1. Save As Much As You Can As Early As You Can.
   Though it's never too late to start, the sooner you begin saving, the more time your money has to grow. Gains each year build on the prior year's -- that's the power of compounding, and the best way to accumulate wealth.
2. Set Realistic Goals.
   Project your retirement expenses based on your needs, not rules of thumb. Be honest about how you want to live in retirement and how much it will cost. Then calculate how much you must save to supplement Social Security and other sources of retirement income.
3. A 401(k) Is One Of The Easiest And Best Ways To Save For Retirement.
   Contributing money to a 401(k) gives you an immediate tax deduction, tax-deferred growth on your savings, and -- usually -- a matching contribution from your company.
4. An IRA Can Also Give Your Savings A Tax-Advantaged Boost.
   Like a 401(k), IRAs offer huge tax breaks. There are two types: a traditional IRA offers tax-deferred growth, meaning you pay taxes on your investment gains only when you make withdrawals, and, if you qualify, your contributions may be deductible; a Roth IRA, by contrast, doesn't allow for deductible contributions but offers tax-free growth, meaning you owe no tax when you make withdrawals, but contributions are not deductible.
5. Focus On Your Asset Allocation More Than On Individual Picks.
   How you divide your portfolio between stocks and bonds will have a big impact on your long-term returns.
6. Stocks Are Best For Long-Term Growth.
   Stocks have the best chance of achieving high returns over long periods. A healthy dose will help ensure that your savings grows faster than inflation, increasing the purchasing power of your nest egg.
7. Don't Move Too Heavily Into Bonds, Even In Retirement.
   Many retirees stash most of their portfolio in bonds for the income. Unfortunately, over 10 to 15 years, inflation easily can erode the purchasing power of bonds' interest payments.
8. Making Tax-Efficient Withdrawals Can Stretch The Life Of Your Nest Egg.
   Once you're retired, your assets can last several more years if you draw on money from taxable accounts first and let tax-advantaged accounts compound for as long as possible.  
9. Working Part-Time In Retirement Can Help In More Ways Than One.
   Working keeps you socially engaged and reduces the amount of your nest egg you must withdraw annually once you retire.
10. There Are Other Creative Ways To Get More Mileage Out Of Retirement Assets.
    You might consider relocating to an area with lower living expenses, or transforming the equity in your home into income by taking out a reverse mortgage.

© CPA Site Solutions

Annuities—a type of insurance product— can be an effective investment vehicle, especially in providing for your retirement. This Financial Guide will help you decide whether annuity investments are right for you and how to use them in retirement planning. It also discusses the tax treatment of annuities.

How Annuities Work

Annuities may help you meet some of your mid- and long-range goals, such as planning for your retirement and for a child's college education. This Financial Guide tells you how annuities work, discusses the various types of annuities, and helps you determine which annuity product (if any) suits your situation. It also discusses the tax aspects of annuities and explains how to shop for both an insurance company and an annuity, once you know which type you'll need.

While traditional life insurance guards against "dying too soon," an annuity, in essence, can be used as insurance against "living too long." In brief, if you buy an annuity (generally from an insurance company, which invests your funds), you will receive in return a series of periodic payments that are guaranteed as to amount and payment period. Thus, if you choose to take the annuity payments over your lifetime (there are many other options), you will have a guaranteed source of "income" until your death. If you "die too soon" (that is, you don't outlive your life expectancy), you will get back from the insurer far less than you paid in. On the other hand, if you "live too long" (and do outlive your life expectancy), you may get back far more than the cost of your annuity (and the resultant earnings). By comparison, if you put your funds into a traditional investment, you may run out of funds before your death.

The earnings that occur during the term of the annuity are tax-deferred. You are not taxed on them until they are paid out. Because of the tax deferral, your funds have the chance to grow more quickly than they would in a taxable investment.

How Annuities Best Serve Investors

Tip: Assess the costs of an annuity relative to the alternatives. Separate purchase of life insurance and tax-deferred investments may be more cost effective.

The two primary reasons to use an annuity as an investment vehicle are:

1. You want to save money for a long-range goal, and/or
2. You want a guaranteed stream of income for a certain period of time.

