Reduce Taxes on S Corporation Dividends
There's a trick to lowering your tax bill, but the IRS is watching S corporations closely.
By Peter Blank
April 11, 2007
My husband and I are the only shareholders of our S corporation. I have heard that we can pay ourselves dividends to reduce the tax imposed on a portion of the corporation's income.
Peter responds:
The trick is to pay yourself less salary and take more of the S corporation's profits as dividends. This way you avoid FICA and Medicare taxes on the dividends.
But be careful. IRS is currently auditing thousands of S firms whose owners took unreasonably low salaries (or no salaries) to maximize their payroll tax savings. Remember the old saying ... Pigs get fat, but hogs get slaughtered.
To learn more about the tax implications of owning a business, see the Kiplinger Taxopedia.
Source: Kiplinger.
Showing posts with label Build Wealth. Show all posts
Showing posts with label Build Wealth. Show all posts
Thursday, April 12, 2007
Wednesday, April 11, 2007
Where to Park Your Tax Refund?
Smart Places to Park Your Refund
You can earn 5% or more with these low-minimum, low-risk accounts.
By Joan Goldwasser
May 2007
Dreaming about how to spend your tax refund? Maybe this is the year to wake up and save some of it instead. If you haven't filed yet, you can still take advantage of the new split-refund option and request that your money be deposited electronically into as many as three separate accounts. But even if you're waiting for a check in the mail, you can squirrel away at least some of your windfall for the future.
With the average refund more than $2,000, you could be halfway to maxing out your IRA contribution for 2007. (If you are 50 or older, you can put an extra $1,000 into an IRA this year.) Or you could direct some or all of your refund to a 529 college-savings plan. Or you might just want to stash some cash in a low-minimum, high-yield savings account (many are paying more than 5% interest). That's money you could use to boost your emergency fund, pay off high-interest-rate credit-card debt -- or save for a small splurge.
Money-market funds. Deposits in taxable money-market mutual funds are not federally insured, but the funds maintain a $1 share price, so your principal is guaranteed to remain intact. For example, anyone can open an account in AARP Money Market fund (800-958-6457; www.aarpfunds.com) with as little as $100. The fund was recently yielding 5.14%, and you may write an unlimited number of checks as long as they're for at least $250. With TIAA-CREF Money Market (800-223-1200; www.tiaa-cref.org), yielding 5.09%, you may write only 24 checks a year and you might have to add to your refund check to meet the $2,500 minimum. At 5.08%, Transamerica Premier Cash Reserve (800-892-7587; www.transamericafunds.com) was yielding a smidgen less than the other funds. The minimum deposit is $1,000, and you may write as many checks as you like. Tax-free funds, which invest in municipal bonds, don't make sense now unless you are in the highest tax bracket or live in a high-tax state.
Bank money-market deposit accounts, particularly those offered by online banks, offer competitive rates these days, and your account is insured up to $100,000 by the Federal Deposit Insurance Corp. You could recently earn a 5.31% yield at UFBDirect.com or 5.30% at iGOBanking.com, with no minimum deposit. OneUnitedBank.com offers a yield of 5.30%, with a $1,000 minimum. With all three, you may make six preauthorized withdrawals a month.
Savings accounts. All bank savings accounts are insured up to $100,000 by the FDIC. HSBCDirect.com is offering a hefty 6% until April 30, after which your account will earn 5.05%. You can link your account to a checking account at any bank or use your HSBC ATM card. E*Trade.com and EmigrantDirect.com also offer no-minimum accounts that pay 5.05%. If you're willing to sacrifice a little return for ease of setup, a no-minimum Orange savings account from ING Direct yields 4.50%.
Online banks are also wooing depositors with generous yields on FDIC-insured certificates of deposit. For example, UmbrellaBank.com was recently offering a six-month CD with a 5.40% yield. Ascencia Bank was offering both six-month and one-year CDs yielding 5.40%. NetBank.com was offering six-month CDs at 5.40%, one-year CDs at 5.45% and five-year CDs at 5.40%.
Get smart. Although you may look forward to receiving a chunk of cash each spring, think again. You're giving Uncle Sam an interest-free loan. Wouldn't you rather get bigger paychecks all year long? You can. Just file a new W-4 form with your employer. To recompute the amount you send the government, use our calculator at kiplinger.com/tools/withholding.
Source: Kiplinger
You can earn 5% or more with these low-minimum, low-risk accounts.
By Joan Goldwasser
May 2007
Dreaming about how to spend your tax refund? Maybe this is the year to wake up and save some of it instead. If you haven't filed yet, you can still take advantage of the new split-refund option and request that your money be deposited electronically into as many as three separate accounts. But even if you're waiting for a check in the mail, you can squirrel away at least some of your windfall for the future.
With the average refund more than $2,000, you could be halfway to maxing out your IRA contribution for 2007. (If you are 50 or older, you can put an extra $1,000 into an IRA this year.) Or you could direct some or all of your refund to a 529 college-savings plan. Or you might just want to stash some cash in a low-minimum, high-yield savings account (many are paying more than 5% interest). That's money you could use to boost your emergency fund, pay off high-interest-rate credit-card debt -- or save for a small splurge.
