Should I open a traditional IRA right now?

[Guest ctfudge07]

I have simplified my question greatly in the hopes of getting some opinions from someone. Here it is:

My husband and I (age 41 and 45, with four young children, not all of whom can be claimed as exemptions for 2006 for reasons not relevant) currently have no IRA accounts whatsover, but in part because of some inheritance funds that have been distributed to us in 2006 (a smaller amount) and will be distributed to us in 2007 (the larger, non-taxable amount), we would like to open Roth IRAs from 2007 forward and are considering opening traditional IRAs by April 17th for 2006 for the primary purpose of taking an $8,000 deduction on our taxable income for 2006.

Does anyone have an idea about whether it is better to ditch the idea of a traditional IRA (which I admit I am motivated to do in order to reduce 2006 taxes) and just plan on Roth IRAs from this time forward?

I get the idea that Roth IRAs are the better choice for just about everyone. I would like to cut $1,200 in my tax bill for 2006 which is what I've calculated we'll be able to do if we open a trad. IRA. I am already aware of eligibility, etc. and our income is not very high (about $48,000 most years and about $65,000 due to a taxable-as-income chunk of money we received in 2006) and I've already figured our taxes. Thanks if anyone has an opinion.

[Guest allancoleman]

Hello ctfudge07 ,

From the details you've provided , you may have answered your own question . It sounds like the best option for you is the Traditional IRA because you've already stated you " would like to cut $1,200 in my tax bill for 2006 which is what I've calculated we'll be able to do if we open a trad. IRA " .

And being a huge fan of Roths , I agree with your opinion , " and just plan on Roths from this point forward " .

It doesn't sound like you're going to have a RMD problem with excessive distributions at age 70 . and really , it probably doesn't matter what investment vehicle you use , Traditional or Roth IRA , although Roths pass to heirs much easier than Traditional IRAs .

Good luck going forward .

[Guest ctfudge07]

Thank you; my impulse is to save $ on taxes right now, but sometimes impulses are penny wise and pound foolish, so I just wanted to check. It seems a little odd from a planning standpoint to open an account that I probably won't contribute to again, but again, I don't want to hand over any more taxes right now than I have to. And I could always convert it later, if I understand correctly. Although that would be a case of "pay now or pay later," correct?

I sure do have a lot to learn. It is mind-boggling starting 3/4 of the way through the book. I think I'll stick to slogging my way through the first few chapters for right now, but thanks for helping me flip ahead and take a shortcut.

[John G]

I hope this initial look into retirement investing will get you started on either a Roth or an IRA. Tilt to Roth if you tax rate in the future will be much higher. But, given you circumstances, taking a tax credit now make some sense.

It is sad that no one in our government is willing to stand up and say that "you are in charge" of you fincial future. SS is a very minor safety net, and it probably will just keep you above the poverty line. You choice is spend now vs spend in the future. Yes, it is hard to get started, but if you can begin any kind of systematic plan, you are better off then just crossing your fingers.

If you choose an stock based mutual fund, your 8k should double about every 7 years. That means that you should be able to build about 100,000 fund by your late 60s. This will provide about a 5,000 supplement each year to what you might get from SS or pensions. If you make additional contributions, that nest egg can grow much larger. Some folks take a short term second job just to fund that retirement account.

Retirement account assets are often not counted in family resources when kids apply for financial aide for college. If you keep your inheritance in taxable accounts, it will get counted.

Best wishes.

[Guest allancoleman]

Yes , you can always convert your IRA later . My answer was mostly driven by your " impulse to save $ on taxes right now " . And I'm not sure there ia anything " penny wise and pound foolish " about either a Traditional or a Roth IRA . They are both excellent investment vehicles .

The ' learning curve ' can seem to be steep in the beginning , but once you've taken a few steps , it gos much faster and easier . You certainly found an excellent forum to learn . I throughly enjoy reading all topics , questions and answers , here frequently . The knowledge of some of the posters here is much more than mine and I learn quite a bit here , especially as it applies to IRS regulations . .

[Guest ctfudge07]

Thanks, we both appreciate the responses of both posters. I'm asking a totally different question now, and I'm sorry to trouble you guys, but we are sort of at a loss right now about who to ask, and we are doing some preliminary thinking now. On to a larger question:

As for making a plan and getting started, with the job my husband just began, he will be eligible to contribute to a 401K as of next summer and his employer will match 50% of his contributions up to 6% (a common match, I believe, meaning that if he contributes 6% of his salary, they'll kick in another 3%.) We intend to do at least that much in addition to contributing the maximum allowed to IRAs. But our situation really has to do now with what we're going to do this spring as an inheritance is distributed to us in only a few short months.

I realize this might be outside the scope of this board, so I appreciate your patience and willingness to counsel green thumbs. What would the two of you (or anyone else) do if you were approximately in our financial places, at our ages (and I realize this might be hard to imagine but just humor me):

*41 and 45 years old, with an income, at this point, from work of about $48,000 and additional tax-free income (from child support) of $8,500

*four children, one disabled (I realize we'll need special consultation on this matter, but she's quite young now); af of now can only claim one child as an exemption

*debt-free in terms of credit cards and intend to stay that way (we do have a car loan for about $20K will will be more favorably refinanced soon within a year or two)(of course we could pay it off, but I don't know if that's a good idea or not - feel free to advise)

*no accrued assets (had some previously and not now - long story not worth going into)

*debt to IRS for roughly $7000 dating back to 2001 and 2002 (you can only imagine the interest and penalties, and yes, they're included in that figure) which will be paid in the next few months

*newly in possession of about $100K we didn't see coming as recently as a few months ago

We are not extravagant spenders. By that I mean that we furnish our (rented, we are not homeowners) home with furniture given to us or bought cheaply second-hand, and we're fine with that; we buy clothing from the $2.99 clearance rack when possible or at least wait till it's half-price, and load up at the warehouse store to save money when we stock the fridge. Most of our books come from the public library. We have no interest whatsoever in keeping up with the Joneses, of which there are plenty around here as we are in a somewhat expensive (to buy right now, but the rent is fair) location. We don't plan to move and don't mind paying a little more for housing than we could ten miles away, because the public schools are among the best in the nation (I'm explaining that we will not fritter a penny of this money away but prefer to watch it grow, because we're smart, mathematically-minded people, my husband having some finance and accounting background and both of us realizing that this is it - this is our chance to get ahead and not only remain debt-free, but cross over to the other side. I mean, we are so averse to ever being in debt again that we both feel a little ill even considering the idea of buying a house. Not saying we're not smart enough to realize it's better to own than to rent, and of course we'd like a house, but saying that at this particular juncture in this particular market, I don't mind paying $1,100 to rent, which seems reasonable when compared to the current price of surrounding real estate... I feel ill also to pay back IRS taxes out of my mother's estate proceeds but that's something that must be done.)

