Tag Archives: ira

Investing, Retirement

Annuities are FUCKED UP… aren’t they?

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As the resident personal financial advisor for my family (despite that I have no idea what I’m talking about half the time), I’ve jumped into understanding my parent’s financial situation (the good the bad and the ugly) as I will have to help my mother manage her finances for the rest of her her life once my father is gone. He may live longer than her but she is relatively healthy right now and he has terminal cancer, so it’s likely I will be the only person able to really help ensure her quality of life since she understands zilch about money.

My parents are doing ok financially – not great – not as good as they should be doing given how much my father earned throughout his life — but they overspent and now they’re left with about $300k in retirement funds and $400k in real estate, give or take a few hundred thousand since I can’t get a straight answer from my father (who unfortunately doesn’t like to talk about this stuff because his go-to answer about any important financial question longer than a few years out int he future is ‘i’ll be dead then’). Continue reading Annuities are FUCKED UP… aren’t they? →

Investing, Retirement

Are 401k Accounts a Scam?

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I’m no financial expert, but I try to follow the basic principles of investing and retirement savings in order to hopefully not be dirt poor in old age. One of these principles has been to consistently max out my 401(k) each year, which I’ve done faithfully now for many years, ever since I finally had access to a retirement account at work. As soon as as started making too much money for a Roth IRA, I socked away $18k a year in my 401k… and now, between all my pre- and post-tax retirement accounts, I have about $235k locked away, compounding over time.

However, after reading more propaganda on 401k investing, I started to suspect something fishy is up. Most of the anti 401k content focuses on issues with high fees — which, indeed, are a big problem with 401ks. But, really, the most suspicious piece of messaging out there on the benefits of the 401k is that you don’t have to pay taxes now so you get the “benefit” of paying them later. Continue reading Are 401k Accounts a Scam? →

Family, Retirement, Wealth

My Parents Are Actually Not That Great with Money

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When I grew up I knew two things to be fact – my dad was talented at earning money and my mom was equally talented at spending it. My mother constantly complained about us not having a lot of nice things – and we indeed were upper middle class and not a millimeter over the upper class line – but we had it rather great. As my father worked a professional job requiring his math brain, the money kept rolling in. And my mom (and I) would keep spending it.

But despite the “every time we come back from the mall” fights on spending it never was  a “real” issue. We weren’t in danger of losing the house. My private college tuition was paid for outright. So was my sister’s private school for a learning disability and then college. Apparently at some point my father’s company was sold and he did fairly well for himself in his stock and income appreciation. My parents should be comfortably set for life and then some.

However my father (who was told he had two years to live about nine years ago, mind you) and my mother have spent and spent and spent post “earning” years and with the stock market underperforming all his estimates about his finances didn’t quite pan out. Shocking for a man who made a career out of calculating risk. Yet, here we are today, with my father looking at all the numbers involved in the family finances and he can’t make heads or tails of it. There’s a massive home equity loan out that has to be paid back fairly soon, and there’s little left on it to borrow at this point anyway. He wanted to spend a lot on my wedding but, now that I better understand their financial situation – I realize it was not a good idea. It’s not that they are broke – they have social security and pension money coming in… about $100k a year. But in order to afford not only my wedding but also a winter condo they bought in the southeast and renovations to that condo and fixing a bunch of things breaking around their main house there is the reality that my dad had to pull out a bunch of money from the IRA bumping him up into a higher tax bracket so most of the income they’re making goes to taxes.

So they have to in the next few years pay back about $200k in home equity. How? The idea seems to be either from a reverse mortgage (which as I learn more about I really don’t like) or taking more money out of the IRA and paying a lot of taxes on it or, well, there aren’t many other options. The money is there, but it isn’t. They’re so much more fortunate than most people their age (due to smart saving at least and the possibility of a one-working-parent household being able to afford a nice life and a decent retirement) but their spending is just out of control. It’s not just my wedding – which theoretically my father had budgeted “forever” for – it’s the lack of acceptance of 1 – what life really costs and 2 – what their life really costs.

