Managing money can be nerve-racking – especially with taxes likely to increase. What's the best strategy for midlifers to take before the end of 2012?
To find out, Family Goes Strong talked with financial planner and certified retirement counselor Rick Rodgers, author of The New Three-Legged Stool: A Tax Efficient Approach To Retirement Planning. Excerpts:
So people can expect taxes to go up?
Are they going up for all of us? That remains to be seen. Whenever you're planning for uncertainty, the best approach and the only prudent approach is to diversify, which means do some things to plan for higher taxes without betting the farm that taxes are going to go higher.
But taxes are unlikely to decrease?
I'm fairly confident in saying they're not going to go lower. They may not go up, but they're not going to go lower. Let's take advantage of low rates today. Maybe cut back on 401(k) contributions and make a Roth [IRA] contribution instead. Those with kids college age, Roth are a good place to save money. Retirement accounts are not counted as a parent's asset. Putting it into a Roth IRA gets it off the radar screen, and yet it is still accessible. The earnings have to stay in there until you're 59 ½. The money you contribute, which next year goes to [maximum contributions of] $5,500 [for people under 50] and $6,500 [for people 50 and older], is accessible to you.
Should people roll any 401(k) money into a Roth IRA?
Possibly. The problem is that's a taxable event. It's kind of unique to each individual, but I only want to convert enough to keep me from going into the next higher tax bracket. Your taxable income, $71,000 and less, is taxed at 15 percent. If I know my taxable income is around $60,000, I could convert $10,000 to a Roth and still be in a 15 percent bracket. If you're in the highest tax bracket, convert your IRA's to Roth IRA's and pay your taxes. The younger you are, the more advantageous the Roth conversion is. The longer the money can stay in the account and grow tax free, the better it's going to be for you.
Is it worth borrowing to pay the tax conversion?
It's worth looking into. I don't want to say it's always going to be the right thing to do. Let's say that you have children in college, if you do a Roth conversion, it could put your income into a place where you don't qualify [for financial aid] any more.
Should parents with college-age kids invest in a 529 education savings plan?
If the money is definitely going to be used for higher education, the 529 has so many advantages. It's not going to be subject to a state tax. In the state of Pennsylvania, it's not included in the FAFSA [Free Application for Federal Student Aid] forms. The earnings are all tax free if it's used for higher education expenses. And in the state of Pennsylvania, you can deduct up to $13,000 of your state income tax.
And people should max out the allowable Roth IRA contribution?
Yes. That's the one that's $5,000 this year, $6,000 if you're over age 60. That's per person.
When people retire, what funds should they plan to take from first?
We structure the distributions based on how much tax we want to pay. Ideally, we get to retirement, and we have money saved in the Roth IRA, the tax-deferred accounts like the 401(k)'s, and brokerage accounts. That's the three-legged stool. If I pull $60,000 out of the 401(k), I'd be paying tax on every bit of it. There is no short answer to your question. Are you drawing Social Security? Social security benefits are tax free — if we keep our income down. There are some tradeoffs, and generally the goal is to try to be equal. We don't know what's going to happen with tax law in the future.
People can read your book – and see a financial planner?
For some of these more sophisticated things, like Roth conversions, things you need to do some calculations, I think that's going to be money well spent.
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