Money-market funds. Deposits in taxable money-market mutual funds are not federally insured, but the funds maintain a $1 share price, so your principal is guaranteed to remain intact. For example, anyone can open an account in AARP Money Market fund (800-958-6457; www.aarpfunds.com) with as little as $100. The fund was recently yielding 5.14%, and you may write an unlimited number of checks as long as they're for at least $250. With TIAA-CREF Money Market (800-223-1200; www.tiaa-cref.org), yielding 5.09%, you may write only 24 checks a year and you might have to add to your refund check to meet the $2,500 minimum. At 5.08%, Transamerica Premier Cash Reserve (800-892-7587; www.transamericafunds.com) was yielding a smidgen less than the other funds. The minimum deposit is $1,000, and you may write as many checks as you like. Tax-free funds, which invest in municipal bonds, don't make sense now unless you are in the highest tax bracket or live in a high-tax state.
Bank money-market deposit accounts, particularly those offered by online banks, offer competitive rates these days, and your account is insured up to $100,000 by the Federal Deposit Insurance Corp. You could recently earn a 5.31% yield at UFBDirect.com or 5.30% at iGOBanking.com, with no minimum deposit. OneUnitedBank.com offers a yield of 5.30%, with a $1,000 minimum. With all three, you may make six preauthorized withdrawals a month.
Savings accounts. All bank savings accounts are insured up to $100,000 by the FDIC. HSBCDirect.com is offering a hefty 6% until April 30, after which your account will earn 5.05%. You can link your account to a checking account at any bank or use your HSBC ATM card. E*Trade.com and EmigrantDirect.com also offer no-minimum accounts that pay 5.05%. If you're willing to sacrifice a little return for ease of setup, a no-minimum Orange savings account from ING Direct yields 4.50%.
Online banks are also wooing depositors with generous yields on FDIC-insured certificates of deposit. For example, UmbrellaBank.com was recently offering a six-month CD with a 5.40% yield. Ascencia Bank was offering both six-month and one-year CDs yielding 5.40%. NetBank.com was offering six-month CDs at 5.40%, one-year CDs at 5.45% and five-year CDs at 5.40%.
Get smart. Although you may look forward to receiving a chunk of cash each spring, think again. You're giving Uncle Sam an interest-free loan. Wouldn't you rather get bigger paychecks all year long? You can. Just file a new W-4 form with your employer. To recompute the amount you send the government, use our calculator at kiplinger.com/tools/withholding.
Source: Kiplinger
Monday, April 9, 2007
Best Buys for Your IRA
Best Buys for Your IRA
By Richard Moore
RealMoney.com Contributor
4/9/2007
You can put anything in an IRA, from bank CDs or Treasury bills, which are virtually risk-free, to highly risky investments such as individual Chinese stocks. Where your own IRA investments fall in this range of risk parameters depends on:
The size and character of your overall investment portfolio.
Your individual attitude about taking risk in the financial markets.
How long you have been investing.
How much time you want to devote to managing your own investments.
The term "risk" is usually used to describe the volatility of investment returns. A high-risk investment might be up 100% one year but down 50% the next. This type of volatility is unacceptable to most investors. On the other end of the spectrum, a low-risk investment might increase in value at 3% to 5% per year for many years.
Generally, risk and return are positively correlated: Riskier or more volatile investments tend to produce higher returns over the long run. Investors demand this additional compensation for putting their money into more volatile investments. In general, common stocks tend to provide higher returns over the long term than bonds, and bonds tend to provide higher returns than money-market funds.
Perhaps you are very new to investing and this is the first year you have contributed to an IRA. Let's further assume that this new IRA is the only investment you own, other than a savings account at the local bank that you use as a reserve fund for emergencies. If you're nowhere near retirement, it probably makes sense to put your initial investment in a stock mutual fund or exchange-traded fund.
If, on the other hand, your IRA represents only a small part of your total investment portfolio, it can be much more concentrated. You can use it to house a single security or asset class. Assuming you have a choice about how to balance your investments, it would be advantageous to put the investments that generate the biggest tax bills in an IRA.
For example, if you want to allocate 60% of your portfolio to stocks and 40% to bonds, you should keep the bonds in an IRA. That's because the interest that bonds pay is taxed as ordinary income, whereas the long-term capital gains generated when you sell stocks held for more than a year are taxed at a lower rate. If, like me, you have substantial short-term capital gains due to investment activity, your IRA would be a good place to concentrate that activity.
Another advantage to putting your least tax-efficient investments in IRAs is that it simplifies your tax returns. It's not necessary to report gains and losses on the individual investments held in an IRA, so you won't have to spend hours slaving over Schedule D forms.
The conventional wisdom is that younger investors can tolerate more volatility than older investors because they have a longer-term time horizon. But that doesn't apply to everyone. If you're going to be pacing the floor all night because your portfolio is down 15%, you should only consider an investment approach that severely limits this possibility.
How can you do that? By owning enough short-term fixed-income instruments to dilute the impact of fluctuations in the more volatile segments of your portfolio, usually represented by common stocks.
