Russell Bailyn -

I’ve been fielding a lot of inquiries lately about Roth IRA tax planning for the future. Let me do my best to explain who should be doing what in terms of Roth conversions for 2010. Let me preface this by saying none of this is an exact science. There are all sorts of moving parts in the tax code and naturally we have no clue where tax rates are going after 2010. We do know they are not changing for 2010 so any planning we do over the next 12 months or so should be for 2011 and beyond.

What I think is likely for 2011 is that marginal tax rates will increase, specifically for small businesses and those earnings over $250,000. It seems inevitable that rates move higher given the level of government spending taking place right now to counter the recession. I don’t believe in the extreme tax hikes some are talking about but I think the marginal rate for the highest income earners will jump from 35% to somewhere around 40%. Any higher than that and you’ll start hearing talk about higher taxes slowing down the growth engine and falling on the shoulders of small business owners with pass-through taxation, etc. We’ll know about these changes sometime during 2010.

Based on my math and what I’ve been hearing at seminars on the Roth conversion, the people that will benefit most are those that can afford to pay the conversion tax out of their own pockets and NOT from the account they are converting. If you were to pay the money out of the account you’re converting—and tax rates didn’t change—you’d be doing nothing but giving the government a gift of up-front taxes. By paying it out of pocket you are effectively adding more money into your Roth IRA which works out nicely in an environment in which tax rates increase and stay increased for the next 10 years or so. Further, if your tax bracket will drop when you retire (because you’re earnings less money) the Roth conversion also becomes a bit less attractive, bringing me back to the point that the government is looking more at high-earners and people with assets into the millions to prioritize doing these conversions.

If you’re under 59 ½ and paying a penalty by taking money out of your IRA to pay the conversion tax, you’re really not doing yourself any favors at all.

The way the rules read, if you do the conversion in 2010, you will pay ½ the conversion tax by April, 2011 (2010 tax return) and the other ½ by April, 2012 (2011 tax return). You can pay it all during 2010 but why give the government your money early? The only reason might be that during 2011 the highest marginal tax rates jump as we discussed above. Then the math becomes what you’re doing with that extra money in the 12 months between 2010 and 2011.

On another note, Congress has been allowing people not to take RMDs (required minimum distributions) during 2009 because it would be counterproductive to force people to take money out of their IRAs with the stock market at such low levels. With the stock market at higher levels now I find it unlikely they will extend waiving RMDs for 2010 and 2011 but who knows. If they do extend it, traditional IRAs become a bit more tolerable.

As far as I know, there is no age cap on who can do the conversion. Someone 62 or 82 can do it. There is also no income cap on doing the conversion. You can earn $80,000 or $800,000 and still convert. You can also convert directly from a traditional 401k or 403b into a Roth IRA without stopping into a traditional IRA first.

Also interesting is a piece I read this month by Darren Neuschwander, a CPA in Robertsdale, Alabama. Neuschwander notes that clients can choose to re-characterize BACK to a traditional IRA anytime until they file their tax return in 2011—which can be April 15th or October 15th if an extension is filed. Neuschwander notes that any client converting a decent amount of money during early 2010 should do a tax extension and carefully analyze the markets and incoming tax information so they can switch back to a traditional IRA if that math ultimately works better.

As always feel free to e-mail me with any questions. I’m not a CPA so any further details may best be answered by your tax professional.

Russell Bailyn
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Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th St. #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@premieradvisors.net

Investors should consult their tax professional or financial advisor for more information regarding their specific tax situations.

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

Posted by Russell Bailyn at 03:15 PM | Permalink | Comments ( 0 ) | TrackBacks ( 0 )

Many conservative investors like Certificates of Deposit (CDs) because of their stability. It is true that your principal rarely fluctuates with a CD. However, the rate you get is variable, volatile and highly unpredictable as has been evidenced by interest rates in the economy over the past 15 years. As a result, if you were rolling over one-year CDs from the late 90’s until now, your income would have fluctuated dramatically. From 1996-1999, one-year rates ranged from about 4.5% - 6.5%: a respectable return for a conservative investor. Keep in mind that the stock market in those years was on fire, so that 5% CD rate may not have felt as warm and fuzzy as it would today. After year 2000, interest rates plunged and you were lucky to get 2% on a one-year CD. The same applies today as interest rates are low and CD investors find themselves scrambling for a ‘good rate’ such as 3% or maybe 4% if you lock in for years. So the new important question becomes, what is more important: stability of principal or stability of income?

