CFP Board eNewsletter
November 2008
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CFP Board eNewsletter |
| Traditional IRAs versus Roth IRAs: Should You Switch? |
The year 2010 may seem like a long way away, especially when turmoil in the financial markets can make it difficult to think beyond the latest headlines. Still, if you’re saving for retirement through an Individual Retirement Account (IRA), then 2010 brings with it an important change you might want to start thinking about now. On January 1, 2010, anyone with a traditional IRA can convert it into a Roth IRA. Previously, only taxpayers with a modified adjusted gross income (MAGI) of less than $100,000 could convert to a Roth IRA. So what? I hear you ask. Well, Roth IRAs have some potential benefits when compared to traditional IRAs. Here’s a quick guide to traditional IRAs, Roth IRAs, and what you need to know when considering whether to make the switch. What is a Traditional IRA? A traditional IRA is a personal retirement savings plan that can be set up by anyone, as long as you receive taxable income from sources such as wages, fees, bonuses, or commissions. Contributions to an IRA can be invested in a wide variety of vehicles, including money market funds, mutual funds, certificates of deposit, stocks, and bonds, among others. As of 2007, some $4.75 trillion was invested in IRAs, according to a study by the Employee Benefit Research Institute (EBRI). But the EBRI also found that just 10% of eligible taxpayers contributed to an IRA each year between 2000 and 2004. All the more reason to start thinking about 2010 now. There is no minimum contribution to an IRA, but the maximum for 2008 is $5,000. If you’re 50 or older, you can make additional “catch-up” contributions; for 2008, up to $1,000. Contributions to traditional IRAs are usually tax-deductible. One exception is if you or your spouse participates in an employer retirement plan, in which case the deductibility phases out at higher income levels. Your original contributions and your earnings (the amount by which your money grows while in the IRA) are not taxed until you withdraw them. There is some fine print to be aware of, though. If you withdraw money from an IRA before the age of 59-and-a-half, you have to pay income tax as well as a 10% penalty. There are exceptions, however. If you use the money for higher education, for example, you won’t have to pay the 10% penalty but you will have to pay income tax on the withdrawal amount. Traditional IRAs also have minimum distribution requirements. In other words, you must begin drawing down a minimum amount of money every year from a traditional IRA by April 1 of the year after you turn 70-and-a-half. If you don’t, be prepared for a 50% tax on the amount of the required withdrawal you failed to take. How is a Roth IRA different? For starters, contributions to a Roth IRA are not tax-deductible. That’s the bad news. The good news is, withdrawals from a Roth IRA are tax-free, as long as the account has been open for at least five years and the withdrawals are made after you turn 59-and-a-half. Tax-free withdrawals can also be made due to death, disability, or a first-time home purchase (up to $10,000). If your withdrawal doesn’t meet these requirements, though, it will be subject to income taxes and possibly also the 10% early withdrawal penalty. Another upside to a Roth IRA is that withdrawals are first treated as a return of your original contributions, which are always tax- and penalty-free. There is no minimum distribution requirement for a Roth IRA, so you can leave the money in your account — growing tax-free — until you need it, or until you die and your heirs must take required minimum distributions. You can even continue to make contributions to a Roth IRA after you’re 70-and-a-half, as long as you still have eligible earned income; with a traditional IRA, you cannot. Taxes will be due if you decide to switch a traditional IRA to a Roth IRA. But if you do a Roth conversion in 2010, you can choose to report half the income in 2011 and the other half in 2012 to spread the tax burden. Alternatively, you can simply report the income in 2010 when the conversion is carried out. For more details on the tax implications of a Roth conversion, consult your financial advisor or accountant. To switch or not to switch? According to Michael Kitces, CFP®, director of financial planning for Pinnacle Advisory Group in Columbia, Maryland, there are four factors to consider when deciding whether to convert a traditional IRA into a Roth IRA.
IRAs are a complicated area of retirement planning; the opportunity in 2010 to switch into a Roth IRA makes them even more so. If you want some professional advice, you can locate CFP® professionals in your vicinity through the Search for a CERTIFIED FINANCIAL PLANNER™ Professional function on CFP Board’s Web site.
