Teenagers and Roth IRAs
August 11, 2011
Dear CPA
Recently I had a discussion with my husband about putting some funds in an IRA for our 18 year old. We have little extra money this year and thought it might be good to get her going with a retirement savings account. Should we do a Roth or traditonal IRA?
Marie, Eden Prairie
Hello Marie,
Yes, I think you’re on to something. Not only would starting a retirement account for your daughter be a good idea, funding a Roth IRA would be an even better idea.
If you daughter is receiving compensation in the form of wages, she could begin a retirement account and (you can) fund it up to $5,000 depending on her compensation. She must have taxable wages in the year.
A Roth contribution is non-deductible for taxes, but once the funds are in a Roth, the earnings would be tax free once withdrawn. Starting a Roth for a younger person offers tremendous benefits over the years.
Keep in mind that you have until the April filing deadline to fund the Roth.
Call me to help get you started!
888-RAPACKI
Joe
photo credit: alancleaver_2000
Roth IRA
November 30, 2009
Joe,
One of my friends just asked me if I planned on converting my IRA to a Roth IRA. He was excited because of a rule change that now made him eligible. He asked me if I were going to do the same thing. I lied and said I was. To be honest, I don’t even know the difference. Should I convert my IRA? What is the rule change he is talking about?
Walter, Stillwater
Walter,
You are not alone in not knowing the difference between a traditional IRA and a Roth IRA. The basic difference rests when the taxes come out. With a traditional IRA you put money in tax free, but are then taxed when you withdraw. With a Roth IRA, you pay an upfront tax on the investment, but then the money is tax-free to withdraw.
My guess is the change he is talking about is the dropping of the income limit for those who can open or convert a Roth IRA. In the past, only investors with a yearly income under S100,000 could access a Roth IRA. A recent study by Fidelity Investments found that 83% of those surveyed knew nothing about the removal of income limits on IRAs. Understandable given that most investors face other financial issues to worry about. Which is a shame because investor ignorance clouds a significant economic opportunity.
So should you convert your traditional IRA to a Roth IRA? Probably. The most obvious reason is the tax-free income stream. With a Roth IRA, an investor pays the upfront tax, based on his income tax percentage, on the contribution. This strategy works especially well for those who plan on being in a higher income bracket upon retirement than they are now. Not just those starting out, but those who are out of work right now.
But even if you are doing well financially a Roth conversion is advisable. In a one time offer, the government will allow investors to defer the tax hit over two years. If you convert your traditional IRA to a Roth IRA in 2010, you can spread the tax liability evenly over 2011 and 2012. This helps to lessen the shock of a one time large tax hit.
Another reason to convert now is to take advantage of a shrunken portfolio. Yes, there is an upside to the freefall of your IRA. When you convert to a Roth IRA, you are taxed on the amount converted. If your IRA has a value reduction of 30%, that means 30% less in taxes. When the account grows, you will not be taxed on the additional growth.
Finally, a conversion to a Roth IRA provides you more control over your estate planning. There are no mandatory deductions at 70.5, meaning a Roth IRA is preferable if you plan to pass on the account to beneficiaries.
All of these factors contribute to the proverbial perfect storm for you to convert your traditional IRAs to a Roth IRA. Don’t let your ignorance or a lack of press contribute to a missed financial opportunity.
Hope this information helps. Maybe you can even give your friend some advice. As always, check with a money manager whom you trust before making any conversions. There are many subtle rules that impact your conversion. Best of luck, Walter.
photo credit: scottwills
IRA converted to Roth
January 3, 2009
Dear CPA
I’ve read that now might be a good time to convert a traditional IRA into a Roth IRA. I don’t understand why this might be a good idea?
Thanks, Alan B., Edina
Hello Alan
Yes, with your stock and/or mutual fund share values down, it might be a good idea to convert a Traditional IRA (or a portion of it ) into a Roth IRA . Your adjusted gross income must be under $100,000 in 2009 to qualify. You will need to pay ordinary income taxes on the converted traditional IRA, but there’s a good chance that your stock or mutual fund shares will recover in several years. Since you would have already paid income taxes on the funds in the Roth IRA, you should be a very good position of never having to pay income taxes during retirement on the Roth IRA distributions.
Good luck!
Joe