Annuities lend themselves particularly well to funding retirement and, in certain cases, education costs.

One negative aspect of an annuity is that you cannot get to your money during the growth period without incurring taxes and penalties. The tax code imposes a 10% premature-withdrawal penalty on money taken out of a tax-deferred annuity before age 59-1/2 and insurers impose penalties on withdrawals made before the term of the annuity is up. The insurers’ penalties are termed "surrender charges," and they usually apply for the first seven years of the annuity contract.

These penalties lead to a de facto restriction on the use of annuities primarily as an investment. It only makes sense to put your money into an annuity if you can leave it there for at least ten years and the withdrawals are scheduled to occur after age 59-1/2. These restrictions explain why annuities work well for either retirement needs or for cases of education funding where the depositor will be at least 59-1/2 when withdrawals begin.

Tip: The greater the investment return, the less punishing the 10% penalty on withdrawal under age 59-1/2 will appear. If your variable annuity investments have grown substantially, you may want to consider taking some of those profits (despite the penalty, which applies only to the taxable portion of the amount withdrawn).

Annuities can also be effective in funding education costs where the annuity is held in the child’s name under the provisions of the Uniform Gifts to Minors Act. The child would then pay tax (and 10% penalty) on the earnings when the time came for withdrawals.

Caution: A major drawback is that the child is free to use the money for any purpose, not just education costs.

The Various Types Of Annuities

The available annuity products vary in terms of (1) how money is paid into the annuity contract, (2) how money is withdrawn, and (3) how the funds are invested. Here is a rundown on some of the annuity products you can buy:

• Single-Premium Annuities: You can purchase a single-premium annuity, in which the investment is made all at once (perhaps using a lump sum from a retirement plan payout). The minimum investment is usually $5,000 or $10,000.
• Flexible-Premium Annuities: With the flexible-premium annuity, the annuity is funded with a series of payments. The first payment can be quite small.
• Immediate Annuities: The immediate annuity starts payments right after the annuity is funded. It is usually funded with a single premium, and is usually purchased by retirees with funds they have accumulated for retirement.
• Deferred Annuities: With a deferred annuity, payouts begin many years after the annuity contract is issued. You can choose to take the scheduled payments either in a lump sum or as an annuity—i.e., as regular annuity payments over some guaranteed period. Deferred annuities are used as long-term investment vehicles by retirees and non-retirees alike. They are used to fund tax-deferred retirement plans and tax-sheltered annuities. They may be funded with a single or flexible premium.
• Fixed Annuities: With a fixed annuity contract, the insurance company puts your funds into conservative fixed income investments such as bonds. Your principal is guaranteed and the insurance company gives you an interest rate that is guaranteed for a certain minimum period—from a month to several years. This guaranteed interest rate is adjusted upwards or downwards at the end of the guarantee period. Thus, the fixed annuity contract is similar to a CD or a money market fund, depending on the length of the period during which interest is guaranteed. The fixed annuity is considered a low-risk investment vehicle. All fixed annuities also guarantee you a certain minimum rate of interest of 3 to 5% for the entirety of the contract. The fixed annuity is a good choice for investors with a low risk tolerance and a short-term investing time horizon. The growth that will occur will be relatively low. Fixed annuity investors benefit if interest rates fall, but not if they rise.
• Variable Annuities: The variable annuity, which is considered to carry with it higher risks than the fixed annuity—about the same risk level as a mutual fund investment— gives you the ability to choose how to allocate your money among several different managed funds. There are usually three types of funds: stocks, bonds, and cash-equivalents. Unlike the fixed annuity, there are no guarantees of principal or interest. However, the variable annuity does benefit from tax deferral on the earnings.

Tip: You can switch your allocations from time to time for a small fee or sometimes for free.

The variable annuity is a good annuity choice for investors with a moderate to high risk tolerance and a long-term investing time horizon.

Caution: Variable annuities have higher costs than similar investments that are not issued by an insurance company.

Caution: The taxable portion of variable annuity distributions is taxable at full ordinary rates, even if they are based on stock investments. They do not enjoy capital gains relief or the reduced taxation available after 2002 and before 2009 for dividends from stock investments (including mutual funds).