Just where should we place the inheritance coming down the pipe in a few months, and I'm not asking for specific investment advice, but rather asking about investment vehicles? We know enough that we wouldn't plan to keep it in a savings account or checking account earning .01% interest (one of my banks offers just that), and the amount being disbursed to us will be in the neighborhood of $100,000, give or take some, and adding a little pension here and a tobacco growers incentive or non-incentive check there (a very small piece of land she owned until recently was used as farmland.) My mother was a teacher and tutor because that was her passion but she used money and land left to her, combined with her own very modest earnings, and invested it so that she'd leave something to her children. She lived frugally but hopefully without undue deprivation (buying the pair of boots she just had to have now and then, going to a restaurant if she so wished), which is where I've learned my lessons on wearing sweats and driving a 10-year-old car, realizing that sofa sets are not truly among the finer things in life, never mind what the Joneses do (the Joneses oftentimes being all flash and a bunch of red ink no one sees). But her investments and the value of her assets were always a mystery to me, and at least partially to her, also, as she allowed someone to have a heavy hand in managing them - although not to say she was completely in the dark - just a little less personally involved than I plan to be.

This money will not be frittered (except to pay the aforementioned IRS debt, if that can be considered frittering) but rather placed aside and put to work while we continue to use the sofa that a neighbor gave us (99% new, I guess it didn't match her wallpaper or something), because that's the way we are content to live. Should all of this be placed into IRAs? Spread out amongst a few different vehicles? I know that she had an array of things like tax-free municipal bonds... the jargon fills my head but I'm not sure how it was spread out. We realize there is a vast array of choices out there in the world, one major example being the option of using some of it as a down payment on a house (but with the least expensive house in our area that is really a little small for our family being around $270K, the idea of putting what would amount 20% down makes my stomach turn. Brick and mortar just doesn't seem very satisfying to me, when it'll eat up a huge chunk of the money, although I could be wrong-headed there.) So, assuming that we're continuing to rent for now, what would you do in terms of putting the aforementioned money where it can start to grow? I realize these are only opinions and much personal consideration will have to be done, and believe me, I'm the last person to do something just because one person suggested it, but I like to turn over many ideas, so I thank you very much in advance for your thoughts.

[Guest allancoleman]

I can appreciate your statement , " debt free ... and intend to stay that way " because I , too , am debt free . Suggest you consider using your inheirtance to pay off your vehicle , or at least save to pay cash for the next vehicle , and also consider putting yourself on a schedule to purchase and pay off your own home too . You may find , as I did , that real estate purchased today , ended up being one of my best investments many years later , especially your own home . There's no urgency to this . But I would plan on being debt free , including your home , when you intend to retire . Certainly makes retirement budgeting easier . Just pizza and a few flights back and forth from Alaska to Hawaii to pay for .

As for investment suggestions , it difficult to go wrong with a index like the Wilshire 5000 for a core investment . And I would give serious consideration to Vanguard because of their lower expense ratios ( fees ) . I found that " paying myself first " was probably the reason for my early retirement at age 55 . Suggest that you ' max ' out on all retirement vehicles like 401(k)s , IRAs , and / or Roths . I realize that may be difficult with your family , but it is doable . Remember , " pay yourself first " and have a plan to stay or get " debt free " . The debtor is slave to the lender . Think about it .

And lastly , visit here often to read others questions about what to do and the various answers from advisors here . This is probably the most knowledgeable group of regular posters I've ever seen on any investment board , and I visit several regularily . Most folks don't plan on failure , they just fail to plan .

[Guest ctfudge07]

Thank you - I never expected such a quick response. And we do plan to max out on those vehicles. As you can guess, with our income, that'll be difficult like you said, but we can easily draw from the inheritance (wherever we put it, wherever it's growing) to do that for future years.

But even if we do buy a house, and max out our retirement contributions for this year, we'll have to place the remainder of the funds somewhere. I'm a little bit confused by the cap of $4000 that each person ($8000 per married couple) is "allowed" to contribute to IRAs. Sorry for the fuzziness, but I assume that cap is put there just because Uncle S. does not want us to get too many tax breaks, so that cap is just a cap on what can be sheltered in that fashion (trad. or Roth IRA). So, assuming we filled out the maximum there and also the 401K (we could go past the employer match and put in as much as allowed which is way up there like 15% or something of salary), then what?

Any suggestions on type of investment after that? You mentioned a core investment, and I'll happily check that out. Any ideas on what else besides the "core"? Would you put it all in one basket?

Thanks very much; I'll consider everything you've said carefully. We also read all we can on the Motley Fool page, including "Fool School," and by the way, my CAPS score (their Beta stock market "game") was 99 the other day. (brag, brag) Again, THANKS, and I'll consider it all carefully.

[Guest allancoleman]

What I meant as a ' core ' investment is a broad index such as the S & P 500 or the Wilshire 5000 as the core of your investments . Some folks like to include other various sectors such as International as another part of their investment portfolios . I usually like to " keep it simple , stupid " or KISS as it's sometimes called .

Not sure why the limits of all these wonderful investment vehicles such as IRAs , 401(k)s , and Roths . But I would max them all out as far as you can . It'll pay off later . You'll find that paying yourself first will become a way of life that will allow you many more options later when you begin to think about retirement .

Good luck .

[John G]

Good questions... and yes, beyond the scope of this site. I won't give you a comprehensive answer but will add a few ideas:

1. Do NOT pay off a car loan early. The interest on these loans is front loaded, so when you pay off the note early, your effective interest rate is actually higher. Talk to a friendly banker if you wish to confirm this. You also would not pay off early low rate education loans (not your situatio), but should pay off all high interest rate credit card debt (sounds like that was already done).

2. IRS debt: you may want to see if the IRS would be willing to accept an immediate payment of the full amount owed, but ask that they waive the penalty. They just might say yes. It sounds like you had family circumstances that put a strain on you, rather than you just spent a load on silly things.

3. Fund either your Roth or IRA for last year. Then fund for 2007 as soon as possible. Each of you have a 4 K max as long as your combined earned income is over 8 K. You might be able to do 4+4 for a number of years by just drawing down upon #8 below.

4. Fund your husbands 401K to the max to get the 50% match. That match is equivilent to what most folks would earn on their investments over 4+ years. You get it immediately and it gives your account a significant boost.

5. You do not appear to have a cash reserve. I would take between 10 and 20K and put it into a separate money market account or perhaps laddered (staggered overlapping dates) CDs. You can find rates in the 3.5 to 5% for your reserves. This is the fund you go to when you run into a financial crunch such as unexpected medical expense or car accident.

