I haven’t seen any numbers to show what impact this particular credit has had on the housing market – but any impact it has had must have been minimal, albeit positive.  The housing market continues to be pretty dismal throughout much of the country, even in the face of continued reductions in mortgage rates, which have now dipped below the 5% level for 30-year typical mortgages.

So, if you weren’t quite ready to take the plunge and buy before December 1, you now have 7 more months to get ready (if you want to take advantage of this credit).

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Through 2010

The law today through the end of 2010 specifies that Earned Income includes only that income which is taxable when calculating the Earned Income Tax Credit.  As such, there are classes of “income” that are excluded, such as 401(k) deferrals and nontaxable combat pay, which is an electable choice (actually coming from the Heroes Act).

Beginning in 2011

Any income from employment, including self employment, is used in the calculation for EITC.  This includes those two items listed above, 401(k) deferrals and nontaxable combat pay.  The Earned Income Tax Credit is reduced as income increases, so adding more sources of income will have the effect of a reduction in this benefit for those folks that are eligible to take advantage of it.

And since this credit’s top end is a family income of $41,646, you quickly come to realize that reducing this benefit is impacting folks with already low incomes and children to support (in most cases).  Just another example of a tax increase that will take place with no effort by the present administration – if they choose to do nothing to rectify the situation.

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The problem with this strategy is that each taxpayer is required to treat all Roth conversion taxation with the same method, either all tax paid in 2010 or half in 2011 and half in 2012.  So even if you make two or more different Roth conversions in 2010 and elect the deferred treatment for the tax (or elect to pay the tax in 2010), then you have to use that election for all of your conversions for 2010.  This rule is per taxpayer… which opens up a possible workaround!

There’s a Workaround

There is one way to work around the tax law on this one – but you have to be married.  I know some folks (both guys and gals) who would say that no amount of tax savings would be enough to get married, and it’s probably not the best idea to rely on tax code provisions as a reason to enter into wedlock.  Rare indeed is the situation where the IRS is responsible for a flourishing union…

But for the purpose of the example, let’s just say you had other reasons, and now you find yourself eligible to file taxes with the status of Married Filing Jointly. Let’s further say that you and your spouse jointly have $300,000 in IRA accounts, split as follows: $200,000 in your name and $100,000 in your spouse’s name.  In order to convert the total amount of $300,000 in 2010 and reduce taxes to the lowest possible amount, your spouse could convert $100,000 and elect to have the conversion taxed in 2010… and then you could convert $200,000 and elect to defer the tax to 2011 and 2012.

Now you’ve effectively spread out the tax over 3 years, with even amounts being taxed each year.  Given the graduated nature of our tax system, this is likely the most tax efficient method for affecting a conversion.  Unfortunately for filers in other statuses (stati?) this option is not available – it’s either all in 2010 or half & half in 2011 and 2012.

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Understandably, this hasn’t really hit the radar for next years’ conversion topics, because this is primarily important to folks with a much lower income.  So if you’re one of those fatcats with an annual retirement income projected above $100,000, then you might not want to bother reading any further – this likely doesn’t apply to you. (But look at the note at the bottom before you leave!)

However, (and there’s always a however in life), this will be important to consider if you are in a position to reduce your net non-Social Security plus ½ of your Social Security Benefit to a level below $44,000 (even moreso if you can reduce it to below $32,000).  Those are the numbers for Married Filing Jointly – the figures for Single, Qualifying Widow(er), Head of Household, or Married Filing Separately are  $34,000 and $25,000, respectively.

Now, it may seem like this is a pretty insurmountable position to be in… after all, you need an income of (for example) $60,000 in order to just get by!  Imagine, though, what would happen if you were able to take a large portion of that $60,000 from a tax-free source, such as a Roth IRA.  In that case, you might be able to get by without having to pay tax on any or a large portion of your Social Security benefits.

