Question #1: Is it possible to have federal taxes withheld from my unemployment check?
Yes. To have taxes withheld from your unemployment compensation you will need to file IRS Form W-4V, Voluntary Withholding Request.
Question #2: What are the differences between traditional and Roth IRAs?
From the Wall Street Journal:
As 2009 came to a close, financial advisers geared up for an expected flood of clients looking to convert their traditional individual retirement accounts to Roth IRAs this year.
Conversions are indeed way up from previous years, thanks to the elimination of the income limit for those wanting to make the switch. But many clients who had expressed interest are deciding not to convert.
Conversion is attractive mainly because withdrawals from Roth IRAs, unlike those from traditional IRAs, are tax-free.
Moreover, Roth IRAs also have no withdrawal requirements; traditional IRAs require investors to begin making withdrawals at age 59½. Several brokerage firms saw conversions by their clients quadruple in the first quarter of 2010, compared with the year-earlier quarter.
However, financial advisers are finding that most clients wouldn't benefit, on balance, from a conversion. Here are the main reasons why:
1. The tax bite is too big.
Clients often come to advisers asking about the Roth IRA conversion opportunity without realizing the immediate tax implications: They will have to pay income tax on any money they move out of a traditional IRA into a Roth account.
Last week I posted this entry discussing changes to IRA’s in 2010. A few days later an associate of mine sent me a link to this article on NCPA.org taking a more detailed look at who would benefit from a Roth IRA conversion. Like any major financial decision, converting your IRA is a big step and you should probably talk to a financial advisor before making the conversion.
Who Would Benefit from a Roth IRA Conversion?
Ostensibly, the benefit of conversion is that the taxes are paid today at a known rate, instead of in the future at an unknown and possibly higher rate. But deciding whether to convert a traditional IRA to a Roth IRA depends largely on the ability to pay the taxes that are due when the conversion takes place. For 2010 conversions, individuals have two years to pay the income tax due. A Roth IRA conversion is ideal for anyone who:
Can pay the taxes using money from nonretirement funds.
Expects that their federal income tax rate when they retire will be much higher than it is today - because their income will be higher and the burden of government will be higher.
Faces little to no federal income tax burden today - so that a conversion would cost very little to complete.
Taxes on a Roth Conversion.
Suppose you convert a traditional IRA to a Roth but take a distribution from the traditional IRA account in order to pay the taxes. Is it worth it? That depends on your current marginal tax rate, income level and how many years you are from retirement. Consider that a distribution from the IRA to pay taxes on the conversion is subject to a 10 percent penalty in addition to federal income taxes if you have not reached 59-and-one-half years.
With these considerations in mind, the table shows the cost of converting $25,000 from a traditional IRA to a Roth IRA and using money from the account to pay the taxes.
From the Wall Street Journal:
Investors and financial advisers are preparing to take advantage of a new tax law that makes it easier to gain access to Roth IRAs—even if it means breaking a sacrosanct rule about Roth conversions.
Starting, Jan. 1, the $100,000 income limit disappears for converting traditional individual retirement accounts and employer-sponsored retirement plans to Roth IRAs, one of the biggest changes on the IRA landscape in years. Roths, of course, have long been viewed as one of the best deals in retirement planning; after investors meet holding requirements, virtually all withdrawals are tax-free.
Just how many investors will make the leap is unclear. Converting to a Roth can be expensive; it requires paying income tax on all pretax contributions and earnings included in the amount converted. What's more, financial advisers have long argued that converting makes sense only if an investor can pay the tax from funds outside the IRA itself - an admonition that seemingly limits the strategy to the very wealthy.
That said, some financial advisers say growing numbers of their clients are leaning toward a Roth conversion, even if they have to tap their traditional IRAs to pay the taxes. The primary reasons: new, contrarian analyses of taxes and conversions—and a desire to gain more control over nest eggs in the years ahead. With a traditional IRA, investors must begin tapping their accounts after reaching age 701/2, which increases taxable income. With a Roth, there are no required distributions, giving retirees more flexibility in managing their investments and cash flow.
Check out the following new Questions for the Tax Lady answers and feel free to ask me questions through one of the links below. You can send me an email, direct message or @ reply, and I will do my best to get an answer for you!
Question #1: Roni, I’m a self-employed taxpayer and I completely forgot about the recent quarterly payment due date. I have the money to make the payment, should I just mail it in late?
Answer: Yes. The most recent quarterly payment due date was September 15th. However, if you were unable to get your payment in then I would recommend sending it in as soon as possible. If you are only a couple of days late then the IRS will most likely not care, but if you just ignore the payment entirely then you might incur a penalty this tax season.
Question #2: What is the difference between a Roth IRA and a traditional IRA?
Earlier today I came across this fascinating article from Bloomberg.com, discussing the changes to the US tax code that would allow more taxpayers to convert to a Roth IRA. In the article, the author discusses how changing may not make as big of a difference as one would think, and provides several examples of why.
Changes to U.S. tax laws next year give high-income earners planning for retirement a decision to make: pay now or pay later.
Taxpayers making more than $100,000 a year in adjusted income will be allowed to convert to Roth IRA accounts from traditional IRAs after that limit is lifted at the end of the year. That means 16 million Americans, according to tax returns filed with the Internal Revenue Service in 2007, can consider whether they want to make tax-deductible contributions if they have a traditional IRA or pay the taxes up front and have tax- free withdrawals during retirement with a Roth IRA.
Which is better depends on future tax rates and how much the conversion will cost. It may not make sense to pay taxes today at a higher rate because many investors will be in a lower tax bracket during retirement, according to Tom Orecchio, a fee-only adviser at Modera Wealth Management in Old Tappan, New Jersey.