Tip: Today, insurers make available annuities that combine both fixed and variable features.

Tip: Before buying an annuity, contribute as much as possible to other tax-deferred options such as IRA’s and 401 (k) plans. The reason is that the fees for these plans is likely to be lower than those of an annuity and early-withdrawal fees on annuities tend to be steep.

Tip:IRA contributions are sometimes invested in flexible premium annuities—with IRA deduction, if otherwise available. You may prefer to use IRAs for non-annuity assets. Non-annuity assets gain the ability to grow tax-free when held in an IRA. The IRA regime adds no such benefit to annuity assets which grow tax-free in or outside IRAs.

Choosing A Payout Option

When it’s time to begin taking withdrawals from your deferred annuity, you have various choices. Most people choose a monthly annuity-type payment, although a lump sum withdrawal is possible.

Caution: Once you have chosen a payment option, you cannot change your mind.

The size of your payout (settlement option) depends on:

1. The size of the amount in your annuity contract
2. Whether there are minimum required payments
3. Your life expectancy (or other payout period)
4. Whether payments continue after your death

Here are summaries of the most common forms of payout:

Fixed Amount

This type gives you a fixed monthly amount—chosen by you—-that continues until your annuity is used up. The risk of using this option is that you may live longer than your money lasts. Thus, if the annuity is your only source of income, the fixed amount is not a good choice. If you die before your annuity is exhausted, your beneficiary gets the rest.

Fixed Period

This option pays you a fixed amount over the time period you choose. For example, you might choose to have the annuity paid out over ten years. If you are seeking retirement income before some other benefits start, this may be a good option. If you die before the period is up, your beneficiary gets the remaining amount.

Lifetime or Straight Life

This form of payments continues until you die. There are no payments to survivors. The life annuity gives you the highest monthly benefit of the options listed here. The risk is that you will die early, thus leaving the insurance company with some of your funds. The life annuity is a good choice if (1) you do not need the annuity funds to provide for the needs of a beneficiary and (2) you want to maximize your monthly income.

Life With Period Certain

This form of payment gives you payments as long as you live (as does the life annuity) but with a minimum period during which you or your beneficiary will receive payments, even if you die earlier than expected. The longer the guarantee period, the lower the monthly benefit.

Installment-Refund

This option pays you as long as you live and guarantees that, should you die early, whatever is left of your original investment will be paid to a beneficiary. Monthly payments are less than with a straight life annuity.

Joint And Survivor

In one joint and survivor option, monthly payments are made during the annuitants' joint lives, with the same or a lesser amount paid to whoever is the survivor. In the option typically used for retired employees (employment model), monthly payments are made to the retired employee, with the same or a lesser amount to the employee's surviving spouse or other beneficiary. The difference is that with the employment model , the spouse's (or other co-annuitant's) death before the employee won't affect what the survivor employee collects. The amount of the monthly payments depends on the annuitants' ages, and whether the survivor's payment is to be 100% of the joint amount or some lesser percentage.

How Payouts Are Taxed

The way your payouts are taxed differs for qualified and non-qualified annuities.

Qualified Annuity

A tax-qualified annuity is one used to fund a qualified retirement plan, such as an IRA, Keogh plan, 401(k) plan, SEP (simplified employee pension), or some other retirement plan. The tax-qualified annuity, when used as a retirement savings vehicle, is entitled to all of the tax benefits—and penalties—that Congress saw fit to attach to such qualified plans.

The tax benefits are:

1. Any nondeductible or after-tax amount you put into the plan is not subject to income tax when withdrawn
2. The earnings on your investment are not taxed until withdrawal

If you withdraw money from a qualified plan annuity before the age of 59-1/2, you will have to pay a 10% penalty on the amount withdrawn in addition to paying the regular income tax. There are exceptions to the 10% penalty, including an exception for taking the annuity out in a series of equal periodic payments over the rest of your life.

Once you reach age 70-1/2, you will have to start taking withdrawals in certain minimum amounts specified by the tax law (with exceptions for Roth IRAs and for employees still working after age 70-1/2).

