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I recently wrote More Than the 10% Penalty - The Dangers of Early Retirement Account Withdrawals for FiLife, a joint venture between The Wall Street Journal and IAC. The dangers are real, starting with taxes, ending with lost growth and a bunch of other financial pain in between. Before you ask for that distribution check (or even think about it), check out my article over at FiLife.
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One of the best parts of the weekly personal finance carnivals, including this week’s carnival hosted by WiseBread, it the wide variety of personal finance topics covered. In addition, I always take the time to enjoy an article or two that I’ve been meaning to write myself but just haven’t gotten to. This week was no exception, even if my post about The New Frugality made the cut. Here are my three favorites of the week:
J. Money from Budgets Are Sexy presents Paying extra towards your loans now, goes a long way later! This is so true it hurts. How much pain? As J. Money says, “It’s like kickin’ compound interest in its head and getting away with it :)” How could you not enjoy?
Another favorite: Save Money By Buying the “Good” Toilet Paper by That One Caveman. Two very important lessons from this title. First, you can never go wrong putting “toilet paper” in a blog posting title, something I learned a while back when I wrote Toilet Paper As an Economic Indicator last fall - still is a bizarre way to look at the world. Second, sometimes paying for quality is actually cheaper than paying for quantity. (Amazingly, this was also the theme of the toast my brother gave for my wife and I at our wedding, but that’s another story for another day.)
Money Lessons from Monopoly is another wonderful article. Free Money Finance reminds us that Monopoly is a great teacher not only of the importance of cash-flow (how much fun is it to mortgage our properties?) but also of luck (the frustration of your opponent consistently missing your hotels as he marches around the board).
Quick FYI: The Total Candor web site was featured in the Philadelphia Inquirer over the weekend for savings help. Did you see it? If not, see it now.
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In response to the market turmoil Congress recently passed a one-year waiver on RMDs.
You: What are RMDs?
Required minimum distributions.
You: That didn’t help.
Shortly after you reach 70 1/2, you must begin to take a proportion of your money out of your qualified retirement plans annually.
You: Or?
You pay a penalty.
You: What if I don’t want to take the money out, since it’s better to save my money longer? Can I just pay the penalty?
The penalty is a 50% extra tax, so it’s never a good idea to ignore the RMD. Still, you are only required to take the money out of the account, not to actually spend it.
However, retirees can skip their 2009 RMDs thanks to the previously mentioned Congressional action. While the waiver sounds simple, in practice it’s not. I wrote a summary article about the 2009 RMD waiver implications and opportunities at the About.com web site, where I guide the Retirement Planning channel and blog. If you or your loved ones are 70 1/2 or older, make sure you take a good read.
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It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.
I will probably not be working in the States during 2009, but I have rented out my condo in Boston, so I will have rental income of about $20,000 in 2009, but I plan to reduce the taxable income by deducting expenses like my condo fee. Can I still say I have earned $20,000, and contribute $5,000 to my Roth IRA?
Hong - somewhere overseas
Straightforward Answer: Could be, if your tax preparer knows what questions to ask.
Detailed Explanation
In order to contribute $5,000 or more to a Roth or regular IRA, you must have earned at least that amount. The types of earnings that count for this purpose are:
It is clear that none of the $20,000 rent you will receive can be considered either employee compensation or alimony. Furthermore, the $20,000 you will receive is not net earnings (profit) but rather gross revenue. As such, your expenses (like condo fees) will be deducted to calculate your net earnings from self-employment. If you had $20,000 or more in expenses, you would have no net earnings and no ability to contribute to an IRA. However, you don’t have to take all of your expenses. You could take $15,000 of expenses and show net earnings of $5,000. Your personal exemption and standard deduction will wipe out any tax you owe on the $5,000 and yet you’d still be able to contribute to a Roth.
Not bad, right?
Keep in mind that in order for net earnings from self-employment to qualify as earnings for the IRA contribution test, you must be actively involved in the business - in your case managing the property - not just an investor.
Great question and another reason why you may very well pay less with a better tax preparer.
