Monday, June 24, 2013

A Word of Caution About the “Backdoor” Roth IRA Strategy

A Word of Caution About the “Backdoor” Roth IRA Strategy

By all accounts the “Backdoor” Roth IRA strategy that I laid out in my previous column is a terrific means through which an otherwise ineligible individual may fund a Roth IRA – legally. But if you already have any other traditional IRAs with pretax contributions, there is a very important caveat to be mindful of.

That is, under IRS rules, all traditional IRA money must be distributed on a pro rata basis. I know we’re getting a bit technical here, but just hang on a moment as I explain how this works using Kimberly’s scenario as an example.

Although Kimberly’s income makes her ineligible to contribute directly to a Roth IRA, she has just discovered that she can still do so, using the “backdoor” strategy. So she makes a $6,500 nondeductible traditional IRA contribution (since she’s over age 50) which she intends to immediately convert to a Roth IRA. However, Kimberly has an existing traditional IRA worth $50,000 from rolling over an old 401(k) – and this completely changes things because of the pro rata rule:

As it stands now, her total traditional IRA assets ($56,500) are made up of $6,500 nondeductible funds plus $50,000 deductible funds. As a result Kimberly’s nondeductible ratio of every dollar that comes out of her total IRA assets is 11.5 percent ($6,500/$56,500). What exactly does this mean for Kimberly?

If she tries to immediately convert the $6,500 to a Roth IRA, thinking that all her contributions are nondeductible (and therefore will be tax-free), she’d be mistaken. The IRS will consider only 11.5 percent of the $6,500 (which amounts to $747.50) as tax-free, meaning the other 88.5 percent (or $5,752.50) will be fully taxable. Remember, the IRS considers ALL traditional IRA money (whether deductible or nondeductible) as a single pot of money.

Nevertheless, Kimberly could get around this rule if her current employer’s retirement plan would allow her to transfer her $50,000 deductible IRA to her 401(k). That would leave her with $6,500 IRA money, 100 percent of which is nondeductible, and therefore everything would qualify for a tax-free Roth conversion.

Just another reason why it is usually a good idea to talk with an experienced financial adviser before actually making any moves – however popular and seemingly straightforward or easy they might sound.
It’s your financial future, no one else’s. Be sure to get the professional advice that will help you protect YOUR money from unforeseen challenges. Call us today at 877.656.9111 or visit us on the Web to schedule your no-strings-attached consultation!

Monday, June 17, 2013

The “Backdoor” Roth IRA Strategy for High Income Earners

The “Backdoor” Roth IRA Strategy for High Income Earners

Roth IRAs have a great tax appeal to many Americans, but ironically “high income earners” are disqualified from making annual contributions. However, there is a backdoor that would allow literally anyone, irrespective of income, to fund a Roth IRA.

But before we get down to the nitty-gritty, let’s get a couple of key points straight.

First, by IRS definition, in 2013 you are considered a high earner and therefore disqualified from contributing the annual sum of $5,500 or $6,500 if you’re age 50+ to a Roth IRA if you and your spouse file jointly with a modified adjusted gross income (MAGI) of $188,000 or more. Or if you’re single with a MAGI of $127,000+. Of course, many folks – especially couples – may disagree with the “higher earner” designation, but the IRS has the last word so let’s leave it at that.

The second point is that this “backdoor” strategy is perfectly legitimate.

Now here’s the thing. There is no income limitation when it comes to contributing to a nondeductible traditional IRA, or for doing a Roth IRA conversion. That’s interesting, because practically anyone – even if they make a gazillion bucks a year – may do either or both. This creates – for lack of a better term – the perfect backdoor for any high earner who wants to fund a Roth IRA.

The steps are, simply:

a.       Make the allowable annual contribution to a nondeductible traditional IRA.
b.      Then, immediately (note the keyword immediately) convert the nondeductible traditional IRA to a Roth IRA.

Since nondeductible contributions create what is called a tax basis, any tax bill that results from the conversion – that’s assuming there is one – will be limited to only the growth in value between the date the traditional IRA was funded and the date the Roth conversion occurs. If a truly savvy financial adviser is in the picture, the final tax bill should be zero or something not far off.

This strategy effectively makes it possible to contribute the same amount to a Roth IRA indirectly, and most importantly do so without breaking any rules.

It’s your financial future, no one else’s. Be sure to get the professional advice that will help you protect YOUR money from unforeseen challenges. Call us today at 877.656.9111 or visit us on the Web to schedule your no-strings-attached consultation!

Monday, June 10, 2013

The Folly of Chasing Returns

Unfortunately, a lot of retirement investors have been made to believe the erroneous idea that in order to be successful with their investments, they must focus on earning high returns. Here's why that perception is wrong - and the important catalyst you should really be mindful of...

It's your financial future, no one else's. Be sure to get the SOLID advice that will truly deliver in the end. Call us today at 877.656.9111 or visit us on the web to schedule your no-strings-attached consultation!

Monday, June 3, 2013

Is Your Cash Protected from Broker Bankruptcy?

Is Your Cash Protected from Broker Bankruptcy?

Undoubtedly, one of the first things every investor wants to be assured of is the safety of his or her account’s value, should the responsible financial institution go belly up. In this instance, however, the concept of “safety” might be anything but – and that very possibility is what makes this is an important issue in the first place. So let’s rephrase the question to explore which guarantees are in place to ensure that you’ll get out of your brokerage account everything you put into it.

There is a lot of misinformation around this topic, so I hope this will help clear it up. Let’s use this scenario to clarify: Mr. White needs to finance a project, so he liquidates a little over $80,000 of the securities in his brokerage account. But a few fine-tuning issues will delay his need to make the payment for four to six months, so he doesn’t need the cash right away. Thinking ahead, he wants to be sure that in the event of any financial troubles at the brokerage firm, his cash will not be compromised.  

His broker reminds him that the firm is a member of the SIPC and therefore, should financial challenges befall the brokerage, Mr. White would be made whole, up to $500,000, out of which not more than $100,000 could be in cash. He needn’t worry, because his total account balance is significantly below the threshold.

Here’s the problem. Although the $80,000 in Mr. White’s brokerage account is below the $100,000 cash limit, it has absolutely no SIPC coverage – none! That’s because only “incidental cash” is covered by SIPC. If the cash is in the account for the purpose of earning interest, it’s not covered.

While I wouldn’t say this broker’s statement was intentionally misleading, his assessment about the SIPC coverage of the cash in Mr. White’s account is totally and completely wrong. I would also say the broker is offering some potentially dangerous advice. Of course, this brokerage firm might be solvent for the next 100 years. But does that make this whole argument moot? Not a chance. I don’t have a crystal ball, and neither does Mr. White. And since brokers generally wither up almost instantaneously – without giving their investors any time to react – we just don’t know what might happen within the four to six months before Mr. White has to make his payment, do we?

Given the specifics of this case, I’d recommend that Mr. White lodge his cash in a savings account with an FDIC member bank, keeping in mind that protection in his name is limited to $250,000 at any given bank. Under FDIC rules, although his $80,000 is intended to earn interest, it is still covered.

Lastly, please remember that every financial situation is different, so don’t take my conclusions here as a matter of general rule. Your situation might lend itself to the exact opposite solution.  Happy investing!

It’s your financial future, no one else’s. Be sure to get the professional advice that will help you protect YOUR money from unforeseen challenges. Call us today at 877.656.9111 or visit us on the Web to schedule your no-strings-attached consultation!