Non-Qualified Annuity

A non-qualified annuity is purchased with after-tax dollars. You still get the benefit of tax deferral on the earnings. However, you pay tax on the part of the withdrawals that represent earnings on your original investment.

If you make a withdrawal before the age of 59-1/2, you will pay the 10% penalty only on the portion of the withdrawal that represents earnings.

With a non-qualified annuity, you are not subject to the minimum distribution rules that apply to qualified plans after you reach age 70-1/2.

Tax on Your Beneficiaries or Heirs

If your annuity is to continue after your death, other taxes may apply to your beneficiary (the person you designate to take further payments) or your heirs (your estate or those who take through the estate if you didn't designate a beneficiary).

Income tax: Annuity payments collected by your beneficiaries or heirs are subject to tax on the same principles that would apply to payments collected by you.

Exception: There's no 10% penalty on withdrawal under age 59-1/2 regardless of the recipient's age, or your age at death.

Estate tax: The present value at your death of the remaining annuity payments is an asset of your estate, and subject to estate tax with other estate assets. Annuities passing to your surviving spouse or to charity would escape this tax.

Tip: Ask your sales representative for a recent survey by Variable Annuity Research & Data Service. Many annuity portfolios are tracked by this service.

If a particular fund has a great track record, ascertain whether the same management is still in place. Although past performance is no guarantee, consistent management will grant you better odds.

How To Shop For An Annuity

Although annuities are issued by insurance companies, they may be purchased through banks, insurance agents, or stockbrokers.

There is considerable variation in the amount of fees that you will pay for a given annuity as well in the quality of the product. Thus, it is important to compare costs and quality before buying an annuity.

First, Check Out The Insurer

Before checking out the product itself, it is important to make sure that the insurance company offering it is financially sound. Because annuity investments are not federally guaranteed, the soundness of the insurance company is the only assurance you can rely on. Consult services such as A.M. Best Company, Moody’s Investor Service, Standard & Poor’s Ratings, Duff & Phelps Credit Rating Company, and Fitch IBCA, The International Rating Agency to find out how the insurer is rated.

Next, Compare Contracts

The way you should go about comparing annuity contracts varies with the type of annuity.

• Immediate annuities: Compare the settlement options. For each $1,000 invested, how much of a monthly payout will you get? Be sure to consider the interest rate and any penalties and charges.
• Deferred annuities: Compare the rate, the length of guarantee period, and a five-year history of rates paid on the contract. It is important to consider all three of these factors and not to be swayed by high interest rates alone.
• Variable annuities: Check out the past performance of the funds involved.

Tip: Ask your sales representative for a recent survey by Variable Annuity Research & Data Service. Many annuity portfolios are tracked by this service.

If a particular fund has a great track record, ascertain whether the same management is still in place. Although past performance is no guarantee, consistent management will grant you better odds.

Costs, Penalties, And Extras

Be sure to compare the following points when considering an annuity contract:

Surrender Penalties

Find out the surrender charges (that is, the amounts charged for early withdrawals). The typical charge is 7% for first-year withdrawals, 6% for the second year, and so on, with no charges after the seventh year. Charges that go beyond seven years, or that exceed the above amounts, should not be acceptable.

Tip: Be sure the surrender charge "clock" starts running with the date your contract begins, not with each new investment.

Fees And Costs

Be sure to ask about all other fees. With variable annuities, the fees must be disclosed in the prospectus. Fees lower your return, so it is important to know about them. Fees might include:

• Mortality fees of 1 to 1.35% of your account (protection for the insurer in case you live a long time)
• Maintenance fees of $20 to $30 per year
• Investment advisory fees of 0.3% to 1% of the assets in the annuity’s portfolios.

Extras

These provisions are not costs, but should be asked about before you invest in the contract.

Some annuity contracts offer "bail-out" provisions that allow you to cash in the annuity if interest rates fall below a stated amount without paying surrender charges.

There may also be a "persistency" bonus which rewards annuitants who keep their annuities for a certain minimum length of time.

