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Archive for August, 2009

Tax Evasion For The Masses

August 13th, 2009 at 06:10 am

The late Senator William Roth was one of America's biggest tax dodgers...and people of all income levels should thank him for that.

No, there was nothing shady about the Delaware Republican. In fact, he was the guiding force behind the legislation that Congress put into law in 1998--the Roth Individual Retirement Account. It may be the most significant investment assistance in the last 20 years for most Americans.

The Roth is a great deal for young people. True, there's no tax deduction up front as there is with traditional IRAs or 401K retirement accounts, but if you're young and don't have a ton of money, the tax deduction isn't substantial. So go ahead and pay income tax on your money, then take out up to $5,000 per year and invest in a Roth IRA tax-free for the rest of your life. You keep putting money in, the beauty of compound interest kicks in (assuming that investments begin behaving normally again) and voila, you have a nice chunk of change when you retire. Then, when everyone else is paying income taxes on withdrawals from their 401(K) and traditional IRAs, you are paying zero taxes on your Roth withdrawals.

It gets even better. Roths give you flexibility. They're best left untouched until retirement, but if an emergency comes up, contributions can be withdrawn at any time (remember, you've already paid taxes on the money you've put in). You can also take out up to $10,000 to buy your first home, or you can tap the keg to pay many educational expenses.

When you hit age 70 1/2, you must begin withdrawing money from your 401(K) or a traditional IRA whether you need the money or not, but with a Roth it's strictly your choice. Since you paid taxes on that money way back in the early 21st century, the IRS can't tax those dollars again. Roth money can even go tax-free to your heirs.

We helped our oldest son open a Roth five years ago when he got his first job at age 17, and younger brother opened his own this summer, also at 17. It takes some searching, but there are well regarded, no-load mutual funds that will allow you to open retirement accounts with $1,000 or less.

There are rules regarding a Roth--(1) you'll get slapped with penalties if you touch any earnings during the first five years, or if you withdraw any earnings before age 59 1/2 except for the aforementioned purchase of a first house, education expenses, or major medical expenses; (2) you must have income at least as high as your Roth contribution each year; (3) you can only put in $5,000 per year; $6,000 if you're 50 or older; and (4) your modified adjusted gross income (MAGI) for 2009 has to be less than $166,000 for those married and filing jointly, or less than $105,000 for single filers. Good news for the more wealthy: beginning in 2010 anyone can transfer money from a traditional IRA to a Roth. Right now that can only be done by those making less than $100,000. Yes, you must pay full taxes on your current IRA before turning it into a Roth.

As great as they are, Roth IRAs should not replace your company retirement plan if the company matches a portion of your contribution. Always take the maximum match; that's free money. However, a growing number of financial planners are suggesting that employees put beyond-the-match retirement money into Roths as a way to create tax-free retirement money, according to consulting firm Hewitt Associates.

You can't get much better in the personal finance world than guilt-free tax evasion. Thanks, Senator Roth.

Next time: OK, you're lapping up the Roth Kool-Aid. Now, how do I invest my money in a Roth?


What The Preacher Says

August 4th, 2009 at 07:12 pm

Much to my chagrin, my wife told me about the birthday present that the minister at our church gave to his wife: a Mustang convertible. That came right after I bought my wife a candle for her birthday.

The Mustang was actually a week-long rental, a sort of trial run after both agreed she could use--and they could afford--a new car. What a guy. I probably would have offered up an '89 Dodge Duster.

So, Barbara falls in love with the Mustang and a week-long garage guest becomes a permanent fixture, right? Nope. She decided on a Ford, alright, but not a Mustang ragtop. She bought a used Fusion. The story was told in church on Sunday as an example of living simply. She could have afforded the Mustang, but the Fusion made their financial life simpler.

That's a good end to the story for some of us, but not everyone is willing to put frugality above shiny new wheels. Just look at how fast the government burned through one billion dollars last month by sponsoring the Cash For Clunkers program. Do you really think anyone saved money by trading in their bucket of bolts for a new vehicle? Of course not. Forty-five hundred bucks won't come close to paying for the privilege of driving a new car or truck off the lot. But the C-For-C participants put new wheels in their driveway, and they're happy about it.

The hard part is having your stuff-- whatever you're lusting for--and keeping life simple. The answer is simple, too--save up before you buy. Americans have proven it's possible. The Labor Department reports that the country's savings rate has gone from negative 1 percent in 2007 to plus 7 percent in 2009. Advertisers try to convince us that we need to call now, go online now, come on down to the dealership now, because these great deals won't last much longer. Yes they will, and a struggling economy will survive without you providing an immediate stimulus package from your own wallet. A great deal today is even greater one year from now after you've socked away $200 or so each month. Not only have you spent 12 months figuring out whether you can make a monthly payment, you've put $2400 toward the purchase of your new car/ATV/helicopter/submarine/whatever.

Better yet is to follow the advice of Dave Ramsey--save up and pay cash for everything with the exception of your home. But if that thought makes you roll your eyes, go ahead and fall in love with that Mustang you've been eyeing. Just make sure your new relationship is on your terms: simple terms.