6. You don't mention insurance. I would highly recommend that you buy simple term insurance (not universal or whole life) which is the cheapest protection in case one of your dies while you have kids. You are probably only going to keep this insurance active until the kids are around 18, unless your husbands pay is your sole source of support. This might cost about $130 to $250 per year if you are non-smokers in good health, which would get you a 100 K policy. Ideally, you should have perhaps 250+ K in insurance on your husband, but think about a basic policy at a minimum. He may have 1x or 2x salary at work, but that is rarely enough. Do be aware that the insurance industry will try to steer you to all sorts of products - you only what a basic term policy.

7. Consider taking a very modest amount of the total an doing something for the family. A vacation, sports equipment, TV, stereo.... It is tough to make a lot of financial decisions that have no "fun" attached. IRAs, IRS, insurance... think of something positive. Given you frugal ways, perhaps some camping equipment.

8. After your put funds into your IRA or Roths, pay off the IRS, enjoy a little bit of fun, set aside a cash reserve, you should have perhaps 50K to put to work. I would suggest sending this money to the same company that will handle your IRA or Roths... which will allow you to show enough household assets to have no annual custodian fee. Be sure to ask about this with each custodian you are considering. Then I would divide these assets between three mutual funds. For example, you might want to choose a total market or S&P500 index fund, an income or bond fund, and something in a small cap or growth fund.

The line up would then look something like this:

Debts Paid + Fun Money (10k)

Roth/IRAs (16)

Cash reserve or safety net (20)

Core index type fund (20)

Bond or income type fund (15)

Growth or small cap (15)

I very much appreciate you honesty in posting your circumstances. I grew up in a family that bought everything on sale and out of season. We had a crude cabin for a summer vacation - and did not miss the TV. My folks clipped coupons and tried to repair their own cars and appliances. We didn't hire vendors to paint the house or tend the yard. I believe it is completely appropriate to live within your means.

One final thought - while you don't sound like are inclined to buy a home, over the long haul, homeownership can be both satisfying and another way to build for the future. Most folks 10% down on their first home rather than 20% you mentioned. Yes, you have maintenance, property taxes, utilities, etc. But, over the long haul, homeownership is a financial plus for many people. I would suggest that you talk with some of your friends that own homes and get their view points. If you change your mind, you will have a couple of investment accounts that can cover the downpayment.

[Guest ctfudge07]

We appreciate all this insight more than you can know. My husband will probably log on (with this sign-in or create his own) later tonight and thank you, also.

Great minds think alike: After I got off my hour-long phone call with the tax man, the husband asked me if I had asked them to waive penalties and offer a lump payment (they set up payment plans or 120-day deferrals which is what we were working on). Good thing that, believe it or not, the IRS was having enough system difficulties that he'll need to call back toward month's end to set this up and I'll have the husband wheel and deal at this point.

I didn't mean to make it sound as if we're miserly monks; I only highlighted our finer habits. We go to the beach when we can; it's a bonus if someone offers us a week free at their condo; and we already do a lot of hiking and other free-ish entertainment, spending money where it's important like on a high-end jogging stroller (worth every penny!). We just like to squeeze a buck here and there and then buy what's really important to us, not caring to keep up appearances as it seems is all the rage in this country right now, and the husband gets whatever new technology is available (TIVO, high-speed internet is a necessity to us, etc. etc.) and he's a musician, so let's not even talk about the rare and hand-carved guitars (which I believe he deserves, and they're for playing, not displaying, and he's OK with treating them as investments - he's bought and sold some at phenomenal profit - smart guy!)

Anyway, thanks for the kick in the pants - it's shameful not to have wills or life insurance with kids in the family, let alone one with a lifelong disability, and that'll be our priority (well, as you guessed, there is life insurance through the job but that'll have to be supplemented, I'm sure, and we'll look at myself, also.) I make a small amount of money writing but it's freelance and not enough to count; it's just supplementary.

Additional quick questions: Somewhere (was it here?) I caught wind of the idea that value in Roth IRAs would be counted against the children when it comes time for applying for college financial aid, whereas value in traditional IRAs would not. Anyone know more on that?

It's been painful to see the houses within sight of us (in an unbeatable location, with nature preserve surrounding) go from about $100K in 2000 when we moved in here (these are townhouse condos I'm talking about, that we have our eye on) to $290K asking prices now (although the one we are most interested in has been taken off the market for now by the disgusted would-be seller; I've been told that a more realistic sales prices is $240 or so - he's a savvy and also stubborn multiple-real estate owner, he missed the bubble and he knows it.) As I understand it, sales prices in this area are espected to go up, but by just a percentage point or two, in the next year. I suppose waiting longer wouldn't really benefit us, would it? And these houses are only 1650 square feet (and no basement), only slightly larger than the 1300 square feet we currently occupy, in contrast to the standard family houses also within sight that sell for around $400K and the megamansions just on the other side of the townhouses, also bordering the government-owned preserve, that are million-or-two-million dollar compounds. My instinct is to pay less for housing, grabbing a small house in this excellent location with protected preserve bordering it, even if we're on top of one another (but we may regret it with three boys quickly becoming teenagers, and a girl too.) Would you reach and stretch and put everything you can in a house, just to get a comfortably large one, or grab the small-but-lovely condo townhouse that unfortunately (another downside) comes with $200 per month condo fee (includes pool)? Those are our only options aside from moving to nearby urban center for cheap urban housing but that's out of the question as we have children in school and the schools there are abysmal. Moving completely out of the area is also not an option, for reasons I won't go into having to do with the ex-spouse and also that the children are getting well-established in rigorous academics, extracurriculars not easily found elsewhere, and volunteer work (the 14-year-old already has management experience to put on his future resume.)

I have owned two houses in the past in another state and I remember despising paying PMI. That's why I had the figure of 20% down payment in mind, to avoid that punitive surcharge. You don't think it's necessarily worth it to do what you can to avoid that? Not sure our income would qualify us for anything other than the small house I mentioned, and even then, with a hefty downpayment to minimize the mortgage amount, so maybe that's our only option.

[John G]

I am always amazed what comes out of Pandora's box when someone puts up multiple posts. Oh my wayward assumptions! (I assumed you never owned a home) And, sometimes you regret your advice because of your incomplete understanding.

New topics to cover.....

College financials:

Colleges vary in how they do family financials. Carnegie Mellon, for example, does not count home equity.... none. Well to be more accurate, they didn't four years ago when my daughters boyfriend applied and his single mom had 425K in home equity but only 10k in all other assets. He got a four year full scholarship. It is not possible to tell you what rules will be in effect when you children start applying, but basic cash always looks more "accessible" than retirement accounts or home equity. Therefore, if you decide to buy a home and put 40K into it and another 16K in IRA/Roths, you will not be showing a low of accessible cash. Your income and dependents will mean that your children will receive substantial financial aide if you play the game right.

The more expensive the school, the bigger the financial support. At more expensive schools, more of the support will be in the form of grants, compared to college loans or work/study at public universities.

