John G

Wooaaa. What students can not utilize is the special credit for IRAs when you have low income. This is totally separate from the deductability issue. I would still recommend the Roth. Tell your daughter she has the right idea and encourage her to stay with the plan.

My point was that too often people assume a drop in tax bracket in retirement and in my experience a drop for today's professionals/managers is pretty rare. Why? Because folks in higher tax brackets or with advanced degrees have generally been successful in life and accumulate assets, home equity, pension and SSN income streams. I can't remember the last time I talked with someone who dropped from 28-31 % to a simple 15%. That 10% part of the population with high incomes is a fast growing group. The group just below them often exceeds 80% of pre-retirement income from the combination of sources. If people are making decisions about retirement based upon a significant drop in tax rate, I would suggest they crunch the numbers because they are likely to be making a wrong assumption. Here is a test question: "If you are systematically contributing as part of a plan for retirement, at what age will you have accumulated half of your retirement assets?" If the person is getting a 10% annual return, the answer is that they will have accumulated more than 1/2 of their retirement assets seven years before they retire. In the last 7 years, this nest egg is likely to double. Rule of 72. A 10% annual rate gets assets to double in about 7 years. Ask the average adult and you will get answers like 10-15 years before they retire, because they just don't incorporate annual compounding into their projection of asset growth. It is my experience that people currently working often underestimate their future financial circumstances.

Agreed. I see a lot of folks who are surprised in retirement about their tax rate. They have a couple of pension income components. Plus SSN. If they downsized the house, their is often a cash component spinning off interest. Perhaps there is some inheritance components giving dividends. If they retire early, they may have gotten a lump sum from an employer. The old mortgage interest rate deduction may be gone along with exemptions from children. Add the required IRA distributions and wham.... a high tax rate. Successful couples just don't drop down to 15% rate and many can't even find 28%. I totally accept your recommendation that your tax status in retirement is complicated by what components are taxable and how that impacts SSN. Not all of the planning tools account for these issues. Since we are talking about 10, 20 and 30 years in to the future you also have the problem of knowing what rules might be in effect then.

Patrick, Not so fast. Students are specifically prohibited from the benefits of the IRA credit. See below: http://www.rothira-advisor.com/economicgrowth.htm If your adjusted income is low enough and you meet other eligibility requirements, you will receive a tax credit of up to 50% for your contribution to an IRA or other eligible retirement plan. (Students and dependents are excluded.) For example, if you are a single mother with an adjusted gross income of $22,500 or less and you contributed $2,000 to an IRA, you would get an income tax credit of $1,000. This credit is in addition to any deduction you may be eligible for. However, in general, I would prefer the contribution be to a Roth IRA rather than a traditional IRA or retirement plan. That seems like a nice break for low-income taxpayers until you think about it for a minute. What single mother with an adjusted gross income of $22,500 or less can afford to make a $2,000 IRA contribution, even if their true after-credit cost would be $1,000? As a practical matter, I intend to take advantage of this provision by telling my wealthy clients to give money to their children (or grandchildren) and have the children use the money to make an IRA contribution. Example: Your single daughter (not a dependent or full-time student) earns $15,000. You give her $2,000 to contribute to her IRA. She makes the Roth IRA contribution and also gets a $1,000 tax credit........ My addition: this option makes a lot of sense the year she graduates and has a job for only perhaps 6 months. So keep this in mind for her senior year. I have trouble imagining children that have income to qualify for an IRA but are not students, so the suggestions above are very limited.

No, your plan does not work. Here is why. When you do step two conversion, you pay tax on the full amount of the account since you took the deduction on all contributions. You therefore owe $450 taxes you just thought you saved. Given the facts you have provided, I would go the Roth route since your daughter is in the 15% tax bracket which she is unlikely to see much longer.