The Facts

I guess I got a little ahead of myself – let’s back up and look at the facts.  If your net AGI (not including line 20b) plus ½ of your Social Security Benefit is less than $32,000 ($25,000 for Singles, et al), then none of your Social Security Benefit is taxed.  If the amount described above is greater than $32,000 but not more than $44,000 (between $25,000 and $34,000 for Singles), then 50% of your Social Security Benefit will be taxed.  If that same figure is above $44,000 ($34,000 for Singles), then 85% of your Social Security Benefit will be taxed.

Example (*uses 2009 tax tables – your mileage may vary)

Let’s say for example that John and Mary’s lifestyle need requires an income of $60,000, and they have a combined Social Security Benefit of $25,000.  So, John and Mary take a total of $35,000 from their IRAs (total balance of $500,000) to make up the difference.  Running the calculation, when we add ½ of the SS benefit to the rest of the income ($12,500 plus $35,000) we get $47,500.  Since this is greater than $44,000, 85% of the SS benefits are taxed.

If John and Mary decided to convert 20% of their IRAs to Roth IRAs ($100,000), now instead of taking $35,000 from the traditional IRA each year, they could take $28,000 from the traditional IRA and $7,000 from the Roth.  Re-running the calculation, now ½ of SS benefit plus AGI ($12,500 plus $28,000) equals $40,500.  Now, only 50% of the SS benefit is taxed!  Granted, in the year of the Roth conversion, John and Mary had to pay considerably more tax on the conversion amount, an additional $21,980, but this pays off in reduced taxable SS benefit after just over 9 years.

Taking this a step further, if John and Mary decided to convert 40% of their IRAs to Roth IRAs ($200,000), we can eliminate taxation of SS benefits altogether.  Now we’re taking only $21,000 in income from the traditional IRA and $14,000 (tax free) from the Roth.  Running the calculation again, we come up with $33,500 ($12,500 plus $21,000) – now we’re less than the $34,000 limit.  At this level, NONE of the Social Security benefit is taxed.  Again, there is a significant tax cost in the year of conversion ($51,415), which is paid off in reduced taxes in just over 11 years at today’s rates.  With both examples, if future tax rates increase when future tax rates increase, the payoff is even faster.

So you can see how this could be a great strategy for folks that are capable of reducing their income component by such a factor.  There’s also the added benefit of reduced amounts against which Required Minimum Distributions are calculated.  As you reach the RMD age limit (70½), you may have determined that you don’t need the amount that is prescribed as income.  If you’ve reduced the traditional IRA balance by converting a good portion to a Roth IRA, the RMD amount will be less by proportion.

Of course, you could also reduce the tax hit by drawing out the time within which you do the conversions – such as splitting up that $200,000 over four years, for example – this way you’d have much more of the conversion being taxed at lower rates.  Obviously, your situation is going to vary from the example, so work closely with your tax advisor as you make plans.

Note:  Keep in mind that this strategy could work for literally anyone at any income level – as long as the income isn’t from a fixed source, such as a traditional pension.  If it’s from investment accounts, IRAs, annuities, or some qualified retirement plan, then you should consider this strategy to see if it makes sense for you.

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However – and if you read here much, you know there’s always a however in life – this decision isn’t as cut-and-dried as conventional wisdom leads us to believe.  As with just about every financial decision we make, it’s not wise to go off willy-nilly without considering all of the benefits that we’re giving up. (If you’ve worked with me in the past, you know I don’t cater much to the willy-nilly…)

