The joy of tax-free retirement income

[ncboman]

The joy of tax-free retirement income

New rules will soon allow many more retirement savers to have a Roth IRA. My advice is go for it.

(MONEY Magazine) -- For the first time since Roth IRAs were introduced almost 10 years ago, politicians are finally ready to give everybody the chance to save in these accounts.

In May, Congress eliminated the restriction barring anyone who makes more than $100,000 from converting a traditional IRA to a Roth IRA. Now no matter what your income is, you'll be able to enjoy the chief benefit of a Roth: tax-free income when you retire.

Call me a Roth-o-maniac, but I think you should probably take Washington up on the offer.

A couple of notes: First, the new provision doesn't kick in until 2010. Second, the new law dealt only with conversions, leaving in place rules that prevent you from contributing to a regular Roth account each year if your income is $110,000 or more ($160,000 for couples).

But there's an easy way around this. Just open a nondeductible IRA - which anyone with earned income can do - and then convert it to a Roth.

So by 2010 everyone will be able to have a Roth one way or another.

The Extra Roth Advantage
You've probably already heard that you're better off with a Roth if you expect to be in a higher tax bracket at retirement. By investing in the Roth, you are paying taxes today, when your rate is lower, and avoiding a tax bill later, when your rate is higher.

But a Roth can also be the better deal if your tax rate stays the same, which is the more likely assumption.

Here's why Say you have $5,000 to invest (the $4,000 max for an IRA this year, plus the $1,000 catch-up for people 50 or older), and assume that your account will earn 8% a year and that you'll be in the 25% tax bracket before and after you retire.

Put your five grand in a Roth, and you'll have $23,305 tax-free after 20 years. If you put your five grand in the traditional IRA instead, it will grow to the same sum, but you'll owe $5,826 in taxes when you withdraw the money, reducing your account to $17,479.

But don't you also get a tax deduction with the traditional IRA? Yes, you do; in this case it's worth $1,250, or 25% of your $5,000 contribution. If you invest that tax savings at 8% a year, after 20 years it will total $5,826. Add that amount to your after-tax balance and you've got $23,305, same as with the Roth.

So it's a wash, right?

Actually, no, and here's why. Even if you were diligent enough to invest your tax savings rather than spend it, you'd have to put that money in a taxable account since you'd already have hit the annual limit on IRA contributions. So you'd have to pay taxes on income and realized gains in that account, producing a lower return, after taxes, than the totally tax-free 8% you'd earn in the Roth.

Bottom Line When you're contributing the max, the Roth has the distinct edge since more of your money grows without the drag of taxes. The advantage is sometimes so large that a Roth remains the better option even if you move to a slightly lower bracket in retirement.

And the same generally holds true when you compare contributing the max to a Roth 401(k) vs. a regular 401(k) and when you consider converting a traditional IRA to a Roth.

Hedging Your Tax Bets
Even if you think you'll move into a much lower tax bracket after you retire - the one situation in which a traditional IRA seems the clear winner - there are compelling reasons to consider a Roth for at least some of your retirement money.

For one, you can't really count on your tax rates dropping in retirement. If you travel a lot or live a particularly comfy lifestyle, your withdrawals from retirement accounts could easily be high enough to keep you in the same bracket that you're in now or knock you into a higher one.

Another tax wild card: Congress. Given the size of the budget deficit, it's hardly a stretch to imagine that future legislators might raise tax rates, which could sharply reduce the after-tax value of the money you have stashed in traditional IRAs and 401(k)s.

By funding a Roth, you hedge against the possibility of higher rates by ensuring you'll have some savings that won't be subject to income taxes at all.

Roths have another nifty advantage. With a regular IRA, you have to take distributions after age 70½. Roths have no such rules, which means you can let your entire balance grow without taxes for the rest of your life if you wish - and pass on the tax-free gravy train to heirs.

So if you qualify for any type of Roth, think seriously about setting one up. And if you're still not eligible, well, 2010 isn't really that far away.

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[Rock Chuck]

The Roth is one of the better things that's come out of Congress. However...if they ever switch to a national sales tax instead of an income tax, it's bye-bye for the Roth and all other tax incentive plans.

Dick

[shoreman]

The Return of the CD
Who needs Bonds

bluecollardollar.com/CDs_return_040406.html

Even as Ben Bernanke ended his first meeting as the new Federal Reserve Board chairman, even as he attempted to make his tenure more transparent, even as he suggested that the Fed is on the right track to keep the economy growing, inflation in check and eventually solve the bond market conundrum, investors were looking the other way.

Certificates of Deposit are back.