You did not indicate her total income, but from the sounds of it she is probably on the low end of the 15% bracket. If the IRA gets $3,000 then you get a tax savings of no more than $450 right now, and it could easily be less if her income is very low or you drop a tax bracket. Lets assume that she puts $3,000 in 2002 into a regular IRA and takes the immediate tax break. If we assume that your daughter is about 20 and keeps the funds sheltered for 40 years at an annual rate of 10% (a common number for mixed stock/bond fund) then she will have over $135,000 at age 60 from just this first year contribution. If she then took an income stream perhaps 10% she would have taxable income every year for the rest of her life of $3,800. Assuming a likely 28% rate and upon her death the remaining assets (which could easily be above 50,000) would also be taxed, perhaps triggering a tax bill of $14,000. Perhaps you should post a specific income number, tax rate, and filing status for your daughter so we can give you a more precise answer.... but I would join Papogi and recommend a Roth now. The Roth will also have $135,000 from growing just this initial 3k, but there will be no specific required dispursement and what every does come out will be tax free. That is a pretty good deal, even if future dollars must be discounted for inflation. For some folks, every $3,000 put into a Roth buys a year of retirement since it comes out tax free. What a system! She does not have to put the money into the IRA. Anyone can fund it for her.... like mom and dad... or perhaps offer a dollar for dollar match to encourage her. Besides getting her an early start in building a retirement next egg, she will also get early lessons on investing. I would highly recommend that you have her read the March issue of Consumer Reports and encourage her to pick a balanced NO-LOAD mutual fund from the ones they list. Conversion of a regular IRA may not always be an option. Plus, you pay taxes on the appreciated assets not the initial contribution. Conclusion: Roth is probably the better option.

Mbozek, I never said that conversions are "very expensive" due to tax payments. My examples did not even attempt to show the net values of conversion and non-conversion. Actually, if the tax bracket is the same now and in the future, then a Roth conversion is roughly a wash. Pay now, pay later. The money you would use to pay taxes now vs that same money allowed to grow to pay the larger tax bill in the future. The most simplistic view is that both scenarios are the same. However, each individual will have specific circumstances that may make conversion a good or bad idea. Here are the some of factors that tip the scales towards a conversion: (1) your current tax bracket is likely to climb in future years due to your success, (2) you are younger and have a very long compounding period of 30+ years, (3) you currently live in a state that does not have an income tax, (4) you suspect that you may not qualify for a conversion in the future and want to do it now, (5) you think Congress may change conversion rules and end this option, (6) you seek to control the timing of your dispersements, (7) your assets are substantial and you want to use the Roth as an inheritance planning tool, and (8) you are a very good investor getting a high annual return. This last point needs some clarification. I know of two people that have averaged annual returns well in excess of 15% per year in their IRA/Roths over more than a decade. They expect to have multiple million dollars of IRA assets in 30 years and can not conceive that their tax rate will ever be lower. They both did substantial conversions in 1998 and have since more than doubled their Roth assets. I find no logic to your comment about "depreciated IRA assets". I assume you mean depressed values. This sounds like you think investments are somehow elastic and that eventually every depressed stock rebounds. Not true. Enron? Montgomery Wards? I think you should take the current snapshot of your IRA assets as a given and make a conversion decision independent of you expectations about a specific stock or the overall market. Converting a depressed stock is playing a hunch. I have never met anyone who can say "this is the bottom" or "this is the top" with any accuracy. At the recent market peak, where were all the folks who "knew" that a top had been reached. At 9800 DOW are we at a short term bottom? This is conjecture not analysis. Your concluding sentence was: " It does not make sense for most taxpayers because of the fact that the taxes have to be paid from non IRA assets which reduces the amount of investible assets for retirement." This statement suggests that conversion is generally a bad idea. It fails to recognize that the front end costs while painful are largely offset by bigger tax costs on the back end. I don't believe that conversions are bad for "most" taxpayers. There are plenty of folks who can be better off by converting. For many others, to convert is about even with not converting but the parties may value being rid of minimum annual dispersements. My conclusion would be: a Roth conversion is neither bad idea nor a panacia and each tax payer must evaluate their specific facts.

Mbozek, I like your response a lot. However, you ran things out to age 70 and machIcj seemed to want to retire at age 62... about 10 years from now. I enjoy crunching the numbers, so I ran out some scenarios on my HP 12c: IRA: 100k initial in the IRA grows by age 62 to $197K or $ 259K using 7% or 10%, and if left untouched to age 70 the assets will be about $338K and $556K. The 7% would represent a mostly bond/utility portfolio and the 10% would represent a general mix of stocks with just some bonds. I would pick 10% for the very long term rate, perhaps a bit lower for the shorter scenarios. ROTH: The annual Roth approach using the $6,600 (Mbozek's taxes paid, which is less than the likely 7,000 current max) would create $91K or $105K using 7%/10% by age 62 or $224K or $300K they worked/contributed to age 70. {wouldn't be my plan... but worth illustrating} Upon retirement: I would imagine there would be the following components of income: (1) SSN, (2) pension, (3) possible IRA withdrawal, (4) other interest and dividends, and (5) possible Roth withdrawals. In the early years, this person might want to draw down on savings, or if they move to a smaller home they might burn off some of the home equity. Depending upon how long you let the IRA grow and the annual return you expect, your income in retirement could vary substantially. Note, that with the Mozbek strategy, the Roth assets are about 2/3 the IRA assets at age 70, or 1/3 at age 62. The hybrid IRA/Roth strategy helps mitigate total taxable income in retirement and gives you some timing/estate flexibility. There are lots of unknown circumstances like other assets, pension, wifes age, investment experience and risk tolerance, home equity, and health status. I don't presume to know the answer to the original questions, but I hope this data helps illustrate some of the scenarios. In my experience, lots of folks underestimate their future economic situation because it is hard to project out decades into the future. I hope this helps machIcj.