For many years, Princeton had a "calculator" on their website. I used a family with 40k in assets, 65K income, 2+2 family size, kid with 3K in savings, etc. as an example for one of my JA classes at an inner high school. Result: kid puts up 3k (probably assuming a summer job), parents put up 3K, and Princeton puts up the other 33K as a grant. As one student said, "its cheaper to go to Princeton than the city branch of University of Colorado". He might have also added, "I wish I had gotten the grades to get accepted to Princeton"... but that's another story.

Homeownership

Yes, there are regional housing bubbles. Too many houses for sale, not enough buyers. Some areas have over a 1.5 year inventory of houses on the market. This means that many homes will not sell and prices will be coming down. In the mid-1980s, Colorado Springs had such a glut. I remember two houses, side by side, same builder, both 5 years old, same size (3400 sq ft, 2 car garages, etc.) were on the market. One seller a divorcing man who had to pay his wife all of the gain. The other a couple wanting to move to a retirement condo. One priced at $220K and the other at $164K... I leave it to you to figure out which was which! Neither sold for 6 months. Neither had any offers as well. This was around the time when we were looking for a home and made three different offers on other properties that were 50k below the asking price. One said yes. The other two houses sold below what we offered later in the year.

What does this long story suggest for you? Well, maybe you should go bargain hunting. There may be some folks in your city who absolutely have to sell. You could make some very low offers and find out you now own a home. Since you have cash and nothing to sell, real estate agents will work with you. But... you will need to be very hard nosed about prices. In a bubble, sticker price means nothing. What they paid for their house means nothing. You say there are homes in the 300s... well maybe one of those can be bought for 240K. The agent must present your offer.

If this all sounds harsh, keep it mind "it's not personal, just business". My daughter has been trying to sell her first house in Maryland and in 6 months has not received even a low ball offer. She's on the other end of the bubble.

Generally, you do not want to own the icest, biggest or most expensive house on the street. One strategy is to find a house that needs an update but has potential. If you can swing a hammer or swish a brush, you can capture increased value by putting your labor into projects.

Hope all this helps. You have added some good "color" to this message board. Best wishes.

[Guest ctfudge07]

The real estate agent we spoke with about the townhouse I mentioned said that he loves negotiating and he had a firm opinion, even last fall, looking forward to this spring, that prices were softening and buyers are in the driver's seat. I think the seller (who knows we're interested but not yet in a position to buy) got disgusted with what he knows is a softening market and gave up, at least temporarily.

But even with softening, what I see is prices now that are twice as high as 6 years ago. I realize that it's always good to own a home (and I'd love to do just that), and I don't mean to be a whiner, but I can't get past the idea that if we had trouble affording a home then and they cost so much more now... that we really missed the boat and I question the whole idea. I see us paying twice as much for housing as neighbors who bought in the 1990s. Not their problem; our problem, I know. Meanwhile, our rent has hardly gone up. Believe me, I would like to own. But when I had a new 1600-sf house with large yard built in 1997 for 100K (in Florida) and I'm looking now at a same-size house (really too small for us) without yard and with a condo fee and it's 2.5-3 times as expensive, my skin crawls.

We are always the oddballs (at least in our affluent neighborhood.) No one buys one of those townhouses and puts six people in it. Some couples consider them too small. Most are occupied by one or two people. Small families move out of their 2400-s.f. houses here because they're "too small," (they're entitled to their opinion) but at prices over $400K, those are not even within our reach.

Am I looking at this wrong? Should I totally ignore those calculators that say how much house you should be able to afford for your income, and how much your housing costs should take from your total budget? Because according to those, we'd be able to afford a kitchen, half bath, and a closet or two.

[John G]

Yes, you might be stretching a lot to buy a home. And, folks on the edge often get taken advantage by predatory mortgage companies. Do an online search for option ARMs and you will see some of the horror stories.

If the guy delisted, and is no longer with a brokerage, you might be able to approach him as a FISBO (for sale by owner). That won't work if you registered ever with his real estate agent. That puts another 6% of the purchase price into the negotiation.

Hey, and how about a nice three bedroom ranch on 1.5 acres with barn down in St Mary's county! Recently remodeled! I warned my daughter she was buying into a possible housing bubble. After 16 months, they both took new jobs.... oh, the lessons you learn when you are young. And in this case, I was a co-conspirator.

[Guest ctfudge07]

Ah, my best friend lives down in St. Mary's. She's a perfect case in point. Got their nice large suburban house for $200K in 2000, and now it's worth a whole heck of a lot more. (Maybe not 400K like a similar house would be here, but certainly 300 or more.)

Will there ever be a better time for buying a house, though? What tough questions here. I guess I'll just have to calculate what I could expect to make on money not tied up in a house and contrast it with expected housing appreciation. I guess I grew up in the day when an engineer with a wife and four kids could easily move into one of the nicest parts of town (in 1965 when I was born), and now the same kind of family finds the same kind of neighborhood out of reach. Again, not whining as much as trying to do some economic analysis. I don't remember where I read it, but I think I read that in this kind of housing market, with a calculator involving monthly rent vs. the theoretical cost of buying he same residence - and ours would cost more than $200K if were for sale - it may be more advantageous to rent (sounds like heresy in the financial world, doesn't it, and goes against our instincts as everyone wants to own.) I just wonder if owning now will take such a large bite out of us that I should consider it carefully. I think I have at least a year to think about it while we get our credit in order, anyway.

Good luck to your daughter and son-in-law! Thanks again - we truly appreciate picking y'alls brains! I'll be re-reading this thread for days or weeks and printing it for future reference.

*oops, I forgot to add that the guy originally listed it by owner, then listed it, then de-listed it. I contacted an agent on my own in the very beginning when he put up his FSBO sign, because I did not want to deal with him without representation and my agent said he'd be glad to take it on, but it's all on hold right now.

[John G]

You really can buy and sell real estate without agents! Really. Bought 1 house, sold 3 houses that way. We tend to buy houses keeping in mind the street traffic that goes by might be important when selling. Eg. no cull de sacs.

Try your library for materials on buying homes.

Home ownership is first and most importantly for you shelter. The primary reason it tends (not guarenteed) to be a good investment is because you are leveraged about 8:1 or 9:1. That means the sales price climbs, but you only invested a fraction of that price. 300K home with 30 down - house climbs in four years to 330. Your 30K equity has grown to 60K. That's very simplistic... no property taxes, utilities, maintenance, but also no rent flowing out, and I did not show the value of a tax deduction for interest paid.

There are a few folks on the west slope of Colorado Rockies that bought homes during the oil shale hayday... it didn't work for them, because Exxon shut down the only industry. But... like I said, no guarentees. It just works a lot more than it doesn't.

[Guest allancoleman]

John G is correct , ctfudge07 . In my scores , I've lost count , of real estate purchases and sells , I've only used a realtor in just a very few . And those very few times , those realtors were personal friends and I wanted to throw some business their way .