One of the unfortunate fallouts of a low interest rate environment, such as the one Greenspan created to give the economy a new feeling of irrational exuberance - his work with the equity markets still stings - by creating a hot housing market, was to take the good old fashioned CD and make it literally worthless. No one, with the exception of those who are in this type of investment for capital protection, really cared. There was money to be made elsewhere.

The stalwart investment for seniors, certificates of deposit offered less than one percent just four years ago. Now that has all changed. The steady rise in interest rates has refueled an interest in these financial tools. Now, these bastions of capital protection along with their FDIC insured status are paying investors over 5% for as little as twelve months.

Along with the rising rates on CDs, money market accounts are also seeing some serious rate increases as well, some not experienced in five years or more.

Most financial professionals worth their weight were warning 401(k) investors about these types of accounts. Money market accounts, the more flexible cousin of the CD, is often the default option in these types of tax-deferred accounts. The call was for more active management of your funds by using those contributions to grow wealth. Now that has changed.

When the 5% plateau was breeched, suddenly, those looking for a profitable, safe and FDIC insured location for their cash c saw the CD and the money market account as the place to not only leave money for the short term, but to leave huge sums parked inside.

The conundrum that Greenspan worried about still exists. In the short term, Treasuries of a maturity of a year or less still pay more than their long term brethren. But these short-term notes are paying less than CD's. Only question now is how long before foreign investors jump in?

You should remember though, the tax treatment of these types of investments will be better kept outside of your 401(k) plans. Because cash is usually locked up in a CD for a year, it is considered a long-term capital gain and is taxed at 15%. It is still a better idea to keep your money actively invested but now the money generated for parking your cash while you decide is much better.

This is an excellent time to begin to ladder your CD portfolio. Often used in bonds to take advantage of different market conditions, laddering allows you to buy different maturity dates. Laddering allows you have your CDs mature at different times giving you the opportunity to buy something else more favorable or roll your money back into another CD if the rates are right.

[Rock Chuck]

Last month our bank had a CD 'sale'. 7 mo. at 5.25%. That's the highest I've seen them in quite a while.

Dick

[ncboman]

I don't use CDs at all. I find it much more profitable to buy inventory of epdm or glue for short term saving. Probably safer too.

Long term investments for me runs to real estate. I don't feel like my money is in someone else's hands in real estate.

[shoreman]

rockchuck said:

Last month our bank had a CD 'sale'. 7 mo. at 5.25%. That's the highest I've seen them in quite a while.

Dick

My Credit Union has an 18-month CD at 6.25%.

[shoreman]

How Can We Protect Against Inflation?

By EILEEN ALT POWELL
AP Business Writer
Posted August 3 2006, 7:39 AM EDT

www.sun-sentinel.com/business/local/sns-ap-biz-on-the-money,0,885740.story?coll=sfla-business-headlines

NEW YORK -- Several recent government reports indicate that inflation is heating up. What can consumers do to protect their savings -- and preserve their buying power?

"The latest inflation numbers are a bit of a wake-up call to look at your spending, your saving and your investment strategy," said Greg McBride, senior financial analyst at Bankrate.com in North Palm Beach, Fla. "Inflation isn't something to ignore."

Inflation -- basically a measure of rising prices -- means people need to spend more to buy the same amount of goods and services. As inflation increases, consumers need to take a hard look at how they're allocating their budget dollars. They also should review their saving and investment accounts to make sure their returns are at least keeping pace with inflation.

Earlier this week, a government inflation gauge tied to personal spending rose 0.2 percent in June, excluding food and energy. Over the past year, this measure of "core" inflation is up by 2.4 percent.

That may not sound like much, but financial planner John Nersesian, managing director of wealth management services with Nuveen Investments in Chicago, points out that "small numbers can have a big impact."

Take the case, for example, of a person who is retiring today who plans to spend $100,000 a year in retirement. If inflation is 2 percent a year, in 20 years that retiree will need $164,000 to cover the same expenses, Nersesian said. If prices go up 4 percent a year, the total that is needed increases to $230,000, he said.

"The lesson," he said, "is that investors need to protect themselves against inflation because it can have a devastating impact on their financial futures."

One way consumers can try to counter inflation is to broaden the assets they invest in, he said.

"Fixed-income investments such as bonds are particularly vulnerable during periods of high inflation," he said. Instead, investors should consider putting more of their money into high-yield online savings accounts or short-term certificates of deposit as well as diversifying into alternatives such as real estate investment trusts.

"Hard assets like real estate, commodities, gold and other precious metals -- or stocks and mutual funds that invest in those assets -- typically do well in times of rising inflation," Nersesian said.

James Swanson, chief investment strategist with MFS Investment Management in Boston, said another alternative is to invest in inflation-linked bonds, such as Treasury Inflation-Protected Securities, or TIPS. These bonds, in maturities of 5 years, 10 years or 15 years, can be purchased at the Treasury's Web site, www.treasurydirect.gov, as well as through banks and brokers. They're set up so that the principal increases as the Consumer Price Index goes up.