Some advisors might suggest that “income guarantees” are more valuable than “principal guarantees.” It becomes difficult to pay retirement expenses and/or plan a budget when every year the income derived from your CD investments changes dramatically. Part of the reason variable annuity sales have skyrocketed over the last few years is that insurance companies are able to offer living benefits including guaranteed income for life. Unlike CDs, annuities rarely make guarantees as to the principal value of your account. But they do provide several guarantees as to the income generated by the account, often for life. The concept of guaranteed income for life is very valuable to investors in an atmosphere in which the stock and bond markets are highly volatile and people are living much longer lives. The ‘peace-of-mind’ component often outweighs the added insurance expenses and people choose to have at least some portion of their retirement funds dedicated to this vehicle. It should be clear that any insurance promise of “guaranteed income for life” is subject to specific restrictions and limitations. For example, these options often require annuity owners to begin receiving income at particular ages with withdrawals limited to specific percentages or dollar amounts. Reading the full prospectus is the only way to get complete information on various product offerings.

Besides offering a more predictable income stream than CDs, variable annuities offer the potential to grow principal on a tax-deferred basis for retirement which may also provide value to your estate plan. It might pay if you’re a conservative investor nearing retirement to look into some variable annuity strategies in addition to those good old CDs.

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th St. #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@premieradvisors.net

*Guarantees are based on claims-paying ability of the issuer. Surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns are principal value of the available sub-account portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than their original value. Optional features may involve additional fees, expenses, limitations and restrictions.

CD’s are FDIC insured and offer a fixed rate of return if held to maturity. Annuities are not FDIC insured.

The enhanced income benefit is based upon the claims paying ability of the issuing insurance company and does not apply to the contract value which fluctuates daily. There may be an additional cost for income benefit features of some variable annuities, and depending on the performance of the investment option(s) selected, the contract value at the time of annuitization could be such that the investor would incur a higher expense with the income benefit feature without receiving any explicit benefit.

Variable annuities are long-term investments designed for retirement. The value of the variable investment options will fluctuate and when redeemed, may be worth more or less than the original cost.

Variable annuities are sold by prospectus. For more complete information about underlying fund investment objectives, risks, charges, limitations and expenses, please read the prospectus carefully before investing or sending money.

Purchasing an annuity within a retirement plan that already provides tax deferral under sections of the Internal Revenue Code results in no additional tax benefit. You should purchase an annuity for the contract features and benefits other than tax deferral.

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

Posted by Russell Bailyn at 02:18 PM | Permalink | Comments ( 0 ) | TrackBacks ( 0 )

There has been much debate over the past decade about the value proposition of actively-managed mutual funds to the average investor. The potential advantage which you’re really paying for with mutual funds is the possibility of choosing a brilliant portfolio manager who can beat their benchmark year after year. I’ll only break out one statistic here among the many which convey the same unfortunate message about the mutual fund industry: six out of ten actively managed stock funds underperformed their indices in 2008, primarily due to fees, according to the Center for Institutional Investment Management at the University of Albany. Besides the fact that actively managed mutual funds, on average, cost investors more to own than index and exchange-traded funds, they are also generally less transparent than index and exchange-traded funds. This isn’t necessarily a criticism of mutual funds, but an inherent operational difference between two very different investment products: mutual funds and exchange-traded funds.

At the time when mutual funds really gained in popularity (the 80’s) the stock market seemed to only move up. Having a nice diversified basket of securities with an active manager was a fine idea. The past ten years have taught us many lessons about the volatility inherent in stock and bond investing and have alienated plenty of 1980’s and 1990’s investors who can’t take the constant fluctuation. So what should you do?

Unfortunately, retirement plans such as 401ks and 403bs usually only allow investors access to actively managed mutual funds. Some offer access to index funds and rarely an exchange-traded fund will make its way onto the menu. Some critics of the mutual fund industry, such as pension expert Matthew Hutcheson have done studies highlighting the long-term potential damage to retirement plan investors caused by excessive costs, hidden fees and an overall lack of industry accountability.*

The Hutcheson paper referenced above also itemizes the different sorts of expenses which are paid by the investor from mutual fund expense ratios. I found, and I'm sure many investors would agree, many of these costs are onerous and burdensome.

My point is basically that many investors have incomplete information about the mutual fund industry. The opinion which has been surfacing more and more lately in financial journals is that investors should pay attention to what they can control—namely fees and expenses within their investment portfolios. In my opinion, one way to do that is through less exposure to actively managed funds and more exposure to cheaper and cleaner portfolios using individual stocks, bonds, and index-style investments.

Russell Bailyn
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Investing in mutual funds involves risk, including possible loss of principle.

Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing. To obtain a prospectus, which contains this and other information about a fund, you may contact your investment representative or call the investment company directly. Please read the prospectus carefully before investing or sending money.

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

*Matthew D. Hutcheson, MS, CPC, AIFA, CRC -- Uncovering and Understanding Hidden Fees in Qualified Retirement Plans: University of Illinois Elder Law Journal: Fall 2007

Posted by Russell Bailyn at 04:26 PM | Permalink | Comments ( 2 ) | TrackBacks ( 0 )