Archive for September, 2009

Taking a Fresh Look at Your 401(K) Allocations

Posted By Marty Higgins | September 28th, 2009

A May survey by Hewitt Associates noted that despite record losses in their 401(k) savings in 2008, individuals stuck with their 401(k) plans. However, more people dealt with their worry about investment conditions by shifting money into more conservative investments. In addition, a significant number of companies either eliminated or cut back significantly on matching employee 401(k) contributions.

Hewitt’s annual Universe Benchmarks study, which examines the saving and investment behaviors of more than 2.7 million employees eligible for 401(k) plans, showed that the average 401(k) balance dropped from $79,600 in 2007 to $57,200 at the end of 2008. 44 percent of employees lost 30 percent or more of their savings. Only 11 percent of employees were able to break even or see a gain in their 401(k) portfolios. Even still, 74 percent of employees participated in their 401(k) plans in 2008, about the same as in 2007.

However, the Hewitt survey stated that some workers are reacting to the market downfall by moving 401(k) assets into less risky investment funds to try and blunt their losses. In 2008, 19.6 percent of investors made trades in their 401(k) plans versus 18.7 percent in 2007. And the volume of money they transferred in 2008 was much higher. Nine of the 10 most active trading days were the day after a large downturn in the market, or days with an average return of negative 4 percent. Employees’ average equity exposure dropped to just 59 percent in 2008—which is an all-time low since Hewitt began tracking it in 1997. Stable-value funds, which are considered less risky investments, experienced an 11 percent increase in asset allocation in 2008.

That’s why it might be wise for investors to get a fresh start with 401(k) advice as the economy improves. For existing investors or those who have never begun to save or invest for retirement, it might be time to consult both financial and tax experts such as a CERTIFIED FINANCIAL PLANNER™ professional to make sure both personal and work-related retirement savings complement each other.

Some recommendations to keep in mind:

Save even if your company fails to match: This is not the easiest thing to do, but even if your company cuts back on matching, it’s important to try and put additional money into personal retirement investments outside of work. You will still realize the benefit of pre-tax contributions made to your traditional 401(k). And, when you have money automatically taken from your paycheck you are “dollar cost averaging”. That means the fixed dollar amount that comes from your paycheck buys more shares when prices are low, and fewer when prices are high. Thus your average cost per share is lower than the average price per share.

Make sure you contribute to a plan: According to 2006 data from the Profit Sharing/401(k) Council of America, more than 22 percent of eligible workers don’t participate in available 401(k) plans. For the companies that are still matching, that’s like giving up free money.

Continue to save while you wait to join a plan: A significant number of companies don’t let you join the 401(k) until you’ve been working there a year. If that’s the case, get in the habit of putting money away for retirement anyway. Start an individual IRA with the funds you would put in the company plan, or set aside money in a savings account so you can supplement your cash flow and put the maximum amount into your 401(k) once you’re allowed to join.

Contribute the maximum: Not every employee can afford to contribute the maximum allowed by the plan, but try. In 2009, the maximum 401(k) contribution will be $16,500, and those older than 50 can make an additional catch-up contribution of $5,000.

Don’t let your company do all the work: More companies are automatically enrolling their workers in their 401(k) plans, but some workers fail to take charge afterward. They don’t know how much they’re allowed to contribute and they don’t discuss or review the types of investments they have in relation to their age or retirement plans. It might make sense to bring an outside investment advisor such as a CFP® professional to review those choices with you.

Avoid poor diversification over time: It’s necessary to do a yearly checkup on all your retirement savings – 401(k) s, individual IRAs and other investments fueling your retirement goals to make sure you’re on track.

Don’t rely on the 401(k) alone: Particularly if matching lags for awhile, 401(k) plans can’t be relied upon as a single source of retirement dollars. You must invest outside your company plans.

Don’t over-invest in company stock: Most financial planners advise that you put no more than 15 to 20 percent of your whole 401(k) portfolio in company stock.

Don’t borrow from the 401(k): The Employee Benefit Research Institute® reports that employees contribute more to plans that let them borrow. Don’t be fooled. A 401(k) shouldn’t be a house fund or a source of emergency cash. You’re taking money out of the account that otherwise would grow tax-deferred, and if you fail to pay back the money, you could face income taxes and penalties. Instead, build an outside emergency fund of three to six months of living expenses you can draw from.

Don’t cash out: Some workers think it’s a great idea to treat a 401(k) as a windfall for when they quit a job. Don’t do it. You’ll pay huge penalties and lose your retirement savings momentum.

Don’t “lose” your old 401(k) accounts: Maybe you’ve changed jobs several times and never got around to moving older, smaller 401(k) accounts from past employers to current ones or into a self-directed retirement account. Always get advice about 401(k) funds when you leave an employer.