9 Special Considerations Before Rolling Over Your 401(k)

1. If you are happy with your former employer’s plan, consider it well-managed, low cost, and possibly with some investment options that are not readily available (such as desirable mutual funds that are closed to new investors), you may want to leave the plan intact.  This would be especially beneficial if you don’t have another employer plan to roll over into, or you are squeamish about establishing your own IRA.
2. Depending upon your opinion of future legislation being considered, it is possible that maintaining a 401(k) account could garner you some employer-sponsored financial advice.  There have been quite a few options floated in Congress regarding the requirement for employers to provide advice for their retirement plan participants, although none have been passed into law as of this writing.  Removal of your funds via a rollover would eliminate this benefit for you.
3. If you have commingled deductible and non-deducted IRA contributions in your IRA account, having an active 401(k) plan can help you to “separate” the deductible IRA assets from the non-deducted.  See this article for more information.  Essentially this benefit gives you a way to bypass the “little bit pregnant” rule wherein you must consider all IRA funds pro-rata when making distributions… a common issue when doing a Roth IRA conversion, for example.  If you have no 401(k) plan, this option is lost.
4. If you have an investment in your former employer’s stock in your 401(k), you need to consider the ramifications of utilizing the Net Unrealized Appreciation (NUA) option – before doing a rollover.  This article explains NUA, in case you need a refresher.  The point is, if you’ve taken even a partial rollover of your 401(k), the NUA treatment is no longer available to you.
5. If you think you may be returning to this employer, it might make sense to leave your funds where they are.  This is especially true for government employers with section 457 plans – due to the nature of these plans’ ability to provide you with retirement income without penalty much earlier than an IRA can.  With the vagaries of governmental policy changes, if you’ve withdrawn and closed your account and come back to work for the same agency, the old plan may no longer be available to you since you’re a “new” participant.
6. If you’re at or above age 55 and are not moving to a new employer (or are undertaking self-employment), maintaining the 401(k) plan gives you an option to begin taking distributions prior to age 59½ without penalty.  If you move these funds over to an IRA, this option is lost.
7. On the off-chance that you might need a loan from your retirement funds, you should know that IRAs do not have this provision.  Retain at least some balance in the plan if you might need this option – but also you should check with your plan administrator to see if this option is available for non-employee plan participants, because it might not be (and actually, it likely is not).  But keeping in mind #5, if you’ve maintained a healthy balance in the plan and you return to work with this same employer, you’d have a much larger account to work with if you needed to borrow.
8. Funds in a 401(k) account are protected by ERISA – and as such are generally not available to creditors.  Depending upon the state you live in, IRA assets may be available to your creditors in the event of a bankruptcy.  If you’d like to bone up more on this, see this article.  At any rate, ERISA protection is pretty much an absolute, so this is yet another reason you might consider leaving funds in a former employer’s 401(k) plan.
9. Take your after-tax contributions out first, if your plan happens to include these.  If you’ve made after-tax contributions, as some plans allow, it makes sense to separate these contributions from the pre-taxed amounts.  You can convert these contributions directly over to a Roth IRA in most cases, income allowing (and in 2010, income won’t be a problem, either).  This is because the 401(k) isn’t subject to the “little bit pregnant” rule alluded to earlier.  Once you’ve removed the after-tax contributions and put them into a Roth IRA, you can then rollover the rest of your 401(k) if it makes sense.

I don’t imagine that this is an exhaustive list of all the reasons you need to stop and think about it before rolling over a 401(k) plan, but we’ve hit the high points.  If you have other good reasons to share, please leave a comment!

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The Combination Plan

A defined benefit plan is the IRS’s description of the old-style pension plan.  And of course, we all know what a 401(k) plan is.  So this new Combination Plan – referred to by many names, such as DB/k, Defined Benefit/401(k), or by the code section it comes from, 414(x) – is a safe-harbor version of both plans combined.  With this type of plan, which is limited to employers of between 2 and 500 employees, the employer can provide the 401(k)-type of savings plan with prescribed matching, along with the old-style pension benefit (you remember, a percentage of your highest annual income, multiplied by your years of service, and all that?).

Being a safe-harbor plan means that there are prescribed percentages that the employer must follow in order to ensure that the plan maintains appropriate balances – such as matching at least 50% of the deferrals of the employee, up to 4%.  In addition, the amounts prescribed for the DB portion of the plans are specific to the age of the employee, ranging from 2% for an employee aged 30 or less, up to 8% for an employee age 50 or better.