"They're guaranteed to beat inflation, and they're very tradable," Swanson said.

A number of mutual funds that invest in TIPS also are available, he said.

Another inflation-linked investment for small savers is the I-Bond, a U.S. savings bond available in denominations as low as $50. These bonds have a fixed rate of interest as well as an adjustable component that resets twice a year to reflect the change in the Consumer Price Index.

The flip side to the pain of inflation is that it's generally accompanied by rising interest rates -- not exactly bad news for savers.

"It's one reason you can get 4.5 percent to 5 percent on a savings account right now," Swanson pointed out.

Bankrate.com's McBride noted that inflation was subdued for a number of years before it began rising in the last year along with prices for oil and other commodities.

Inflation is one reason consumers have been "throttling back" on purchases, as seen in slower consumer spending nationwide in the second quarter as well as subdued retail sales. "Prices are rising, so people have to stretch those dollars further," McBride said.

"As to savings, the idea here isn't that you're going to alter your investment strategy every time the wind changes," McBride said. "But an effective strategy requires a checkup from time to time, and inflation is a reminder of that need."

This is especially true for older savers, he added.

"A 65-year-old retiree needs to preserve buying power over the next 30 years, so inflation has to be issue No. 1," he said.

* __

On the Net:

www.bankrate.com

www.nuveen.com

www.mfs.com

[shoreman]

SAVING WITH A DRAC

Thursday, August 24, 2006

freemarketnews.com/Analysis/81/5833/saving.asp?wid=81&nid=5833

A DRAC? That’s a buzzword for a “designated Roth account,” also call the Roth 401(k) plan. Introduced in 2006, this new option for retirement saving has been slow to catch on. Perhaps employers do not understand it. We are convinced that most employees do not understand it.

You have heard of a Roth IRA. If eligible, you may contribute 100% of earned income up to $4,000. If you are age 50 or older you may add an additional “catch-up” contribution of $1,000. A non-employed spouse may also contribute. Unlike a Traditional IRA , contributions are not tax-deductible.

But, here’s the big plus! Earnings and growth are tax-free! You give up a tax break now and all gains never will be taxed. That is a very good deal, especially if the money will grow for ten years or longer.

As with any good deal, Uncle Sam does not want “fat cats” to get a break. For a full Roth IRA contribution, single filers with Adjusted Gross Income (AGI) up to $95,000 are eligible; for joint filers, up to $150k. Single filers may make a partial contribution between $95k and $100k; joint filers, $150k to $160k. Make more than the upper limit - nada! No Roth IRA.

But with a Roth 401(k), or DRAC, there are no income limits or phase-outs. If your employer amends your current 401(k) plan to add a DRAC, you have an additional option for elective salary deferrals.

A DRAC works like a Roth IRA. You pay tax on what you currently defer, but all contributions and the growth of that money comes back completely tax-free to you or your beneficiary.

The dollar limit for elective 401(k) deferrals for 2006 is $15,000, plus $5,000 catch-up for an employee 50 or older by the end of the year. You can direct 100% of your deferral to the DRAC, or split it between the DRAC and the regular tax-deductible and tax-deferred standard option. You cannot exceed the overall limit, however.

Only the employee can contribute to the DRAC. If your employer makes a matching contribution, that must go into the regular tax-deferred 401(k) account.

If later you leave your employer prior to your retirement, or at retirement, you may roll over your DRAC contributions to a Roth IRA, even if your income is too high for regular Roth IRA contributions.

Why pay taxes now, on either a Roth IRA or a DRAC, when you can defer taxes until later? Define “later.” If you plan to leave Roth money to grow over a period of years, the benefit of tax-free growth could more than eclipse the loss of the up front deduction. You also may have substantial pre-tax money built up in various retirement plans, money to be taxed at ordinary income rates as high as 35%. You may wish to have a tax-free bucket as an added resource. When converted to a Roth IRA at retirement, you do not have to start liquidating the account at 70 ½, creating interesting estate planning and legacy possibilities if the account is passed to a younger non-spousal beneficiary.

Unfortunately, investors have more retirement planning vehicles available than they use. Participation rates in 401(k) plans is lower than it was a decade ago and the average salary deferral rate is 6.9% of compensation. If you are doing more, congratulations! You are holding up the curve!

Like everything that the government comes up with, rules and complications have impeded employer interest, and it is too soon to call the Roth 401(k) a success. If it is available, look into it. If not, review other retirement plan options and take advantage.

Retirement is not for sissies or the underfunded. Have you noticed how expensive “leisure” is getting?