I'm a strong believer in diversification. If you're just starting out, this means that you will probably want to use mutual funds or ETFs as investment vehicles. Personally, I would recommend going with a low-cost index fund such as those offered by Vanguard, or the use of Spyders (SPY) , an exchange-traded fund that tracks the S&P 500 index, for the equity portion.
There is no evidence that it's possible to pick an actively managed mutual fund that will outperform the overall market over time.
There are also mutual funds and ETFs that track bond indices.
Using index funds and ETFs satisfies a couple of important requirements. First, your portfolio will track the market, reducing your anxiety. You may still lose some sleep when the market is down, but you won't have to worry about your fund underperforming the market. Second, investing in index funds is easy and doesn't require much time. The only thing you need to worry about is occasional rebalancing to keep your portfolio in line with your asset-allocation objectives.
If you have a larger portfolio, you may still want to use index funds or ETFs. There are plenty of alternatives that allow you to track a wide range of assets, including foreign stock markets or individual industries. The more complex the approach, however, the more time you will probably have to spend monitoring your investments.
As I said, my own approach is to reserve my IRA for U.S. common stocks that I usually hold for less than a year. I have other investments outside my IRA, including real estate, fixed income and oil and gas royalties, so my total investment portfolio is well diversified. This approach keeps me very busy, and I spend a couple of hours each day following my stocks and looking for new ideas to invest in. It is time-consuming, but it is something I love to do, and the results so far have made the time spent worthwhile.
Source: The Street.com
By Richard Moore
RealMoney.com Contributor
4/9/2007
You can put anything in an IRA, from bank CDs or Treasury bills, which are virtually risk-free, to highly risky investments such as individual Chinese stocks. Where your own IRA investments fall in this range of risk parameters depends on:
The size and character of your overall investment portfolio.
Your individual attitude about taking risk in the financial markets.
How long you have been investing.
How much time you want to devote to managing your own investments.
The term "risk" is usually used to describe the volatility of investment returns. A high-risk investment might be up 100% one year but down 50% the next. This type of volatility is unacceptable to most investors. On the other end of the spectrum, a low-risk investment might increase in value at 3% to 5% per year for many years.
Generally, risk and return are positively correlated: Riskier or more volatile investments tend to produce higher returns over the long run. Investors demand this additional compensation for putting their money into more volatile investments. In general, common stocks tend to provide higher returns over the long term than bonds, and bonds tend to provide higher returns than money-market funds.
Perhaps you are very new to investing and this is the first year you have contributed to an IRA. Let's further assume that this new IRA is the only investment you own, other than a savings account at the local bank that you use as a reserve fund for emergencies. If you're nowhere near retirement, it probably makes sense to put your initial investment in a stock mutual fund or exchange-traded fund.
If, on the other hand, your IRA represents only a small part of your total investment portfolio, it can be much more concentrated. You can use it to house a single security or asset class. Assuming you have a choice about how to balance your investments, it would be advantageous to put the investments that generate the biggest tax bills in an IRA.
For example, if you want to allocate 60% of your portfolio to stocks and 40% to bonds, you should keep the bonds in an IRA. That's because the interest that bonds pay is taxed as ordinary income, whereas the long-term capital gains generated when you sell stocks held for more than a year are taxed at a lower rate. If, like me, you have substantial short-term capital gains due to investment activity, your IRA would be a good place to concentrate that activity.
Another advantage to putting your least tax-efficient investments in IRAs is that it simplifies your tax returns. It's not necessary to report gains and losses on the individual investments held in an IRA, so you won't have to spend hours slaving over Schedule D forms.
The conventional wisdom is that younger investors can tolerate more volatility than older investors because they have a longer-term time horizon. But that doesn't apply to everyone. If you're going to be pacing the floor all night because your portfolio is down 15%, you should only consider an investment approach that severely limits this possibility.
How can you do that? By owning enough short-term fixed-income instruments to dilute the impact of fluctuations in the more volatile segments of your portfolio, usually represented by common stocks.
I'm a strong believer in diversification. If you're just starting out, this means that you will probably want to use mutual funds or ETFs as investment vehicles. Personally, I would recommend going with a low-cost index fund such as those offered by Vanguard, or the use of Spyders (SPY) , an exchange-traded fund that tracks the S&P 500 index, for the equity portion.
There is no evidence that it's possible to pick an actively managed mutual fund that will outperform the overall market over time.
There are also mutual funds and ETFs that track bond indices.
Using index funds and ETFs satisfies a couple of important requirements. First, your portfolio will track the market, reducing your anxiety. You may still lose some sleep when the market is down, but you won't have to worry about your fund underperforming the market. Second, investing in index funds is easy and doesn't require much time. The only thing you need to worry about is occasional rebalancing to keep your portfolio in line with your asset-allocation objectives.
If you have a larger portfolio, you may still want to use index funds or ETFs. There are plenty of alternatives that allow you to track a wide range of assets, including foreign stock markets or individual industries. The more complex the approach, however, the more time you will probably have to spend monitoring your investments.
