Next Year’s Roth IRA Loophole: Get In If You Fit In?

We’ll start with a question: when you retire, do you think you’ll be in a higher tax bracket or a lower tax bracket when you quit your job? Let me explain why this question is important. If you have and regularly contribute to a 401(k) or IRA, you are storing money away pre-tax—which means you get to store away some savings from your gross pay, and then Uncle Sam comes and gets his cut. So you’re earning interest on untaxed money. Then at retirement, whichever tax bracket you ended up in is where you will be taxed as you make withdrawals from your account.

In a Roth IRA/401(k), the government gets his cut first, and then you get to save off of the remainder. But at retirement, you get to take out as much money as you want as often as you want without the money being taxed. So generally, if you expect to be in a higher tax bracket in your last few years of work, the Roth IRA is for you.

The problem, however, is that Roth IRAs are subject a several limits. From Reuters:

Only taxpayers who earn less than $105,000 ($166,000 for joint filers) in 2009 can contribute the maximum amount ($5,000 per person, with a $1,000 additional catch up contribution for folks 50 or older) to a Roth IRA. And only people earning less than $100,000, single or married filing jointly, can convert their traditional IRAs to Roths.

That would probably qualify all but a few of you. However, for you unlucky few who are in the upper echelon, that income limit will disappear next year...for one year. You will have to pay taxes on the rollover however, and depending on the size of the nest egg you’re rolling over, you’ll need a pretty significant cash reserve to cover it. For instance, if you have $40,000 in an IRA and fall in the 25% tax bracket, you’d owe $10,000 to the government to switching. So if you can afford it, go for it!

I won’t spoil anymore for the article (and besides, I’m not there yet). But I think you should give the whole article a read. They include other factors to consider if you think about making the switch.

Mutual Fund Fee Lawsuit Heads toward Supreme Court

Here’s a story that caught my attention as an investor:

Nov. 2 (Bloomberg) -- John Bogle helped create a mutual-fund industry that has grown to $10 trillion in assets. Now the Vanguard Group Inc. founder is backing investors asking the U.S. Supreme Court to limit the fees charged by fund managers…
The dispute pits the fund industry against trial lawyers, consumer-rights groups and Bogle, an industry pioneer who started Vanguard in 1974. Bogle, who filed a brief supporting the Oakmark investors, says mutual fund shareholders are being overcharged with fees that seem low when expressed as percentages yet add up to a multibillion-dollar windfall for advisers.

Emphasis on the last sentence mine. So let’s unpack this. It’s no secret that the mutual fund companies charge high fees for managing their funds. Called an expensive ratio, it’s the management fee the company charges for “taking care of your money.” The article is right that these companies take up to 1.5%, some more, of your returns (or lack of returns) as a fee.

This demands a closer look. Let’s say the S&P 500 returns 5% this year. If a mutual fund company gains you 6%, (1% above the market from your investment over last year) they will deduct 1.5% of it leaving you with and effective 4.5% return. If they LOSE 6%, they STILL deduct 1.5%, leaving you with a 7.5% loss. And don’t forget that “stellar” track record that actively managed mutual funds have. But “what difference does 1% or so make over the long term?” you may ask. After all, you get to keep the other 99%, right? Well:

Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.

This is what the plaintiffs are fighting against. I’m a bit unsure of what they want to happen (certainly they don’t want the feds setting profit rates). I think there is still a large enough amount of mutual fund companies out there where consumers can shop around for a balance of cost and service.

The “No Sugar-Tax” Ad Shows We’re Not Pure Libertarians

Have you seen it? It’s the series of ads with the “average mom” walking into a home concerned that raising the price of sugary foods will break the family budget. If you haven’t seen it yet, check it out below:






The ad is run by the Americans Against Food Taxes, with a mother agonizing against taxes on sodas and juice drinks, as if it’s the only beverages available at the store. (Full disclosure—AAFT is a consortium of mostly large convenience stores and fast food places that depend on sugar for revenue.) If times are tough, maybe it will require us to cut back on the sugar, you know? I’m pretty agnostic on the issue—if the taxes go up on soda from 1.50 to 1.75, dah well.

I see why the government has decided to propose “mini-taxes” here and there. I’ve never really been anti-tax, but the taxes have to be sensible. If you’re simply raising my taxes to build a monument in your district, then no dice. However, if we’re trying to come up with a way to keep me from paying far higher taxes down the road, then I’ll listen to you.

We as a society don’t fully subscribe to the “live and let live” mantra politicians put forth. We’ve decided that we’re not going to let people die in the street if they didn’t save enough for retirement, or if they are strung out on drugs, or if they don’t keep themselves healthy. Most of us have a rugged individualist streak, but when things go wrong, we turn to others to bail us out of bad lifestyle choices. And now that the economy has gone sour, people are looking to the government, which means they (read: WE) will foot the bill for expensive health-related problems, and entitlement programs like Social Security and Medicare. It’s a choice that we’ve implicitly made.

Such choices have to be paid for—and people are living longer (but not necessarily healthier), which taxes the entitlement systems which is growing to include near-universal health care. We can talk all day about prevention and education on the dangers of consumption of unhealthy foods and drinks in excess, but as the folks over at the Radical Rationalist say:

For some reason, logical arguments based on medical facts do not convince Americans to curtail economically disruptive, physically harmful or just plain stupid activities. What works? Money.

Pretty much.