More questions about taxes? Two of the most widely read posts in the history of the Beyond Paycheck to Paycheck blog are First Time Homebuyer Tax Credit: When a credit isn’t a credit but it’s still free money and Economic Stimulus Payments are now Recovery Rebate Credits - will you get yours?
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It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.
I want to open a Roth IRA, but how do I know how much maximum I can put into the account for 2008?
- Diana C., Los Angeles, CA
Straightforward Answer: $5,000
Detailed Explanation:
Calculating your allowable Roth IRA contribution could have been simple. Then Congress got involved
Maximum Allowable Contribution
If you are under 50 years old, $5,000 is the most you may be allowed to contribute to a Roth. If you are 50 or older, your potential maximum contribution is $6,000. However,
Minimum Income Limitations - You Must Work
Roth IRA contributions are limited to the amount you earn from working. Income from interest and dividends do not count. Therefore, retirees cannot contribute to a Roth IRA. Neither can a newborn. Your Roth IRA contribution cannot exceed your earnings.
Example 1
Ryan earned $3,500 last year working after school. He also received $12 of interest income. The most Ryan can contribute to a Roth IRA is $3,500.
If Your Spouse Works, That Could Help
If you are married, don’t work (or earn less than the $5,000 or $6,000 maximum), and your spouse does work, your spouse’s income can be used to increase your contribution limit. However, the same income cannot be used for both you and your spouse’s IRA contribution.
Example 2
Trisha is a stay-at-home mother and doesn’t receive payment for her work. Her husband, Pete, earns $75,000 a year. Both Trisha and Pete can contribute $5,000 a year to their Roth IRAs, even though Trisha has no earned income.
Example 3
Karen and Pat have mostly retired from the workforce. Karen, who is 63, worked part-time last year and earned $7,500. Pat, age 64, did volunteer work and didn’t earn any money. Together, Karen and Pat can put a total of $7,500 in their Roth IRAs. They can put up to $6,000 in either one. If they do so, the other spouse can contribute up to $1,500. Alternatively, they could split it $3,750 each or any other combination totaling $7,500 so long that neither account received more than its $6,000 maximum.
Maximum Income Limitations
Not everyone is eligible to contribute to a Roth IRA, even if they have earned income. High income earners are excluded from this opportunity to receive tax-free growth. However, if you are single and your income was less than $101,000 for 2008, you can contribute up to $5,000 ($6,000 if 50+) until April 15. If your income was more than $116,000, you cannot contribute to a Roth IRA. If your income is between those amounts, you’re able to contribute some amount less than the maximum. Note that we’re talking income here, not just earnings. So these figures above include items such as interest, dividends, capital gains, etc.
Married individuals with incomes less than $159,000 can contribute the maximum to their Roth IRAs. Those with incomes exceeding $169,000 may not contribute at all. Those with incomes within that range are eligible to contribute a lesser amount.
View the 2009 Roth IRA limits here.
# # #
Will you contribute the maximum this year? Why or Why not?
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Year-end obsessive man is here again. Previously, I wrote of the importance of using your FSA funds before losing them, maximizing your match in December and taking tax advantage of any capital losses. Today, is tip # 4 and concerns IRAs.
Don’t wait until April 15, 2009 to make your 2008 IRA contribution.
Certainly, don’t wait until April 15, 2009 to figure out where your 2008 IRA contribution money is coming from.
Whether with finances or a birthday party, when you wait to the last minute, things typically don’t go as well as you had hoped (or as if you had planned). By saving between now and next April in your IRA two good things happen:
Don’t wait. Also, remember: if you miss making your entire 2008 IRA contribution by April 15, 2009, you can’t make it up later.
Check out the 2008 and 2009 IRA limits. Disclosure: I wrote it.
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Continuing on my year-end theme, I blogged yesterday about using your FSA funds before losing them. Previously, I discussed the importance of maximizing your match in December. Today’s tip, and one of the most commonly discussed, is those capital losses.
You: What are capital losses?
When the DC hockey team plays the Bruins.
You: What?
Forget it. Inside joke.
You: This is a blog.
Yeah, might be the last time I try the inside joke thing. Getting back to it: capital losses occur when you buy an investment and then sell it for less. Such investments could include stocks or mutual funds.