September 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V.Higgins, CFP, CLU, AEP, a local member of FPA.

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7 steps to a 2010 Roth IRA conversion

Posted By Marty Higgins | September 28th, 2009

  • The IRS offers a 3-year window in 2010 to pay taxes on a Roth conversion.
  • The IRS is letting tax payments on a conversion to be made in 2011 and 2012.
  • Figuring out the tax due on a Roth conversion is not that complicated.If you have funds in an individual retirement account, converting them into a Roth IRA in 2010 presents an unprecedented opportunity to sock away tax-free retirement income.

The IRS is even offering taxpayers a three-year window in 2010 to pay taxes due on a conversion and is removing income limits that have kept higher-income taxpayers from setting up Roth IRAs.

Many taxpayers have been able to convert their traditional IRAs to Roth IRAs since Roth IRAs were created in 1998. However, income limits and other restrictions have kept many taxpayers from converting. If their modified gross income is more than $100,000, they haven’t been able to convert. But in 2010, they’ll get their first opportunity.

You don’t have to wait until then if your  modified adjusted gross income — your income minus certain deductions — is less than $100,000 and, if married, you file as “married filing jointly.” You could convert in 2009. However, to take advantage of special tax breaks offered only after Jan. 1, it may make sense to hold off, says Brent Lindell, a certified trust and financial adviser with Savant Capital Management in Rockford, Ill.

Roth IRAs differ from traditional IRAs in several crucial ways. While you don’t get a tax deduction for making a contribution to a Roth IRA, those contributions you may not have to pay any tax upon withdrawal in retirement. In addition, Roth IRAs aren’t subject to the same minimum distribution requirements that traditional IRAs are, so you don’t have to begin withdrawals from your Roth IRA at age 70½.

And because most retirement accounts took a heavy beating in the stock market in 2007 and 2008 and still haven’t recovered, the taxes due on a conversion are less than they would be had the market risen, making the case for conversion even more compelling, says Dave Sadler, a certified public accountant and Certified Financial Planner with Moneta Group, a wealth management firm in St. Louis.

If that’s not enough, the IRS is allowing taxpayers a one-time opportunity to spread out the payment of taxes due on a Roth conversion in 2010 over 2011 and 2012.

Taxes are due on a Roth conversion because you get a tax deduction on your initial contributions to most traditional IRAs, so you must pay the taxes due on those initial contributions and any growth in your IRA. Your tax bill on conversion also depends on a number of other factors, including your income, your federal tax bracket and your state tax rate.

Roth IRA conversions don’t make sense for everyone, but it’s worth investigating to decide whether it makes sense for you.

“The issue comes down to what your tax situation is in the year of conversion versus what it might be in retirement,” Sadler says.

“It’s a hard thing to know for sure, but I would say it makes the most sense for younger taxpayers who will have their income grow over time,” he says.

7 steps to a Roth IRA conversion

  1. Evaluate your IRA and 401(k).
  2. Seek advice if you’re unsure.
  3. Weigh financial and tax factors.
  4. Calculate the potential tax due.
  5. Decide when to pay the tax bill.
  6. Consider when to convert.
  7. Fill out conversion paperwork.

Step 1: Evaluate your IRA and 401(k)

First, you need to get a handle on what assets you’ve got that are eligible for conversion into a Roth. Generally, any assets that you hold in a traditional IRA, whether they are deductible or nondeductible, are eligible. Nondeductible IRA contributions are not taxed when you make a conversion, although earnings from those contributions are taxed.

If you have a 401(k) or 403(b) from a former employer, you may want to roll them into an IRA this year so they will be eligible for rollover along with your other IRA assets. It’s a two-step process, first you roll over your old 401(k)s and 403(b)s into a traditional IRA. Then, you convert the traditional IRA to a Roth. That’s where the tax is due.

The higher the balance in your IRA or IRAs, the higher your tax bill will be if you convert. However, if you invested aggressively in the stock market and your account value is still down from two years ago, you won’t owe as much in taxes as you would have if the account total had been higher, Lindell says.

Under IRS rules, you have to consider the entire value of all of your IRAs when converting and figuring taxes on the conversion, if you have nondeductible IRA contributions.

“(In that instance,) even if you don’t want to convert the entire balance of all of your IRA accounts, whatever percentage you want to convert has to include assets from all of your IRA accounts,” Lindell says.

For example, if you have four traditional IRAs worth $100,000 and those accounts included nondeductible contributions, but you only want to convert $50,000 of those assets (all from one IRA), the IRS won’t allow you to convert only the assets that lost money. You have to take assets from all of your IRAs, not just the losing ones.

Step 2: Seek advice if you’re unsure

If you are considering conversion but are too confused to attempt it on your own, there are lots of places to find help, including the financial services firm that is the custodian of your IRA, or your tax professional or financial adviser.