My father keeps talking about how they’re going to have to “get frugal” and I can’t help but laugh. They aren’t exactly going on luxury vacations but my parents do spend. My mother has no concept of money and I worry she’s going to eventually spend every last cent of her retirement money leaving her with “just” the monthly income – which at some point may not be enough to pay for her care. I’ll help, of course, as much as I can – but I’m stuck in the reality of my world which = I cannot ever afford a house, I cannot figure out how to save enough for my own/my family’s retirement, even on my current substantial income (which will not last because I’m about to completely crack in my current career and my next step is something less profitable but more personally fulfilling, I hope) – in any case, I’ll need to help out of guilt knowing how much my own life has cost them, but it’s still frustrating that this didn’t have to happen… they were doing so well and then they had to put an addition on the house and had to buy too-nice further for the vacation property and had to get a new dress for every wedding-related event coming up (I’m glad I talked my mother out of purchasing a $2000 dress for my wedding when the $300 dress she got looked WAY better than the one the fancy store was trying to sell her.)

I just worry too because I know that in so many years my father’s cancer will eventually end his life (I hope this is a long time out but who knows) and my mother will – god willing – life a very long time. But as bad with money and gullible as she is she’s suceptable to all sorts of scams and con arts and just about any potential way for her money to disappear. My dad likes to talk to me (so awkwardly) about how he wants my sister and I to get an inheritance – and I can’t comment on that because on and hand I think inheritances are just plain awful and unfair and should not be allowed and on the other hand the world we live in is one where people can or can not afford to, say, buy a house or send their kids to college due to such mini dynasties. It’s not a topic I’m comfortable talking about and I certainly don’t want to be the person held responsible for convincing my mom not to, you know, spend that money that one day would possibly end up trickling down to me and my sister – even though I honestly don’t want it if she needs to spend it, I just don’t want to see her getting conned. I worry I’ll have to be the responsible one because my sister knows nothing about money and clearly I’m the best educated on the topic (I don’t know how that happened but anyway, it happened.)

My father was even asking my advice on how to repay the home equity. I have no idea. $200 is a lot of money. It took me a very long time to save $200. Now I have almost double that. But it’s all locked up in retirement funds and such. It’s about half of the cost of their actual house. I don’t understand home ownership and the whole taking loans out against your property. It seems like he has a really great rate (2 percent?) so maybe that’s a smart/good thing. But it’s only smart insofar as the needed to spend the money. It’s my wedding but it’s more than that for sure. It’s just this nature of spending and spending and spending and being delusional slash not wanting to deal with the time to come when they really do need to be “frugal” in their own middle class sort of way… not something my mother has known how to do for years. I worry they’ll lose their home – though my father said that will never happen – but I’m starting to doubt his ability to predict these things. He seems rather surprised about how much taxes he owes in general and how things add up and money keeps disappearing. He seems perplexed that the stock market didn’t perform strongly so his networth shrunk more than expected and he didn’t have a backup plan to deal with this. And this all has led me to the conclusion that my father – the math guy – the financial industry risk expert – is actually really bad with personal finances. I worry for them, and I also hope somehow I can do better with my own family and wealth. I’m beginning to think that all starts with NOT owning property – EVER. Rent is expensive but at least it’s not handcuffs.

Investing, Retirement

Current Investment Portfolio ($323k)

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Some of you have emailed asking, so here is an overview of my current portfolio:

STOCKS – now @ $144,385 (2016 goal = $200k … which may be a stretch!)

  • $18402 – AAPL
  • $8665 – AMZN
  • $1891 – DIS
  • $1130 – FTR
  • $2783 – GE
  • $649 – GOOG
  • $20408 – IHI
  • $7315 – JNJ
  • $7862 – MCD
  • $6951 – SBUX
  • $2935 – VOO
  • $8178 – VZ
  • $33392 – VGHCX
  • $13690 – VMGMX
  • $5634 – Loyal3 Account (multi-stock)
  • $4500 – Robinhood Account (multi-stock)

RETIREMENT (mostly pre-tax) – now @ ~ $154,824 (2016 goal = $190k)

  • $9172 – DVY
  • $1487 – GLD
  • $2898 – XRT
  • $3088 – AMZN
  • $2199 – GOOGL
  • $2299 – NFLX
  • $347 – TEL
  • $2106 – VTI
  • $4658 – VFWIX
  • $12867 – VEMAX
  • $21943 – VIGAX
  • $16169 – VTIAX
  • $31170 – VTSAX
  • $12612 – VDADX
  • $5078 – VDIGX
  • $10928 – VSGAX
  • $15803 – 401k to rollover

OTHER ($24,164)

  • $6464 – 529 plan
  • $873 – Prosper
  • $427 – Lending Club
  • $16.4k – stock options that will likely be worth $0 in 2016
Career, Family, Investing, Networth, Parenting & Motherhood, Wealth

November Networth Check-In and Retirement Update

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Now that I am “in between incomes,” so to speak, I am re-focusing my objectives for total assets this year, and beginning planning for 2016 based on my potential earnings at my new opportunities.

