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MONTHLY TAX NEWSLETTER

CAVEAT FOR ROTH CONVERTERS

by Andrew D. Schwartz, CPA

Roth conversion season is in full swing.  Remember, 2010 marks the first time since Roth IRAs were introduced back in 1998 that people earning more than $100k can convert their IRAs and other eligible retirement accounts to a Roth IRA.  Plus, anyone who converts their retirement savings to a Roth IRA this year has the option of reporting that income on their 2010 return, or splitting the income equally over the subsequent two tax years.

During this past winter, I heard from a handful of clients who began the process of converting some of their retirement accounts to a Roth IRA, and was surprised by one specific issue that many of those clients called me to discuss.  Apparently, certain financial institutions seem to be recommending that their customers elect to withhold federal and state income taxes on the money being converted.

If you plan to convert, please be aware that withholding income taxes on a Roth conversion is a huge pitfall.  While you'll owe income taxes on the amount converted, you don't owe the 10% early withdrawal penalty on money rolled into your Roth account within 60 days. Since any money withheld for taxes is not deposited into your Roth account, expect to pay income taxes plus a 10% early withdrawal penalty on the taxes withheld. 

According to the IRS in Publication 590 on Individual Retirement Accounts:

You can withdraw all or part of the assets from a traditional IRA and reinvest them (within 60 days) in a Roth IRA. The amount that you withdraw and timely contribute (convert) to the Roth IRA is called a conversion contribution. If properly (and timely) rolled over, the 10% additional tax on early distributions will not apply.

You can roll over part of the withdrawal into a Roth IRA and keep the rest of it. The amount you keep will generally be taxable (except for the part that is a return of nondeductible contributions) and may be subject to the 10% additional tax on early distributions.

Another huge problem with having taxes withheld on the Roth conversion is that you end up with less money within your retirement savings accounts following the conversion.  Unless the money will remain invested for decades, wouldn't you be better off having 100% of your money growing tax-deferred within your IRA than having 75% of your money growing tax-free within a Roth IRA?

As part our revised 2010 Roth Conversion Quiz, we include whether you have enough money to pay the taxes due on the Roth conversion as one of the ten criteria to consider prior to converting.  Please note that our Roth Conversion quiz is like golf where the lower the score the better. Let's take a look at question number 4 from the Quiz as reprinted below:

Question 4: How will you pay the taxes that will be due in connection with the conversion? Remember, the taxes on the 2010 conversion can be spread over two years starting in 2011.

• You currently have enough money sitting in a savings account to pay the taxes that will be due. (2 points)
• You will be able to adjust your withholding at work to cover the additional taxes that will be due without impacting your family budget too badly. (4 points)
• The money needed to pay the taxes is fully invested in stocks and mutual funds. To pay the taxes that will be due, you will need to sell some of those investments. (6 points)
• You will not be able to come up with the money to pay the taxes on the conversion without withdrawing money from the Roth IRA. (8 points)

60 Day Solution

What happens if you already converted your IRAs to a Roth IRA, and you elected to have taxes withheld?  If 60 days have not elapsed from the date of the conversion, you can transfer money from your non-retirement savings account into the Roth IRA to cover the taxes withheld.  When you complete your tax returns next winter, you'll get back those taxes withheld on the Roth conversion.

De-Convert If Necessary

If more than 60 days have passed, or you do not have the money to repay your Roth account for the taxes that were withheld, you can always undo the Roth conversion.  Just make sure that the financial institution reverses any taxes that were previously withheld.

And don't forget that you are not allowed to reconvert your recharacterized IRA account during the same calendar year.  According to the IRS, "You cannot convert and reconvert an amount during the same tax year or, if later, during the 30-day period following a recharacterization. If you reconvert during either of these periods, it will be a failed conversion."

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QUESTIONS ABOUT COLLEGE FINANCIAL PLANNING

Are you concerned about the high cost of sending a child to college? Do you have a child who is in high school and will be starting their undergraduate career in the next few years?

If so, please post your college financial planning questions on our new College Financial Planning Forum.  We have a specialist waiting to answer your questions and give you some great tips to help make the cost of a child's college education more affordable.

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SPRING CLEANING

by Andrew D. Schwartz, CPA

Spring is traditionally a time to clean up your yard upon the completion of another winter.  While you're in the cleaning mood, why not take a few steps to clean up your personal credit as well.

Review and Revise

May is a great month to take a step back and review your outstanding credit card debt.  That's because the summer spending season is still more than one month away, and you have more than a half a year before you will even commence your shopping for the 2010 holidays (unless you're really a Type A holiday shopper).

Start by taking an inventory of what you currently owe on each of your credit cards.  Then, take a few minutes to reset how much you plan to pay towards your credit card debt each month for the remainder of the year. 

Need help crunching these numbers?  Downloading our (Microsoft Excel) debt/savings calculator should save you a lot of time with this step.

Order Your Free Credit Report

Currently, three companies, Equifax, Experian, and TransUnion, track everyone's credit histories.  Don't forget that banks, lenders, retailers, landlords, and other "credit grantors" use credit reports generated by these companies to determine your creditworthiness.

Your credit report reflects quite a bit of information about you and your financial affairs. 

• The bulk of your credit report focuses on your various loans and credit card accounts. Included is the name of each of your creditors, as well as the type of account, the minimum monthly payment, the account's limit or high balance, and the current outstanding balance.

• Your credit report also reflects the most recent twenty-four month payment history for each creditor, showing whether each month's payments were current, delinquent, or in default.

• Another section on your credit report details inquiries that were made by potential creditors.  In this section, the name of the creditor and the date of inquiry are listed for each request that has been made.

• Your credit report also includes "public records" such as tax liens, bankruptcies, and judgments made against you.  Most public records remain part of your credit history for seven to ten years.  If you have any tax liens, they won't be removed from your credit report until they are paid off.

The best way to find out how your credit report looks is to order one.  You're now allowed to order three free credit reports per year - one from each credit bureau - through annualcreditreport.com. 

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TAX AND FINANCIAL PLANNING CALENDAR FOR MAY, 2010

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2009 & 2010 TAX FACTS

• For 2009 and 2010, the standard deduction for a single individual is $5,700 and for a married couple is $11,400. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.
• For 2009and 2010, the personal exemption is $3,650. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  
• The maximum earnings subject to social security taxes is $106,800 for 2009 and 2010.
  
• The standard mileage rate is $.50 per business mile as of January 1, 2010, down from $.55 per mile for 2009.
  
• The maximum annual contribution into a 401(k) plan or a 403(b) plan is $16,500 in 2010.  And if you'll be 50 or older by December 31st, you can contribute an extra $5,500 into your 401(k) or 403(b) account that year.
• The maximum annual contribution to your IRA is $5,000 for 2010.  And if you turn 50 by December 31st, you can contribute an extra $1,000 that year.  You have until April 15, 2011 to make your 2010 IRA contributions. 

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