show, Jim went on to explain the ins and outs of various trusts including living trusts, spendthrift trusts, charitable trusts and trusts for minors. Keep in mind that every case needs to be evaluated on an individual basis. If you have questions about any of these trusts or think that you need a thorough review, be sure to call the office at 412-521-2732 and a member of the Lange team can help.

Tax-loss Harvesting — Reduce Your Taxes

Posted on May 28, 2009 by James Lange in IRS and tagged Bob Keebler, James Lange, Tax-loss Harvesting.

Possibly the single most important tool for reducing your taxes is tax-loss harvesting. Usually, tax-loss harvesting is done at the end of the year. But, as Jim Lange and radio guest Bob Keebler pointed out during the May 20th edition of The Lange Money Hour, the current down market has created an opportunity to harvest losses right now.

Bob is a partner with Virchow, Krause & Company in Wisconsin and has been busy all year executing this strategy for his clients. (By the way, congrats to Bob on being named one of the Top Most Influential CPAs in America by CPA magazine 4 out of the last 6 years).

If you have never used this strategy before, tax-loss harvesting is the art of selling securities at a loss in order to offset a capital gains tax liability. It truly is an art and Bob strongly advised against trying to execute this strategy yourself. Turn first to your trusted financial professional for their advice.

The key to this strategy is to take losses at their deepest point without getting out of the market completely. As Jim and Bob mentioned, you don’t want to miss a good run in the market. Therefore, a slow and methodical approach to tax-loss harvesting is the way to go.

What if you’ve accumulated thousands of dollars in losses, but don’t have an equal amount in capital gains? There are a couple of things to consider — a capital loss can offset only $3,000 of ordinary income as adjusted to your AGI (Adjusted Gross Income). The good news is that tax losses may be carried forward onto future tax returns.

If you have the bright idea that you can buy an asset and sell it solely to pay less taxes, you’ll have to think again. The IRS figured that taxpayers would try this, so their rule is that your loss won’t be allowed if you purchased the same asset within 30 days.

Tax-loss harvesting takes some serious analysis, but the results can be well worth it — especially in this down market. Jim and Bob’s final piece of advice was to sit down with your CPA now if you have losses. Don’t wait until the end of the year when the market may be on a rebound.

Thanks again to Bob for his great advice. His material is always incredibly helpful and informative and his latest product is designed to make the complicated topic of IRAs easy to understand. It’s called The Big IRA Book (literally big with 11 x 17 pages) and is packed with charts, graphs and tools to help you make informed decisions. For more information, call 800-955-0554.

As always, if you’d like to listen to Jim and Bob, the audio is available on this website.

The Importance of a Safe Withdrawal Rate

Posted on April 23, 2009 by James Lange in Uncategorized and tagged James Lange, Paul Merriman, Safe Withdrawal Rate.

Now that tax season is behind us (thanks to the whole Lange staff for another great year), we are working on a newsletter that will direct you to some outstanding resources designed to help you with your financial planning. If you are not currently receiving our newsletter, sign up for the e-newsletter on retiresecure.com.

One area that we think deserves special attention, especially since most portfolios have dropped in value, is a review of the sustainable withdrawal rate during retirement. A good plan is critical to ensure that you don’t outlive your money.

With that in mind, Jim invited Paul Merriman to be his guest on his radio show, The Lange Money Hour, on April 22nd. Paul is the author of “Live It Up Without Outliving Your Money” and founder of Merriman, an investment advisory firm based in Seattle that manages over $1 billion in assets.

Both Jim and Paul agree that many variables come into play when trying to determine a safe withdrawal rate. You have to consider the client’s portfolio, age, risk-tolerance, other sources of income and current market conditions. An excellent article on the subject can be found on Paul’s website www.FundAdvice.com. On the right hand side of the home page – under articles – click on ‘Retirement: When Your Portfolio Starts Paying You.’

Jim and Paul also discussed what they consider to be the number one mistake that most investors make. Jim believes the number one investment mistake is letting your emotions guide you (instead of logic.) Paul believes the biggest investment mistake is trusting in the wrong people. For instance, many investors act on financial advice solely from their co-workers or relatives. Paul says that you can’t even trust Wall Street – believe the academics instead – they have the research to back up their claims.

It was another show filled with great advice — thanks to Paul for taking the time to join us. If you missed the show, look for the complete audio on retiresecure.com the week of April 27th.