If you don’t work with a tax professional, get a referral to a reputable local firm. Many offer consultations on these issues for free, says Jim Ciocia, a certified public accountant and chairman at Gilman Ciocia Inc., a tax and financial planning firm in Tampa, Fla. Make sure any advice you get is specific to your situation, he adds.

Step 3: Weigh financial and tax factors

For many taxpayers, the decision to convert is highly individual. How old you are and your present tax bracket all factor in.

“An important factor in deciding whether to convert is considering how much time you have before you retire and will potentially need to use the money,” Ciocia says.

The higher your tax bracket, the more tax you will have to pay on conversion. But if you expect taxes to go up in the long term, conversion makes sense because you may have to pay a higher tax rate in retirement than you expect now, Ciocia says. If you convert, you’ll have a tax-free source of retirement income along with any taxable source of income, such as a traditional IRA, 401(k) or 403(b).

As Ciocia puts it, “Would you rather pay taxes when you plant the seeds or harvest the crop?” In other words, you likely would pay less in taxes on a $5,000 Roth IRA contribution than you would if you had left the money in a traditional IRA and it grew to $34,242 after 25 years of tax-free growth at 8 percent.

In that example, even at a low 15 percent tax rate, your taxes would be $5,136.30 if you left the money in a traditional IRA — far higher than what you will pay now on a $5,000 conversion to a Roth.

Step 4: Calculate the potential tax due

Figuring out the tax due on conversion is not that complicated. Basically, you owe federal and state taxes on your contributions and any gains, meaning the entire value of your IRA, unless you made nondeductible contributions. If you made nondeductible contributions, you would subtract those from your current total IRA account balances to come up with the amount that will be taxed.

Here’s an example:

Current value IRA account:


Nondeductible IRA contributions:


Total taxable value:


Times the current federal tax rate

x 0.25

And the current state tax rate

x 0.05

Tax bill for conversion


You’ll still get a break in when you pay your taxes. Using the above example, with $12,000 in federal taxes due, you wouldn’t have to pay any of that in 2010; you’ll owe $6,000 in 2011 and another $6,000 in 2012.

Step 5: Decide when to pay the tax bill

There are a few other issues to consider when deciding whether to pay the tax due immediately after conversion — if you can afford to — or defer it.

“Whether you want to pay the taxes in 2010 or spread it out over the next two years depends on how consistent your tax situation is,” Sadler says. “If you’re a W-2 employee and don’t have any capital gains or other types of holdings that might create surprises along the way, … you aren’t likely to see a huge tax increase. So I would think deferring those taxes over a two-year period would make sense.”

Many tax advisers agree that for a Roth conversion to make sense, you should be able to pay taxes from your income or another source, not from funds taken from your IRA.

“If you’re thinking about cashing in part of your IRA to pay the tax bill on it, forget it,” Savant Capital’s Lindell says. “You’re defeated already.”

That’s because you’ll have to pay interest and penalties on any IRA funds you remove from your account to pay taxes. Paying the taxes from your IRA account also will reduce your balance and your ultimate nest egg when you retire, he adds.

Step 6: Consider when to convert

The earliest you can convert if you want to take advantage of the two-year tax deferral is Jan. 1, 2010, if your income is currently over the $100,000 limit and/or you plan to file as “married, filing separately.” If your income isn’t over the limit and you can afford to pay the tax now, there’s no reason to wait, especially if your traditional IRA dropped in value. If it appreciates between now and Jan. 1, your taxes in conversion will be higher, says Ciocia of Gilman Ciocia.

For many taxpayers, it makes sense to convert as early in 2010 as possible to gain as much possible from the tax-free growth that a Roth offers. However, if you’re unsure of what your income will be and what tax bracket you’ll be in, it makes sense to wait until the second half of 2010 to get a better handle on the tax consequences, says Sadler.

And don’t forget, there are no income limits beginning in 2010. So if you wait to convert, you can do it regardless of your income.

Step 7: Fill out conversion paperwork

The conversion paperwork isn’t that complicated. If you have made nondeductible contributions to your IRA, you will need to know how much you contributed in nondeductible contributions, which you can find in your income tax forms on Form 8606, Nondeductible IRAs.

You’ll need to let the custodian of your IRA — the mutual fund, bank or other financial services company that holds your account — know certain information, including:

  • How you want your converted assets invested.
  • Whether you will pay the taxes due yourself or want the custodian to withhold the amount from the IRA’s assets to pay them.
  • Who you want to name as a beneficiary to receive the money upon your death.

By Amy E. Buttell •

Amy E. Buttell is a frequent contributor to, and Better Investing Magazine. From her home base in Erie, Pa., she is studying accounting and financial planning with the goal of earning the certified public accountant and certified financial planner designations.

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