What a boring looking topic. But Roth IRA conversions from regular IRAs are hot news this year for several reasons. First because of a one year special income tax smoothing on the amount converted from a regular IRA to a Roth IRA in 2010. What this means is that instead of paying income tax in 2010 on the entire amount converted from a regular IRA to a Roth IRA in 2010, you can elect to pay income tax on one-half of the 2010 conversion amount in 2011, and pay income tax on the other one-half of the 2010 conversion amount in 2112. Or you can simply elect to pay the tax on the whole amount in 2010 as you normally would have to do. Decisions on this tax election will of course depend on various personal factors including projected taxable income and estimates of tax brackets in 2011 and 2012 and depending possibly on some of the considerations below.
Regular IRA to Roth IRA conversions are also in the news this year because beginning in 2010, and possibly beyond 2010, there are no limits on the dollar amount of a regular IRA that can be converted to a Roth IRA. Until 2010 one could not and cannot convert to a Roth IRA if your modified adjusted gross income exceeded $100,000, so removing the income limits will be a big advantage for higher income taxpayers with large IRA balances. Also, of course, it's also a great benefit for the IRS since it will speed up their tax collection on tax-deferred IRA balances.
I've recently read quite a few retirement specialists, including several who have written books on Roth IRAs and/or who have subscription-based retirement newsletters. Most of them do not write clearly on the issue of potential taxes or penalties on some Roth IRA distributions. The main reason for a Roth IRA in the first place is that future earnings or gains in a ROTH IRA will not be taxed either in the Roth IRA or when withdrawn. So to hear confusing inforamtion that some distributions can be taxed is off-putting to say the least. I was confused by this for some time.
There are two types of legally permissible non-taxable distributions from Roth IRAs: "qualified" and "non-qualified". "Qualified" distributions were the original basic plan of Roth IRAs. If you hold your Roth IRA contributions in the Roth for five years and you are 59 1/2 years old or older, you can then withdraw whatever you like and pay no income tax or penalty. Period.
"Non-qualified" non-taxable distributions are possible due to several legally defined exemptions from income taxation and penalties if you are either under 59 1/2 or haven't held the assets five full years or both. Basically you can always remove at any time a dollar amount up to the total of what you have put into or converted into your Roth IRA less any prior year withdrawals. So if you need the money for whatever reason or just want to take some out every year, you may do so. Let me say it a different way: if you have put or converted $200,000 into your Roth and have made $15,000 in dividends or capital gains on it so far, you can at any time remove cumulatively up to $200,000 from your Roth IRA tax-free and penalty-free even if you only set up the Roth IRA six months ago. After all it's your money and you already paid the income tax on that amount you put in or converted into the Roth IRA, so this should be a no-brainer. But the experts have not explained this very well in most cases. The $15,000 of earnings or capital gains you've made in the Roth IRA need to be held for five years before payout unless you want to pay both income tax and a 10% penalty on withdrawing it.
Basically that's the whole story. The IRS has a very thorough explanation of all the exemptions as well as forms for figuring it all out at the website above.
If you been reading me for a while, you know that I've been considering cashing out my and my family's IRAs this year for a variety of reasons you can read about here: http://tinyurl.com/ycm5z33http://tinyurl.com/yaf2q28 Some of the reasons may be somewhat controversial but others are simple rational considerations of taxation and inflation probabilities. For someone facing mandatory annual and annually increasing Required Minimum Distributions (RMDs) from regular IRAs, getting pushed into higher and higher tax brackets as you get older is a reality.
Converting a regular IRA into a Roth IRA means paying exactly the same income taxes you would pay if you were just cashing out your IRA completely. Both are, in effect, cashing out the regular IRA, except in the Roth instance your are cashing out directly into a new Roth IRA. The advantage of the Roth IRA choice is that any income or gains you make in the Roth will be tax-free whereas what you simply cash out of a regular IRA and invest in a pesonal private will produce potentially taxable income going forward.