As I said, my own approach is to reserve my IRA for U.S. common stocks that I usually hold for less than a year. I have other investments outside my IRA, including real estate, fixed income and oil and gas royalties, so my total investment portfolio is well diversified. This approach keeps me very busy, and I spend a couple of hours each day following my stocks and looking for new ideas to invest in. It is time-consuming, but it is something I love to do, and the results so far have made the time spent worthwhile.
Source: The Street.com
Thursday, April 5, 2007
Roth 401(k) rah-rah chorus
Meet one dissenter from Roth 401(k) rah-rah chorusBy Robert Powell, MarketWatch
Last Update: 8:40 PM ET Apr 4, 2007
BOSTON (MarketWatch) -- To many, the newly introduced Roth 401(k) is the greatest retirement account (along with the Roth IRA) ever created. With a Roth 401(k), one contributes after-tax dollars into an employer-sponsored retirement account in which the money grows (as it does in a traditional IRA) tax-free and (unlike a traditional IRA) is distributed tax-free too.
But while many experts praise the benefits of Roth 401(k)s, there's a lone wolf out there with a contrary point of view, penning articles under such headlines as "Roth 401(k): Dumb and Dumber" and "Roth 401(k): Still Dumber."
What doesn't Lawrence Starr, president of Qualified Plan Consultants, like about Roth 401(k)s? Let us count the reasons.
For starters, Starr says workers have to evaluate which is better from a tax standpoint -- the Roth 401(k) or the traditional 401(k). Typically the experts, including Starr, say that workers who are in a low tax bracket when they contribute to a tax-deferred retirement account and expect to be in a higher tax bracket when they withdraw their funds are better off using a Roth account.
But, according to Starr, very few fit into this category. Those include young workers with little or no income, those in a low income tax bracket because of large deductions for child care and homeownership or those whose income will be significantly higher in retirement.
Most workers, he says, will likely be in a lower or the same tax bracket when they retire. And those folks, he says, are better off with the current tax deduction, the traditional 401(k) contribution.
Yes, there are some experts (and regular Americans as well) who say that tax rates are historically low and are likely to rise over time. And given that prediction, the experts say workers should give up the current tax deduction in the hopes that tax rates will be higher later on.
"That is what I call a dumb solution," wrote Starr in the Journal of Pension Benefits. "The (worker) has to give up a sure thing (the current deduction) for what is just a chance that the future benefit will be more valuable -- dumb move, if you ask me."
Do you trust Congress?
Starr is also not fond of Roth-type accounts for this reason: Congress, he predicts, will likely change the laws in midstream and tax Roth distributions at some point. What's more, he predicts that Congress won't even give Roth account owners the courtesy of being grandfathered.
"We have to count on Congress not to change the laws between now and then that provide Roth-type distributions are tax free," he wrote. And that, he says, is just not a "wise bet" anytime.
Consider, he notes, how Congress has often changed tax laws once thought to be unchangeable. For instance, Congress decided to tax up to 50% of Social Security benefits and no one had the luxury of being grandfathered.
For Roth contributions to be better than traditional 401(k) contributions, you have to give up the deduction in hand, hope to be in a higher tax bracket when you take the money out of the retirement account and hope that Congress doesn't change the rules in between. Says Starr: "There are just too many unknowns for this decision to be sensible for most people."
To be fair, Starr does say Roth IRAs have one big advantage over traditional IRAs. With a Roth IRA, he says, account owners never have to take a required minimum distribution as do owners of traditional IRAs and they can contribute to a Roth IRA well past the usual cut-off age of 701/2. "So, substantially more assets can be socked away for oneself and one's heirs," he wrote.
But in the main, Starr says there are other devil-is-in-the-details issues that make Roth-type accounts dumb and dumber. For instance, workers who contribute to a Roth 401(k) will have a higher adjusted gross income than if they put the money in a traditional 401(k) and that could result in the loss of other tax benefits that have phase out limits, such as child-care tax credit. In addition, a higher adjusted gross income could bring the alternative minimum tax into play.
In addition, it's not yet known how Roth 401(k)s will affect divorce agreements that split retirement accounts in two, the Qualified Domestic Relations Order or QDRO. The lawyers will have to calculate the net present after-tax value of the Roth 401(k) and the traditional 401(k).
Plus, there are some questions about the death benefits when there are multiple beneficiaries and Roth and traditional 401(k) accounts. Will someone get the account with the taxable distributions and someone get the account with the tax-free distributions?
Headaches for employers
What else? Well, for employers, especially small businesses, the problems with Roth 401(k)s are many. For one, small business owners would have to change what's called summary plan documents, adding the Roth option. Payroll records would have to be modified.
Plus, the plan's service provider would need to put in place separate tracking and record-keeping for the Roth and traditional 401(k) contributions. And the costs associated with those activities are not insignificant, Starr says.
"These small businesses don't have a personnel staff" as do large employers, he said. What's more, employers must establish rules for hardship distributions and participant loans.
And last, Starr notes that small-business owners will have the unenviable task of trying to educate workers about Roth 401(k)s. And on this point, he says, the center does not hold.
