Roth IRA Conversion

If you want to contribute to a Roth IRA but think your income is too high, there is another back door option. Here is what you do: Open a Traditional IRA; Make a nondeductible contribution; Convert the contribution to a Roth IRA.

Why go through the trouble of converting money into a Roth IRA? They are an amazing deal, especially for younger, long-term planners who want to hedge against higher tax rates in the future. With a Roth IRA you don’t ever have to take money out, and when you do start taking money out, it’s all income-tax-free, including the earnings. By contrast, with a traditional IRA, earnings grow tax-deferred, you have to start taking required mandatory distributions the year after you turn 70.5, and distributions count as income. A Roth can help minimize your tax bill come April.

Contributions are still limited to $5,000 (or $6,000 if you’re 50 and older) each year that grows in the Roth IRA income tax free. That’s $10,000 (or $12,000 for 50 and older) a year for a married couple. Income restrictions on conversions were lifted on Jan. 1, 2010, so anyone—regardless of income—can convert a traditional IRA to a Roth. Once your modified adjusted gross income is $183,000 for a couple filing jointly or $125,000 for singles, no Roth IRA contributions are allowed.

Other benefits to having Roth IRA money: 

• Medicare premiums are based on income. By regulating how much money comes from retirement accounts the lower your Medicare premium can be.
• Leaving a Roth to a child, he or she will have to take a minimum amount out each year, but the withdrawal is income tax free.

One thing to thoroughly consider before making a conversion is the pro rata rule. When you calculate the taxes due on a conversion, you have to take into account all your IRA assets, not just the new $5,000 nondeductible IRA. 

College Funding Choices

In a previous article, I wrote about how much it might cost us to send our three girls to college. Now, we will consider the funding choices and types of accounts available to save for college.

529 Plan: Back in 2001, Congress passed a bill that gave all 529 plans tax relief. 529s do not create federal capital gains, dividend, or interest taxes. This tax break gives them a big advantage over other college savings strategies. All 50 states offer 529 plans, although, each one is unique. For financial aid purposes, parents should open the account in their name and make the child or children beneficiary. You are allowed to change the beneficiary at any time to pay for qualified college expenses. 

You are allowed to put up to the $13,000 gift tax limit per year ($26,000 for a married couple) per beneficiary. Or, you have the option of front loading up to 5 years of contributions for a total of $65,000 ($130,000 for married couples). Although, no other gifts can be given for the next 4 years. Each plan has maximum amounts that can be accumulated in each individual 529 account. So, if you have two kids you may need to open two accounts instead of just having one 529 account and changing the beneficiary.

Contributions go into an investment account offered by financial institutions like Vanguard, American Funds, etc. They offer age-based choices that get more conservative as the beneficiary gets closer to college or you can pick the investments on your own. There are limits and rules including allowing just one investment change per year. The Vanguard 529 plan offers low cost funds and a variety of fund choices.

Depending on the state you live in, you may be able to deduct contributions from your state income tax return as long as you contribute to the state 529 plan.

Prepaid College Plans: Prepaid tuition plans are accounts that allow you to pay for your child's future college tuition at today's prices. If you have enough money now, you could pay for a complete four-year degree that your child won't use for another 18 years. Or, you can break payments down into more manageable monthly payments.

Some plans allow you to purchase individual tuition credits. Others let you buy a semester's or year's worth of tuition. Prepaid tuition plans are actually a variation on 529 plans, but with lower risk. What you lose is the potential to earn more by investing that money in a college investment plan described above. The money you put in is guaranteed by the state administering the plan. Most prepaid plans can only be redeemed at public colleges and universities in that state. In many cases, you or the student beneficiary of the account must also live in that state. 

If the child goes to a private or out-of-state university most prepaid plans will pay the average cost of a public university in the year the child is attending college. In most cases, this amount will not cover all costs and the gap will have to be covered by other funds. About 250 private schools have come together to form their own prepaid tuition plan called the Independent 529 Plan, which began in 2003. The tuition plan consortium includes Princeton, Stanford, MIT, Notre Dame, and many other private universities.

If you purchase this plan, your child can use the tuition credits at any participating school. If your child decides not to go to one of these schools, the plan will give you a full refund with interest. The minimal amount of interest isn't taxed as long as you spend the money on higher education.