Suppose you have enough money in the current regular IRA to make two different kinds of accounts, and you'd also like to spread out the income taxes on the cash-out and/or Roth IRA conversion over four years instead of one or two years. For example, let's say you want to put part of your money coming out of the regular IRA into tax-free municipals or long term growth assets and put another part of your investments into high yield investments or short term capital gains possibilities such as gold or penny stocks or whatever you choose. Obviously the municipals and slow growth long term investments would better go in the new taxable account, and the high yield and short term capital gains investments would better be bought in the new Roth IRA account.
Let's say further that you have $500,000 in your regular IRAs this year and will be facing RMDs next year at age 70 or 71. The first year you will have to take out $19,000 and pay tax on it. Given the IRS's annual RMD escalation schedule and based on a 6% return each year, in ten years you'd be up to withdrawing and paying tax on $32,500 that year, and ten years after that the RMD will have escalated, year by year, to $45,100. You have to withdraw and pay tax on these amounts every year whether you need the money or not. This is the "bracket creep" taxation issue. Also in so doing you are spending down the value for any possible heir. http://tinyurl.com/ybuas4c
If you took all $500,000 out of your regular IRA this year or next either as a simple cash out or by conversion to a Roth IRA, you would pay roughly $150,000-$160,000 in income tax on it. If you cashed out $125,000 this year and $125,000 next year and then converted the remaining $250,000 next year into a Roth IRA, you could pay income tax on one-fourth of the $500,000 each year for 2009, 2010, 2011, and 2012. The tax would be roughly $18,000 per year or $72,000 total, or less than one-half of the total tax you would pay by doing it all at once! Bear in mind that these are rough calculations and do not take any state or local taxes into consideration nor possible tax rate increases. The totals however are so strikingly different for the two approaches that you couldn't lose by doing the four year income tax spread-out. And you could do the whole cash out and Roth IRA conversion between now and January 3, 2010 and get the assets bought in each new account according to the new plan. Naturally you'd have to set aside sufficient funds (~$72,000) to pay the taxes for the four years which you probably will NOT want to take out of the current IRA for reasons I won't get into today.
Meanwhile you'll have your new "low tax" taxable account with one-half of your cash-out and your "no tax" Roth IRA with the other one-half, with NO RMDs to pay every year, and you'll stay in a fairly low tax bracket going forward.
Let me repeat, as I always do here, that I am not a financial advisor, nor a money manager except for myself and family, and certainly not a tax expert, nor an accountant, and definitely not a lawyer. I am just a private investor. Anything I say here is just what I am thinking for myself based upon my own research and should be seen entirely as my "financial diary" and not as advice to anyone who reads it. If you get interested in the concepts, consult your own professional advisers as I will be doing with mine. One other caveat: I have not spoken about 401ks and other retirement plans as the rules are different, and I have none of those plans. I am told that some 401k plans have a Roth IRA option and others do not.
There are some real advantages to cashing out or converting IRAs to Roth IRAs right now and next year which m
As of tonight the 2cs has dropped to 88, rounded. It hasn't been that low since two days after the high (close) of SPX in May 2008. You may recall that SPX hit the 400 dma on the very day of the high on May 19 2008 at 1425.35 (close). Today the 400 dma is @ 1059.90. I sure would like to see a couple of days up to put the 2cs under 80..it was 72.31 on May 19 2008. Four days before that it had been 89.14.
I'd like to see a Dow clx indicator confirmation, but it's possible we had it last week. It was a week early in May 2008.
I did not get bullish immediately in early March 2009. I'm investing in retirement, so I'm not a rabid high risk trader as I once was. But I started getting long in equity substitutes like corporate bonds and beaten-down closed-end funds in April and May, and I'm up 12.6% on the year to date which is nearly double my goal.
Despite all that, the 2CS has kept me long through all the uncertainty since March/April. It's possible we will slow down here again and extend the timing out further. I am certainly not hoping for negatives. But we are set up for a possible sell if the market gains more this week. On any real strength this week I am going to be selling the parts of accounts that are most likely to be influenced by an equity decline.
