Beyond Roth IRA

[Guest theedge]

I'm at the point where I will not be able to contribute to my Roth IRA for 2007 because my income is over the limit. In order to provide the same effect, my financial advisor would like me to open a Variable Universal Life Insurance (VUL) policy. I am single and do not need extra life insurance, and I don't like the idea of insurance acting as an investment.

Are there any other alternatives available for me that will replace the Roth IRA other than the insurance? I also have a 401k, but like the idea of tax-free income in retirement. Any input would be greatly appreciated.

[WDIK]

I am certainly not an expert on IRAs, insurance or anything else, but I do have two thoughts to share.

1) I fail to see how a VUL policy will "provide the same effect" as a Roth IRA.

2) It is now possible for a 401(k) to allow Roth deferrals if the plan document is appropriately amended.

[John G]

VUL ? You are right to be suspicious of insurance products being hawked as "investments". If you don't need insurance (no wife? no kids? you didn't say why) then the only reason to buy insurance of any kind right now would be to lock in a policy at your current health status.

Is your financial advisor going to get a commission on selling you this product? If so, dump you advisor and start fresh. Avoid advisors who get any fees based upon their recommendations. That taints their judgement.

Alternatives:

You may have many. Are you self employed? Do you own a business? Do you have a company plan? You gave us little info on which to understand your current choices. If any of these apply to you, its time to talk with your accountant about your options. Most accountants are aware of a variety of plans used by their customers.

At a minimum, you have the option of long term investing with your eventual taxes at the long term cap gain rate. For example, you could build a large nest egg with either an portfolio of stocks, an index fund, Exchange Traded Fund (a stock traded version of an index fund), or a tax managed fund. You would have minimal tax exposure until you sold the position. Most of your gains would be at more favorable LTCG.

[Guest allancoleman]

I agree with WDIK and John G , theedge . Suggest you find others ways to invest your money until 2010 when income limits are supposed to be lifted from Roth conversions . I love taxfree Roths too , but If no can do , then no can do . I certainly wouldn't follow the advice of this insurance salesperson .

Good luck . I can see it's still a cold hard world out there on the investment scene where folks still have to protect themselves from bad advice .

[Guest theedge]

Thank you for the quick response. Here's a little more about my situation. I am a 27 year old single male who is an engineer in the oil industry. My company offers a regular 401k and match up to 5% of my salary. I have been in this plan since I started working. However, they do not offer a Roth 401k or any other alternatives, and I think its better to fully fund a Roth IRA before fully funding the 401k because of the taxes.

I received a big raise this year and decided to meet with a personal financial advisor through Ameriprise in order to answer my question of how to manage my cash flow every month to achieve my goals. In order to minimize the taxes paid, he said that about 40% of my retirement income should come from my 401k, 30% from a Roth IRA, and 30% through liquid savings accounts.

This year my income will be over the amount allowed to contribute to the Roth IRA, and my financial advisor recommended that I sign up for a VUL which will provide some life insurance and also act as a retirement account. I will contribute after tax dollars to the VUL and will be open to all investments possible, then at age 59.5 I can withdrawl the money tax free. Since I am single (no dependents) and my company provides some life insurance, I don't see a need for supplimental life insurance.

I don't know if my financial advisor will get commission on the VUL, however I do know that the insurance is through another company, not Ameriprise. Right now the process is in underwriting, and I was told after the underwriting process is complete, then we'll find out the monthly insurance premium as well as the maximum amount I can contribute.

Alancoleman, I'm not very familiar with the laws, but are you saying that in 2010, we'll be able to contribute to our Roth IRAs no matter how much our income will be. I like the idea of talking to my accountant, and I'll follow this advice.

