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MONTHLY TAX NEWSLETTERJune 2007
2007 marks the tenth year that Roth IRAs have been in existence. For the first time since being introduced back in 1998, the income threshold limiting the number of people eligible for this tax-free investment opportunity has increased.
What Is A Roth IRA?
IRA stands for Individual Retirement Account. Before the introduction of the Roth IRA, only one type of IRA was available. Money contributed to a traditional IRA may or may not be tax deductible, but always grows tax-deferred. That means you will owe income taxes on money withdrawn from these accounts down the road.
With a Roth IRA, you forego a tax deduction today in exchange for the government's promise of tax-free growth. Assuming the rules don't change between today and when you retire, you won't owe a dime in taxes on distributions taken from your Roth as long as you've owned a Roth IRA for at least 5 years and amounts withdrawn are taken after you reach the age of 59 1/2 or are used for up to $10,000 towards first time home buyer expenses.
Roth IRAs Are Not Available to Everyone
An interesting trend of recent tax law changes is that many of the newer tax breaks aren't available to all taxpayers any more. The Roth IRA is no exception.
Since their introduction ten years ago, you could only contribute the full amount to a Roth IRA if your Adjusted Gross Income (AGI) did not exceed $95,000 if single or $150,000 if married. No contribution was allowed for single individuals whose AGI surpassed $110,000 and for married couples whose AGI surpassed $160,000.
From 1998 through 2006, this phase-out range has held steady. A pro-rata contribution is allowed for years that your AGI falls within the phase-out range.
4 Percent Jump
For the first time in ten years, the income limitation for Roth IRAs has increased. Thanks to a four percent jump, the phase-out range begins at $99,000 for single individuals and $156,000 for married couples, effective for 2007.
The amount you can contribute is on the rise as well. While the maximum contribution into your IRAs remains at $4,000 for 2007, it is slated to increase by 25% to $5,000 for 2008. Anyone 50 or older by December 31st can sock away an additional $1,000 per year into their IRA. You have until April 15, 2008 to contribute to your Roth or traditional IRA for 2007.
The Financial Triple Crown
Wondering how to win the Triple Crown of personal finances? Forget about wagering a lot of money trying to successfully pick the winner of the Kentucky Derby, the Preakness Stakes, and the Belmont Stakes.
Instead, start by maxing out your contributions to your 403(b) and 401(k) plan at work and your SEP IRA, SIMPLE IRA or Solo 401k if you're self-employed. Second, once you know where you'll be living for the long-term, own where you live. And lastly, if your income is low enough, max out your contributions into your Roth IRA each year. Thanks to the recent increase in the phase-outs, you have a little better odds of qualifying for a Roth IRA in 2007.
For many healthcare professionals, the student loan interest deduction has become nothing more than a cruel irony. Basically, when you can deduct it, you're not paying it. And when you're paying it, you can't deduct it.
Each year, individuals are allowed to deduct up to $2,500 of student loan interest paid. You can claim this deduction whether you itemize or not.
If you're married, your combined student loan interest deduction is limited to the same $2,500 that a single person can claim. Filing separately from your spouse won't help you get around this rule, since no student loan interest deduction is allowed for married couples who don't file jointly. When people refer to the marriage penalty, they are talking about rules like this one.
Wondering how you'll know how much student loan interest you pay each year? During January, each of your loan processors is required to send you a Form 1098-E reflecting the interest you paid to them during the prior calendar year.
A huge pitfall to this tax break is that you can only deduct your student loan interest if your income falls below a certain threshold. While the phase-out range for 2007 has increased by $5,000 over the prior year, most healthcare professionals who have completed their training will find that their income is too high to qualify.
Single individuals begin to lose out on this tax break once their income exceeds $55,000 (in 2007). The student loan interest deduction is completely phased out once an unmarried person's income exceeds $70,000. For married couples, the 2007 phase-out range is double those amounts, or $110,000 - $140,000.
The phase-out calculation is fairly straightforward. If your Adjusted Gross Income (AGI) falls within the applicable range, you lose out on that percentage of your student loan interest paid during the year equal to where your AGI falls within the $15,000 ($30,000 for married couples) phase-out range.
Let's assume you're single, and your AGI is $65,000. Since your AGI exceeds the $55,000 threshold by $10,000, and the phase-out range is $15,000, you'll only be able to deduct one-third of the first $2,500 of student loan interest paid. If you paid more than $2,500 in interest during the year, you would claim $833. Otherwise, the total interest reflected on all your 1098-E's would be cut by two-thirds.
Pay or Defer
The second source of this cruel irony is that while you're in your training, the bulk of your student loans are most likely in deferment. So during those years that your income falls below the relatively low threshold, you're not required to make any payments towards your student loan debt. No payments equal no deduction.
Should you consider making payments towards your student debt while your loans are in deferment? Even though money is probably very tight, paying some of your loans each year might cut your income tax bill, and will also reduce the amount of unpaid interest that will be added to your student loan nut when your loans come out of deferment.
The $625 Question
Since this tax break is a deduction, the taxes you save are based on the amount you can deduct multiplied by your marginal tax rage. Let's say you're in the 25% tax bracket, and you paid more than $2,500 of student loan interest. Assuming your income is low enough so you can take full advantage of this deduction, you'll end up saving $625 ($2,500 * 25%) in federal income taxes that year.
There are many variables to consider when deciding whether it makes sense for you to pay your student loans while you're still in your training. For more information and strategies regarding your student loan portfolio, check out GradLoans.com.
by Jonathan B. Schwartz
Editor's note: Is frugality hereditary? Can frugality be taught? My oldest child, Jonathan, was born in 1998. Coincidentally, I drive a 1998 Jeep Cherokee, which I hope to continue to drive for many, many more years. On more than one occasion, I have promised Jonathan that he can have my Jeep when he gets his driver's license. Below is an essay he wrote for school about an old item from the house:
My old item is my dad's 1998 Jeep Cherokee. 1998 may not seem old, but my dad's car is ancient!! (P.S. It stinks!) He says that I will drive his car when I get my license. Except, I don't want it! I already called my mom's car.
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