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Finding Your Feet when You Lose Your Job: How Financial Planning Can Help |
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Consumers just can’t get a break. First came the credit crunch, then the stock market crash, and now the spike in joblessness. The unemployment rate increased to 6.5% in October, with a total of some 10.1 million people now out of work, the highest level in 25 years. And given the limited prospects for economic growth, higher unemployment may be around for a while. According to a recent survey by human resources consulting firm Mercer, 30% of employers have already reduced staff and another 37% are considering it. It’s easy to become discouraged in the face of such consistently bad economic news. But there are things you can do to prepare should the downturn impact your employment status. “You have to prepare for job loss because, regardless of whether your job is actually in jeopardy or not, you need to presume that it is,” says Sheryl Garrett, CFP®, founder of the Garrett Planning Network. “Smart financial planning involves thinking about ‘what if’ scenarios. One of those scenarios is, ‘What if I lose my job?’” The first step is to do everything you can to make sure job loss doesn’t happen to you. According to Garrett, that can involve anything from taking classes for an additional certification to staying up to date on the latest trends in your profession to pursuing an advanced degree. “Your most valuable asset is not your 401(k) or your other investments,” Garrett says, “but your ability to earn money. Losing your income or your job is the greatest danger, so you need to protect that asset by continuing to build your skill set, by making yourself an indispensable resource to your employer. If you’re self-employed, you need to make sure that your business planning enhances the profitability and stability of your business.” The next step, Garrett says, is to build up as much cash reserves and pay down as much consumer debt as you can. She tells the story of a client who was considering taking out a home equity line of credit (HELOC) to do some home remodeling. He asked if Garrett thought that was wise. “Is the remodeling necessary?” she asked. “No,” he said. “Then don’t do it,” she advised. “Only spend money on required things right now,” Garrett counsels. “No optional purchases. Keep an emergency fund: six months in expenses in safe cash reserves. The prudent thing to do if you’re feeling queasiness in the economy is to hoard cash as much as possible. There will be lots of amazing sales between now and January, but you just need to walk away from them. If you don’t have six months in cash reserves, don’t buy anything optional.” For more on emergency funds, and how to start saving for one, check out In Case of Emergency, Use This Fund! in the September 2007 issue of It’s Your Turn. For tips on how to cut down on debt and start saving, see It’s Nifty to be Thrifty in the September 2008 issue of It’s Your Turn. A HELOC is a good idea, Garrett stresses, but it should only be used in an emergency. What qualifies as an emergency? Well, if something happens to your car and you need it to get to work, then you might consider using the HELOC to purchase another vehicle — but to save money, buy used not new, Garrett urges. “That’s why we have the cash reserve, for unexpected emergencies,” she says. “The HELOC is an extra safety net beyond the emergency fund. It’s there in case we need more than six months in expenses, since it can take longer than that to find a job.” For more information on HELOCs, see How to Handle Home Equity in the May 20008 issue of It’s Your Turn. Should the worst-case scenario happen and you lose your job, Garrett suggests looking for another one — right away. “Losing your job is an emotional situation and you’re feeling rotten about it, but it’s no time to sit back and withdraw,” she says. “You need to find a new job, even if that may mean accepting a temporary position just to bring in some money.” Garrett relates the experience of an unemployed friend who was holding out for a job she felt was worthy of her. Then she ran out of money, and now has to take whatever job is on offer. “You can’t wait for the perfect position,” Garrett explains. “Income and benefits such as health insurance are more important. So you should do everything you can to find another job as soon as possible, to ensure that you have health insurance and an income stream.” Meanwhile, until you land that new position, Garrett suggests eliminating every expense you can: If you have two cars, get rid of one, thus saving on maintenance, insurance, and gas; shop at supermarkets rather than convenience stores, which are more expensive; prepare meals at home instead of going out to restaurants; get rid of unnecessary cell phones and cable services. “Pay-per-view is not a life necessity,” Garrett says. “Examine your budget and watch every penny. Do everything in moderation, like with dieting — move towards your goal step-by-step. Maybe a spouse or teenager can add more income. Rethink how you spend money. Ask yourself, ‘What is a necessity?’” The best time to prepare for job loss is long before it actually occurs. “Bad things can and will happen,” Garrett says, “so be prepared. Get your finances in order. We should all come away from this turbulence with an attitude adjustment: Things don’t always go up; you don’t always get a raise; the value of your home doesn’t always rise. For now, stable is good enough. Financial planning means planning for all eventualities.” If you would like professional advice on any of the issues raised in this article, you can locate CFP® professionals in your vicinity through the Search for a CERTIFIED FINANCIAL PLANNER™ Professional function on CFP Board’s Web site.
