MONEY Kids and Money

The Surprising Place Your Kid Should Save His Summer Earnings

Pitcher of lemonade and a money jar
Your teen's summer earnings may not seem like much now, but they can serve as a cornerstone for his retirement 50-odd years in the future. Somos/Veer—Getty Images

Get your teen started off now in a Roth IRA for a big payoff down the road, says financial planner Kevin McKinley.

A few weeks ago, I wrote about how to figure out how much money you need to become financially independent, and how the process could help you teach your kids to reach the same goal.

But talking the talk only goes so far. You can walk the walk by helping them start saving for retirement in…drumroll, please…a Roth IRA.

Why a Roth IRA?

For most younger workers, the Roth IRA is preferable to a traditional IRA for two reasons.

The first is that contributions to a Roth IRA can be withdrawn at any time for any reason with no taxes or penalties whatsoever. Therefore, that portion of the account can be taken out for other expenses, such as college or a down payment on a house, without a severe cost.

The second reason the Roth IRA rules is that younger workers typically are in a low tax bracket, and therefore don’t need the deduction that a traditional IRA provides. But once they get to retirement, all the money in the Roth can generally be withdrawn with no taxes at all.

How much your kid can save

Children of any age can open a Roth IRA account—as long as they have legitimate earned income. Flipping burgers and bagging groceries certainly counts, but so does self-employment like babysitting and yard work, especially if it’s done for someone other than you.

Just make sure to keep track of what your kid makes so you know how much can be deposited in to the Roth IRA. For 2014 the contributions to a Roth IRA are limited to the lesser of the kid’s earnings, or $5,500.

Technically, for the 2104 tax year, the money doesn’t have to be deposited until April 15, 2015, the usual deadline for the federal income tax filing.

What you can do to encourage him

Congratulations to you—and your child—if you can convince her straightaway to put her hard-earned paychecks into an account that isn’t meant to be tapped for another 50 years.

But even if you can’t immediately get your teen into the savings habit, you may be able to motivate her by using some of your own money. The money for the Roth IRA doesn’t necessarily have to come from her. She can spend her earnings, and you can deposit into the Roth on her behalf.(Just remember that your deposits then become her money, and she’s free to do with it as she pleases once she reaches adulthood.)

Also, keep in mind that the source of the deposit to your child’s Roth IRA doesn’t have to be an all-or-nothing proposition. You may want to tell your kid that you will match every dollar she contributes with one of your own.

For further motivation, try showing your child how time can turn a relatively-small amount of money into a small (or large) fortune.

For instance, let’s say you and your child deposits $5,000 into a Roth IRA when he’s 15 years old, and it grows at a hypothetical annual rate of 6% per year.

By the time he’s 65 (and it will happen sooner than he thinks), the account would be worth over $92,000.

But if he has the earnings and discipline required to set aside $5,000 in to the same account every year until he turns 65, the Roth IRA will provide him with a tax-free total of $1.6 million.

And if that doesn’t get his attention, no amount of walking and talking will.


Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

Read more from Kevin McKinley

Four Reasons You Shouldn’t Be Saving for College Just Yet

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MONEY Kids and Money

This is What Sting Should Have Done for His Kids

Musician Sting performs during the 44th Annual Songwriters Hall of Fame ceremony in New York June 13, 2013. Carlo Allegri—Reuters

Financial Planner Kevin McKinley argues that there are ways to give your children money without having to worry about them becoming trust-fund brats.

Recently rock legend Sting made headlines when he declared that his six children would be receiving little to none of his estimated $300 million fortune.

He joked that he intended to spend all of his money before he died. But on a more serious note, he explained that he wanted his kids to develop a work ethic, and not let the wealth become “albatrosses around their necks.”

His motives are admirable, and he’s certainly within his rights to use his money however he pleases. But as a financial planner and a dad, I’d argue that there is a lot of room between over-indulgence and complete denial. And in fact, used the right way, your wealth can help motivate your child.

Here are three ways you can sensibly use a relatively small amount of your own money—during your lifetime—to encourage your kid’s productivity and self-reliance, without spoiling him rotten.