Coverdell: These have an annual contribution limit of $2,000. Also, the tax break for using Coverdell funds to pay for K-12 tuition is scheduled to expire at the end of 2012.

Taxable Accounts: The choices here are quite varied and include joint accounts, accounts for minors, and savings accounts. The biggest difference is the tax treatment. Interest, dividends, and capital gains are all taxed either at the parents tax rate or the child's. You also have to worry about disqualifying the child from financial aid depending on who's account it is and how much is in it. Accounts for minor such as UTMA or UGMA by law have to be handed over to the minor on the account at age 18 or 21 depending on the state. This means the money could be used for things other than college.

The Greater Good

Just as physicians, lawyers, and CPAs perform an essential role in society, so do Certified Financial Planners.

When I ask myself why I am a financial planner, I have come to discover my over arching goal is for the greater good. I have experienced the positives of saving/investing along with the negatives of spending too much. I devote myself to helping client's discover what is important, how we can accomplish their goals, and avoid or lessen financially difficult times.

My desire to serve the greater good is realized through my desire to gain specialized knowledge and experience and continually improve my skills and business practices. After four years at university, I earned a bachelors degree in business administration/finance. I spent over three years studying to pass the 10-hour Certified Financial Planner exam. I broke away from a company that put shareholders and management interests first to start a Registered Investment Advisor firm that puts the client's interests first.

The service I provide gives clients a sense of fulfillment and happiness knowing they were wise with money.  I want us to be independent in all stages of life and less dependent on others including government. These are values intended to improve each family, strengthen their self-image and improve our country. By helping people save and invest they will experience less stress financially and mentally. Citizens who manage their finances effectively are in better positions to support others like aging parents, pay for children's college, and contributing to charities. They can invest in new or expand businesses that employ people and support agencies to those in need.

Occasionally we hear comments that financial planners only help "rich" people with millions of dollars to invest. This just isn't true. There are groups of planners who have free financial workshops in low-income areas. Some concentrate their practices on middle-income earners while others only work with professionals just starting their careers. Most of us are called to this profession because we want to help people. I am a financial planner because I want to serve the greater good.

Holmes on Finance - Financial Renovations

From time to time I watch the television program Holmes on Homes on one of the home improvement channels. The show is hosted by general contractor Mike Holmes who helps homeowners who need help with renovations gone bad. Mr. Holmes comes in and solves the problems and mistakes made by incompetent or con artist contractors. Its amazing to see what he finds wrong and the level of deception by some contractors.

Sadly, I see similar mistakes and improper actions by financial sales people. Some problems may show up immediately while others can become issues in the future. Managing personal finances is complex and it is easy for bad people to take advantage of unsuspecting individuals.

Here are some of the things I have seen that need to be torn down and renovated:

• Products sold to client because the broker received more revenue.
• Client put in high fee broker account program because of account minimums.
• Using actively traded funds when historical results have shown the majority of indexes beat active managers. In 2011, 79% of large cap active managers didn't beat the S&P 500 according to Morningstar. 
• Paying a combined annual fee of 4% split between the advisor and fund manager. 
• "A" share mutual funds with up front commissions of 5.75%, they also hit investors with annual management fees.
• Guidance from brokers and 401(k) plans putting too much money in stocks right before retirement.
• Having the majority of client assets in individual junk bonds and calling it diversified and low risk.
• Selling structured notes to clients inside a fee-based account. This means the client pays a 2% commission up front and an annual fee on top of that.
• Annuities!
• Realistic expectations of investing
• The risks associated with buying individual stocks
• Being too conservative with the asset allocation which then guarantees the client won't reach their retirement goals.

So how do you find a reputable financial planner/advisor? Follow the same steps that you would a home contractor:

• Ask Friends for Referrals - People you respect can lead you to some different choices

• Look for Credentials - Certified Financial Planner (CFP), works for Registered Investment Advisor firm

• Interview Candidates - Meet with 2 or 3 planners; find someone who listens; gives advice and doesn't sell products

• History/Experience - Being a CFP requires 3 years of working experience. 

A quality financial planner will take the time to understand your vision, offer advice that is in your best interest and help you construct a solid, well built plan to last a lifetime.