As a reminder, my goal was to close out 2015 with $400,000 in net worth. That figure was always a stretch, but it isn’t going to happen this year. My new goal is to wrap up the year with at least $350,000 in net worth, which is about a 15% increase in my nest egg – not bad but not great either. My goal is to give birth to my first child in the summer of 2017, when I’m about to turn 34 (yikes.) That means getting pregnant in the fall of 2016 or soon after would be ideal. That means that I still want to aim for $500k in net worth by the time I have my first kid (let’s call that July of 2017.) This is about 19 months to increase my net worth by $150k.

Let’s start with where I am today — according to www.networthIQ.com my current net worth is $380,783. I will subtract my car ($8000) and stock options that will soon be worth nothing from that ($16,000) to what is my “actual” net worth — so about $356k. I’m also losing money now since unemployment doesn’t cover my monthly expenditures, so assuming the stock market does decently this month and I land a new job for December start (which is looking quite likely) I should be able to close out the year about $350k. A reminder, in January of 2009 I had about $5k to my name (see graph below.)

november net worth

In order to hit my goal of saving $150k in 18 months (assuming ending 2015 with $350k), I need to “save” $8333 per month. How is THAT going to happen?

If I (knock on wood)  increase my income levels in my next job to $190k (which is super exciting and feels like too much yet if the market will pay that for my services, I’ll take it!), that is a take-home of about $9400 a month (which is a lot and really starts making this dream possible – this is where it gets exciting!) Even with my average spending of about $3500 a month,  I will have $5900 per month to put away. But this also, theoretically, is two years of 401k investment, which I can max out each year. So that’s $36,000 of the total $150k right there (assuming I can keep my job and do well at it!) Ok, so one opportunity has a 3% match of your salary on that, which is awesome (I’ve NEVER had a 401k match in my entire career!) That means each year I’d make an extra ~$5700 just for putting the money in my 401k (if I’m understanding the match thing correctly.) So that is $11,400 on top of the $36k. Ok, so that takes care of $47,400 of the $150,000, and leaves a slightly more realistic $102.6k left to save over 18 months, or, $5700 per month. Income is reduced a bit with the 401k investment, of course, by $18000 a year – but that’s all pre-tax. But with bonus, etc, it should balance out to still taking home somewhere around $9k a month, or maybe a little less. That’s still a lot for the short-term goal.

Now, let’s assume my stock portfolio / the market increases by an average of 5% each year. It could be less and it could be more, but let’s say 2% – 5%. That is somewhere between $7000 and $17500 for year one, and a max of $20.9k in year two (at 5%), minimum of $8368 (for the entire year, but I’ll count that in these numbers since even if I’m not working my portfolio will continue to gain interest.) Ok, so on the more conservative end with just a 2% year-over-year gain, I’ll have another $15,368 covered by investment interest…

$150,000 goal
$36,000 = 401k investment
$11,400 = 401k match @ 3% of income
$15,368 = portfolio interest at 2% YoY
———————————————
$87,232 to save in 18 months, or,
$4846 per month

This is very doable, as long as I select a job where I can stay a minimum of 18 months. One opportunity does not have 401k match, so I am leaning toward the one that does, since this clearly helps substantially in reaching my long-standing goal of $500k by childbirth.

Once I have kids, I am expecting to work part-time and see my annual savings levels decrease. Of course, I’ll have a husband who is also working, but he doesn’t earn as much as I do or invest his savings beyond a Roth IRA (which he’ll no longer be eligible for once we’re married – yeay marriage.) We’re not really combining incomes when we’re married – just continuing to split major household expenses. We’ll probably start to split a little more… right now we just split rent (I pay more since I make more) and food (we spend way too much on food for two people) — but in the future when we’re married I can see us splitting healthcare expenses, and maybe things like gas/transit. When we have a kid all those expenses will be split too. Luckily I have a penchant for household accounting. What a great hobby!

Seriously, though, if I can get to $500k before I have a kid, this frees me up so much from this looming fear of the future I have. It’s not exactly a nest egg that will make me rich, but it’s a very good start to be at $500k by 34. The goal was by 30 but so what… goals are meant to be hard to reach, but they keep you focused on getting to where you need to be.