1. Save something for his college

You don’t need to put every dollar you have in to a college savings account, nor do you need to pay the full cost of some high-priced private school.

But setting a little aside sets an example of your commitment to your child’s education. It also can ensure that she doesn’t have to choose between taking on a six-figure debt load, and not going to college at all.

Let’s say the parents of a recent high school graduate started saving just $50 per month at her birth, and it returned a 6% hypothetical annual rate. By now they would have over $19,000—enough to pay tuition, room, and board for a year at a typical in-state four-year university, according to the College Board.

The remaining years can then be paid for by some combination of parent earnings, a relatively manageable amount of student loans, and the student’s part-time job.

2. Jumpstart retirement savings

Speaking of jobs, once your kid earns his first paycheck you have another chance to use a little money to teach a valuable lesson.

Open a Roth IRA on his behalf by April 15th of the year after he gets his first job. He’s eligible to deposit the lesser of his earnings, or $5,500.

Kudos to you if you can get him to contribute his own money. But if you can’t get a teenager to understand the importance of retirement—I mean, let’s be realistic—you can instead make the contribution out of your own pocket. Or offer to match an amount he puts in, which you can explain to him is the easiest way to double his money. (This is also a good way to set up his understanding of an employer retirement match down the road.)

One way or the other, saving a little now could mean a lot down the road. A $5,000 deposit today into a 16 year-old’s Roth IRA earning the aforementioned 6% annually would be worth almost $100,000 by the time he turns 66.

And if the initial gesture inspires him to deposit $5,000 of his own money into the Roth IRA every year for those fifty years, the account could be worth a cool $1.5 million by the time he hits 66.

3. Help with the house

Hopefully your child eventually becomes an adult in both age and responsibility. That might be the time she wants to buy her first home.

The National Association of Realtors says the median home price in the U.S. as of May of 2014 is about $214,000.

If your child’s (and/or her spouse’s) annual income totals around $60,000, she should be able to qualify for a 30-year 4% mortgage to purchase a home in that price range, leaving her with a monthly mortgage payment of about $1,300. But she may still need to overcome the biggest obstacle to the purchase of a first home: the down payment.

Even the savviest young adult might have a hard time saving up the $42,000 needed to make a 20% down payment on that average purchase price.

Helping her meet that down payment requirement will not only get her the satisfaction of home ownership, but it will help her build equity in something with her own money. And it might mean you have a place to stay if, like Sting, you end up spending all of your money before your time is up.


Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

Read more from Kevin McKinley

Four Reasons You Shouldn’t Be Saving for College Just Yet

Yes, You Can Skip a Faraway Wedding

MONEY Kids and Money

Four Reasons You Shouldn’t Be Saving for College Just Yet

KidStock—Blend Images/Getty Images

You should make these moves before you start funneling away money for tuition, says financial planner Kevin McKinley.

As graduation ceremony season nears its peak, I’m seeing a steady drumbeat of stories warning of ever-rising tuition costs and education debt loads. It’s no wonder many parents of smaller children are panicked into thinking they have to drop everything and start saving all their money for their kids’ college expenses RIGHT NOW.

Hang on just a second there, moms and dads.

Although I’m certainly in favor of getting parents to save, there are four things I’d suggest you should do—and one you shouldn’t—before making “saving for college” the top priority. (Already completed all of these steps? Check out the MONEY 101 section on college for help getting started on your college savings journey.)

DO save for retirement

Since it’s possible to borrow money to pay for college but not to fund retirement, working parents have to put their own needs first.

You should start by putting money in any pre-tax retirement savings plans at work (such as a 401k or 403b), at least up to any available matching contributions from employers.

If no employer-sponsored plan is available, those with earned income should fully fund an IRA. You may be able to make a deposit for a stay-at-home spouse, as well. You can save up to $5,500 in 2014, or $6,500 if you’re 55 or older.

The tax savings on the contributions to a pre-tax retirement plan will likely exceed what the deposits to a college savings account are likely to earn, especially in the first year.

Then if you end up with a well-funded retirement, you can tap their overstuffed accounts once you hit 59 1/2—and have passed the penalty zone—to pay for college expenses as needed or pay off student debt incurred by your children.