In deciding whether to use annuities in your retirement planning (or for any other reason) and which types of annuities to use, professional guidance is advisable.

Risk To Retirees of Using An Immediate Annuity

At first glance, the immediate annuity would seem to make sense for retirees with lump-sum distributions from retirement plans. After all, an initial lump-sum premium can be converted into a series of monthly, quarterly, or yearly payments that represent a portion of principal plus interest and is guaranteed to last for life. The portion of the periodic payout that constitutes a return of principal is excluded from taxable income.

However, this strategy contains risks. For one thing, when you lock yourself into a lifetime of level payments, you fail to guard against inflation. Furthermore, you are gambling that you will live long enough to get your money back. Thus, if you buy a $150,000 annuity and die after collecting only $60,000, the insurer often gets to keep the rest. Unlike other investments, the balance doesn't go to your heirs. Finally, since the interest rate is fixed by the insurer when you buy it, you may be locking yourself into low rates.

You can hedge your bets by opting for a "period certain", or "term certain" which, in the event of your death, guarantees payment for some years to your beneficiaries. There are also "joint-and-survivor" options (which pay your spouse for the remainder of his or her life after you die) or a "refund" feature (in which some or all of the remaining principal is resumed to your beneficiaries).

Some plans offer quasi-inflation adjusted payments. One company offers a guaranteed increase in payments of $10 at three-year intervals for the first 15 years. Payments then get an annual cost-of-living adjustment with a 3% maximum. However, for these enhancements to apply, you will have to settle for much lower monthly payments than the simple version.

Recently, a few companies have introduced immediate annuities that offer potentially higher returns in return for some market risk. These "variable immediate annuities" convert an initial premium into a lifetime income; however, they tie the monthly payments to the returns on a basket of mutual funds.

Older seniors—75 years of age and up— may have fewer worries about inflation or liquidity. Nevertheless, they should question whether they really need such annuities at all.

If you want a comfortable retirement income, consider a balanced portfolio of mutual funds. If you want to guarantee that you will not outlive your money, you can plan your withdrawals over a longer time horizon.

Source: CPA Site Solutions

Creating a Roth IRA can make a big difference in your retirement savings. There is no tax deduction for contributions made to a Roth IRA, however all future earnings are sheltered from taxes. The Roth IRA provides truly tax-free growth.

What is the advantage of converting to a Roth IRA?

In 1997, the Roth IRA was introduced. Since then, many people have converted all or a portion of their existing Traditional IRAs to Roth IRAs, where interest earned may be completely tax-free.

Is this a good option for you? A conversion has both advantages and disadvantages that should be carefully considered before you make a decision.

This calculator estimates the change in total net-worth, at retirement, if you convert your Traditional IRA into a Roth IRA.

Roth IRAs differ from other tax-favored retirement plans, including other IRAs (called "traditional IRAs"), in that they promise complete tax exemption on distribution. But there are other important differences as well, and many qualifications about their use. This Financial Guide shows how they work, how they compare with other retirement devices--and why YOU might want one, or more.

With most tax-favored retirement plans, the contribution to (i.e., investment in) the plan is deductible, the investment compounds tax-free until distributed, and distributions are taxable as received. There are variations from this pattern, as with 401(k)s where the exemption for salary diverted to a 401(k) takes the place of a deduction and for after-tax investments where invested capital is tax-free when distributed

With a Roth IRA, there’s never an up-front deduction for contributions. Funds contributed compound tax-free until distributed (standard for all tax-favored plans). And distributions are completely exempt from income tax.

How Contributions Are Treated

Except for conversion of traditional IRAs to Roth IRAs—and that’s a huge exception, as we’ll see—no more than $4,000 can go into a Roth IRA. To put in even that much, you must earn $4,000 from personal services and have income (technically, modified adjusted gross income or MAGI) below $95,000 if single or $150,000 on a joint return. The $4,000 limit phases out on incomes between $95,000--$110,000 (single) and $150,000--$160,000 (joint). Also, the $4,000 limit is reduced for contributions to traditional IRAs though not SEP or SIMPLE IRAs.

