Monthly Archive for January, 2010

Financial Wellness for 2010 & Beyond – The Decade of Roth Savings Plans

Published by JS Wolff on January 19, 2010 in Financial Education, Financial Tools and Financial Wellness. 0 Comments Tags: , , , .

A real change over the next decade could be a massive reconsideration of tax deferred savings plans. Exemplifying this shift, the new 2010 Roth IRA conversion rules seem to be getting lots of press and stirring widespread investor interest. So what’s behind the buzz?

In our September 09’ blog, “Rethinking the 401(k) Pitch”  , we underscored how the tax landscape had changed since IRA’s were introduced in the early 80’s.  We recounted that federal income tax brackets reached as high as 70% when 401(k)’s and IRA’s were introduced and it made perfect sense to shield everything we could from the taxman and bank on taking the money out at lower tax rates in the future

For the following 30 years, the retirement planning community coached us to maximize tax deferral benefits of the 401(k). But over those same 30 years, tax rates moved steadily downward. Currently the top federal rate is 35%, which is historically very reasonable. However, with the current out of control budget deficits and government spending, this trend may very well start to move the other way. Translation…we seem to be on a collision course toward higher taxes.

The 2010 Roth conversion affords a timely opportunity for a course correction. You can pay taxes now, hopefully before they go up, and be set for tax free distributions at retirement.  It works like this:

  • If you have an existing traditional IRA, you can convert it or part to a Roth IRA. A Roth IRA allows tax-free growth and tax-free income — if you are at least age 59½ — and as long as you have held your Roth account for five years or longer.
  • When you convert, income taxes will be due.  The amount converted will be added to your W-2 income.
  • For 2010 conversions only, you can include the full conversion amount on your 2010 federal income tax return or you can split it equally between your 2011 and 2012 tax returns.

So the filters to making the decision to convert are…

  • Do you have an existing traditional IRA?
  • Do you think taxes (or your tax rate) will be going up the future?
  • If you believe they are going up, do you think this will directly affect your likely retirement income?
  • Do you have the extra cash to pay the taxes over the next 2 years?

If you answered, “yes” to all of the above, then a Roth conversion may be the right option for you.

To fine tune your Roth conversion decision process, you might want to model a few scenarios on a calculator built for this purpose.

Contrasting your FSA Employee Benefit and the Child and Dependent Care Tax Credit

Published by JLarocque on January 12, 2010 in Benefits, Financial Education and Financial Wellness. 0 Comments Tags: , , , .

A mainstay of employer Benefits Communications is to preach the virtues of Flexible Spending Accounts.  But is there perhaps a better tax opportunity out there for your dependent care related expenses?

Tax is an important area of focus when it comes to attaining a productive benefits education.  Before digging into the details of this particular tax opportunity, it’s important that you understand the difference between a tax deduction and a tax credit.  Tax deductions are taken “off the top” and ultimately reduce your taxable income, and, of course your taxable income is what ultimately drives the amount of taxes owed.  A tax credit on the other hand, is a dollar-for-dollar reduction subtracted from your tax liability.  If you had a $50 tax credit, it’s sort of like the government saying that they are giving you credit for having already paid them $50 in tax.

You may or may not be aware of the Child and Dependent Care Tax Credit available for work-related dependent care expenses.  This tax credit is calculated by applying a percentage to your total work-related dependent care expenses.  This percentage can be as high as 35% or as low as 20% depending on your adjusted gross income.  Now, there are a couple of rules to be aware of:

  • The work related dependent care expenses that are applied may not exceed $3,000 for one qualifying dependent and $6,000 for two or more
  • AND importantly, you can’t claim expenses for the purposes of the Child and Dependent Care Tax Credit that you’ve directed into your dependent care FSA

This raises an important question to ask yourself.   Should you apply eligible expenses towards the Dependent Care FSA or Dependent Care Tax Credit?  Well, this of course, will depend on your personal situation.

A good first step is to review the worksheet that the IRS has put together on the Child and Dependent Care Tax Credit.  You’ll want to understand eligibility requirements and the amount of the credit, based on your adjusted gross income.  Now, apply that percentage to your projected work-related dependent care expenses for the year (keeping in mind the IRS limits) to come up with your potential tax credit.  You’ll likely want to work with a tax advisor to compare this Tax Credit with what the tax benefits of the Dependent Care FSA Tax Deduction.

It may be the case that you have work related dependent care expenses that exceed the IRS limits for both the Child and Dependent Care Tax Credit and Dependent Care FSA.  In this case, it may be possible to leverage both of these opportunities.  Because tax laws are complex and evolving, it’s important that you consult your tax advisor to understand how these two opportunities apply to your particular situation.

Financial Wellness for 2010 & Beyond – Interest Payments

Published by JS Wolff on January 2, 2010 in Financial Tools and Financial Wellness. 0 Comments Tags: , , , .

The next few entries look at creating a positive financial future into the next decade by employing some common sense financial wellness principals.

First let’s consider using someone else’s money for to finance our stuff.

The financial wellness rule of thumb is that borrowing money to make a purchase only makes sense if the commodity to be purchased has a realistic chance of appreciating in value.

In other words, both the lender and the borrower should profit from the transaction. The lender benefits from the interest earned and the borrower’s asset has an opportunity to grow in value beyond the cost of interest paid.  While the real estate market has taken a recent short term hit, over the long haul purchasing the right property in the right area has a reasonable potential to achieve this objective.

But as we know, realistically, this mutually profitable borrowing scenario may not always possible.

For example, most of us need a car and it obviously is not an appreciating asset. If we have to finance a car or anything else, the key is to minimize the collateral financial damage.

Calculating the cost of borrowing

Calculating the cost of borrowing

Edmunds.com has some useful calculators and I used this one to model buying a car.  My fictitious purchase was a $30K car with a $5K down payment, financing the purchase over 60 months at a currently competitive rate of 5%.  Including taxes, license and other fees, the financed amount came to just shy of $28K, making the payment $527 a month. The total finance cost over those 60 months is $31,620 or $3,620 of total interest.  The monthly interest cost then calculated to about $60/month.

I also ran the numbers as if my credit score was damaged and the best interest rate offered was 9%.  The payment popped up to $580 per month making the total interest paid over the 60 months a hefty $6,800, or $113 per month in interest.

The next decade advice for those whom the second example hits close to home, would be to live with the clunker, ride a bus or do whatever while working on repairing the credit problem. Put the extra $53 per month totaling nearly $3,200 in your pocket, instead of someone else’s.