DO open a Roth IRA

For eligible depositors, Roth IRAs can serve as a hybrid college/retirement savings account. These accounts—which allow for tax-free withdrawals—are typically thought of as a retirement savings vehicle.

But if parents want or need the money before retirement for college (or other) costs, they can withdraw the Roth IRA contributions at any time for any reason with no taxes or penalties whatsoever.

As an added bonus, money held in parents’ retirement accounts is less likely to be counted in a school’s need-based financial aid calculation than funds in the child’s name.

DO pay off credit cards

Double-digit interest rates charged on outstanding balances—the average APR is now around 16%—usually greatly exceed what you’d earn on your money elsewhere. So you’re better off erasing your debt before putting a lot of attention toward college.

Plus, an improved credit score will make it easier for you to obtain higher education loans for your kids should the need arises in the future.

DO prepare for the worst

The majority of parents of younger children haven’t established wills, guardians, and other necessary legal steps—much less purchased enough life insurance to ensure that the tragic death of a parent will only be an emotional nightmare, and not a financial disaster as well.

Moms and dads should see lawyer as soon as possible, and plan on spending a few hundred to a few thousand dollars, depending on the complexity of the situation. You should then purchase enough term life insurance to cover all future expenses—including college—that the survivors might endure.

DON’T pre-pay the mortgage

Well-meaning parents often try to pay down their housing debt as quickly as possible, thereby saving interest expenses and freeing up money that would otherwise go toward the monthly mortgage payment.

But that step should only be considered if the parents are ahead of their retirement savings schedule, have no other debt outstanding, no future major expenses on the horizon, and have at least a year’s worth of living expenses saved up.

Those parents who don’t meet these criteria should stop paying anything extra on their mortgage until they have fulfilled the other aforementioned financial obligations.

Otherwise, parents could end up house-rich and cash-poor—just when it’s time to pay for their kids’ college expenses and their own retirement.


Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

MONEY Ask the Expert

No 401(k)? You’ve Got Options

Q: The company I work for does not offer a 401(k), and as a young professional I want to start a retirement plan. What is the best option for me? I don’t have a large amount of money to contribute, but would obviously like to maximize my investment. — Elizabeth, Herndon, Va.

A: As one of the millions of workers who does not have access to a workplace 401(k) — or the added perk of an employer match — the responsibility for saving for retirement rests squarely on your shoulders.

The good news is that you have several options. And the earlier you start, the longer your savings has to grow. Even small sums set aside now can grow into significant savings

For example, let’s say you invest only $100 a month for the next 40 years. With an average annual return of 6%, that modest monthly contribution would grow into nearly $200,000 in four decades.

“So just getting in that habit can really set the stage for a solid financial picture.” said Sophia Bera, a Minneapolis-based certified financial planner who specializes in working with Millennial clients across the country.

Just be sure you have at least three to six months of easily accessible savings set aside for an emergency before you start investing. Once you do, here are a few options to consider that can help you get more bang for your buck:

Traditional IRA: Opening a traditional Individual Retirement Account allows you to invest your savings while realizing some sizable tax breaks.

Under federal tax rules, you can contribute up to $5,500 a year to an IRA. If you’re single and don’t have a workplace plan, you can deduct your entire IRA contribution, which could result in more than $1,000 in tax savings.

Related: 401(k) vs. Roth 401(k): Which one’s right for you?

Instead of paying the taxes now, you’ll pay them when you withdraw your money during retirement. That’s great — as long as you don’t expect to be in a higher tax bracket when you retire. If you think you will be, a traditional IRA may not be the best choice, Bera said.

IRAs also have some limitations: If you tap into the money before you turn 59 1/2, you will be hit with income taxes and a 10% early withdrawal penalty. And by age 70 1/2, you will be forced to make withdrawals, and pay the accompanying taxes.

Roth IRA: For savers who are in a lower tax bracket and can do without the immediate tax savings, a Roth IRA may be a better option, said Wendy Weaver, a Bethesda, Md.-based certified financial planner and portfolio manager at FBB Capital.