You can contribute to a Roth IRA for your spouse, subject to the income limits above. So assuming earnings (your own or combined with your spouse) of at least $8,000, up to $8,000 ($4,000 each) can go into the couple’s Roth IRAs. As with traditional IRAs, there’s a 6% penalty on excess contributions. Contribution dollar limits for your own Roth IRA rise to $5,000 for 2008, and after (double these amounts for Roth IRAs of a couple). Additional "catch-up" contributions are allowed persons age 50 or over, of $1,000 (2006 and after). The rule continues that the dollar limits are reduced by contributions to traditional IRAs.

Credit for low-income Roth IRA investors. "Lower-bracket" taxpayers age 18 and over are allowed a tax credit for their contributions to a plan or traditional or Roth IRA. Credit is allowed on joint returns of couples with modified adjusted gross income (MAGI) below $50,000, heads-of-household below $37,500 and others (single, married filing separately) below $25,000. These amounts are indexed for inflation starting in 2007. Credit is a percentage (10%, 20%, 50%) of the contribution, up to a contribution total (considering all contributions to all plans and IRAs) of $2,000. The lower the MAGI, the higher the credit percentage: the maximum credit is $1,000 (50% of $2,000).

How Withdrawals Are Treated

Since all your investments in a Roth IRA are after-tax, your withdrawals, whenever you make them, are often tax-free. But the best kind of withdrawal, which allows earnings as well as contributions and conversion amounts to come out completely tax-free, are qualified distributions. These are withdrawals meeting these conditions:

1. At least 5 years have elapsed since the first year a Roth IRA contribution was made or, in the case of a conversion, since the conversion occurred and
2. At least one of these additional conditions is met:

• The owner is age 59 ½ .
• The owner is disabled.
• The owner has died (distribution is to estate or heir).
• Withdrawal is for a first-time home purchase (tax-free limit of $10,000).

A qualified distribution isn’t subject to the 10% early withdrawal penalty.

Where a withdrawal isn’t a qualified distribution, it’s still generally treated as tax-free until after all after-tax contributions and conversion amounts have been recovered. However, nonqualified distributions can be hit by the early withdrawal penalty even if not subject to income tax.

Qualified distributions after the owner’s death are tax-free to heirs. Nonqualified distributions after death—which are distributions where the 5-year holding period wasn’t met—are taxable income to heirs as they would be to the owner (the earnings are taxed), except there’s no penalty tax on early withdrawal. However, an owner’s surviving spouse can convert an inherited Roth IRA into his or her own Roth IRA. This way, distribution can be postponed, so that nonqualified amounts can become qualified, and the tax shelter prolonged.

Roth IRA assets left at death are subject to federal estate tax, just as traditional IRA assets are.

Converting From a Traditional IRA

Opportunity. Cost. Risk. These features of your option to convert your traditional IRA to a Roth IRA are what’s caused most of the excitement about Roth IRAs. Conversion means that what would be taxable traditional IRA distributions can be made tax-exempt Roth IRA distributions. That’s the Opportunity. The Cost—tax cost—is that the amount converted this year or after is fully taxable in the year converted, except for the portion of after-tax investment in the traditional IRA.

So you must pay tax now (though there’s no early withdrawal penalty) for the opportunity to withdraw tax-free later, an opportunity that can extend to your heirs.

Conversion is allowed only to taxpayers with income (again, MAGI) of $100,000 or less in the conversion year. That’s $100,000 for a single person and $100,000 for a couple filing jointly; a married person filing separately can’t convert. (The taxable amount converted isn’t counted in figuring whether income exceeded $100,000.) The risk is that if income exceeds $100,000, the conversion is taxable—as you expected—but the IRA your funds went to doesn’t qualify as a Roth IRA. And you will owe a 6% excess contribution penalty and maybe a 10% early withdrawal penalty (on the traditional IRA withdrawal).

The rule barring conversion to Roth IRA for taxpayers with MAGI above $100,000 is scheduled to end in 2010.

Note: Congress passed the removal of the $100,000 MAGI ceiling under unusual circumstances.  Some tax professionals question whether the rule will actually go into effect.