This employment analysis by the economists at Northern Trust does not support a vibrant recovery in the US. The persistent and drastic declines since 1945 in factory employment, now only 9% of total employment, will continue. Although service industry employment is showing some potential signs of slowing employment decline rates, most of the new service jobs are with government. This sector is not known for its productive output, but government employees' record high wages compared to the non-government sector may provide some support for normal family spending.
Many of the government programs for giving cash to people and asking them to spend it are running down, but they are so popular with the public and with Congressional "economists" who have elections coming up next year that the give-aways will doubtless be extended to buy votes. Some people taking advantage of Cash for Clunkers or new mortgages to qualify for the $8000 Federal new owner tax credit are already apparently wondering if they will be able to make payments on their new debt, according to a report by CNW Marketing Research several weeks ago. Also new waves of residential mortgage rate upward re-sets are coming this fall, and banks will also be getting hit by a massive wave of commercial mortgage defaults. The recent increase in numbers of small community banks being taken over by FDIC is probably an early warning sign of coming disasters in commercial real estate.
It would be too easy to go on and on about the future in this train of thought, about which each of us individuals can do very little. But we can do something about investing our own funds. Despite this potentially horrendous future, like last year at this time, the investment markets by and large are doing very well. Given the hoards of cash at the banks and in money market funds paying effectively 0%, people and banks are being forced into the markets to get any returns at all. This is how bubbles and parabolic hyper-inflationary runs are born.
James Stack has done a study of September and October stock market performance since 1928. September has had the worst record of any month of the year with only 43% of Septembers rising. But for September and October returns, those two months' totals were up 55% of the time. And for Septembers and Octobers of the years when a bear market move bottoms, 80% in such years were up. So this may not be as serious a period as many fear for an immediate decline. Given the massive FED and Treasury and Congressional pump priming and zero percent interest rates, we could see a giant parabolic rise in stocks and gold up to January, as happened ten years ago in 1999.
Then too, we don't really know at what point the realization hits home that the FED won't be able to tighten back toward normal interest rates or when the bubble becomes imbedded and when persistent hyperinflation develops with a huge decline in the US dollar. The deflationary possibility has become the consensus view in recent months, judging by what I read everywhere. But with the dollar breaking new lows and gold threatening to break out permanently above $1000, I'm becoming more dubious about the consensus view. Many commentators are convinced that the US reflation program won't work. But if people and banks are fleeing the dollar where there is no interest rate to earn, perhaps the massive reflation is beginning to work "too well" and will lead shortly to hyper-inflation.
We don't have to decide on intellectual grounds or by economic analysis. We can simply watch where the markets go in the next few months and go with them. The three easiest to watch are the US stock markets, the 30 year US Treasury bond market, and gold. If stocks continue to do well, gold stays above $1000 and the 30 year Treasury bond stays under 123 (futures) or the yield on the 30 year stays above 4% and starts rising, hyper-inflation will be the outcome. The opposite or inverse market outcomes for stocks, bonds, and gold will lead to deflation.
I'm keeping a foot in both camps right now. In the tax-deferred accounts, which will probably be closed out this year, especially if hyperinflation looks probable, I have mainly high yield vehicles, but most of them have an inflationary tilt. Obvious examples are the oil and gas trusts, GGN (gold option writer), IRR (energy stock option writer), LSBDX (higher yield corporate and foreign bonds), and GIM (foreign bonds). In the taxable accounts it's primarily short to intermediate term munis and gold and a slew of hedge-fund like and nimble funds (see recent list). Changes can and will be made quickly if events make the outcome clear.
If the economy doesn't make it well out out of its recession low, that's when a "second dip" into recession will cause social dislocations. With the President mocking and threatening his health bill opponents in Congress during his speech there last week and a congressman calling him a liar on funding health care for illegal resident aliens, we got a vivid glimpse of the frustration on both sides even in that august national building. It won't be pretty if reflation fails, whereas hyperinflation will mask the problems perhaps for several years or longer. Stay tuned to the markets for clues.