“From a tax perspective, I think when people do the math, it’s not going to be as game changing as they expect it to be,” Orecchio said.
Higher-income households that could benefit from the income limit changes are not rushing to switch, according to a survey released today by San Antonio-based United Services Automobile Association. The national survey of 1,259 adults between 45 and 64 years of age shows that for those with an IRA and a household income of $100,000 or more, 9 percent are planning to convert in 2010.
Tax Assumptions
Most IRA assets are held in traditional IRAs, based on a June report by the Investment Company Institute, a Washington- based trade group for mutual funds. Investors held $3.2 trillion, or 89 percent of IRA assets, in traditional IRAs at the end of 2008. Roth IRAs accounted for $165 billion, or 5 percent, of all IRA assets.
Ron Lieber of the New York Times recently published an article discussing the unpredictable future of Roth IRAs. At one point, Lieber even proposes the possibility of taxes on withdrawals from Roth IRAs. Lieber predicts that “at the most extreme end, the federal government might try to tax the earnings on a Roth after all, say through the capital gains tax, which is currently at 15 percent for long-term gains but could go up in the next few years.”
You’ll be hearing a lot in the next six months about Roth Individual Retirement Accounts — but not as much as you should about a long-term threat that hangs over them.
Starting Jan. 1, you’ll be able to take a regular IRA, say, one that you have in a brokerage account after having rolled an old 401(k) into it, and turn it into a Roth. You’ll be able to do this no matter how much money you make, though you’ll have to pay income taxes at your current rate on whatever you move. Currently, you can’t make the conversion at all if your household has more than $100,000 in modified adjusted gross income. (That’s a technical Internal Revenue Service term, which it defines in Publication 590, available on its Web site).
Why would you want to make such a swap? Because you think you or your heirs could end up with more money over the long haul by investing in a Roth instead of a regular IRA.
With a Roth IRA, you pay no taxes on your earnings in most instances when you take money out; distributions from regular IRA’s are taxable the same way that income is, though the basic IRA does offer a tax deduction when you first deposit money into the account. The Roth offers no such deduction when you contribute money to it.
So if you think your tax rate will be higher during retirement than it is now, say if you’re fairly young for instance, making the conversion early in 2010 looks sensible.
From the ChicagoTribune.com:
Joe Cunningham is convinced that income taxes are going up, even for middle-class people like him.
Attempts to fix the economy can't work without an enormous tax increase, the Pasadena, Md., retiree said: "It will be on everybody who pays taxes, which ultimately always is the working class or retired working class."
For that reason, the 68-year-old wants to convert his traditional individual retirement account to a Roth IRA. By doing so, he'll have to pay regular income tax now on the funds he transfers to the Roth. But from then on, money coming out of the Roth will be tax-free. So no matter how high taxes go, Cunningham won't have to worry.
If he's right about taxes, his timing to convert couldn't be better.
Tax rates are historically low now. IRA account values also have fallen with the markets, so there are fewer gains to tax during a conversion. And the outlook for higher federal income taxes is good--at least for those in the top two brackets. President Barack Obama favors raising the rates on families making more than $250,000. Even if Uncle Sam doesn't raise income taxes on those making less than that, cash-strapped states might do so, said Ed Slott, an accountant and IRA expert. That's another factor favoring the Roth.
IRAs give you the choice of receiving a tax break upfront or on the back end.
A traditional IRA rewards you on the front end, where contributions often are deductible. Once you take money out in retirement, you pay regular income tax on the earnings and any deductible contributions.
Money goes into a Roth after taxes have been paid on it, but comes out tax-free in retirement. Basically, you're better off with a Roth IRA if you expect to be in a higher tax bracket in retirement than while working.
So should you, like Cunningham, make the switch?
There are several factors, besides the tax outlook, you need to consider.
Right now, only singles and married joint filers with adjusted gross incomes up to $100,000 can convert a traditional IRA into a Roth. Next year, that cap disappears. And if you convert to a Roth IRA next year only, you will be able to spread the tax bite over 2011 and 2012.
You shouldn't convert if you will need to take the money out of the Roth within five years. If you do so, you will trigger taxes on the earnings withdrawn, Slott said. Plus, you can be hit with a stiff penalty if you're under age 591/2.
"There is really no benefit today, or next year or two years" for converting, said Jim Sloan, a financial adviser in Friendswood, Texas. "The benefits are five, 10 or 15 years from now" when your Roth has had time to grow, he said.
Don't convert if you don't have money outside the IRA to pay your tax bill. Using IRA cash to pay taxes means fewer dollars going into the Roth. Plus, that cash will be subject to an early withdrawal penalty if you're under age 591/2.
As an alternative, you could convert only part of your IRA to reduce the tax bite to an amount you can afford to pay out-of-pocket, Slott suggested. For retirees who don't need the money, the Roth has another attractive feature: No required distributions after age 70 1/2.
To see whether a conversion makes sense for you, check out the Morningstar IRA calculator on T. Rowe Price Associates' Web site (troweprice.com). Click on "individual investors," then "tools and calculators."
Of course, there is no guarantee taxes will go up.
That's why Joel Dickson, a tax expert with the Vanguard Group, recommends a mix of traditional and Roth IRAs as a hedge against whatever happens to tax rates.
If you regret converting, you have a certain amount of time to switch the Roth back to a traditional IRA and have the money you paid in taxes returned, Slott said. You will need to contact the custodian of your IRA and file Form 8606 with your federal tax return to convert, Sloan said.
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