Archives For Roth IRA

Tax diversity has become a more common discussion among personal finance experts in recent years. This is due not only to the plethora of tax-free, tax-advantaged, and taxable investment options that people have today, but also to the uncertainty of our future tax system.

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I found out yesterday that my wife’s company will begin offering the Roth 401(k) in January, 2008. Immediately I started thinking about whether or not it is a good deal for us. Believe it or not, it’s not a simple decision because there are numerous variables to consider.

NOTE: It’s important to keep in mind that I am NOT a tax expert. So, if some of my thought processes don’t make sense here, that’s why.

So, here are some PROS and CONS (if I missed any, please let me know by leaving a comment) of the Roth 401(k):

PROS to the Roth 401(k):

1. Roth 401(k) offers the ability for tax-free income at retirement.

2. Roth 401(k) can be rolled into a Roth IRA. For those who make a lot of money, this could be an easy way to move money into a Roth IRA.

3. As of right now, income received from a Roth IRA during retirement does not count when figuring the taxation of Social Security benefits.

4. Unlike other accounts during retirement, there are no required minimum distributions with a Roth IRA.

5. Tax rates could be higher in the future, which would make tax-free income in the future, more valuable.

CONS to the Roth 401(k):

1. A Roth 401(k) is funded with after-tax money, which means higher tax bills now and could possibly subject you to the dreaded Alternative Minimum Tax. I did a quick calculation and figured that our tax bill for 2006 would have been around $2,000 higher had we gone with the Roth 401(k).

2. Along the lines with number 1, Roth 401(k) contributions will mean higher taxable income now. This could affect deductions.

3. There’s really no guarantee that lawmakers won’t change their minds and begin taxing Roth IRAs at some point in the future.

4. The employer match is put into a separate account, which will then be fully taxable at retirement. This is a wash since you don’t pay taxes or get a tax benefit from an employer match.

Those are the pros and cons that I can think of. I’m sure there are lots more that I just haven’t thought of. If I missed some, let me know and I’ll add them to the list.

For me, the jury is still out on whether this is a good deal for our family. I’m thinking about going half and half and trying it out.

I received this email from a reader:

JLP,

I am starting a new job with a small firm that offers a 401k through Principal Financial Group. The company matches dollar for dollar up to $5000 per year. There are 17 funds in the plan including lifetime funds and funds covering all the major asset classes. The problem is that the fees for the funds are exorbitant, averaging about 2.3% for the active funds and 1.6% for the two index funds. What’s more, the performance of the active funds is poor for the respective asset class across nearly all funds.

I read your post from April 3, 2007 about 401k fees (How Much is Your 401(k) Costing You?), as well as the comments, but I still wonder what to do here. Should I a) forget the 401k and invest in the IRA ($8000 max for wife and me), b) invest in the 401k up to the matching, then supplement with the IRA, or c) forget about the fees and invest in the 401k as much as I can afford.

My company is small, so I imagine they are getting a raw deal from 401k providers. I used to work for a different small firm that used a simple IRA through Fidelity that let me invest in anything I want via Fidelity. Maybe I’ll see if my new company could be persuaded to go that route.

Any advice or comments on this topic?

Thanks!

Those fees are high. My guess is that the fees are high because it is a small firm and they either went with an annuity or they are spreading the costs of the plan among the employees. Administration of a 401(k) plan is not cheap and providers would much rather service large plans than small plans. In any case, those fees are high and I think you should bring it up with your employer. Hopefully it’s not a political issue (like the boss’ brother is a broker or something like that). Be careful though. As the “new guy,” you don’t want to cause any problems.

Under these circumstances I would put in just enough to get the company match and use Roth IRAs for the rest. Even with the high fees, it is hard to walk away from free money. Even at 1.6% (wow, 1.6% for an INDEX fund!), I would stick with the index funds and use the Roth IRAs for diversification.

Good luck!