With $500k, if I can manage to not touch that money until I’m 65, at an annual return of 5%, that gets me to about $2M in retirement (not counting any future earnings or my husband’s earnings/savings. At a 10% YoY return that’s about $8.7M in retirement. Heck, if that grows at 10% YoY in 20 years once hitting $500k, that will be worth $3.3M – not exactly placing me in the .01%, but certainly providing enough income for early retirement / starting my own business / doing what I want when I’m 55 years old. I know a lot of women in their early 50s and I can see this age being a good time to have that flexibility. You’re still healthy enough to trade and have fun, your kids are old enough to appreciate spending time with you (hopefully) and overall if you’ve been smart about saving over the years, you can take a moment to actually enjoy life.

So when people read this blog and comment about how this $500k goal is so silly, well, it really isn’t.

The MOST important thing right now for all of this is picking a job where I can stay stable at for the next 19 months, at a minimum. That’s a long time and I’m going to take it month by month and focus on being so productive my employer couldn’t even dream of replacing me. 18 months is just 6 quarters, and that will go fast, especially if I’m pregnant for half of them!

I really hope I can do it. I’ve come so far. This seems within reach. Having my first kid at 33/34 is not ideal, I’m going to have to have my second at 36 and if I want a third, well, that’s going to have to be pretty much right away after that. This leaves me little time to keep earning at the same rate, especially in my field, where having kids doesn’t seem to align with the amount of hours required to work. I have to make the money now, so I can leave the options open for the future.

 

 

 

 

 

 

 

 

Investing, Retirement

One month left to recharacterize your IRA from Roth to Traditional or Vice Versa

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On my to-do list for this month: recharacterize my IRA from a Roth to traditional IRA. Why? Roth IRAs have maximum income levels where you’re eligible for this type of investment – and it’s fairly impossible to know if you’ll hit these levels earlier in the year when you’re investing. Luckily, the government realizes you might not be trying to sneak your way into a Roth for the year, and gives you to Oct 15 to fix your classifications.

Fixing the classification isn’t as easy as filling out your simple taxes on TurboTax. It gets a bit complicated. This is why I’ve been putting it off… until now.

Not only do you have to follow the rules of the firm where you invested your money in the Roth IRA to recharacterize it, you also have to refile your tax return if you already submitted it earlier in the year (see IRA website).

If you have already filed your return, you can file an amended return and subtract the amount recharacterized from the taxable amount of the rollover or conversion reported on your original return. Form 1040X, Amended U.S. Individual Income Tax Return (instructions), can be used to amend your return. Generally, for a credit or refund, you must file Form 1040X by the later of:

  • three years (including extensions) after the date you filed your original return, or
  • within two years after the date you paid the tax.

My Roth IRA is at Vanguard, so I will need to first go through their recharacterization process which I haven’t figured out yet. I am probably going to end up calling them to figure this out.

Have you recharacterized a Roth IRA before to a traditional IRA? Are there any gotchca’s I should be aware of?

Class & Wealth

How to Give Financial Advice to People Who Ask But Won’t Listen

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Recently a friend of mine from childhood, who now lives in a different part of the state, was in town on a road trip and stopped to have dinner with me. While we grew up in the same middle class neighborhood, her family was definitely more “middle class” versus mine which was “upper middle class.” So when she asked me for some financial advice due to a potential windfall from a recent family death, I paused before sharing my typical spiel.

Said friend currently owns property with a mortgage (her parents helped her with the downpayment), but otherwise lives paycheck to paycheck. She makes $60k a year and to her that’s a lot (I did not mention that my income is north of $150k right now, but that’s neither here nor there because that’s a short-lived situation anyway.) She mentioned that she was considering investing in Primerica Financial Services, which I hadn’t heard of before, but sounded a bit like a god-awful pyramid scheme. She acknowledged that it sort of a pyramid scheme, but she was interested in it anyway. If you tell me that and ask for financial advice, I’m going to give it to you.

My advice was fairly simple. I asked her if she had any retirement savings and she said yes, she had invested in 401ks at other jobs before, up to the match (great) but then went on to tell me that she had no idea where any of these accounts were. “Is there one 401k account somewhere that I can just call up?” She asked. I tried to explain to her that she should call her old employers, locate where her accounts are, and ideally roll these over into a Vanguard IRA. In the meantime, if she were to get the small windfall, to invest this in a Roth IRA in order to continue saving for retirement. She wanted access to the money sooner than that, so I recommended a taxable Vanguard STAR fund, but to consider putting it into a Roth anyway and forgetting it ever happened.