Six months ago at the depth of the 2007-2009 crash and two months into the new US government administration I was sensing the federal financing pressures ahead. This is primarily a site about investing in or near retirement, not about making a killing in the markets as a thirty year old might do. So retirement accounts and taxable accounts in retirement are what I deeply care about. If this topic interests you, look at this first.
My fear about taxes rising after currently being at multi-generational lows was a major motivation for my "modest proposal" for cashing out of IRA tax-deferred accounts this year. All tax-deferred accounts eventually have to be withdrawn as ordinary income and be subjected to then current ordinary income tax rates. This is simply a fact of life which we knew when we set up these accounts many years ago. So if income tax rates climb, as seems likely, more tax will be paid in future.
Another very simple factor was that the mandated increased withdrawals for every year after age 70 would tend to push older retirees progressively into higher tax brackets and other income categories which could decrease Social Security payments and increase MediCare premiums and cause other tax liabilities.
These were and are troublesome probabilities but were not in themselves immediately major issues. But we also did have the example of the 2008 Argentine pension grab right before our eyes. Late last year the Argentine government was pressed to pay its bills and was finding it hard to sell sovereign TBonds. They demanded that Argentine pension funds sell their assets and buy Argentine government bonds. No more choice of investments. Only Argentine TBonds.
William Buckler of The Privateer has just published on several new programs of the US administration which appear to set the Argentine seizure possibilities into action in the US far earlier than I had expected. Buckler has agreed to permit me to quote from his current issue:
"On September 5, Mr Obama gave the latest in his weekly series of radio broadcasts to the nation. For most of the northern summer, the number one item on Mr Obama’s agenda has been his $US 1 TRILLION “health plan”. This plan is facing mounting opposition from the American people and is facing an uphill struggle in Congress. It is said by the US media to be the “defining issue” of Mr Obama’s fledgling presidency.
"One would have expected it to be the subject of his talk. In the event, the health plan was not mentioned. Instead, Mr Obama chose to talk about the need for Americans to “save”?! Yes, you read that right. While their government borrows and spends at rates never before approached and while Mr Obama puts all his considerable rhetorical skills behind yet another $US 1 TRILLION government “program”, the American people are being urged to “save. But as one would expect in this context, “saving” has a very specific meaning to the US government. Mr Obama, with Treasury Secretary Geithner and Fed Chairman Bernanke right behind him, wants this saving to be done exclusively by means of “US Savings Bonds” (aka US Treasury debt paper).
"The Fed has stated that they will end their program of directly buying US Treasuries with newly created Federal Reserve Notes (US Dollars) next month. It is becoming clearer almost every day that foreign central banks are fast losing their formerly insatiable appetite for Treasuries. Clearly, a new “buyer” must be found - and FAST! Hence, Mr Obama’s fire sale chat to his fellow Americans. Your Country Needs YOU!!: Mr Obama announced a four-pronged plan to induce Americans to increase their “savings”. All of these initiatives are covered under the heading of “administrative actions”, which means that they do NOT require Congressional approval. They are apparently scheduled to come into force immediately. The headline item is a change to US tax forms which makes it possible for any American getting a tax refund to choose to take the refund in the form of a “savings bond”. All that is required is to tick a box. White House officials promptly pointed out that there are about 100 million tax refunds a year in the US which average about $2000 each. We’ll do the “math” for you. If everybody ticks the box - that comes to $US 200 Billion - enough to fuel current US federal government spending for about three weeks. The government won’t have to worry about servicing these bonds, something that they do out of future “general revenues” anyway. Treasury “Series I Savings Bonds” are currently “earning” 0.00 percent.
Here we have the bare bones of an Argentine solution, right out in the open and announced by the President. This completely changes the rules and potentially the playing field for US approved tax-deferred retirement plans. You may choose to continue to bet on the old rules. I don't.