You: Like in my 401(k)?
Although you may very well have investments in your 401(k) that have gone down in value and that you chose to sell at a loss, such losses aren’t the capital losses I am talking about.
You: Why not? That’s what I want to talk about.
Sorry, but this post isn’t about year-end strategies concerning your 401(k) losses. Today, we’re talking about stocks and mutual funds you own outside of your retirement plans.
You: Again, why?
Because selling the stocks and mutual funds you own outside of your retirement plans at a loss can potentially reduce your taxes. Selling the investments held inside a 401(k) or IRA won’t do that.
You: Why?
Who am I talking to today, Bryant Gumbel?
You: No. Bryant who?
Forget it. Since your 401(k) and IRA accounts grow tax-deferred, you don’t pay tax when you sell investments within the plan that have gone up in value (gains). On the other hand, if you sell such investments at a loss, you don’t get to deduct that loss either. (Note: there are very rare exceptions to this rule, but you typically need to nearly liquidate your account, not a good retirement planning strategy.)
Investments you sell within a taxable account lead to either capital gains or capital losses. This year, most people who are selling investments are selling them for less than they originally paid.
You: Thanks for that insight, Mr. Madden.
Touche.
The year-end strategy here is to make sure that if you are sitting on investment losers in your taxable accounts which you are considering selling, to do so prior to December 31. You can deduct your capital losses up to the total of any 2008 capital gains plus up to $3,000 of ordinary income.
You: Ordinary income? My income certainly feels very ordinary.
Ordinary income has a tax definition and includes your salary, bonus, even interest income. So selling an asset triggering a loss of $3,000 or more means, for tax purposes, that you made $3,000 less than you actually di.
You: Works for me.
Just make sure you don’t sell something just for the tax benefits.
You: Right. Can I sell an investment and then buy it right back?
Yes, but if you don’t wait at least 31 days before buying it back, then you can’t deduct any loss.
You: Why not?
Because then it is known as a “wash sale” and the rules say you can’t deduct losses from wash sales.
You: Is that where the phrase “It’s a wash” comes from?
I don’t know.
# # #
How many obtuse sports-related jokes can you identify? Are any of them actually funny?
What about personal finance comments? Ever sell something and then realize that wasn’t such a good idea after all?
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We could all benefit from year-round attention to our finances. Yet, in a typical year (2008 is not typical) most people only think about their finances from January 2 until the last Monday of a full week in January. In 2009, this is January 19.
You: Where did you get such a crazy statistic?
From this Time magazine article, which quotes a person who has calculated depressing day of the year. (Note: the reporter actually says that the “theory has been discounted by many in the academic community” so take it for what it’s worth.)
Still, many people will find that they have completely abandoned their annual New Year’s resolutions by the third week of January, including many aspirations for improving their financial affairs. So, rather than waiting until January to quit better habits, let’s start now.
You: Start quitting now?
No! Start better habits now.
You: I knew that.
Maybe with some early momentum, we can keep going well into 2009 and beyond. Here is the first of five year-end planning tips:
Tip # 1: Maximize Your 2008 401(k) Match
Did you know that the amount of money any employer will match in a 401(k) is limited?
You: Yes. Plus, many folks don’t have a 401(k) match or even a 401(k) plan.
True enough. But for those who do have a matching plan, December is an important time of year to realize that the match limit is an annual one.
You: I thought the limit was up to a certain percentage of gross pay, like 6%.
That’s true, too. Let’s say you work for a company earning $40,000 per year and your employer matches 50% on the dollar up to 6% of your gross pay. This means that the maximum match you can receive from your employer is $1,200. (This is calculated as 6% (the most they’ll match) multiplied by your $40,000 salary = $2,400. Take the $2,400 and multiply it by the 50% matching percentage for your maximum match of $1,200.)
You: And, in order to get the $1,200 you have to contribute at least $2,400, or 6% of gross pay, to the plan.
Precisely.
You: But how is this related to year-end? This limit true throughout the year, isn’t it?