There are many excellent books at your local Barnes & Noble or other book stores on real estate where you can walk in , buy a cup of coffee , pick a comfortable soft easy chair and preview several good books in a afternoon . When you find yourself picking up the same book more than a couple times , buy it and add it to your reference library at home .

You don't need a realtor . And unless you're really knowledgeable about real estate , going through a realtor can cost you more money AND limit what you're looking at .

[Guest ctfudge07]

Here's why I thought I would need an agent: The guy selling this particular house is a 70 (approx.)-yr-old former real estate agent whose sons are in the building business; he has bought and sold many houses of his own, probably making income from renting some of them (this one, which he and his wife are occupying, he needs to get out of soon because his knees can't handle the stairs). In other words, he's a shrewd and wealthy businessman (I talked to him on his sofa in his living room several times enough to figure this out - it wasn't a secret or anything.) My best friend, who worked as a loan officer for some time, advised me that it would be worth the one or two grand I'd offer to pay a buyer's agent so that I'd be protected by that agent from getting the wrong end of many aspects of the contract and the entire process. Since I don't intend to learn as much as the seller knows about these transactions, and I believe he's a nice guy but out to make every nickel he can and then some off my ignorance, I thought it would be a good idea.

So I agree with you to some extent, but this guy seems like a shark, and the real estate agent did give me some pointers - for example, the seller offered to rent the property to us for a set period and the agent explained to me what was and was not standard or reasonable in the particulars of his offer, as well as giving me pretty good advice on the actual fair price of the property.

At any rate, I don't think he's selling right now. Since we're on friendly terms, living in the same neighborhood, I may ask him what his plans are, but it may be a sore subject since he changed the price several times, down a little (still unreasonable) and up a little to cover listing fees (still unreasonable) and has now given up for the time being.

[Guest allancoleman]

Ultimately , the decision is yours , ctfudge07 . And there is a certain ' sleep ' factor involved in making decisions that you can live with personally . I respect your decision .

I have worked with a lot of realtors and they earn their money and are well worth what they charge . It's just that I'm probably coming from where your ' seller ' is coming from in the respect that I've personally owned , bought and sold alot of real estate . And ultimately , whether a buyer came to me personally on their own or with a agent acting in their behalf would NOT change the bottom line on my deal . I know , for a fact , that if I had to calculate the agent's commission into my deal , the expense of the sale would have to increase by that amount . In others words , the deal is going to cost you more I think . You may feel much better about the sale with an expert handling your end of the business , but it is probably going to cost you more I think .

Good luck and let us know how you do . John G is correct that owning your own home , at any price , over time , is probably your best investment . And that includes all your other 401(k)s , IRAs , and Roths . It'll certainly bring you much more personal satisfaction and pleasure , especially with your family . Whatever you do , get it paid off as soon as possible . You can't imagine the personal sense of accomplishment in owning your own home with NO mortgage payments . It gives you an automatic " leg up " on anyone else that has to make debt payments in life's struggle .

[John G]

In Maryland, home info is likely to be readily available at town hall, library or on line. You might also have some fun using:

www.Zillow.com

This site is about 1 year old. It attempts to give you an estimate of individual homes, based upon statistical analysis. In areas with large tracts of similiar homes that also have extensive electronic data, the estimates can be helpful. But homes in rural areas, or in states or counties that don't provide access to electronic data can be way off. You can see areas by address or zip code. You can select an arial photo as the base or simple drawings. Put your cursor on any home and Zillow tells you when it last sold and the price. Zillow automatically makes the selection of a comparable home set to do statistical analysis on a property. But, you can also hand pick you comps based upon your local knowledge.

This website is far from perfect and accuracy ranges from almost to not close. But, I think Zillow represents a pioneering way to giving the public access to key housing sales data.

You are right to be wary of a more experienced homeowner. Don't forget to be wary of real estate agents as well... they sometimes forget to tell you things and urge you to bid more to get a sale and their commission. I doubt you will find any agent willing to work with you for less than 2.5% of the sale price... so its not likely to be just 1 or 2 grand.

[Guest ctfudge07]

I have already used Zillow, and I enjoy it (it gets addictive), and I have noticed as of lately that their "zestimates" are pretty high, so much that I can pretty much take a percentage off to arrive at what's generally agreed on as the true value (like I said, as of right now, around here.)

I'm pondering:"Do NOT pay off a car loan early. The interest on these loans is front loaded, so when you pay off the note early, your effective interest rate is actually higher. Talk to a friendly banker if you wish to confirm this."

I think there are some puzzle pieces you didn't know here. The balance was originally $22,499, (now $20,452) the term is 72 months, and we're only 11 months into it, and the rate is (hold your stomach) 12.65%. Obviously I'd want to refinance at the very least. But you see, even with our financial circumstances being changed, I've found the credit world to be ruthless, and I believe we'd be laughed at if applying for the best used car rates (5.9%.) By the way, we're not getting rid of the car (I would think it might pop into someone's head, not mine, though) because it's our first new-ish car and only car that has seated our entire family. We love it, and we've been driving around in 15-yr-old maintenance nightmares long enough. But anyway, even if, theoretically, we could refinance at 5,9%, it would be nice to be free of the upper-300s payment we'd have ($450 as of now) so we could do other things with that money each month. I've already calculated what we pay, in total, at our current rate, and what we'd pay at a rock bottom rate.

If anyone has an opinion on that pondering, please chime in.

[Guest ctfudge07]

Well, I think I answered my own question. Assuming I'd be able to get 12% return on investments, it's advantageous to pay off the car. I'd come out ahead that way to the tune of $8,000, and I'd rather not have a loan on our credit record. (Decreases greatly the amount we'd be able to qualify for, mortgage-wise.)

And even if we were able to refnance the car at the best possible rate (which I highly doubt - there's a credit-score reason we have a loan with such high interest - that score will improve dramatically but not immediately), it'd be approximately a wash, and I'd still rather be debt-free.

[Guest allancoleman]

Hello again ctfudge07 ,

Irregardless of the excellent advice that John G gave to NOT pay off a interest front loaded loan , my recommendation still stands to pay OFF the vehicle IF you are able for just the reason you mentioned above that it frees up your monthly payment for other more beneficial things . You'll find after you've paid off more and more outstanding payments , your free cash flow really allows you more options for you and your famlies goals .

Also keep in mind about buying your neighbor's house , you may never reach agreement and it's probably NOT worth your lost time waiting . There'll be plenty of destressed sellers out there that will be more than willing to consider your reasonable offers . I did alot of " bottom fishing " in my real estate buying days and it was fun . Make an offer , let'em sit on it awhile and move on to the next one . You might be surprised who'll get back with you later when they still haven't sold . Worked for me .