Although these amounts have been set forth by the law, it’s really not clear how the plan makes up the difference for employees… since an employee age 60 with 20 years’ time with the company, making $50,000 per year would have $4,000 credited to his account, somehow the account has to come up with a total of $10,000 (the 20 years times 1% times his salary) in annual pension payments when the employee retires.  I suppose in time this will work out.

The Bottom Line

The bottom line for the DB/k in my opinion is that this is a nice plan, but it is likely to be 1) ignored, due to the complexity; or 2) dismissed altogether due to the costs.  Either way, I wouldn’t expect to see a lot of DB/k plans in the industry, but I could be wrong.  (Note:  This likely accounts for the dearth of information available about these plans.  Heck the IRS only asked for technical input on these plans a few months ago.)  This sort of plan may be exactly what small employers have been looking for to make a difference and retain employees.  I think that some sort of defined benefit (or rather, guaranteed income) component is likely to become an important part of retirement plans in the future, but I also believe that it will come as part of existing plans, such as low-cost annuities.

What do you think?  Are you hearing a lot about these plans?  Let me know in the comments section…

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Of course, many advances have occurred since 1918, and as such it is expected that the death rate will be dramatically less than the 2.5% of the infected rate that occurred then. First of all, these days we have vaccines available, albeit fewer doses than we’d hoped for by now.  Secondly, we have quite a few advance plans ready to go – school closings, business readiness and travel bans, to name a few – to help with management and containing the pandemic.  And thirdly, our treatments are far more advanced than what little was available back then.  But these reasons aren’t what I was referring to in the title of this post…

The Bright Side of H1N1

There are no absolutes in life, especially when it comes to global relations and economics… but I believe that in the evolution of the H1N1 pandemic to date we’ve seen some baby steps toward reconciliation – a more “normal” economic environment. While there are bound to be some short term negatives, global focus on resolving this pandemic quite likely will help to lead our worldwide economy out of the doldrums that we’ve been experiencing.  Don’t get me wrong, I don’t think it’s reasonable to think that we will see world markets rallying in short order.  In fact, the pandemic could lead to a dampening effect – but in the end result this could be good as well, by forestalling too-rapid growth in the economy, thereby negating inflationary concerns.

It’s not a sure thing by any stretch, but it’s my guess that we will come out of this crisis in much better condition than we’re going into it… what do you think?

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Confidence is one of your most important success ingredients. With it, you can achieve most anything. Without it, there is no psychological pill that can make you succeed.

Faith is the ability to believe even when you have no reason to. Faith is necessary sometimes to move forward and do something you don’t know if you can do, or when the world around you is telling you that you cannot. This is also when a trusted guide can be useful to help you figure out what is valid and what is not.

Experience gives you the proof you want and need to build future confidence on, and is something you get after you use faith and confidence first to achieve what you want. Experience is developed incrementally – in baby steps at first, with more momentum as you gain more confidence.

It is easy to make grand gains when the greater forces like “the economy” are going in your favor. Those who are truly successful make gains by having faith and confidence in themselves no matter what direction the so-called greater forces around them appear to be going. Short-term “noise” doesn’t bother these folks one bit.

In all things you can benefit by strengthening your confidence and faith in yourself. Seek guidance from others who have the experience that you lack.  Look to and recall your past successes as a foundation to build your confidence in yourself and your plans.

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Prognosticators

Things may be a little different from what I described in the earlier post.  Some very smart guys (John Buckley, Chief Counsel for the House Ways and Means Committee, author and Estate Tax expert Jonathan Blattmachr, and Frank Berall, co-Chair of the Notre Dame Estate and Tax Planning Institute, among others) who make it their business to know everything about the Estate Tax from 1939 forward (when the current system was put in place), have been looking at the possibilities with regard to the projected 2010 repeal of the Estate Tax, and they have several predictions that could come into play.