When she was asking me about stocks, it became apparent that she understood practically nothing about personal finance. It also became apparent to me that I’ve learned quite a bit in the last 10 years of my life since starting this blog – not enough to be a CFP but enough to hold my own in advising on basic money moves. I enjoyed providing advice and helping her, but I have a feeling she isn’t going to take a bit of my advice. Oh well. At least I tried.

Investing, Retirement

Question for my Readers: Should I do a Roth IRA conversion?

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One of my biggest financial mistakes to date was rolling over my 401k – or at least, I think it was. By rolling over my 401k accounts I made a Roth IRA conversion of my post-tax “traditional IRAs” unwise. There is, however, a way go around my mistake in order to convert my post tax IRA accounts to a Roth. I’m just not sure if it makes sense to do this. In lieu of hiring a CFA, I pose this question to my readers: should I convert (by doing the following) or not?

The Data

I currently have $14,803 in a post-tax IRA (i.e., I thought I was ineligible for a Roth for two years, at which time I funded a post-tax IRA. This was probably a mistake to begin with, but nonetheless, I have $14,803 in the post-tax IRA. I’d like to convert it to a Roth.)

Where did this money come from?

2010 – $5000 contribution
2011 – $5000 contribution

Thus, I currently have $4,803 in unrealized gains in this account.

If I were to convert to a Roth I would have to pay taxes on this… which maybe not worth it to begin with. However, even if that would be worth it, I have another IRA account from my Rollover 401k. If I were to convert to a Roth I would not only have to pay tax on the $4803, but I’d also have to pay income taxes on the entirety of my 401k account (or a percentage of it, depending on the total conversion.)

The catch is — it is possible to rollover my prior 401k and current IRA account into my new work 401k. At least it looks like it’s possible to do this. By doing this I would no longer have an additional IRA so I’d be able to rollover my post-tax IRA into a Roth IRA and pay tax on “just” the $4803 in gains (or whatever it is at the time I do the conversion.)

However… the funds I have access to in my work 401k are not nearly as compelling as those I have access to in my Vanguard IRA. At the moment, most of my investments in this IRA have a .10 expense ratio. My employer 401k options seem to be mostly in the 1.10 expense ratio, with one S&P fund at .54 or something like that. So, ultimately, I would need to do the math to figure out if it would make any sense to bother with all this hassle to convert my two years of traditional IRA investing to a Roth. I’m really not even sure if I wasn’t eligible for a Roth at the time, but I’m pretty sure it’s too late to fix this error if it was an error. Hmm.

My thoughts are as follows:

1) Wait until the last minute to rollover my current IRA into my work 401k. The last minute mean whenever in the future I am about to leave my company, or, in the case of being laid off, filing the paperwork on the day I’m laid off.

2) If that works, I’d wait until the rollover cleared, and I no longer had an existing IRA beyond the Sharebuilder 2010/2011 contributed-to account.

3) Then I wait… until a year when my income is low (probably when I have my first child or when/if I go to grad school, though this is all a hypothetical time/year to begin with – and needs to happen before I get married!)… and convert the existing post-tax funds to a Roth, so my tax rate is low.

4) That said, does it really matter? In 35 years the account will be worth $415,916 if it makes 10% in interest per year. So I’d have to pay tax in retirement on $405,916. Or, I figure out how to do the conversion in the near future and pay tax now on $5000, give or take. I’m not sure if the tax comes out of the account or you can pay that separately, assuming you can pay it separately then I’d still have $15k or so to compound over the years for retirement, and just pay $2500 or whatever it is right now in taxes on the conversion – if I can actually rollover my old 401k IRA into my new 401k.

But… then I need to look at how much is lost due to the higher expense ratios in the 401k account on the $91k-ish that is in my current IRA. If I have to pay 1% more per year in expenses then…

According to this calculator, if I left my $91k in the new 401k for 5 years, paying an additional 1.00% in expenses each year, with a 10% YoY rate of return, the total fees would be $7885.21, including operating fees and opportunity costs, versus $731.32 if I left it alone in my Vanguard account w/ the .10% expense ratio. So, basically, for the five years waiting for a year when I don’t make that much money (assuming I don’t actually get married) then I’d lose $7500 or so waiting to convert the existing post-tax IRA to a Roth, plus I’d lose whatever tax I’d pay on the gains on the interest gained in the post-tax account. So I’d end up probably paying $10k now in order to avoid paying tax on my hypothetical $405k in retirement.