"Employee communication which is already overwhelming many plans and participants, is going to find a significant new challenge in explaining the Roth 401(k) plan in a manner that is easy to understand for employees," he wrote. "Good luck."
Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.
Source: Marketwatch.
Last Update: 8:40 PM ET Apr 4, 2007
BOSTON (MarketWatch) -- To many, the newly introduced Roth 401(k) is the greatest retirement account (along with the Roth IRA) ever created. With a Roth 401(k), one contributes after-tax dollars into an employer-sponsored retirement account in which the money grows (as it does in a traditional IRA) tax-free and (unlike a traditional IRA) is distributed tax-free too.
But while many experts praise the benefits of Roth 401(k)s, there's a lone wolf out there with a contrary point of view, penning articles under such headlines as "Roth 401(k): Dumb and Dumber" and "Roth 401(k): Still Dumber."
What doesn't Lawrence Starr, president of Qualified Plan Consultants, like about Roth 401(k)s? Let us count the reasons.
For starters, Starr says workers have to evaluate which is better from a tax standpoint -- the Roth 401(k) or the traditional 401(k). Typically the experts, including Starr, say that workers who are in a low tax bracket when they contribute to a tax-deferred retirement account and expect to be in a higher tax bracket when they withdraw their funds are better off using a Roth account.
But, according to Starr, very few fit into this category. Those include young workers with little or no income, those in a low income tax bracket because of large deductions for child care and homeownership or those whose income will be significantly higher in retirement.
Most workers, he says, will likely be in a lower or the same tax bracket when they retire. And those folks, he says, are better off with the current tax deduction, the traditional 401(k) contribution.
Yes, there are some experts (and regular Americans as well) who say that tax rates are historically low and are likely to rise over time. And given that prediction, the experts say workers should give up the current tax deduction in the hopes that tax rates will be higher later on.
"That is what I call a dumb solution," wrote Starr in the Journal of Pension Benefits. "The (worker) has to give up a sure thing (the current deduction) for what is just a chance that the future benefit will be more valuable -- dumb move, if you ask me."
Do you trust Congress?
Starr is also not fond of Roth-type accounts for this reason: Congress, he predicts, will likely change the laws in midstream and tax Roth distributions at some point. What's more, he predicts that Congress won't even give Roth account owners the courtesy of being grandfathered.
"We have to count on Congress not to change the laws between now and then that provide Roth-type distributions are tax free," he wrote. And that, he says, is just not a "wise bet" anytime.
Consider, he notes, how Congress has often changed tax laws once thought to be unchangeable. For instance, Congress decided to tax up to 50% of Social Security benefits and no one had the luxury of being grandfathered.
For Roth contributions to be better than traditional 401(k) contributions, you have to give up the deduction in hand, hope to be in a higher tax bracket when you take the money out of the retirement account and hope that Congress doesn't change the rules in between. Says Starr: "There are just too many unknowns for this decision to be sensible for most people."
To be fair, Starr does say Roth IRAs have one big advantage over traditional IRAs. With a Roth IRA, he says, account owners never have to take a required minimum distribution as do owners of traditional IRAs and they can contribute to a Roth IRA well past the usual cut-off age of 701/2. "So, substantially more assets can be socked away for oneself and one's heirs," he wrote.
But in the main, Starr says there are other devil-is-in-the-details issues that make Roth-type accounts dumb and dumber. For instance, workers who contribute to a Roth 401(k) will have a higher adjusted gross income than if they put the money in a traditional 401(k) and that could result in the loss of other tax benefits that have phase out limits, such as child-care tax credit. In addition, a higher adjusted gross income could bring the alternative minimum tax into play.
In addition, it's not yet known how Roth 401(k)s will affect divorce agreements that split retirement accounts in two, the Qualified Domestic Relations Order or QDRO. The lawyers will have to calculate the net present after-tax value of the Roth 401(k) and the traditional 401(k).
Plus, there are some questions about the death benefits when there are multiple beneficiaries and Roth and traditional 401(k) accounts. Will someone get the account with the taxable distributions and someone get the account with the tax-free distributions?
Headaches for employers
What else? Well, for employers, especially small businesses, the problems with Roth 401(k)s are many. For one, small business owners would have to change what's called summary plan documents, adding the Roth option. Payroll records would have to be modified.
Plus, the plan's service provider would need to put in place separate tracking and record-keeping for the Roth and traditional 401(k) contributions. And the costs associated with those activities are not insignificant, Starr says.
"These small businesses don't have a personnel staff" as do large employers, he said. What's more, employers must establish rules for hardship distributions and participant loans.
And last, Starr notes that small-business owners will have the unenviable task of trying to educate workers about Roth 401(k)s. And on this point, he says, the center does not hold.
"Employee communication which is already overwhelming many plans and participants, is going to find a significant new challenge in explaining the Roth 401(k) plan in a manner that is easy to understand for employees," he wrote. "Good luck."
Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.
Source: Marketwatch.
Wednesday, April 4, 2007
More IRA Informaiton
Check out these articles from TheStreet.com.