With a Roth, you contribute after-tax dollars, but don’t pay any taxes on withdrawals during retirement. The accounts are ideal for young workers since contributions can grow for decades tax-free, helping you to avoid a big tax hit come retirement.

The contribution limit is the same as a traditional IRA($5,500) as long as you don”t exceed income thresholds ($114,000 for single filers and $181,000 for married couples).

Some other pluses: unlike a traditional IRA, you can withdraw your contributions at anytime without any taxes or penalties.However, if you withdraw any investment earnings on those contributions, you will get hit with taxes and the 10% penalty.

Special provisions in federal law allow you to use the earnings from your Roth or tap a traditional IRA without penalty for education expenses or for a first-time home purchase (up to $10,000). You’ll still have to pay income taxes though.

Related: What you need to know about Obama’s ‘myRA’ retirement accounts

If you want to balance out your tax hits between now and retirement, you can split your contributions among a Roth and traditional account, said Weaver. “When it’s time to make withdrawals, you have different buckets of money that have different tax treatments,” she said.

Brokerage account: Still have extra cash to save after you max out your IRA contributions? Brokerage accounts offer a flexible place to invest after-tax dollars, Bera said. Discount brokerage firms like Charles Schwab or TD Ameritrade, for example, allow you to invest in a variety of low-cost mutual funds.

And since you’re using after tax-dollars, brokerage savings can be used for non-retirement purposes as well, such as a down payment on a home. But remember, any earnings you make on your investments will be subject to capital gains tax when you sell them.

MyRA: Should investing in stocks on your own make you a little uneasy,President Obama recently announced the creation of a new “myRA” savings account aimed at workers without workplace retirement benefits.

The accounts, which will be offered through a pilot program later this year, won’t lose money since they will invest in government bonds. But they will also get paltry returns of around 2% to 3%, which will likely barely outpace inflation.


Find Hidden IRA Savings

Illustration by Serge Bloch for TIME

These three lesser-known strategies can help you shelter even more income from Uncle Sam.

Tax day is fast approaching, and with it the deadline for one of the best opportunities to juice your retirement savings and cut your tax bill: an individual retirement account.

Unlike most tax breaks, which expire at the end of the tax year, you have until midnight on April 15 to make a 2013 IRA contribution — of up to $5,500, or $6,500 if you’re 50-plus.

Already putting money in? Pat yourself on the back: Only 15% of households saved in an IRA last year, according to the Investment Company Institute. But you may be missing opportunities to sock away even more. And if you’re not participating because you think your income doesn’t allow it? There’s a workaround for that too, which you ought to consider.

After all, the more you can put away in IRAs, the better. “They’re one of the best tax breaks you can take advantage of for retirement,” says New York CPA Ed Slott, founder of

As you may know, contributions to a traditional IRA are fully deductible up to certain income limits — for 2013, $59,000 in modified adjusted gross income for single folks and $95,000 for couples filing jointly. With a Roth — eligibility for which starts phasing out at $178,000 for couples in 2013 — you get no write-off upfront, but get to withdraw funds tax-free in retirement.

In both types, your money grows without the drag of taxes. (President Obama recently announced another IRA for beginning savers, the MyRA.) Maximize these benefits with the tactics that follow, but you may want to hurry. Time’s running out to reduce your 2013 bill.

Save for a spouse

While the IRS says you must have earned income to stash cash in an IRA, there’s one exception: You can put money in on a spouse’s behalf if he or she has no income, so long as you file jointly. “The IRS doesn’t want to penalize a spouse for not working,” says Adam Glassberg, a financial planner in the Chicago area.

A spousal IRA can be either traditional or Roth, with the same contribution allowances. One big, important difference is that contributions made to a traditional spousal IRA are fully deductible up to a higher income — $178,000 in modified adjusted gross — than for joint filers who both have access to a 401(k). Assuming you qualify for that deduction, a $5,500 contribution will shave $1,540 off your 2013 taxes if you’re in the 28% tax bracket.

Stash self-employment income

Do you work for yourself? Or did you do a freelance gig or two on the side last year? The savings opportunity is especially good for you.