Indeed. However, that $1,200 limit is an annual limit. If you haven’t received the whole $1,200 yet, you probably have two or three paychecks left in 2008 during which you can try to get as much of it as possible.
You: But to do so, you must contribute more! But that’s true all yearlong!
Yes, but now you don’t have 12 months left. You only have a few weeks. So, instead of raising your 401(k) contribution rate to 6%, raise your contribution level as high as you can possibly afford for just a few weeks- then lower it come January. By doing so, you’ll dramatically increase the amount you have saved for retirement during 2008, maximize the amount of free money you accept and, importantly, avoid permanently forgoing this free money.
You: Permanently forgo?
Once 2009 rolls around, you can never get your 2008 contribution money. Now you’ll have the 2009 limits to contend with. That’s why December matters. And it matters every year.
# # #
What other year-end strategies do you wish to share?
Have you ever temporarily adjusted your 401(k) contribution rate strategically? How did it work out?
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As I flew across the country yesterday, I sat next to a woman who was heading to Tahiti. She explained to me that this was supposed to be a retirement trip, but with the market’s recent slide, she decided to work another six months. Still, she was going to take the trip because much of it was already paid for. Clearly, I don’t know her entire financial situation, but I thought it was a bit odd.
I mean if you really got hurt badly by the correction, then six months of additional pay probably isn’t going to matter, especially after subtracting the costs of what I can imagine to be a rather expensive vacation to Tahiti (nice lady, but she and her husband spent over $30 on airplane liquor by the time we got to South Dakota).
But the brief exchange did get me to thinking, what have you changed, if anything, since the recent worldwide realization of slower growth, a recession and a market crash? All answers are acceptable, including buying less branded groceries, smaller packets of toilet paper, no change at all, even delaying your retirement for six months!
P.S. I am in Hawaii this week delivering several seminars at the ING DIRECT cafe grand opening there. As a result, I may be a little less active on the blog this week.
Aloha and mahalo!
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It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.
I just received a significant raise and now I can afford to save more. I already max out my 401(k) and a friend of mine said that the best thing to do now is to buy an annuity because that way I can get more tax-deferred growth. But my wife’s friend told her a whole life insurance policy would be better since there’s an insurance component. Last, a friend of mine at work says I shouldn’t do either; instead, he says, I should just get index funds. Who’s right?
–Jonathan P., 26, Cincinnati, OH
Congratulations on your raise, Jonathan. It appears that your increased income has made you attractive to a few others already.
Gary: Indeed, I scour the “Movers and Shakers” column every week. When’s the best time to catch you, JP?
While your dilemma may seem confusing, it’s actually not. Let’s address a few points:
Tax-Deferred Growth
While tax-deferred growth is important - especially for long-term saving objectives like retirement - it is far from the only consideration. You must also think about risk, required return, ability to access funds in an emergency, fees/penalties, and so forth. Both annuities and whole life insurance policies do promise the benefit of tax-deferred growth.
Gary: Amen!
However, so does an IRA. With an IRA, you can invest in index funds, which will have very low expenses. So, if you are looking to save more for retirement and have not yet done an IRA, I’d start there. (You should also consider a Roth IRA, which allows the benefit of tax-free growth.)
An annuity is seldom an appropriate product for a 20-something because of the lack of flexibility in the product and the existence of other greater financial priorities typically not yet met by a 20-something (including full funding of 401(k), IRA, emergency fund, etc.). A whole life insurance policy is also not something relevant to a 20-something, especially one without any dependents. Life insurance is arguably the most important financial consideration out there - once you have a child (or, perhaps someone else) depending on your income. But if no one is hurt - financially speaking - by your untimely demise, you don’t need life insurance, and certainly not just to get the tax-deferred benefit.
But before you go ahead and put your money into an index fund, make sure you understand the goals for your money. If it’s for something long-term such as retirement, go ahead. But if you have not yet paid off all your high-interest debt, established an emergency fund, made significant progress towards a housing downpayment (or already own a home), I suggest starting in one of those places before putting more money in the stock market.
And be sure to continue to ask questions first, buying (perhaps) later. You’ll never regret sleeping on a financial decisions. If it’s a great idea today, it will still be a great idea tomorrow.
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