Annual income under 100k is needed to qualify for a conversion if you are married filling jointly. When you convert all/part of your IRA you will immediately increase your income and you could easily jump up a bracket or even two. That is not a great idea if in retirement you would be drawing down on your IRA at 28% or lower. On the other hand, if you have reason to believe that your income and assets will grow substantially and in retirement you will be at 28% or higher then a conversion might make sense. The conversion might be attractive if you plan not to use the Roth during your lifetime but to pass it on as part of your estate, or if you just want a better control of dispersements since there are no required start dates or required schedules with a Roth. If you expect to stay below the 100k limit for a few years, you might want to consider converting just a partial amount each year, say perhaps 10k. The case to convert is stronger if your current state has no income tax state but you may later live in a state with income taxes in the future or in retirement. Often a hybrid solution: part IRA , part Roth gets you lots of flexibility and benefits without the immediate tax impact of a full conversion. To think through a conversion decision, you need a spreadsheet or conversion calculator. Assumptions you need to make include tax rate now, tax rate in drawdown, number of years to you start drawdown, likely annual rate of return on investments, etc. Since these predictions look into the future 10 or 20+ years, the accuracy of assumptions is suspect. A number of mutual fund and brokerage web sites used to have Roth conversion calculators. Sadly, many of these were too simplistic or had math/structural errors. Perhaps another reader can comment on the state-of-the-art or see the articles at www.rothira.com . You may want to see if your accountant has access to a good spreadsheet. There is no simple answer to your question. Often convert and stay IRA produce very similiar results. If both you and your spouse are over 50 years old, you can put $3,500 each into a Roth while you ponder the conversion option.

Below is a tiddy except from Motley Fool that I thought the "just getting started" readers would appreciate. MF advice varies, but the writing is always crisp and worth reading. Motley Fool By Brian Graney April 25, 2002 Last week we discussed how to start direct investment plans. The more important issue is when to start. There's an ad floating around the Internet that poses the question, "Is this the right time to invest?" For folks new to investing, this single question often seems about as daunting as the Riddle of the Sphinx. Here's the situation (insert hypnotic, time-warp music here): Let's say that you are ready to make the move up from Fool Junior Grade to Fool First Class. The 13 Steps to Investing Foolishly have been read and committed to memory, those pesky credit cards are all paid off, and maybe you've given a little bit of thought to what to do for retirement. Check, check, check. What's next? A little bit of dedicated research about stocks and investing might not be a bad idea at this point. You might read some good books, find out what those stock valuation ratios are all about, form some opinions about a few companies that have caught your eye, and share what you have learned with others on the Fool discussion boards. These are all good things to do. Meanwhile, days pass, weeks sail by, seasons turn, TV sitcoms come and go -- pretty soon, it's months later and still no stocks. Is this what everyone around here means by Foolishness? Is it supposed to take this long to get started on this investing thing? And, more importantly, is there a point to all of this rambling? What all this boils down to is the following: Take your time when you are getting ready to invest. If you can't tell a balance sheet from a balance beam, then set aside some time to figure out the difference between the two before plunking your money into your first stock. Learn as much as possible about your investment before it actually is your investment. That way, there is much less chance that your first investment will also end up being your dumbest investment. Second verse, same as the first: Take your time. If you're Foolish and you want to become an owner in an excellent business for a long time, then there is no rush. Great businesses don't just appear and disappear overnight, of course. And, here's a newsflash -- neither do great investors. I can hear the collective yawn of long-time Fools at this point, but for investing beginners these things are worth emphasizing (and for the veterans seeking new stocks, a little reiteration never hurts). Unfortunately, the Wise on Wall Street often tend to gloss over ground-breaking concepts such as "learning." Sure, learning all this investing stuff takes time and perseverance. But, like trays of meat by-products being ground into a high-quality sausage, all of your learning will form a solid basis for what kind of investor you want to be. It's a messy process, but it's worth it. If you are struggling to find your "inner investor," there are lots of places right here at the Fool to seek solace. {witty - would love to write this well, give this guy a scholarship}