For 2006, the Roth IRA contribution phaseout is as follows:

Filing Status: Married Filing Jointly & Qualifying Widow(er)

The phaseout based on your modified adjusted gross income (MAGI) is $150,000 – $160,000

Filing Status: Single, Head of Household, or Married Filing Separately

The phaseout, again based on your modified adjusted gross income (MAGI) is $95,000 – $110,000

If your MAGI is below the low end of the phaseout, you can make a full contribution. If your MAGI falls within the phaseout, your contribution will be reduced. If your MAGI is above the upper limit of the phaseout, you cannot contribute to a Roth. However, you can still contribute to a non-deductible Traditional IRA, which you might be able to convert to a Roth IRA in the future.

For 2007, the Roth IRA contribution phaseout is EXPECTED to be the following:

Filing Status: Married Filing Jointly & Qualifying Widow(er)

The phaseout based on your modified adjusted gross income (MAGI) is $156,000 – $166,000

Filing Status: Single, Head of Household, or Married Filing Separately

The phaseout, again based on your modified adjusted gross income (MAGI) is $99,000 – $114,000

It’s good to see them raise the phaseout threshhold. Personally, I think it is silly to have a phaseout in the first place since the MOST a person can contribute is $4,000 ($5,000 if over age 50).

Roth IRA Contribution Limits

December 6, 2006

Don’t forget that if you haven’t contributed to your Roth IRA yet this year, you have until April 15, 2007 to make a 2006 contribution.

The maximum contribution for 2006 is $4,000 (or $5,000 if you are 50 years old or older). These amounts remain unchanged for 2007.

Who Can Contribute?

According to Publication 590 from the IRS:

Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:

$160,000 for married filing jointly or qualifying widow(er),

$10,000 for married filing separately and you lived with your spouse at any time during the year, and

$110,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year.

There is a phaseout on Roth IRA contributions, based on your filing status and modified adjusted gross income (MAGI). The Roth IRA phaseout is:

For Married Filing Jointly or Qualifying Widow(er): $150,000 – $160,000

For Single Filers, Head of Household or Married Filing Separately: $95,000 – $110,000

If your modified adjusted gross income falls within the phaseout range you can still contribute to a Roth but at a reduced amount. The IRS website has a worksheet you can use to figure out your reduced contribution amount. There’s no direct link to the worksheet (although you can find it if you scroll down on this page) but it looks like this:

Reduced Contribution Worksheet for Roth IRAs
You can click on the worsheet to open up a new window for printing

How’s that for a catchy title?

This post was inspired by the following comment I received from a reader: Continue Reading…

Scottrade ticked off a lot of people when they added a $17 fee for purchases of mutual funds that aren’t included in their No-Load, No-Transaction Fee (NTF) Fund List. There is a way around most of the $17 fee but it requires systematic purchases or redemptions of at least $100, for which Scottrade will charge $2 per transaction. At first glance, $2 doesn’t seem like that big of a deal. But, with a $100 investment, it represents a 2% front-end and back-end load.

Since the $2 is charged PER transaction, one route to go would be to simply save up the $100 per month and then invest $600 twice a year or $1,200 once a year. This would cut the fee percentage way down ($2 &#247 $600 = 0.33% compared to 2.00% for a $100 transaction). The problem with this strategy is that the money really isn’t working for you during the months while you are saving it up and it also defeats the purpose of dollar-cost-averaging, which is to invest consistent sums over long periods of time in order to decrease risk.

One way around this fee is to simply invest directly with the mutual fund company. You will give up some freedom of choice but most people’s needs could be easily met with a company like Vanguard or T. Rowe Price. Vanguard does have a $3,000 minimum initial investment for their IRAs, which may be a bit steep for someone just starting out. Vanguard also charges an account fee of $10 per fund for IRAs with balances of less than $5,000. Remember that fee is PER FUND, so if you have 2 funds (like the Vanguard Total Stock Market Index and the Vanguard Total International Stock Index Fund) inside your IRA and your account balance is under $5,000, you will be charged $20 per year. This might be a reason to stick with ONE fund until your account has reached $5,000. T. Rowe Price has a $1,000 minimum initial investment for IRAs. They also charge $10 per year PER FUND for IRAs with balances of less than $5,000, which is similar to Vanguard’s policy. Their mutual fund expenses are somewhat higher than Vanguard’s but still low compared to the average mutual fund. And, T. Rowe Price has an excellent reputation.

There are other choices out there and I’m not necessarily saying that you should go this route. No matter what you decide, the most important thing is to GET STARTED saving for retirement.