You can contribute as much as 25% of net self-employment earnings, up to $51,000 for 2013, to a simplified employee pension plan, or SEP IRA. That’s in addition to the $5,500 you can put in a traditional or Roth IRA, plus the $17,500 you can put in a 401(k) if you have one through a primary occupation. So it’s an especially worthwhile strategy for moonlighters who are already maxing out a workplace retirement plan. Plus, SEP contributions are fully deductible.

“It’s a really valuable way to save and reduce your taxes,” says Newport Beach, Calif., financial planner Dan Thomas.

Use the back door to a Roth

Even if you make too much to write off a traditional IRA contribution, you’re still eligible to stash money in such an account. Without the deduction, a traditional IRA can lag behind a brokerage account invested in index funds or other tax-efficient holdings. But you may still have good reason to open one: A nondeductible IRA allows you to sidestep your way into a Roth if you wouldn’t otherwise be eligible based on income.

You can convert a traditional IRA to a Roth at any time, no matter your AGI. Assuming you have no other IRAs and shift over the funds immediately — before you have gains — you won’t owe any taxes. (If you do have any existing deductible IRA savings, you will owe prorated tax based on the total balance, to essentially pay back the write-off you took upfront.)

Moving to a Roth can be especially beneficial if you think your tax bracket will be the same or higher in retirement. Unfortunately, this strategy won’t help you fend off Uncle Sam this month, but you might be quite thankful 20 years down the road.

MONEY Ask the Expert

Can My 80-Year-Old Dad Give Me Money from His IRA?

You can't transfer money directly from an IRA to a child. Photo: Shutterstock

Q: My 80-year-old father has a substantial amount in his IRA. Can he give it to his children right now? — Roxanne, Brownsville, Texas

A: Your dad can’t transfer the account directly, says Ed Slott, publisher of Ed Slott’s IRA Advisor newsletter; he could, however, take out all he wants, pay any taxes due, and then hand out the money.

His withdrawals from a traditional IRA, other than nondeductible contributions, would be taxed as ordinary income; Roth IRA withdrawals are tax-free if the account has been open for five years.

Unless the kids need cash urgently, it’s better to name them as beneficiaries.

Upon your dad’s death, a child can keep the assets growing tax-deferred in an IRA, taking mandatory minimum distributions based on life expectancy. Money from a traditional IRA is taxable; inherited Roth money generally isn’t.


Maxed out Your 401(k)? Here’s How to Save More for Retirement

B.A.E. Inc.—Alamy

My 401(k) contribution has been capped at 6%. How do I save more for retirement? — Frankie L., Arlington, Va.

As you’ve found, the IRS limits 401(k) contributions by high earners — chiefly those who earned more than $115,000 in 2012 — unless their company ensures that lower-paid workers are also saving for retirement.

Start by putting $5,500 ($6,500 if you’re at least 50 by year-end) into a Roth IRA, which offers tax-free withdrawals in retirement, says Moline, III., financial planner Marty Kurtz.

In 2013 your allowed contribution falls to zero if your income tops $188,000 ($127,000 if you’re single), but anyone under 70½ with earnings can fund a nondeductible IRA and then convert it to a Roth. But you may owe taxes on this back-door deposit if you have other traditional IRAs.

Then buy low-fee, tax-efficient funds in a taxable account, says Kurtz. Index funds work well; their infrequent trading minimizes taxable gains.


Retiring? Make the Best Use of Tax-Deferred Plans

From the years you spend tending to your portfolio to the time when you finally get to enjoy sweet success, you face questions about what to do. Ace these and prosper.

This story is part of Money magazine’s story 5 retirement choices: Get ‘em right, live well which covers big decisions that can dramatically boost your income in retirement.

Once you determine how much of a saver you are, you have several more decisions to make — including how to best take advantage of tax-deferred plans.

Decision No. 4: What’s the best use of tax-deferred plans?

The decision: When it comes to your 401(k), IRA, and Roth IRA, you potentially face two decisions. One is divvying up your investments between taxable and tax-advantaged accounts. The other is when to tap each type of account.

Why it’s important: You have virtually no control over what happens to tax rates. But you can reduce the drag that taxes can have on your investments.