I have a hardcopy of this example I use with my Junior Achievement high school econ classes. You can do the math on an HP12c or with any spreadsheet. The basic lesson is that the early starter ussually gets far enough ahead that the late starting investor never catches up. (Note, the new max annual has been bumped up to $3,000 for IRAs.) Just a little off point: I have found that some of the graphics from mutual funds like Washington Mutual are extremely good for explaining overall investment performance including the variations over long time periods in the stock market. It seems that not many adults understand the power of compounding, and teenagers are just amazed. After an hour of talking about the Roth option, most of my classes understand that they can be millionaires if they have a small amount of discipline and a plan.

You can convert any regular IRAs in to Roth if you are below the income threshold which is 100,000 if you are married filing jointly. Note this is lower than the income threshold to just contribute to a Roth. If you were in the 150-160K range in the prior year, your income would have to decline substantially to qualify for a conversion. A good time for a conversion is when you change jobs and have an income gap which might allow you to qualify and keep your tax rate down. Prior classifications of the assets or reclassifications which occured in an earlier tax year will have no impact on the conversion. There are some IRA rules that limit actions to just once per year.... they don't appear to apply here. See the below article on conversions which can be found at www.rothira.com : http://www.rothira.com/recharacter.htm

A follow up on Papogi. "Long term hold" from my view starts with 10 years. Under 10 years a bond/stock mix may make more sense. Bear in mind that if you are 55 right now, your hold period is not the difference between 55 and the day you retire. You may still have IRA money 10 or 20 years beyond the date of your retirement. If this is a Roth account, the sequencing of what assets you will use may lead to Roth assets coming out later or perhaps becoming part of your estate, so the funds could be invested for multiple decades. Investments that involve blocks of 2k or 3k can readily be invested in NO LOAD mutual funds, that is funds that do not charge up front or back end commissions. You generally will not find these options at banks. Vanguard is a major name in mutual funds and has a "family" of funds to choose from. Your financial objectives and your tolerance for risk are a very personal issue. Yes, the stock market has risk, but the risks are reduced as the holding period lengthens. Putting money in fixed income investments also carries risk, even if the CDs are government insured. Here the risk would be that inflation is eroding much of your annual increase and you might not meet your retirement needs. Your problem and the response should help a lot of folks. Thanks for posting a good question. PS: in original post you refered to 2002/2003 contributions. You can not yet contribute for the 2003 year. The max contribution this year has moved up to 3,000 or 3,500 if you are older than 50.

You have raised a couple of issues: 1. Your bank may be saying that you can not add to the CD that it looks like you opened given the interest rate you report. Read the document that you signed when the account was opened, because it may state that you can add to it. The document rules unless it was modified by letter later. 2. I agree with Barry, the Bank is imposing their rules, not IRS requirements. They are probably saying they don't want to give you the higher yielding rate that was available a couple years back. 3. You did not indicate your age or make any comment about your retirement objective. If you are young, or have a long holding period before you expect to use the IRA assets, CDs are a ultra conservative investment option. For example, the difference between 5.83 and a 10% annual return over a 30 year period leads to more than a 3X difference in assets! The 10% return is a rate most financial planners use to represent a broad based stock portfolio... an S&P 500 index fund type of rate. 4. If you are dealing with a clerk at the bank, try going up the chain of command or speaking to someone in the IRA department. The back office IRA dept which may not even be in the building you visited is more likely to be more knowledgable. 5. Sounds like you might be shifting your account. I recommend a direct custodian to custodian transfer. The new "home" can arrange the details. As mentioned above, you need to read the rules you agreed to with the CD about the date the note comes due and possible fees to rollover the IRA to a new custodian. 6. I sure hope this bank is not trying to get multiple IRA accounts so that each account can be charged a fee. Many custodians do not charge any annual fees, especially if your IRA assets are above 5k or 10k, or if you have other business relationships with the firm. 7. This is a "first" for me. I have never heard of any custodian setting up an IRA and requiring you to open a whole new one every year. Not exactly paperwork reduction. Mutual Funds and brokerages do not normally do this.

Convert should be recharacterize - yes, got a little sloppy with the language there. Thanks for catching it. Here is a second reference with some examples that may be more helpful: http://www.fool.com/taxes/2002/taxes020222.htm

Caught in the phase out.... You have the option to instruct the custodian to convert {correction: recharaterize is the right term} the Roth contribution over to a standard IRA. If you closed all your Roth accounts, the $500 loss could only be taken if you filed Schedule A and you exceeded the % of income threshold. This loss by itself would not. If on rechecking your 1040 you find that your income drops below 150k, the problem goes away as you can keep the Roth.