[Guest allancoleman]

" Effective in 2010 , anyone may convert a traditional IRA to a Roth IRA , regardless of income or filing status "

" Consider making contributions ( deductable and nondeductable ) to a traditional IRA and then shifting them to a Roth IRA IN 2010 "

I've seen several brokerage investments houses avertise now for their higher income people to make a traditional IRA contribution now in order to have a sizeable amount of money there in 2010 to convert to a Roth . Alrthough I've done most of my Roth converstions in the 25% marginal tax bracket , theedge , I'm not so sure the Roth conversions would make as much financial sense in higher brackets . However , in that 25% tax bracket , my " effective " tax rate was 14% . Marginal tax bracket rates are on your " last " dollar earned and effective tax rates are on every single dollar earned . In the past , I've paid as much as 22% effective tax rates . As I've learned ti fine tune my total income , including my Roth conversion amount , I've gotten it down to 14% . Think I could actually get it down to 13% if I really tried . For those in the 15% marginal tax bracket , the effective tax rate would be even lower .

Also keep in mind , theedge , that " Beginning in 2008 , direct rollover from an employer plan to a Roth IRA is permissible " . " When changing jobs or retiring , consider rolling over employer plan assets to a Roth IRA instead of a traditional IRA " . " ( Rollover of a traditional 401(k) to a Roth IRA will be taxable ) " . I am very much looking forward , theedge , to transfering money straight from my 401(k) next year , 2008 , to a Roth and skipping the traditional IRA stage that's necessary now .

Starting in 2008 , theedge , " Lower rates for capital gains distributions and qualified dividends extended through 2010 : " . In tax years 2008 - 2010 , I'll actually pay ZERO percent capital gains IF I can keep myself in the 10% to 15% bracket . Currently that's up to $63,700 for my married filing joint return status . I have ESOP shares left from my retirement in 2000 that I intend to sell next year , 2008 , in order to take advantage of this tax break . I doult the next administration will extend this tax break . ? ?

The above quotes come from my " In the Vanguard " winter 2007 Voyager Edition .

Commend you , theedge , for meeting with a " personal financial advisor " , BUT I personally feel that forward tax planning is much too important to leave to professionals .

p.s. I totally agree with John G's post below too .

[John G]

WARNING - - I am highly suspicious that you are being steered into a plan that you do not need and will give you meager returns. You got it right when you said you don't need insurance. Single! That's the key point. No kids, no wife - no insurance. Some of these insurance products give you very meager annual returns. Do not be lured by the "free" in retirement statement. Free can be very expensive if your money does not grow over the next 40+ years. Same goes with annuities. When you have little experience in money matters you are more open to bad suggestions from folks who may have a financial conflict with their advice. A commissioned mutual fund, various insurance products and annuities all fall into this catagory of products that may have hidden costs.

I would fully fund a Roth when ever you can. There are gaps in the rules in 2010, but that may all change. New programs may be created, old limits may be changed. You just have to monitor the news stories. [i highly recommend that you suscribe to Kiplinger Financial magazine which is a good fit to folks early in the careers as it covers investing, credit, buying homes, etc. And at around $15 a year is a bargain]

You should fully fund your company plan - not just for the match, but because beyond that it is your second best tax shelter after the Roth.

Don't buy anything from anyone that you don't understand. I would rather you build up a cash reserve (emergency fund, home down payment fund) for a couple of years than see you plung into something you don't understand and can't get out of.

Where does that cash eventually go? You should make a commitment to yourself to learn more about basic investing choices. A good place to start is with no load mutual funds. You can get more info at your local library or book store. Magazines like Kiplinger, Money and Worth are reasonable sources. You can also look at comments here by using the search engine for key words like: index, mutual, beginner or novice. If you commit to spending 2 hours a month reading about various investment options, you soon be more comfortable making a choice. You will pay "tuition" along the way, making good/bad choices. We all do. [my first investment was in a company that sold toilet paper... which we all need, but it was not a good investment]

Besides your accountant...you need to strike up some conversations with the engineers who are about 10 years older than you a have gone down your path.

Your situation is pretty common. Keep posting as many will learn from what you are looking at and how you are making a decision.

[Guest theedge]

Wow, I am amazed at all the great information and ideas y'all have. To sum up, it looks like the best way to proceed is:

1. Fully fund a Roth IRA.

2. When I get to the point where I cannot fund the Roth IRA due to income restrictions, then fund a traditional IRA.

3. Starting in the year 2010, convert money from the traditional IRA to the Roth IRA.

4. Talk to other engineers, my accountant, and older people who have been in the same situation for their advice and recommendations.