Back to the Future

Instead of the supposed $1.3 million cutoff for basis step up, these guys figure that it’s every bit as likely that, IF the repeal goes through for 2010, that we’ll revert to the rules that were in effect with the 1976 Tax Reform Act.  This means that the old “carryover basis” rule would go into effect – meaning that, when you inherit a piece of capital property, be it a stock or 80 acres of farmland, instead of receiving the step-up value as of the date of death of the decedent, you’d have to retain the original basis, or purchase price.  So if granddad bought AT&T at $2 and now it’s worth a split-adjusted $300, you’d still have to use the carried-over basis of $2 when you sell the stock, and owe capital gains tax on the difference.

The reason this rule is expected (again, IF the repeal goes through for 2010) is because there is a significant amount of tax revenue that would be foregone, otherwise.  It’s always about the Benjamins, right?

The good news is that those same guys don’t think the repeal will go through at all…

Back to the Present

Instead of the repeal, it is expected that the real outcome will be an extension of 2009’s limits:  45% maximum rate and $3.5 million exemption, with the same step-up basis rules in effect.  The primary reason that this is the most likely outcome is because even with the carryover basis rule in effect, there would be an adverse impact on revenues, and with the “pay as you go” rule in place, any benefits must be paid for with cuts or increased revenues – however Estate Tax and Gift Tax provisions are exempt from paygo.

The extension is expected to be announced sometime in December, possibly just before Christmas, although it is possible that Congress could delay and pass the law sometime in 2010 retroactive to the first of the year – which has been deemed a constitutionally-allowed action.

However it works out, it’s going to be interesting to see what does happen with Estate Tax in 2010 and beyond.  Stay tuned!

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What Happens When Your IRA Will No Longer Support Your SOSEPP?

Here’s an example:  You’ve set up a SOSEPP in your IRA, beginning at age 50.  As we all know (see this post for details) you have to keep the payments going until you reach age 59½.  During that time, many things can happen, both positive and negative.  In this case, the IRA began with a balance of $100,000, and your annual payments are $3,000.  Things go fine for the first few years, although your account doesn’t seem to be growing.  So, you decide to take a leap and invest it all in a wild-eyed fund – some Madoff fellow’s running it.  Then, lo and behold, one morning you wake up and find that your IRA balance has become – $12 total.  You’re age 56, so you have three and a half more years that you are supposed to be taking this regular payment of $3,000 from your account!  What do you do?  You’ve read about the crazy penalties for busting a 72t payout plan – yikes!

Options

Calm down.  Take a breath, it’s really not so bad.  There are several options:  You could rollover funds from another account into the IRA, either from another IRA account or a 401(k).  You could also choose to make your one-time change to your SOSEPP plan.  Or, you could choose to let it die, and go on with your life.  The best option is the last one – it allows you to be as flexible as you can be.

If you chose the first option, it certainly would work – and your SOSEPP would just continue on as originally planned.  But what if you have decided at this stage that you really don’t need that series of payments anyway?  And it’s just a pain in the rear keeping up with the paperwork and remembering to take the payment each year…?

The same holds true for the one-time change to the RMD method.  If you did that, now you’d have to re-calculate your payment each year on a very small balance.  Once again, a pain in the rear – so why not just take the third option?

Let it die

If you go ahead and take the last payment out of your account (the remaining $12) and close the account – your SOSEPP is no longer in effect.  You now have the option of starting a new SOSEPP from another IRA account, or just discontinuing the idea of the 72t payout.  If you chose to start a new plan, you’d have to start over with a new five-year or (since in the example, you’re age 56) for three and a half more years until you reach age 59½.

What’s key to understand in this is that, for SOSEPP’s, the IRS considers each IRA account separately – yeah, I know, for everything else, all IRAs are considered as one.  What can I say?  They don’t want you to get too comfortable and start predicting how they’ll move – just when you think they’re gonna zig?  they zag.  So with that in mind, if one account (the one with the SOSEPP attached) runs dry, there’s no penalty if you just drop it and move on with your life.

That’s literally all there is to it.  No penalty, no muss, no fuss.

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