Tag Archives: roth ira

Despite Consumer Confidence Growth, We Still Fear Tax Hikes

According to a recent report from Bloomberg News, “the number of Americans saying the U.S. economy is getting better rose in March to the highest level since 2004 as a decline in claims for unemployment benefits offered more evidence of a labor-market recovery.”

The Labor Department showed jobless claims had decreased by 5,000 to 348,000 last week. That number represented the lowest since February 2008.

Despite those positive numbers, the fear of tax hikes coming down, and coming down soon, has consumers running scared.

Economic prognosticators are sure those tax hikes are coming soon due to tax cuts, wars, the recession and our growing population of retirees. Plus the federal government continues to spend more than it takes in.

These same experts say that in 2013 the top U.S. income bracket will go from paying 35% to almost 30%.

Tax Hike Fear Fueling Roth IRAs

Already the most popular retirement saving product, holding $4.7 trillion in assets as of the end of 2010, according to Mintel Market Research, Roth IRAs are gaining popularity as consumers look for savvier ways to protect their money.

Now read this breakdown from Ross Kenneth Urken on why consumers are doing the flocking to Roth IRAs:

The Roth Individual Retirement Arrangement is a retirement plan that allows you to withdraw money tax-free in retirement. That contrasts with traditional IRAs and retirement plans, that let you deposit pre-tax funds, but tax your withdrawals.

Now, in a traditional IRA, you can deduct your contribution (up to $5,000 annually) from your taxable income. But let’s think about the future.

There’s an old business school trick called the Rule of 72 for estimating how many years it will take for an investment to double: Divide 72 by your average return on investment percentage, and you have a rough answer. So, if someone earns 8% on a Roth IRA, — 72/8 = 9 — their money will double every 9 years. Thus, $5,000 invested at age 30 will become $10,000 at 39, $20,000 at 48, $40,000 at 57 and $80,000 at 66. If that were a traditional IRA, the investor would then have to pay income taxes on the $80,000.

With the Roth, you don’t get a deduction for your contribution, so you pay the taxes on the initial $5,000 you put in. Your investment grows the same way, but when you take money out, it’s tax free. Basically, you’re choosing between paying taxes on the seeds or on the crops.

The crux of the matter comes down to people’s belief that taxes will continue to increase. Based on that premise, it’s better to pay the taxes on your initial investments now, while rates are lower, than to wait and pay a higher rate on your total returns when you remove the money at retirement.

Bottom line – your Roth is never going to be taxed again, has capital appreciation as long as it grows and you get it back tax free. This means even more to younger workers who are unsure that Social Security will be available to them once they retire.

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What do you think? Do you have a Roth IRA? How are you feeling about the economy in 2012?

Roth IRA Conversion: Is It Right For You?

Any time there is a new marketing push by financial companies, you are bombarded by statistics about why you should do what will make more money for them. What I have noticed about people using statistics is that they either a) use them inappropriately, b) don’t disclose analysis methods or c) just make up numbers. Any of these three are hardly a process to engender trust.

Take the Roth IRA conversion push that is going on right now. In 2010, the income caps on Roth IRAs will be lifted and anybody will be able to invest in a Roth IRA. For those of you who don’t know, a Roth IRA is funded with after-tax money and grows tax-deferred. At the age of 59 1/2, owners of Roth IRAs may take money out of the account tax-free. No capital gains taxes, no income taxes.

This differs from Traditional IRAs in that when you begin taking distributions from your IRA, it is taxed at your current income level; the logic being that you will be in a lower tax bracket in retirement and the tax will not impact you as much. Traditional IRAs are funded with pre-tax dollars and thus the government wants to tax the money at some point.

So, back to our topic. Roth IRAs have had income levels on them so that if you made over a certain amount of income, you could not contribute. With the new law taking effect in 2010, this income cap is removed. Because withdrawals are tax-free, it can be argued that converting an existing (likely larger) Traditional IRA to a Roth makes much more sense.

However, you must pay the tax man. Uncle Sam will still want his slice. The act of converting a Traditional IRA to a Roth IRA will cause a taxable event (technically, you are taking money out of the Traditional IRA and then placing the money into a Roth IRA). Normally, you will pay a 10% penalty on top of the tax paid because you took a distribution from your IRA. For example, if you have a Traditional IRA with $100,000 in it and convert it to a Roth, you are adding an additional $100,000 to your income for the year. In addition to the tax you would normally pay on your income, your tax bracket is raised an you may pay additional taxes.

That could really NOT be fun in a recovery year when you need every dime you can possibly get. There is no penalty for early withdrawal on the conversion, so you are reducing your tax burden. Further, if you make the conversion in 2010, you will be able to spread the tax you owe over 2010, 2011, and 2012, helping to reduce the bit of the tax you will pay on your income.

So, what was I talking about earlier? Statistics. Like gold, you will start to see advertisements of Roth IRA conversions. You will see things like, “A Roth conversion makes sense for 95% of IRA owners”, and “You will make back the money you paid in taxes within seven years”. Please ignore these statistics.

Most “advisors” will want to meet with their clients in 2010 to discuss a Roth conversion. Those that are commission-based or even fee-based may take this opportunity to make “changes” to your account, which may or may not be appropriate. For the most part, the advertising is a way to get you in the door. The statistics used can be misleading and may or may not be appropriate for your situation.

Consult with a financial expert other than your broker or advisor. See if the conversion is right for you.