Tip: Such a removal would benefit higher-income taxpayers by effectively eliminating the rule barring ROTH IRA contributions for taxpayers with incomes above $110,000 (single) or $160,000 (married filing jointly).  That is, such taxpayers could contribute to traditional IRAs (where there is no such barrier) and then convert them to Roth IRAs in 2010.  If this technique interest you, check for your professional adviser's view.

The IRS has done what it can to make conversion easy. You can have a fund transfer of your traditional IRA assets to a Roth IRA, which is done between the trustees of the two IRAs, whether they are in the same or different financial institutions. Or you can do it yourself, moving the assets from the traditional to the new Roth IRA, which is subject to tax withholding and which must be completed within 60 days of withdrawal (the 60-day deadline can be extended in hardship cases).

Conversions from traditional to Roth IRAs are sometimes called rollovers. But you may rollover—tax-free—from one Roth IRA to another Roth IRA. This might be done to set up separate Roth IRAs for different beneficiaries.

Directly converting retirement assets from a company or Keogh plan to a Roth IRA won't be allowed until 2008. But it’s legal to rollover from such plans to a traditional IRA, and then convert. And you can convert SEP and SIMPLE IRAs to Roth IRAs.

Undoing a Conversion to a Roth IRA

Since everyone recognizes that conversion is a high-risk exercise, the law and liberal IRS rules provide an escape hatch: You can undo a Roth IRA conversion by what IRS calls a "re-characterization". This move, by which you move your conversion assets from a Roth IRA back to a traditional IRA, makes what would have been a taxable conversion into a tax-free rollover between traditional IRAs.

Tip: One reason to do this would be where you find you’ve exceeded the $100,000 income ceiling for Roth IRA conversions.

Tip: Another reason to do this, dramatized by a volatile stock market, is where the value of your portfolio drops sharply after the conversion.

Example: If your assets are worth $180,000 at conversion and fall to $140,000 later, you’re taxed on up to $180,000, which is $40,000 more than you now have. Undoing—re-characterization—avoids the tax, and gets you out of the Roth IRA.

Re-characterization can be done any time until the due date for the return for the year of conversion. Unfortunately, there’s no current protection against the case where a taxpayer is later—say, on audit—found to exceed the $100,000 income ceiling because of overlooked income or mistaken deductions—one more example of conversion’s high risk. (IRS can grant special relief, on request, for good faith errors.)

Can you undo one Roth IRA conversion and then make another one—a reconversion? Yes—once, subject to these requirements: Reconversion must take place in the tax year following the original conversion to Roth IRA, and the reconversion date must also be more than 30 days after the previous recharacterization transfer from the Roth IRA back to the traditional IRA.

Withdrawal Requirements

Since tax-favored retirement plans are for retirement, there’s a general requirement that plan withdrawals must begin when the owner reaches age 70 ½, and continue at a rate calculated to pay out completely at the end of the owner’s life expectancy (or a joint and survivor life expectancy with a beneficiary). The beginning date can generally be postponed for employees who continue working, but the rule is absolute for business owners and for IRAs.

But not for Roth IRAs. Roth IRA owners need not withdraw at any age, and an IRA beneficiary can spread withdrawal over his or her life expectancy.

Also, unlike traditional IRAs (but like other tax-favored retirement plans), a Roth IRA owner who continues working may continue to contribute to the Roth IRA.

Use In Estate Planning

Though Roth IRAs enjoy no estate tax relief, they are already figuring in estate plans. The aim is to build a large Roth IRA fund—largely through conversion of traditional IRAs—to pass to beneficiaries in later generations. The beneficiaries will be tax exempt on withdrawals (of qualified distributions) and the Roth IRA tax shelter continues by spreading withdrawal over their lifetimes.

*   *   *   *

Long-term planning with Roth IRAs. If you would be allowed a deduction for a contribution to a traditional IRA, contributing to a Roth IRA means surrendering current tax reduction for future tax reduction (to zero) for qualified distributions. This can be presented as an after-tax return-on-investment calculation involving assumed future tax rates. The higher the projected tax rate at withdrawal, the more tax Roth IRA saves.