That seems like a fair trade, if it actually worked out. I’m sure there’s a catch somewhere, I just don’t know enough about finances to see it. That’s why I’m asking my readers…  should I rollover my $91k IRA to my 401k in order to convert my $15k post-tax IRA to a Roth?

 

 

 

 

Investing, Retirement

Understanding the Roth IRA Conversion Pro Rata Rule & a Great Trick!

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IRAs come in two flavors — traditional and roth. Both have income and contribution limits per year in order to take advantage of their benefits. Roth IRAs require that you pay taxes up front on any income you put into them, but then — this is where the magic happens — your interest grows tax free forever. You can take the total amount out at retirement and not pay any tax on it! You can also pass the total amount onto your heirs without them having to pay taxes. It’s a pretty spectacular deal, especially when you’re in a very low income bracket so you aren’t paying much in the form of taxes up front.

Traditional IRAs, on the other hand, are available for low income earners, often who do not have access to a 401k. With the traditional IRA one would put their money in and not pay taxes on this money up front, but then when they retire and take the money out it’s taxed as income for that year (theoretically your tax bracket would be lower in retirement, but this may not be true.)

Up until recently if you made too much money for an IRA you really couldn’t do anything other than invest in taxable accounts. Traditional IRAs were available but you weren’t able to take the tax deduction up front or when you took the money out in retirement, so the only benefit there was the years of dividends not being taxed and reinvested into your investments. It’s not even that great of a deal because then you’re paying income tax rates on your dividend yields versus dividend rates. Generally traditional IRAs for high income earners are useless.

However for tax benefits, today a higher income earner can do a little trick called a Roth IRA conversion. This occurs when the individual puts up to the year’s limit in a traditional IRA ($5500 currently)  and then immediately converts that to a Roth IRA. Because the individual put in post-tax money and the conversion happened right away, no taxes are owed and basically that higher income individual has gone through a loophole to invest in a Roth. For younger folks in their 20s and 30s the ongoing compound interest and ultimate ability to take out the investments tax free might be better (do your own math to figure out if this makes sense for you.)

The trouble comes when you have multiple IRA accounts. Most often this is from 401k rollovers when you leave a job. A 401k is pre-tax money so if you want to roll that over to a Roth you will have to pay tax on not only the interest earned but also the entire amount of basis. That can be an expensive proposition!

That is where the “pro rata” rule comes in. Understanding how this works is a bit challenging. I’ll try to explain this in simple terms based on my research so it’s accurate and makes sense.

How the Roth IRA Conversion Pro Rata Rule works

At the end of the tax year (not the day you do the conversion) the government will look at all your non-Roth IRA funds to determine how much tax you need to pay. They aren’t nice enough to let you get away without paying taxes on a conversion when there is tax money they could make. Instead they require you to pay pro rata on the amount you convert.

Let’s take an example very near and dear to my heart (so I can finally understand what sort of tax liability I’m looking at here.)

I would like to convert my current IRAs to Roth IRAs before rolling over my high-fee 401k (*or I need to get a new job with a better 401k as I can rollover my 401k to that so I can continue to do Roth conversions year after year.)

Vanguard IRA (from rollover 401k)

$26,987 (all pre-tax)

Sharebuilder IRA

$14,027.47 ($10k is post-tax, $4027.47 is pre-tax)

Due to the pro-rata rule it is not possible for me to rollover just the $10k of post-tax money today.

If I rollover the $10,000 of post-tax money, the pro-rata rule would take my total amount of IRA money $41014.47 to determine how much I actually owe.

To figure this out for yourself, follow the steps listed here.

1. Total up all of your IRAs (non Roth): $41,014.47
2. Total up all of your after-tax dollars in IRAs: $10000
3. Calculate your % of after-tax dollars: 24.38%
4. Determine the taxable amount of your distribution: ($20,000 distributed = $4876 tax free, $15124 taxable(!))
5. Exception for rollovers to a company plan: n/a

…

In order to take out the full $10,000 of post-tax money, I’d have to convert the entire amount ($41,014.47) and pay taxes on $31,014.47.

