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.

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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.

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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!

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...

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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!

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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!

Are Equity-Linked CDs Right for You?

Are Equity-Linked CDs Right for You?

Pretty much everyone knows what Certificates of Deposit – affectionately known as CDs – are, so let’s not bore ourselves with another description. However, I’d like to share my thoughts on equity-linked CDs which, although they have been around since the 1980s, seem to be generating a lot of renewed buzz, good or bad.

Let me be crystal clear, right off the bat, though. This discussion is not going to amount to any wholesale declaration of whether these CDs are “good” or “not good.” Such comments don’t fit my mold at all. In fact, my goal here is to expose the ridiculously unprofessional and, quite frankly, shameful spin that surrounds the discussion about these CDs.

Instead of plain vanilla fixed interest, equity-linked CDs tie your interest to the performance of a given stock market index, such as the S&P 500 or DOW, up to a certain predetermined cap. So in a generic sense, if the underlying index does well, you stand to earn a higher return, up to the cap.

Of course, like any normal person would and should expect, there are tons of caveats involved, from exactly how your interest will be calculated to penalties for early withdrawal to maturity periods to taxation and a whole host of others. It therefore makes sense to be sure that before you choose one of these – or any other investment under the sun – you comb the fine print and know for certain that it fits your intended situation. That is where an objective, thorough, thoughtful, and above all honest financial advisor comes in handy.

Now to the point I’m trying to get at. Be extremely skeptical of those so-called know-it-all “experts” who have issued blanket “good” or “bad” judgments on equity-linked CDs, for the simple reason that they haven’t reviewed every one of them. I’m also guessing they probably don’t know you personally, let alone what your investing goals and principles are.

For a classic case that makes this point, contrast an objective review by the Securities and Exchange Commission with Frank Armstrong III’s column in Forbes, where he basically branded every equity-linked CD as “garbage.” I’m hoping you take your investing decisions rather seriously – meaning you give it more thought than any columnist, TV expert, blogger, or other financial “expert” can give you in a five-minute overview.

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It’s your financial future, no one else’s. Be sure to get the best professional advice for your situation. Call us today at   877.656.9111  or visit us on the Web to schedule your no-strings-attached consultation!

Are You Letting Your Financial Advisor Off the Hook?

Are You Letting Your Financial Advisor Off the Hook?

By and large, the way most of us prepare financially for our retirements or our kids’ college

tuition begins and ends with signing up for the “best” program we can find. As a result, we tend, for lack of a better term, to completely ignore what happens in between those years — which is a rather unfortunate mistake.

Of course you want to make sure that whatever you ultimately sign up for looks attractive enough. But it is no secret that, sadly, most financial professionals are experts at presenting powerful, rosy outlooks — either by using unrealistic assumptions, being naive, being genuinely clueless, and sometimes even being flat out disingenuous. And by the way, this is also the case with many so-called media money experts, marketing materials, and plans offered through your job.

So how do you keep from becoming a victim of the proverbial “it sounded really good — had I only known” syndrome? By making annual reviews a must, a without-fail part of your financial plan. I cannot reiterate this strongly enough. Ninety-nine percent of cases of disappointing financial outcomes I have helped folks deal with could have been salvaged if they’d done a simple, thorough review years ago. You see, only the rarest financial plan won’t need some sort of change or adjustment over time. But how are you supposed to know what needs to be changed or adjusted?

Besides knowing exactly where things are, a review will allow you to confirm the validity of your assumptions — and your advisor’s assumptions, too. In fact, if you ask me how you can tell if a financial professional is genuinely superior at his or her work, I’d say at the very top of the list of things is finding one who INSISTS on performing regular annual reviews, come what may, whether things are good or otherwise.

Sure, investing is a long-term venture. No question about that. But what, really, does “long-term” mean? Isn’t it simply an aggregation of what goes on over short-term periods? So, in a nutshell, it is essential that you hold your financial professionals’ feet to the fire — not literally, though — by demanding regular annual reviews.

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It’s your financial future, no one else’s. Be sure to get the best professional advice for your situation. Call us today at   877.656.9111  or visit us on the Web to schedule your no-strings-attached consultation!

Why 401(k)s and IRAs Could be Toxic for Social Security Recipients

If you plan on reducing your tax bill during retirement, one of the things you must pay attention to today is where you are investing.  This 2-minute video explains something that most financial advisors either don't know about or don't think is important.

It’s your financial future, no one else’s. Be sure to get the best professional advice for your situation. Call us today at  877.656.9111 or visit us on the Web to schedule your no-strings-attached consultation!