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401(k) Contribution Limits Raised for 2009 |
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Contributing to a retirement plan is one of the best tax shelters available to people during their working years. Recently, the IRS announced that most of the retirement savings limits will increase for 2009. "Most working professionals have access to a 401(k) plan or a 403(b) plan at work. The amount you contribute to these plans generally reduces your taxable earnings and always grows tax deferred. For 2009, you can contribute up to $16,500 into a 401(k) or 403(b) plan through salary deferrals," explains David G. Strege, CFP®. In 2009, you can contribute $16,500 to your 401(k). That is $1,000 higher than in 2008. If you are age 50 or higher, you will be able to contribute an additional $5,500 for a total of $22,000. The catch up provision is $5,000 in 2008. These increased limits also apply to 403(b) plans and 457 plans. See this IRS release for more information. Looking to set a monthly budget for 2009? To max out the allowable 401(k) or 403(b) salary deferrals next year, people should instruct their employer to withhold $1,375.00 a month from their pay as of January 1st. If you’ll be eligible to take advantage of the catch-up provision, your total annual contribution of $22,000 translates to $1,833.33 a month. Unfortunately, there are no increases in the amounts you are able to contribute to traditional and Roth IRAs. Those limits remain at $5,000 or $6,000 if you are age 50 or older. While these increased limits are good news, there is also some bad "tax news" to throw into the mix. That bad news comes in the form of a higher Social Security wage base in 2009. In 2009, wages up to $106,800 will be subject to 6.2 percent in FICA taxes and 1.45 percent in Medicare taxes. In 2008, the limit was $102,000 so this increased limit causes an extra $298 tax bill for employees.
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Savers are paying more for banking services as banks respond to our troubled economy by raising fees and minimum-balance requirements for checking accounts and fees and surcharges for ATMs. According to a new study by research firm Bankrate Inc., the average costs of checking-account fees, including ATM surcharges, bounced-check fees and monthly service fees have hit record highs. Bounce a check and you'll pay an average of $28.95. That's 2.5 percent higher than last year. If you're lucky, that's all you'll pay. Too often, even occasional check bouncers tripped up by banks' practice of paying the largest check first when they're clearing several checks received around the same time. If that first check drains your account and there are three or four smaller checks behind it, you'll be charged for multiple insufficient funds fees. ATM and debit cards can make balancing a checkbook a challenge since you may forget to deduct the withdrawal or the purchase. Unless you routinely check your balance online, it's easy to overdraw your account. Speaking of ATMs, the average ATM surcharge this year $1.97, nearly 11 percent higher than last year's average of $1.78. The surcharge is a fee the owner of the ATM charges non-account holders. In other words, if you're a Bank A customer and you use Bank B's ATM; Bank B will zap your account with a surcharge. According to Bankrate, nearly all ATMs have a surcharge. Running out of cash when a branch of your bank is nowhere in sight is especially costly because most banks charge their customers for using another company's ATM. The average fee for that is $1.46, up from $1.25 a year ago. So expect to get dinged on both ends. Understanding yourself as a banking customer is a key to keeping your banking costs down. Unless you bounce a lot of checks, most bank fees aren't going to put a big dent in your weekly budget. Nevertheless, this is money that falls through the cracks. When it's all added up, it matters a lot. Banks charge all sorts of fees. Some fees you'd be hard-pressed to avoid, but when it comes to checking accounts, most consumers should be able to dodge the bullets. Balance your checkbook and forget about trying to take advantage of "float" if you want to avoid bounced-check fees. In the old days when mail went by the Postal Service, you had a few days to fund the account after writing the check. That's gone, but there are some legitimate ways to buy time. If you don't frequently monitor your account balance online, then keep tabs with an old-fashioned check register. Banks still have them, and they may be more convenient for some people. Debit and ATM cards can make it tough to keep track of transactions. Save your receipts -- put them in your wallet or wherever you're sure to see them when you get home and can enter them into your register. If none of this works for you, then sign up at the bank for overdraft protection. This is not "bounce protection," which you automatically get with most checking accounts. You must