[Guest ctfudge07]

Oh, believe me, I already know the feeling of eliminating outstanding payments and improving cash flow, because the car loan is the last of our obligations, and then we will truly be debt-free. And since we're old enough and experienced enough to have traversed a good portion of the map, financially, we know enough not to go down that road again - just trust me on that. You can't even imagine the satisfaction of paying off the truly horrible credit card companies we dealt with (think of the highest rates allowed to be charged by law, and those were some of our rates, and those companies are vicious at every turn re: fees, etc. - even a collection of small accounts like those can keep you in a financial noose) and knowing we'd never do business with them again. (or any other credit card company, if I can help it, except the few cards we kept that have a zero balance or the occasional small balance. We want to have a good credit profile.) We cancelled and closed most of the accounts and it was like kicking a disease.

You see... the stereotype is that those mired in horrible-rate debt are not the smartest people and have very poor financial habits and knowledge. I'm sure that's true to some extent, and I don't deny having made plenty of poor financial decisions or missing some opportunities, but at the same time, sometimes there's more to life than bringing in every dollar possible, and sometimes we have to start over exactly where we are and put the past behind us. Believe it or not, sometimes people read the very fine print, understand it perfectly well, and still sign on the line in part because of being risk-takers, overconfident, or just plan inexperienced and unrealistic, but nonetheless able to learn lessons and not cover that ground again. In other words, as I said before, we're well-smarter-than-average people who found ourselves in a hole hard to climb out of, and it would have been a long, slow climb without my mother's and father's estates. I want to honor their memory by doing the very best possible with what they left to us. We're fortunate that only a small percentage was needed to pull us out of the hole and now we're above ground with plenty to get us started, and just about as motivated as people can possibly get.

The real estate agent I chose told me exactly what you did: Don't spend too much time pining over that house, because another will open up and you'll be in the driver's seat by then.

Yes, I think John G's advice would have been great except he did not realize how expensive our loan is or how new. Had it been a reasonable rate and farther along, it would be a different story. It's still a really close choice, since, as I said, if I refinanced it would be more or less a wash, but I'm going to err on the side of being in more control because I like it that way.

You think like I do - I think the cash flow would be beneficial, and in fact, we've pledged to invest exactly the amount we would have been paying as a car payment. Honestly, I think we're going to need it, anyway, to max out on the 401K, not to mention the IRAs.

We really appreciate the insight and thoughts. I have no parents left to consult obviously, and my husband's parents are not especially helpful (and we also suspect they're in deep debt, and therefore we don't want to chat money with them), nor are the siblings helpful, so we consider you guys the angels of the internet to be giving us any insight whatsoever. Give yourselves a pat on the back for doing a good deed. THANKS!! Now I'll stop writing essays on this fine board - I'm sure people are tired of seeing them! By the way - the 14-yr-old is following this just about step-by-step. Hub and I were both brought to be in the dark about finances, but we're making sure that the kids learn, and early.

[John G]

Clarification: car loans are structured in many ways. Some use the "Rule of 78". This approach is so consumer ugly that both Congress and some states have outlawed it for many loans. But, if that is the type of loan you have, then interest is heavily loaded into earlier payments.

If you want to learn more about this try this website:

http://www.bankrate.com/brm/news/auto/20010827a.asp

You need to look at your loan papers and specifically get a printout of the interest and principal schedule. Another thing to look for is any prepayment clause.

You did not specify payment amount, size of loan, or duration. My response was therefore generic and I thought it prudent to alert about how some auto loans are structured.

[Mike Preston]

It is hard to find anything to say that hasn't already been said, but I shall try. ;-_

Also, I wanted to add my appreciation for ctfudge07's participation here on benefitslink. And, of course, to the other contributors in this educational thread.

You started out focusing on IRA's. But as it has developed, the discussion has highlighted how important one's entire financial picture is. One seemingly small detail can sway the recommended course of action dramatically. Focusing on whether you can save $1,200 in taxes this year and in each of the next few years may not be the right thing to focus on.

As long as you keep to some sound basic financial decisions such as not extending yourself, debtwise, beyond what you are comfortable handling, you should be fine whether you go with traditional IRA's or not.

With that said, it seems to me that a basic issue your family will be facing within a (too) short period of time is funding for college. In fact, I'd suggest it may be the fulcrum upon which the rest of your decisions might be based. Only your family can know the likelihood (how many of your children will go to college) and the expense anticipated (in-state, out-of-state, whether you and your husband believe in participating in the cost of college, etc.).

If you find that the institutions you think your children are likely to attend have favorable rules regarding grants and scholarships predicated on ignoring home equity (as has been discussed), it may be in your family's best interest to maximize your home equity at the expense of cash reserves. Of course, to do so blindly would not be prudent, but I will suggest that it may be the best course; that is if all other things fall into place nicely.

Those other things might include: 1) ensure your credit will allow you to establish a home equity line of credit (more about this below); 2) find a home that you believe you can add value to through improvements you can do yourself; 3) ensure your insurance is up to date and protects your family from financial ruin; 4) feel comfortable enough with the entire picture that you don't end up creating more anxiety than it is worth.

That last point is crucial. You've been through some painful times and you may therefore be a bit gunshy with respect to a plan that diminishes liquidity. If so, that is just fine and nobody should try to force such a strategy on you.

But if your family can deal with it emotionally, you might find that the potential additional scholarships/grants, coupled with the fact that the strategy I'm discussing might currently put you in a larger home than you might otherwise be thinking of can pay off in more ways than one.

Based on your thought process relative to the real estate professional you worked with, you seem to know the value of professional assistance. You might consider laying everything out with a trusted financial planner who can balance all of your personal details and emotional needs. Research your choice of professional, of course. For example, some papers run periodic analyses by local planners. You might be able to find somebody who has just the right kind of pencil sharpener for you.

Here are some other random thoughts.

One of the often overlooked tax breaks that we have is the rule that says once you have owned a home for two years any (reasonable) gain that you realize upon sale is tax free. There is a limit, but it is not likely to be reached in a two or three year period if you start with a value of between $240 and $400k. Would you and your family consider moving every two or three years to maximize or lock in the tax free gains that might be available?

Couple the above with the fact that the interest you pay on your home loan is deductible. Now go back to the example given earlier in the thread. You can see that your rate of return on home ownership is dramatic, even with a modest uptick in the value of the property. In fact, it dwarfs the tax savings you can get from your IRA's, even at relatively low income tax rates.

By the way, with respect to the home equity line of credit I mentioned, I did so based on the assumption that it would never, ever be accessed. That is, it is there as a safety net for staving off disaster, not for dipping into on a whim. Based on what you have said about your desire to remain debt free, I don't think you would be tempted to invade the line of credit without good reason, but I did want to point out that I wasn't thinking of it as a piggy bank.

Here's my basic point. If the $8,000 (actually $6,800 after taxes) makes the difference between you being able to comfortably enter the real estate market or not, I'd avoid the IRA's entirely and plan on putting that money to use on a down payment.

Nothing I've said means that you should scarf up the first home that becomes available. But if you put pencil to paper and find, in conjunction with a professional planner, that this concept has merit, I would think your focus would be to find that (currently distressed?) property. Which requires work, as you know.