The Power of Tax-Deferred Savings
By Richard Moore
RealMoney.com Contributor
4/3/2007 11:03 AM EDT
URL: http://www.thestreet.com/funds/maxira/10345909.html
Americans are terrible savers, and most people approaching retirement age don't have enough assets to maintain a comfortable lifestyle once they leave the workforce.
Add to this the potential looming problems with Social Security and Medicare and you can see that any attempt to save for retirement is probably a good thing.
IRAs and other retirement plans give the investor a great advantage -- tax-free or tax-deferred savings. Over long time periods, this can really boost wealth creation. For example, a portfolio growing at 10% a year that isn't taxed will grow substantially faster than a taxed portfolio growing at the same rate. If the tax rate on a portfolio's return is 25%, the portfolio will be 25% bigger after 10 years if it is not taxed.
Traditional IRAs have the added advantage that contributions to it are not subject to tax if your income falls below a certain threshold. This gives investors the ability to use money that would otherwise go to the government to partially finance their own retirement portfolios. The higher the tax rate, the better the bargain for the traditional IRA investor.
While withdrawals from traditional IRAs are taxed at ordinary income tax rates, many people are in lower income tax brackets when they retire than when they're in the workforce. If your income is low enough (less than $50,000 for joint filers for 2006), Uncle Sam may give you a direct credit on income tax of up to $1,000 if you invest $2,000 in an IRA.
One critical requirement for contributing to an IRA is that the IRA's owner must have earned income. If you spend most of your time sitting on the veranda clipping municipal bond coupons and adding up your oil and gas royalty checks, you probably won't qualify. Then again, you probably won't need one.
However, if you're like most people who go to work every day or toil at your own business, you should be eligible. (For those who are self-employed in a business with no other employees, I have found that the self-employed 401(k) is a better option.) By the way, husbands and wives can each have their own IRA even if only one has earned income.
The other limitations to IRA contributions relate to income level and whether the participants are already covered by a retirement plan at work. There is no income restriction on deductible contributions to a traditional IRA if neither husband nor wife is covered by a plan at work. However, you can't contribute to a Roth IRA if your joint income exceeds $160,000, and traditional IRA contributions are not deductible for plan participants if joint income exceeds $85,000, and are not deductible for spouses of plan participants if joint income exceeds $160,000.
Nondeductible contributions to traditional IRAs can still be made at any income level, though. Those nondeductible contributions will still grow tax-free until withdrawals commence, at which time there is a formula for deciding how much of any withdrawal is taxable. Speaking of formulas, the details of all aspects relating to IRAs are available in IRS Publication 590. If your situation is complex, IRS publications or a good tax adviser are other places to look for answers.
For tax year 2006, total IRA contributions are limited to $4,000 per person (or $5,000 per person if age 50 or more). If your earned income is below the appropriate threshold, then this earned income would be the limit for any IRA contribution. IRA contributions can be made to traditional IRAs or Roth IRAs in any combination up to the total contribution limit.
Converting to a Roth IRABy Richard Moore
RealMoney.com Contributor
4/4/2007 12:16 PM EDT
URL: http://www.thestreet.com/funds/maxira/10345911.html
Let's assume that you like the idea of saving for retirement and using a tax-deferred or tax-free method of doing so. Let's further assume that you are married, that you and your spouse are both around 40 years old, and that your total income is less than $150,000 per year. Which IRA, traditional or Roth, would be better?
First we'll discuss the basic differences. Contributions to a traditional IRA are tax-deductible in the year made. That means that our hypothetical couple can reduce their adjusted gross income by $8,000 by making the maximum contributions to their individual IRAs. If they are in the 25% tax bracket, then they will save one-quarter of the total contributed, or $2,000, on their taxes due for the year. Therefore, in addition to that savings, they only need $6,000 to fund their contributions.
There are a couple of negatives here, however. Uncle Sam requires that taxes be paid eventually and, in the case of the traditional IRA, these taxes will be paid when withdrawals are made, usually in retirement years over the age of 59 1/2. There are penalties associated with making early withdrawals (usually 10% of the amount withdrawn), but these penalties are waived in certain circumstances, such as the taxpayer becoming disabled, various financial calamities or when the withdrawal is being used to make a first-time home purchase.
Also, at age 70 1/2, withdrawals are mandated on a schedule that roughly coincides with standard mortality life-expectancy tables.
The Roth IRA reverses the timing of tax liability for the contributions and withdrawals. Contributions are not deductible in the year made. So our couple would need to have $8,000 available to make the maximum contribution. But the huge advantage of a Roth IRA, especially for younger people, is that withdrawals are not subject to tax. Over a period of 20 years, the $8,000 contribution could easily appreciate to $25,000 at a 6% rate of return. None of that amount would be subject to tax.
There are still penalties associated with early withdrawals, but those penalties are only assessed on the earnings withdrawn -- not the original contributions. There are also penalties on any withdrawals made during an initial five-year holding period. However, there are no age-related withdrawal requirements, so assets can continue to grow tax-free for life and then will pass to heirs. While the Roth IRA is part of the estate and may trigger estate taxes, the beneficiary of a Roth IRA can avoid any income taxes by following very simple rules.