Regardless of how Congress may change taxes in the future, you’ll almost certainly continue to face different tax rates on different types of investments.All gains in 401(k)s and traditional IRAs are taxed at ordinary income rates when withdrawn (a top rate of39.6% in 2013); outside of these plans, you face lower rates on long-term capital gains and dividends (a max of 20% in 2013).

You can minimize the tax man’s take by keeping investments like stock index funds, stock ETFs, and dividend funds in taxable accounts to take advantage of long-term capital gains rates and holding bond funds and actively managed stock funds that trade a lot in tax-deferred accounts.

In retirement, the idea is to blunt the effect of taxes by tapping your nest egg in a tax-efficient manner. The traditional advice is to pull money from taxable accounts first, where you’ll presumable pay the lower capital gains rate, then move on to tax-deferred accounts like 401(k)s and IRAs, and finally Roth IRAs. The balances in your tax-advantaged accounts will have more time to compound tax-free.

Best move: While these strategies can be effective — Morningstar estimates that following both in retirement can up your income by roughly 8% — stay flexible. In fact, says David Blanchett, Morningstar’s head of retirement research, “you should maintain your target stocks/bonds mix first and then allocate your assets as best you can for tax efficiency.”

Related: The other way to invest in a Roth IRA

Similarly, you don’t want to be too rigid about withdrawals. In some years, for example, you may be able to sell taxable investments at a loss and use that loss to offset taxes on your 401(k) or IRA withdrawals. By liquidating taxable accounts early in retirement, you lose that flexibility. And once you reach age 70½, you’re required to draw at least some money from your IRA and, unless you’re still working, your 401(k).

Besides, you can’t know what the tax system will look like down the road. Having savings in a variety of accounts that receive different tax treatment gives you more leeway for managing withdrawals — and your tax bill — later.



The other way to invest in a Roth IRA

My income is too high to contribute to either a deductible IRA or a Roth IRA. So am I better off investing in a nondeductible IRA or should I just invest my money in a regular taxable account? — Dennis, Cranston, R.I.

You’re giving up on the Roth IRA too easily.

Even if your income exceeds the Roth IRA income eligibility requirements — and I suggest you check out this calculator to verify whether that’s really the case — you can easily get around that hurdle: Simply open up a nondeductible IRA — which anyone under age 70½ with earned income can do — and then immediately convert the nondeductible IRA to a Roth IRA.

If you avail yourself of this option — colloquially known as a backdoor Roth IRA — before April 15th, you can make the contribution for the 2012 tax year. By doing that, you’ll still preserve the option of making a contribution for 2013 as well.

The maximum contribution for 2012 is $5,000 ($6,000 if you’re 50 or older), while the limit for 2013 is $5,500 ($6,500 if you’re 50 or older). So if you contribute for both years, you can get quite a nice sum into that Roth this year: as much $10,500 if you’re under 50, $12,500 otherwise.

Keep in mind that whenever you convert funds to a Roth, you must pay income tax on any portion of the converted amount that has yet to be taxed. This isn’t likely to be much of an issue if the only IRA you own is the nondeductible IRA you open and then convert.

Related: Your future self thinks you should save more

After all, you made your contribution in after-tax dollars, so those funds won’t be taxed again. The only tax bill you would incur is on investment gains, if any, that accumulate in your nondeductible IRA between the time you opened it and the conversion.

But if you also have money in other non-Roth IRAs — say, traditional deductible or nondeductible IRAs you opened years ago or a rollover IRA that holds money from a 401(k) with a previous employer — then you’ve got to consider the balances in those accounts when figuring the tax on the conversion.

For example, if you have $45,000 in an IRA rollover that consists totally of pre-tax dollars and you contribute $5,000 to a nondeductible IRA that you plan to convert, 90% ($45,000 in pretax dollars divided by your total IRA balance of $50,000), or $4,500, of your $5,000 conversion would be taxable. If your nondeductible IRA had investment earnings, those untaxed gains would have to be included in the calculation as well.

So if you were in, say, the 33% tax bracket, you would owe $1,485 in taxes on the conversion, which means you would effectively have to come up with $6,485 to get $5,000 into a Roth IRA.