Happy planning. I'm sure you will find a path that is right for you and that you are comfortable with.

[Guest ctfudge07]

I appreciated your comment, John G, and it prompted me to get out the loan papers and find an amortization calculator specifically for car loans at Bankrate.com, and I scrutinized the issue for hours before figuring out that over the life of the loan, we'd pay 9,000 in interest for the car, we've already paid 2,000 (I'm rounding here) and after paying for one year at $450 per month, we've paid only about $200 in principal on the car... let's just say I crunched it out pretty well and compared it to other calculators involving investment amounts. I don't know why I didn't pursue a career in something involving math, because I really do like calculating and analyzing. But your comment was helpful, and it did inspire me to find several different calculators and tools that are really helpful for a variety of applications.

Mike Preston: I appreciate the time and effort you and each other respondent here has put in for me. I will carefully go over everything you've said. We're going to print this thread out and refer to, from time to time, like it's a book. I feel fortunate to have tripped over a forum filled with so many sharp (and helpful) minds.

I have thought about a financial advisor and I'm sure we'll need one at some point, even if not right now. We all learn somewhat by example and my mother had an accountant and an advisor, and changed advisors when she saw fit. I do want to manage my money a little bit more (well, a lot more) hands-on than she did, (in fact, she told me that my mantra from the time I could talk was "I'll do it myself!" so it'll be hard for me to let anyone tell me much of anything) not that she was in the dark by any means, and I have to remember that one reason she did it that way was that in the early 1970s when she began investing, there was no information superhighway, no Ameritrade or Etrade or Motley Fool or much in the way of resources for the average person. I guess the only way a non-financial professional could invest easily was to find an advisor with access to financial products. But I also noticed that she was not afraid of investing aggressively, and in fact was sometimes advised to scale things down, probably due to her age, and I'm also not afraid to be probably more aggressive (maybe I should be a little afraid. )

I'll be going over the advice carefully. I'm sure we will have a house soon; just probably not for more than a year. Really, when the kids are small, you can give the oldest his own room and bunk two younger boys and a toddler girl in the same room, (they actually like having the little sister in their room, that's how sweet they are) but that arrangement won't make everyone happy much longer!

[John G]

Car loan math:

"The balance was originally $22,499, (now $20,452) the term is 72 months, and we're only 11 months into it, and the rate is (hold your stomach) 12.65%."

I think you said 200 rather than $2000 in principal payments that appear to have been made.

My trust HP 12C calculator says your payments should be $442.84 per month if 22.499 financed, 72 months at 12.65 percent. That's close to your monthly payment, but it should not be off more than a penny. So, I suspect you have something like "insurance" or other fudge factor in there.

Did you get this at a dealership? If yes, that may have contributed to your high loan cost. Dealer loan rates are generally not as competitive as a bank or credit union. I have trouble believing that you would get this rate if you shopped four loan sources.

I know this doesn't apply to you, but there are folks going to the "Bank of Mom" and offering 2% over her current CD rate (something like 6.5%) - both sides do better.

Maybe you are paying the price for a low credit score, but I haven't heard of an auto loan over 10% in years. If you had gotten a bad rate at 9.4%, you would have reduced your payment by about $50 per month.

If this was the best deal you could have arranged, leasing a car might have been better. But frankly, given the financial shape you portrayed, I would have opted for a five year old vehicle with about 80K miles. I bought a clean full size Pontiac from an FBI agent who was leaving the country for 5K (a very good price) last summer, and that car will be used by someone in our family for another 6+ years. You didn't say if this is a new car, or something special because of your one child... but I would not have committed to $5,400 a year - more than 12 percent of your income to any car. In that price range, some folks would just not buy collision, another way to cut down on expenses. I am not walking in your shoes, but from this vantage point, I would have opted for a less expensive vehicle.

Refinancing: First problem is does your car loan have a prepayment penalty? Second problem, it looks like even with a very low percent rate, you will have trouble getting you car payment below $400 per month.

Do you really save $9000 if you pay off the loan now? Not exactly. There is an "opportunity cost", the value of having the cash working for you. Let's say that instead of burning $20,452 to retire the loan that you instead put it in a conservative bond/stock fund and earn 6% each year. At the end of 6 years, you would have $29,011 to offset the interest paid out or about a gain of $8,559. I make not attempt to examine the tax liability/deductibility of this example, this is not a symetric set of solutions since the loan is fixed but the earnings of the investment are variable. I just do the math to say that what you could do with the cash offsets against the interest on the loan. Some scenarios could be more favorable to you then what I have used as an example.

[Guest ctfudge07]

I mis-stated the original loan amount. It was somewhat over 23,000 and I plugged it into a calculator that spits out an amortization table on bankrate.com. The actual payments are 449.86 per month, and the balance is right now 20,452.46 (oddly, the payoff balance given to me on the phone today is about $300 more, and it's good for 15 days, and the additional has to do with interest - can't remember the exact information.)

I rounded a little by using a figure of 20,000 and plugging that into another calculator, showing me what I'd end up with in five years if it brought a return of 12%, and then by contrast I took the amount of the monthly payment (rounding to 450) and plugged that into another calculator showing me what I'd end up with in five years if those monthly contributions returned 12%. Of course these are all hypotheticals.

I even compared, recalculating for the "what if" of the scenario of refinancing at 5.9%, assuming no fees or anything, and I came up just about exactly even. NOT refinancing, I came out ahead to pay it off.

I'll go over it again and make sure I didn't make a mistake. You could use the same calculator I did (it's right in bankrate.com's auto financing section) but I did forget the exact original figure. I'll look it all over again.

Yes, it was from a dealer, and we were not in a position to do much comparison shopping for loans. (see short paragraph on credit, below.) I realize that it was an implusive decision to buy such a nice car, but I still don't regret it. We've had some real problem cars, not including the 8-yr-old Suzuki I've been driving for 7 years which is a no-trouble, reliable car. The one with the loan in question is a 2005, bought used in early 2006; it's a Chrysler Pacifica (seats 6) and cost considerably less than the new price of over $30,000. It seemed and still seems brand new. Our daughter only has a mild/moderate developmental delay and needs no special seating, but 6 people just don't fit (legally, with seatbelts) in a standard car and we dislike mini-vans.

I'm going to omit the details, but our credit was worse than you think, and people with poor credit cannot even get in the door at credit unions.

So yes, I get your point, but this is the nicest vehicle we've owned in... forever and we plan to keep it forever (I've never traded in or sold a car, I don't think. I believe they've all basically been junked since prior to these two cars we have now, we've had end-stage cars, if you want to callthem that.) When I got the Suzuki (courtesy of my mom helping me out quite a bit by taking out the low-interest loan, making initial payments, and letting me co-sign, I finished paying the $192 payments in 2005 just before jumping into this newer car - we need two cars), it was the nicest car I'd ever owned too, also only one year old at the time (in 2000), but also $10,000 at the time, being a small Suzuki wagon. I can't say enough good about it, though, because aside from some brake maintenance and tires, it's needed nothing! (only seats 5 - uncomfortably - though.)