5. Subscribe to Kiplinger Financial magazine.

6. Do not contribute to the VUL.

7. Keep the system going to 30+ years and retire wealthy!!

[JanetM]

theedge, Just checking, are you maxing out on 401k plan?

[Guest allancoleman]

And after you've followed JanetM's excellent advice on 401(k)'s , theedge , check to see if your 401(k) plan has a " after " tax account that you can deposit funds to after you've maxed out the Fed " before " tax limits of that 401(k) . By doing that I managed to stuff twice as much money into my 401(k) each year . Just be prepared for a heavy tax hit on your paycheck because unlike the before tax contribution that comes out of your paycheck " before " your paycheck amount is taxed , with the after tax contribution , you will pay the full tax bite and then that amount goes into your 401(k) . Even now , my after tax account of my 401(k) is TWICE the amount of my before tax accounts .

PAY YOURSELF FIRST and then second figure out how you're going to live and pay bills later .

[Guest allancoleman]

Also forgot to mention , theedge , that " Conversions that occur in 2010 will be able to have half of the converted amount taxed in 2011 and half in 2012 . "

This is a " one time " only thing , theedge . I was able to take advantage of one of the very first Roth conversions where I got to spread the tax bill over the next four years at that time . It was interesting to get a letter each year from the IRS reminding me of the amount I would need to add to my taxable income for my following year's conversion .

For myself , I may decide to convert $200k in 2010 and pay taxes on $100k in 2011 and $100k in 2012 . The advantage of this is to put a maximum amount to a taxfree forever account to begin earning right off the bat in 2010 and spread the tax bill over the next two years . In the past , my adverage Roth conversion amount has been approximately that same $100k . This'll allow me to jam $200k into a Roth right off the bat in 2010 and spread the tax bill .

Think about your own amounts and various issues . This is the beauty of forward tax planning . You and I have the next three years ( 2007 - 2008 - 2009 ) to get ready to pull it off in 2010 . See ya there maybe .

[John G]

A contrary view on putting a massive percent of your assets into a Roth, at some point you could be worse off! Yep, there I said it. Worse off.

It may be a stretch of math, but worse off is possible. Consider the taxes owed if in retirement your income stream is 40k taxable and 200k Roth. Would you really be interested in Roth conversions in 2010 (assuming those rules don't change) that would jack to to higher tax brackets now?

A hybrid or mixed approach may garner significant benefits.

I am doing some scenarios for a guy that has about 4M in a Roth (due to a conversion and some successful investing) but is never likely to have over 50k in taxable retirement income, mostly SSN and a partial pension. He has little incentive to do any more converting. Future investments will probably be in the form of long term stock holdings that will probably never be sold in his lifetime and pass to his heirs.

[Guest theedge]

I'm currently contributing 5% of my income to my 401k. 5% is the amount the company will match, so I'm not passing up "free" money. However, I believe that I'll be in a higher tax bracket when I retire, so the non-taxable income from a Roth IRA in retirement will be great. I'd rather max out a Roth IRA before contributing more to my 401k.

Will there be any limit on the coversions to the Roth in 2010? For example, I believe this year the maximum we can contribute is $4,000 to the Roth IRA.

My overall goal is to provide adequate income in retirement and fully reduce the taxable burden. Do y'all be lieve this is the best strategy?

[JanetM]

I would max out the 401K also and get some tax savings now in addition to the Roth.

[John G]

You have made a strong positive statement about your future financial success. Good for you.

I can't emphasize enough that YOU play an important role in making smart financial decisions. It's your money and you should be motivated to invested it. You may need the expert advice of others, but don't abdicate your responsibilities. Dedicate a modest amount of time each month to educating yourself about investment options. You may discover you like investing in directly in stocks picking, real estate (directly or via LLPs), mutual funds or some combination. There is no easy route ~ a set it and forget it approach to money management.

Good luck. Post again.