…

Is either scenario worth it? Let’s play this out to the conclusions…

Assumptions:

  • 35 years growth
  • .05% average interest rate
  • 30% federal and 10% state tax in retirement (40% taxes)

1. I do nothing, and leave my $41,014.47 to grow for 35 years until I turn 65 and retire.

  • $226,235 pre-tax
  • Total Value = $135,741 (@40% tax bracket)
  • ((15% tax bracket, in 0% income tax state, low annual withdrawals, would = $192,229))

2. I convert 25% of my IRA plans today

  • Pay tax on $15,124 at today’s tax rates (28% fed, 10% state – $5747.12 in tax)
  • Have $14252.88 remaining to grow tax free forever
  • $78,619 post-tax on conversion
  • + $116068 * 40% tax = $69640
  • Total Value = $148,260

3. Just for kicks, I convert 100% of my IRA today, paying tax on $31,014.47

  • Pay tax on $31,014.47 at 38% rate — $11785.50 in tax paid today
  • $29228.97 remaining to growth tax free forever
  • Total Value = $161,227

4. Additional test thrown in — low income year, 25% tax today

  • Pay tax on $31,014.47 at 25% rate — $7753.61
  • $33260.86 remaining to grow tax free forever
  • Total Value = $183,467

…

What do these calculations teach us?

  • The value of a Roth Conversion (if you have both deductible and non-deductible IRAs) is determined largely by your current tax rate and your expected tax rate in retirement (oh fun, guessing games.) Apparently people tend to overestimate how much taxes they will pay in retirement (i.e. maybe my 40% estimate is too high. You think?)
  • The conversion for an account that looks like mine MAY make sense if I can hold it for 35 years or longer. But it’s still not a sure bet. (I calculated everything at a 5% return YoY to be conservative.)

When Does the Roth Conversion Not Make Sense?

I haven’t done all of the calculations, but I assume at some age the roth conversions do not make sense UNLESS you have no taxable money to deal with. If you don’t have many years for the interest to compound and make up for what you paid in tax, then you’ve just paid a lot of money to the government to make less in the end. That’s what they want you to do. That’s what a lot of people who aren’t running the numbers are going to do thanks to this new rule.

When Does the Roth Conversion Make a Lot of Sense?

If you have one year of your life where you happen to not be making a lot of money — maybe it’s a year you went to school or took time off to have a kid — you will be able to do the conversion and pay your income tax on that conversion. If you are single and have no income, your first $36,900 of taxable conversion (or mix of conversion amount and income) is taxed at just 15% (the first $9600 at 10%.) This changes the numbers quite a bit! So say you want to convert $20k with $10k of it non taxable and $10k taxable. You pay $1k on the first $9600 and 15% on the $400 ($60) so you’d pay just $1060 to convert your $20k, leaving you with $18940 to grow tax free forever — if you live in a no income tax state, anyway (most states will charge you income tax so factor this into your calculations as well.) That’s still a pretty great deal, but you’re also losing all of the money you could have made that year and put into your investment accounts, so it’s not worth it to do this unless you are already planning to take the time off. (And if you really want to be tricky move to a state with no income tax and don’t work for a year!)

(Note, married couples can stay in the 15% tax bracket up to $73,800 income including the taxable IRA conversion amount.)

The Best Trick I’ve Found (That is legal, at least for now)

If you have a work-sponsored 401k, find out if it allows you to “reverse rollover” pre-tax IRA investments. If you can do this, take all of your pre-tax IRA investments and move them into your 401k. You will have to keep those investments in the 401k until you change jobs again (and at least for a year) so if the 401k offers crappy, high-fee, high-load mutual funds you’re going to want to run all the numbers in your specific situation. That said, if you have a decent 401k and can rollover your funds into it — you can roll them over and then only pay taxes on  your interest on any post-tax IRA contributions for the Roth conversion. This means that you can save a lot of money and do a few years of IRA conversions to grow your roth (esp if you are a high income earner and are already maxing out your 401k.)

Now that I’ve figured out this is do-able, I’ve immediately decided to rollover my existing crap high-fee 401k into my Vanguard low-fee, no-load Admiral funds IRA account. I’ll let those babies grow until I have a nice 401k at a future job (knock on wood) that lets me roll over my IRA for a while, and I’ll convert at least the $14k of traditional IRA investment plus probably another $5.5k for the current plan year. I will have to run the numbers myself at the time but I think this is probably the best idea.