But if you’re in this position — that is, you already have money in non-Roth IRAs andwant to get money into a Roth IRA but earn too much — there are two other maneuvers you may want to consider.

If you have a 401(k) plan through work and it accepts IRA rollover money (as most do) you could roll your IRA funds into the 401(k) and then convert your nondeductible IRA. Since you would have no other IRA money, you could convert your nondeductible IRA and avoid taxes (assuming your nondeductible IRA had no investment gains).

The other move you might consider is taking the money that you would have contributed to the nondeductible IRA and paid in taxes to convert that account ($6,485 in the example above) and use those funds to pay the tax to convert as much of the money in any existing IRAs as possible.

This would allow you to get more dough into a Roth than you could via the backdoor method, or nearly $20,000 assuming a 33% tax rate.

If you choose this last route, don’t forget that any pretax dollars you convert are considered taxable income. So moving more money into a Roth could push you into a higher tax bracket and boost your conversion tax bill.

Remember too that converting IRA funds to a Roth IRA — or contributing to a Roth IRA, for that matter — usually makes the most sense if you think you’ll face the same or higher tax rate when you withdraw the money as you did when converting.

That said, unless you’re absolutely sure you’ll face a lower tax rate in retirement, I think it’s a good idea to have at least some money in a Roth account if only to diversify your tax exposure.

Bottom line: if you would really rather invest money in a Roth IRA than a nondeductible IRA or a taxable account, you can easily do so. Okay, maybe “easily” is going too far. But you should definitely be able to pull it off.


New 401(k) Tax Break Is Just around the Corner

People with 401(k) plans got a nice tax break last month, but they’ll have to wait for some red tape to be cleared out of the way before they can actually take advantage of it.

Thanks to a provision in the Small Business Jobs Act, which President Obama signed into law last month, 401(k) plan participants will be permitted to roll their accounts over into Roth 401(k)s. The change will give many people with defined-contribution plans greater flexibility in paying taxes; while holders of conventional 401(k)s deposit pre-tax dollars into their accounts and pay taxes upon withdrawal, Roth 401(k) holders fund their accounts with after-tax dollars but withdraw the money tax-free. (In both cases, any investment growth within the account comes free of taxes you don’t have to pay taxes as your investments grow within your account.)

The new option is similar to that already enjoyed by conventional IRA owners, who have leeway to convert those accounts into Roth IRAs. And the tradeoffs are the same, too: As with conversions of traditional IRAs to Roth IRAs, 401(k) holders converting to a Roth 401(k) will pay taxes upfront on the amount of money they convert.

Thus, the Roth option is best for people who expect to eventually jump into a higher tax bracket (or just want to hedge against the possibility that income tax rates will rise), since account-holders who roll over now won’t have to pay taxes on money they withdraw later.

It would be great to be able to make the rollover this year, but recent public comments by a Treasury official suggest that if it happens, there will be a last-minute crunch in December. Speaking at a convention of pension professionals, associate benefits tax counsel William Bortz indicated that the government was hurrying to give guidance on how to implement the new law, but that plan sponsors should wait for the guidance to come out before allowing the rollovers.

That’s not the only catch. Among the conditions that have to be met for you to enjoy this new rollover option, your employer’s retirement savings plan must offer a Roth 401(k). Nearly a third of employers currently offer plans with Roth 401(k)s and a quarter more are likely to add the feature, according to Hewitt Associates.

Other restrictions within your plan may prevent you from rolling over portions of your 401(k) before certain age or time limits, but the new law may encourage employers to make distribution rules more flexible, since employees who want a Roth option might then be less likely to pull funds out of their 401(k).

If you are interested in a conversion, you’ll need to talk to your employer about whether your plan will allow for the 401(k) to Roth 401(k) rollover and — if so — what additional restrictions might apply, says tax and elder law expert Richard Kaplan, a professor at the University of Illinois.

The new rule, built into the Small Business Jobs Act of 2010, was an unexpected provision included, in part, to generate short-term tax revenue to offset the costs of other tax breaks in the bill, says Kaplan. “The result is that it’s caught many people by surprise,” he says, “including plan administrators.”

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