For more details click on below link: http://www.benefitslink.com/mbmirror/12458.html It is not a perfect match for your circumstances but gives you and idea of how difficult taking a loss can become. A 25% loss is not uncommon when you have a very short market snapshot. You can't avoid short term down drafts, but over the long haul if you have a well balanced portfolio you should be fine.

Risk reward for being to "clever" is not good. This is the kind of stuff that someone at the bank or a neighbor could report to the IRS as an abuse for the finder fee. The upside is you have a normal investment. The downside you lose you tax shelter, owe taxes and may have penalties. So... why take a dumb risk.

My non-legally trained opinion: Assuming that the wife signed the divorce decree, you have in writing that she waived rights to these assets. You stated that the DD is more recent than the IRA. If, however, the deceased changed the account/custodian or did a conversion after the divorce and did not correct the beneficiary then someone might argue that the bene was proactively left the form wife.... 'cause he was such a nice guy.... Get a good lawyer. The custodian will probably not act until they get a clear court ruling.

If I were the IRS, I would wonder why someone insists on a questionable investment when there are 8,000 stocks, 8,000 mutual funds, a huge number of bonds and other basic things in which to invest. Just the pursuit of these kinds of odd investments might appear suspicious. The APCG site seems to think everyone should have a Nevada Corporation, apparently even if they don't actually have a business. The pitch seems to cater to the tax evasion crowd as their number one reason for a Nevada Corp is that Nevada does not share info with the IRS. If not a Nevada Corp then something in the Bahamas..... does everyone get the picture? I would be very wary about any advice offered by these folks.

You defeat the purpose of a Roth tax shelter if you start dipping into the funds. Have you considered a home equity loan, borrowing from a relative, deferring a purchase to a later date, taking a weekend job, etc. I would sure think long and hard before busting up a great tax shelter. It is hard to stuff money into a Roth because of the income requirements, limit to $3k per year.... and remember, Congress could change the rules and you might not be eligible in the future.

Did you say that the IRA owner was involved in the transactions and handled the money for loan repayment? It seems to me that this situation could allow fraudulent pumping of funds into the account that were not loan repayments at all. I also find it very strange that the IRA owner was not sending in the funds... sounds to me like the owner may have been receiving the funds and "using" them which would be analogous to taking a rollover beyond the 60 days. If the IRA owner was not actually getting paid on the loans, then I wonder why the IRA owner was not screaming and taking people to court. Why would a custodian tolerate this type of arrangement? Payments on loans should have been made directly to the bank. Did anyone consider that the IRA owner may have died? In our society, it is a little hard to avoid "communications".

I agree with Papogi. The key fact constraining your choices now is that you are talking about the 2000 tax year. If your friend actually opened a Roth but deducted it like a traditional IRA, she needs to correct her prior tax filing. If you had asked in 2000 which option to elect, most folks would say go with the Roth. You give up a modest initial subsidy (the tax deduction) but gain tax freedom from the accumulated value many years from now. You also have no required schedule for withdrawals with a Roth so you can keep the funds sheltered longer and possibly use it as an inheritance tool. I find it hard to make a rational arguement that taxes are likely to be lower in the future for people that are salting away funds via various retirement programs, especially if they start early. Multi-million dollar accounts 35 years in the future are a strong possibility. Get your friend a copy of IRS Pub 590. And... congratulate her for planning ahead. On a different issue: I hope she is more knowledgable about her investment options. Post again if you want input on this too.

The most basic source is Pub 590 which is all about IRAs , Roths, conversions, distributions, etc. You may also want to cruise around the www.rothira.com web site which has lots of articles and some technical refs.

Your question is not very clear. Let me ask some clarifying questions... 1. Did your friend have earned income? Like paychecks that generated a W2? Did the earned income exceed $2,000 ? 2. What tax filing status did this person elect? Single? Married filing jointly? Claimed by parents? 3. If this persons adjusted gross income is greater than $90,000 you need to give the approximate amount. 4. When you say "last year" are you refering to calander year 2001 or an earlier year? 5. When you say she reported the Roth on her tax return, are you saying that she claimed a deduction? Or do you mean some other way of reporting? If you answer these questions, I think we can answer IF the Roth was wrong and then what to do about it. You see, your assumption that she could not open a Roth may be wrong. Lets get that squared away first.