Even if that doesn’t work out, the actual growth on my pre-tax accounts will still be beneficial and perhaps my actual tax rate in retirement won’t be quite as high as I think it will be. It still might be best just to leave these accounts alone and continue putting $5.5k in a Roth every year that I’m eligible, whether I’m in school and working part-time or unemployed and unexpectedly coming in within the income limits to contribute to a Roth.

Have anything else to add? Think I don’t explain this well?

Leave a comment with your tips and ideas for when a Roth IRA conversion makes sense, and when it doesn’t. Did I get something wrong here? Let me know. Thanks!

 

Investing, Retirement

Vanguard Admiral Funds: Rebalancing for Lower Fees

3 Comments

One of the things I realized recently that I’ve been spending more than I have to on fees inside of my IRA accounts. While Vanguard funds are low fee to begin with, did you know that Admiral funds (which require $10k minimum investment per fund vs $3k) still have significantly lower fees?

Fees can significantly eat away at your investments, especially over time in your retirement accounts. I know for a fact my old 401k that I haven’t rolled over is wasting money with some of its funds at .90% fees or higher! I’m holding off on rolling that over in the case I will do a Roth IRA conversion if/when I go to grad school on about $100k of other IRA investments, but for all my other accounts I want to be as fee-efficient as possible.

Expense Fees Add Up Fast!

Here’s a little experiment… (try your own out in this expense ratio calculator) say I invest 100,000 today and plan to keep that money invested for 30 years. I earn an average of 10% each of those 30 years (woohoo.)

If my fund has a low .10% expense ratio then I’ll see a 2.96% reduction of my future value due to fees (costing $51,596.) This sounds like a lot, but it really isn’t compared to the cost of most funds.

Say you have a still relatively low-cost fund at .20% expense ratio. You are then spending 5.83% of your future value on fees ($101,716!)

Some funds have high expense ratios too. If you are investing in a fund that has an expense ratio of .80%, 21.51% of your future value is gone thanks to this fee ($373645.77!!) So you see how a little expense ratio can quickly add up.

After reading a bit more about taxes and what funds to hold in Roth IRAs vs traditional IRAs I decided to shift around funds in my Vanguard accounts. I also changed things up over at Sharebuilder because my $10500 basis Roth over there is significantly underperforming, but I’ll cover those changes in another post.

Also, I read that high-dividend funds make sense in your Roth IRA but not in your traditional IRA. Why?  Because dividends have two purposes — to provide you income today at low(ish) capital gains tax rates, or to compound over time in your investments and to be taken out tax free upon retirement (in a Roth.) Going high dividend in a traditional IRA is silly because you have to pay income tax on it when you retire and take it out — i.e. those proceeds would be cheaper today in a taxable account!

Until today, my Vanguard IRA accounts looked like this:

Traditional IRA

VDAIX / .20%
VHDYX / .19%
VGSIX / .24%
VTTSX / .18%
VGTSX / .22%

Roth IRA

VFIFX / .18%
VTSAX / .05%

Updates to my Portfolio

While there was nothing wrong with this breakdown, per se, I had high-dividend REIT and dividend growth funds in my traditional IRA while I had index growth funds in my Roth. I also had certain funds split between my Roth and Traditional IRA where because I had $10k split between two accounts I couldn’t qualify for the lower admiral fund rates.

Luckily at Vanguard it’s free to trade your funds inside your account, so rebalancing is easy (unlike at Sharebuilder where I’m wasting tons of money trading and will eventually give in and just move my “fun money” to Vanguard.)

I made quite a few (free) trades at Vanguard to fix my portfolio. Here is what I have now, which, as you can see is greatly simplified:

Traditional IRA

VIGAX / growth index fund admiral shares .09% expense
VTIAX / admiral version of VGTSX — .14% expense vs .22%

Roth IRA

VDADZ / dividend appreciation index fund — .10% expense ratio
VGSLX / admiral REIT fund — .10% expense to .24% of VGSIX

I also killed off all of my “target retirement date” funds because I’ve read they are too conservative and at my ripe young age of 30 I want to be aggressive but not stupid (working on the not stupid part.)

Why keep my Sharebuilder account open at all?

Good question! Mostly I keep it open so I can trade precious metals in my Roth IRA (i.e. GLD) since they are taxed at a collectible rate (high tax) unless they’re in an IRA, and I can’t buy gold or silver in my Vanguard fund. I also have some specific REITs which I like to watch to learn more about REITs because they are interesting — especially since I do not actually own any tangible real estate. More on that later.