Clearly, to me at least, the Roth IRA is the preferred vehicle for most people and especially for younger investors. However, there are lots of variables to be considered, including current tax rates, future tax rates and the age of the investors. And, as a practical matter, availability of capital to invest has to be considered.
In most cases, I would rather maximize a contribution to a traditional IRA than invest a smaller amount in a Roth IRA. For that reason, and also because I like to take my tax breaks now rather than later, my own personal IRA is currently totally a traditional IRA. I'm expecting, though, that I may have a future opportunity to have the best of both worlds by converting my traditional IRA into a Roth IRA.
Converting to a Roth IRA
The ramifications of converting a traditional IRA into a Roth IRA are complex and different for each individual. There are a couple of constants, however. First, we know that taxes on the amount converted will be due immediately. If those taxes must be paid from the amount withdrawn from the traditional IRA, it is almost impossible to make a case for conversion unless there is a lengthy time between conversion and retirement to make up the taxes paid.
However, if assets are available from other sources to pay the tax bill, a conversion makes much more sense. Conversion is even more attractive if tax rates in retirement are the same or higher than current rates. While it may seem unlikely that your tax rate will be higher in retirement than while you are working, inheritances could boost the size of your investment portfolio substantially. Also, let's not forget, politicians who insist on growing the government instead of the economy have a way of increasing tax rates whenever possible.
There is an income restriction on IRA conversions. Currently, adjusted gross income must be less than $100,000 (not including the conversion amount) before a conversion is allowed. Fortunately, there is good news on this limitation due to last year's tax bill. Starting in 2010, this limitation will no longer apply, and conversions that occur in 2010 will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.
Personally, because my earned income is low and most of my other income is capital gains, I might get an opportunity to convert my own traditional IRA into a Roth if the market goes against me for a year, thus keeping my taxable income at a low level. It should be noted that, in order to avoid any penalties, assets have to be held in a Roth IRA for at least five years after conversion.
The Power of Tax-Deferred Savings
By Richard Moore
RealMoney.com Contributor
4/3/2007 11:03 AM EDT
URL: http://www.thestreet.com/funds/maxira/10345909.html
Americans are terrible savers, and most people approaching retirement age don't have enough assets to maintain a comfortable lifestyle once they leave the workforce.
Add to this the potential looming problems with Social Security and Medicare and you can see that any attempt to save for retirement is probably a good thing.
IRAs and other retirement plans give the investor a great advantage -- tax-free or tax-deferred savings. Over long time periods, this can really boost wealth creation. For example, a portfolio growing at 10% a year that isn't taxed will grow substantially faster than a taxed portfolio growing at the same rate. If the tax rate on a portfolio's return is 25%, the portfolio will be 25% bigger after 10 years if it is not taxed.
Traditional IRAs have the added advantage that contributions to it are not subject to tax if your income falls below a certain threshold. This gives investors the ability to use money that would otherwise go to the government to partially finance their own retirement portfolios. The higher the tax rate, the better the bargain for the traditional IRA investor.
While withdrawals from traditional IRAs are taxed at ordinary income tax rates, many people are in lower income tax brackets when they retire than when they're in the workforce. If your income is low enough (less than $50,000 for joint filers for 2006), Uncle Sam may give you a direct credit on income tax of up to $1,000 if you invest $2,000 in an IRA.
One critical requirement for contributing to an IRA is that the IRA's owner must have earned income. If you spend most of your time sitting on the veranda clipping municipal bond coupons and adding up your oil and gas royalty checks, you probably won't qualify. Then again, you probably won't need one.
However, if you're like most people who go to work every day or toil at your own business, you should be eligible. (For those who are self-employed in a business with no other employees, I have found that the self-employed 401(k) is a better option.) By the way, husbands and wives can each have their own IRA even if only one has earned income.
The other limitations to IRA contributions relate to income level and whether the participants are already covered by a retirement plan at work. There is no income restriction on deductible contributions to a traditional IRA if neither husband nor wife is covered by a plan at work. However, you can't contribute to a Roth IRA if your joint income exceeds $160,000, and traditional IRA contributions are not deductible for plan participants if joint income exceeds $85,000, and are not deductible for spouses of plan participants if joint income exceeds $160,000.
Nondeductible contributions to traditional IRAs can still be made at any income level, though. Those nondeductible contributions will still grow tax-free until withdrawals commence, at which time there is a formula for deciding how much of any withdrawal is taxable. Speaking of formulas, the details of all aspects relating to IRAs are available in IRS Publication 590. If your situation is complex, IRS publications or a good tax adviser are other places to look for answers.
For tax year 2006, total IRA contributions are limited to $4,000 per person (or $5,000 per person if age 50 or more). If your earned income is below the appropriate threshold, then this earned income would be the limit for any IRA contribution. IRA contributions can be made to traditional IRAs or Roth IRAs in any combination up to the total contribution limit.