The car we had in between this expensive one and the lemon Ford was FREE, though. 15 years old, over 200K miles and leaking a quart of so of oil a day, my friend gave it to us just to get it off their insurance. We had it for less than a year before it went off to the demolition derby but hey, it got the husband to work and back every day for that year! The oil spot is still there for us to remember it by. And those kind of cars - the ones with no loan, either bought for a few hundred dollars or maybe even given away, they're such problems, are the main kind of car I've driven for a very long time. So we spent a little here and saved a lot there and there and there.

[Guest jims]

Back to the IRA ---

I assume your 2006 income is extra high compared to 2005 and 2007 due to the inheritance. I also assume you like Roth IRA better than traditional IRA (I agree.). So here's how to get the best of both and save taxes. Contribute the max to traditional IRA for 2006 - you can still do it in 2007 up until you file your tax return (4/16/2007). At your income level, you can still get an IRA deduction (even though you contributed to a 401(k)) along with the Savers Credit to reduce your taxes for 2006. After you contribute for 2006, immediately convert to Roth IRA for tax year 2007. You'll owe taxes on the conversion and you should make an estimated tax payment to the IRS. Convert now and pay taxes while you have the extra cash, otherwise you'll never get back to it. Plus the sooner you convert, the less taxable earnings you'll have. When you convert, make sure you covert the entire balance to Roth IRA. Use other funds to pay the taxes. You effectively contributed to a Roth IRA, but you didn't waste the regular IRA deduction for the year you had high income.

[Guest ctfudge07]

Thank you so much. Theoretically, our income should not be higher in any year since the proceeds of the estate come to us tax-free, but there was one part outside of the estate that we received in 2006 and that sum of $21,000 sure did drive our income up for that year only (I knew full well that it would.)

I follow what you are suggesting but I am unclear on this point: Will the tax on the conversion be less than the tax I would pay if I just opened a Roth IRA (and thus did not get the $8000 deduction from income in 2006)? I calculated that the tax savings I would get upon opening regular IRAs (one for each of us for a total of $8000 for each year) are $1,200.

Opening a traditional and converting it has crossed my mind but I assumed that Uncle Sam has crafty ways to keep people from pulling a fast one like you described. Let me mull this over, and in the meantime, let me know if the tax savings is substantial (I have not explored that.) Another drawback to that is that the five years (which may or may not matter but is used for purposes of withdrawals, like if we need to draw out of it for some reason like house downpayment) would not start untl 2007 this way.

I had pretty much decided on going with Roths only and eating the tax bite. I tend to believe in paying the taxes now rather than taking a little incentive and then having Uncle S. involved in every little thing I do with that money from here till eternity (with penalties at every step, too.) (Don't worry, I understand there are rules involved with Roths, also, and I've done a lot of calculating, too.)

I understand what you're saying about "wasting" the IRA deduction, but does it really matter when we're normally in the 15% bracket and have barely bumped up into the next bracket, even in 2006? (our total income for 2006 is 65,000). THANKS

[Guest jims]

The quick conversion is NOT pulling a fast one on Uncle Sam. As a matter of fact you are allowed on unconvert up until October of the year following the tax year of conversion. Why? Suppose you converted a regular $20,000 IRA to a Roth IRA and paid taxes on that amount. Then shortly after, the investments tank to $15,000. Wouldn't you rather pay taxes on $15k than $20k.

But back to your original question on taxes. The taxes on conversion or Roth are really the same. A traditional IRA costs you both $8000 before tax since its a deductible amount in your situation. When you convert this to an Roth IRA, you pay taxes on the value of the account at conversion. Assume its still worth $8k - you owe taxes on ordinary income at your tax rate in the year of conversion. You should convert the full $8k and pay taxes from other funds. If you contribute $8k to Roth IRA, that money is after tax. So if its from current income, you paid taxes at your current tax rate. I was suggesting you contribute traditional for 2006 tax year to keep you from creeping into the 25% tax bracket.

[John G]

Creating and IRA then converting in a subsequent deal is a completely legal two step process as long as you meet the various qualifications. For example, you meet the income threshold and filing status in the year of conversion.

If you have the same marginal tax rate in year 1 and year 2, then there is essentially no advantage. In fact, if your investments moved up a lot in year 1, you would be taxed for more dollars being converted in year 2.

However, if your income in one year throws you into a higher tax bracket, the very crudely calculated advantage would be delta taxes (difference between the high and lower rate) applied to $8,000. Why "crude"... because it also depends upon state taxes (they can change, your residence might change), changes in federal tax rates, change in IRA assets over the year, etc.

I think you said that your boosted income barely throws you in the next bracket. Then you potential savings from the two step approach is the percent difference between the two brackets multiplied by the amount of dollars above the bracket step. If you only went 2,000 over the bracket and your tax rate delta was 13%, your savings would be around $260.

If you applied a 13% delta to the full $8,000, then your savings might reach $940.

Work your own numbers to determine if a two step is cost effective and worth the time/effort.

[Guest ctfudge07]

I see now; thanks. It's a very good suggestion that would have benefited us a lot if our income had been huge for 2006, so I do appreciate the thought. Yes, we're only several thousand dollars into the next tax bracket, and I think the tax saved by completing this maneuver would be about $300. I think that, in combination with not getting access to the money for another year (if we needed it, and a five-year period starts when we start the IRA), it's probably not worth it.

I do appreciate the advice, though - I like to turn over every possibility.

[John G]

Woops missed that point.

One more aspect of a Roth is that you can always take out contributions without penalty and without tax impact. No five year wait on a contributory Roth.

But... that's not the point... taking out money prematurely erases the tax shelter value.

But this removal of Roth contributions at anytime feature does mean that your Roth can act in some way as a safety net - a no penalty source of funds in a pinch. A standard IRA carries a 10% early withdrawal penalty, plus everything is taxed as ordinary income.

[Guest jims]

To ctfudge07 - I think you are putting too much emphasis on getting the 5 year clock started so you can access the money. In general for tax free distributions, the account must be 5 years old AND you must be age 59 1/2. Based on your age, there's no rush. Plus you can always get the contributions out with no penalty, and contributions always come out before ANY earnings do. You don't need to sacrifice $300 in tax savings just to make your money more accessable. It already is the most accessable retirement savings there is! (And therefore, you need good discipline not to touch it too soon.)

[Guest ctfudge07]

You're right - I forgot that the five years applied only to earnings, and I considered it the most minor point, anyway.

I'll put more thought into this! Delaying taxes (if the amount does not increase, and in this case they'll actually decrease) is always a good thing!