sign up for overdraft protection in order to receive it. Avoiding ATM surcharges and fees is easy if you can estimate your cash needs well enough in advance that you have time to use your bank's ATM. If you have to pay a total of $3.50 to take $40 from an ATM, you’re paying 9 percent interest—a big waste. It's hard to imagine anyone who needs an interest checking account that pays 0.24 percent, especially when the bank wants you to keep thousands of dollars in the account to avoid fees. Some institutions in Bankrate's Online Interest Checking database pay a worthwhile rate and don't require an exorbitant amount of money to stay in the account. You also might consider doing a search for reward checking if you use a debit card frequently. But for most people, a plain vanilla free checking account will work just fine. Pair it up with a high yield money market account at another institution, link them electronically, and you're set. For a growing number of people, online banking works great. Setting up direct deposit for a regular check might help you avoid fees, and most online banks have liberal ATM policies that reimburse your account for multiple ATM transactions per month. You know what works best for you. Find a bank that suits your habits and meets your needs and you won't get caught in the fee trap.
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Hundreds of Consumers Connect with CFP® Professionals at CFP Board’s Financial Planning Clinic in Miami |
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On November 15 the hallways and meeting rooms at the Hyatt Regency at Miami Convention Center were bustling with hundreds of consumers who turned out for CFP Board’s 4th Financial Planning Clinic. The consumers ignored the tropical weather outside in favor of getting advice from CERTIFIED FINANCIAL PLANNER™ professionals on a host of financial planning issues, including retirement and investment planning, debt management, tax planning, college funding, insurance and employee benefits. On hand were 88 CFP® professionals, some from as far away as New York and Texas, who volunteered their time and expertise to educate consumers on the benefits of working with a financial planner who holds CFP® certification, the recognized standard of excellence for personal financial planning. CFP Board CEO Kevin Keller kicked off the event with a welcome address to the volunteer CFP® professionals. The volunteers also heard from Larry Spring, Chief Financial Officer of the City of Miami, who conveyed the City’s appreciation to the volunteers for providing valuable guidance and advice to help Miami residents cope with today’s uncertain economic times. When the Clinic opened to the public, each consumer attended a brief orientation session that included information about the value of CFP® certification and examples of financial questions to ask the volunteers will be able to assist with. Attendees were also given a program book that included the names and contact information for volunteer CFP® professionals who were on hand to meet one-on-one with consumers to discuss their financial questions and concerns in a pressure-free, no-sales environment. The Clinic also featured sixteen 50-minute educational workshops on topics such as Young Professionals: Launching Your Financial Plan, Managing Debt, Investment Planning for Retirement Assets, Financial Planning for Small Business and Living Beyond Paycheck to Paycheck. The Miami Clinic received attention from local media outlets and community groups, many of whom were unfamiliar with CFP® certification and CFP Board prior to the event. The Miami Herald promoted the Clinic to its readers and also covered the Clinic for a post-event story. Univision Channel 23 was the official media partner and promoted the Clinic through an interview with a local CFP® professional and Public Service Announcements on its station as well as on its sister station Telefutura 69. The City of Miami was the official event sponsor and helped turn out attendance along with a dozen other community-based organizations from the Miami area.
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Financial Alerts |
The Fed Warns of Loan Scams
New Rules Tighten Identity theft Measures Read more financial alerts.
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About This eNewsletter |
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CFP Board's "It's Your Turn" eNewsletter is sent monthly to those who have subscribed through CFP Board's Web site, www.CFP.net/learn. CFP Board exists to make people aware of the benefits of financial planning and to encourage people to seek out individuals who can help them apply the financial planning process to improve their financial lives. This eNewsletter is designed to provide information about financial planning, financial planning tools and resources, consumer alerts and more. Suggestions and feedback are welcome at mail@CFPBoard.org.
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