Converting to a Roth IRABy Richard Moore
RealMoney.com Contributor
4/4/2007 12:16 PM EDT
URL: http://www.thestreet.com/funds/maxira/10345911.html
Let's assume that you like the idea of saving for retirement and using a tax-deferred or tax-free method of doing so. Let's further assume that you are married, that you and your spouse are both around 40 years old, and that your total income is less than $150,000 per year. Which IRA, traditional or Roth, would be better?
First we'll discuss the basic differences. Contributions to a traditional IRA are tax-deductible in the year made. That means that our hypothetical couple can reduce their adjusted gross income by $8,000 by making the maximum contributions to their individual IRAs. If they are in the 25% tax bracket, then they will save one-quarter of the total contributed, or $2,000, on their taxes due for the year. Therefore, in addition to that savings, they only need $6,000 to fund their contributions.
There are a couple of negatives here, however. Uncle Sam requires that taxes be paid eventually and, in the case of the traditional IRA, these taxes will be paid when withdrawals are made, usually in retirement years over the age of 59 1/2. There are penalties associated with making early withdrawals (usually 10% of the amount withdrawn), but these penalties are waived in certain circumstances, such as the taxpayer becoming disabled, various financial calamities or when the withdrawal is being used to make a first-time home purchase.
Also, at age 70 1/2, withdrawals are mandated on a schedule that roughly coincides with standard mortality life-expectancy tables.
The Roth IRA reverses the timing of tax liability for the contributions and withdrawals. Contributions are not deductible in the year made. So our couple would need to have $8,000 available to make the maximum contribution. But the huge advantage of a Roth IRA, especially for younger people, is that withdrawals are not subject to tax. Over a period of 20 years, the $8,000 contribution could easily appreciate to $25,000 at a 6% rate of return. None of that amount would be subject to tax.
There are still penalties associated with early withdrawals, but those penalties are only assessed on the earnings withdrawn -- not the original contributions. There are also penalties on any withdrawals made during an initial five-year holding period. However, there are no age-related withdrawal requirements, so assets can continue to grow tax-free for life and then will pass to heirs. While the Roth IRA is part of the estate and may trigger estate taxes, the beneficiary of a Roth IRA can avoid any income taxes by following very simple rules.
Clearly, to me at least, the Roth IRA is the preferred vehicle for most people and especially for younger investors. However, there are lots of variables to be considered, including current tax rates, future tax rates and the age of the investors. And, as a practical matter, availability of capital to invest has to be considered.
In most cases, I would rather maximize a contribution to a traditional IRA than invest a smaller amount in a Roth IRA. For that reason, and also because I like to take my tax breaks now rather than later, my own personal IRA is currently totally a traditional IRA. I'm expecting, though, that I may have a future opportunity to have the best of both worlds by converting my traditional IRA into a Roth IRA.
Converting to a Roth IRA
The ramifications of converting a traditional IRA into a Roth IRA are complex and different for each individual. There are a couple of constants, however. First, we know that taxes on the amount converted will be due immediately. If those taxes must be paid from the amount withdrawn from the traditional IRA, it is almost impossible to make a case for conversion unless there is a lengthy time between conversion and retirement to make up the taxes paid.
However, if assets are available from other sources to pay the tax bill, a conversion makes much more sense. Conversion is even more attractive if tax rates in retirement are the same or higher than current rates. While it may seem unlikely that your tax rate will be higher in retirement than while you are working, inheritances could boost the size of your investment portfolio substantially. Also, let's not forget, politicians who insist on growing the government instead of the economy have a way of increasing tax rates whenever possible.
There is an income restriction on IRA conversions. Currently, adjusted gross income must be less than $100,000 (not including the conversion amount) before a conversion is allowed. Fortunately, there is good news on this limitation due to last year's tax bill. Starting in 2010, this limitation will no longer apply, and conversions that occur in 2010 will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.
Personally, because my earned income is low and most of my other income is capital gains, I might get an opportunity to convert my own traditional IRA into a Roth if the market goes against me for a year, thus keeping my taxable income at a low level. It should be noted that, in order to avoid any penalties, assets have to be held in a Roth IRA for at least five years after conversion.
Wednesday, March 28, 2007
10 Reasons You Aren't Rich
The reason why you aren't a millionaire (or on your way to becoming one) is really quite simple. You probably assume it's because you aren't earning enough money, but the truth is that for most people, whether or not you become a millionaire has very little to do with the amount of money you make. It's the way that you treat money in your daily life.
Here are 10 possible reasons you aren't a millionaire:
1. You Care What Your Neighbors Think: If you're competing against them and their material possessions, you're wasting your hard-earned money on toys to impress them instead of building your wealth.
2. You Aren't Patient: Until the era of credit cards, it was difficult to spend more than you had. That is not the case today. If you have credit card debt because you couldn't wait until you had enough money to purchase something in cash, you are making others wealthy while keeping yourself in debt.
3. You Have Bad Habits: Whether it's smoking, drinking, gambling or some other bad habit, the habit is using up a lot of money that could go toward building wealth. Most people don't realize that the cost of their bad habits extends far beyond the immediate cost. Take smoking, for example: It costs a lot more than the pack of cigarettes purchased. It also negatively affects your wealth in the form of higher insurance rates and decreased value of your home.
Read the rest here.
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