Comparable considerations apply to conversions to Roth IRAs. Here the taxpayer incurs substantial current tax cost (directly or indirectly reducing the amount invested) for future tax relief to the taxpayer or an heir. So the return on investment resulting from conversion increases as projected future rates rise.

A key element in making such projections is the possibility that current and future federal deficits will lead to future tax rate increases—a factor which would tend to encourage current Roth IRA investment and conversion. On the other hand, there’s the question whether Roth IRA benefits currently promised will survive into future decades.

Highly sophisticated planning is required for Roth IRA conversions. Consultation with a qualified advisor is a must.

© CPA Site Solutions

Don't rely solely on Social Security for your retirement needs. It is an iffy proposition since the percentage of people 65 and older is increasing rapidly.

The Big Social Security Myth: It ensures that we’re financially “secure” in our later years.

Fact: Its own financial future is in peril. In other words, don’t count on Social Security offering the same financial security in 20 or 30 years as it does for today's retirees.

It’s hard to imagine surviving retirement without the comfort of monthly Social Security checks arriving in the mail. Before 1935, Americans did exactly that, however. It took the abject poverty of the elderly during the Great Depression to convince Congress to approve President Roosevelt's plan for basic subsistence payments to senior citizens.

The Salad Days Are Over
The program’s salad days started in 1972, when benefits were linked to the nation’s inflation rate, guaranteeing recipients that their monthly payments would rise with each year’s cost of living. The party’s over. The burden on working Americans grows each year. Payroll taxes siphon 6.2% of the first $94,200 a person earned in 2006-- an all-time high.

It Cuts Both Ways
From a financial planning perspective, Social Security is a double-edged sword. The program has a positive impact because it provides a basic level of retirement income. The flip side is that Social Security engenders a false sense of security, lulling many people into thinking they do not need to work very hard and sacrifice very much to save for retirement because those government checks will just keep rolling in.

Times have changed since 1935, and for the worse. When Social Security was started, 16 workers were paying into the system for every retiree receiving benefits. Now, only three workers contribute per retiree and by the year 2020 the ratio will be two to one -- two workers paying in for every retiree taking out. Even with several changes enacted in recent years to address the shortfall, Social Security still can't provide the same level of benefits 20 years from now that it does today.

Charting Your Own ‘Survival’ Route
What does this mean for your retirement planning? You should count on getting something, but "something" is not going to increase with inflation. Your retirement benefits depend on the number of fiscal quarters (or three-month increments) you have worked, the amount of your annual income in each of the last 35 years of your working life, and your age at retirement.

The higher your earned income, the more your monthly benefits will be, although these increases are not proportional. For example, let’s assume that you are single and your lifetime income inched upward from year to year. If you received $30,000 during your last year of work, your monthly benefits would start at somewhere around $1,100. But if you double your income to $60,000, the benefits only increase about 15% to $1,250.

Benefits provide a minimum level of coverage, but don't expect to live on Social Security alone. The average monthly payment in 2006 was $1,010. Women are particularly vulnerable to lower benefits -- they often leave the work force for periods of time to raise children, and they generally received lower pay than men throughout their working lives.

Get A Social Security Statement
Regardless of your exact future benefits, Social Security is still an important part of your retirement planning. The best way to start is by finding out your estimated benefits through the Social Security’s Internet request for a statement on its website. The Social Security Administration also is now sending out annual updates of the statement, sent shortly after your birthday.

The report shows your estimated annual benefits at age 62, at your "normal" retirement age (65 to 67, depending on your year of birth), and at age 70. These are estimates of future benefits, with an actual dollar amount at that time. If a projected benefit is $1,500 a month at age 65, that may sound terrific to you now because you’re thinking of what $1,500 buys today.

Taking Steps To Protect Yourself
There are some important steps to take when you get your report. First, check your reported earnings for each year you worked. Just like any other bureaucracy, mistakes are made.

Second, take a good look at how your benefit varies according to your retirement age. If you retire at 62, generally you will only get 80% of your benefits at normal retirement age. Conversely, you will get an extra 8% for each year you work past your normal retirement age. If you’re married, your non-working spouse will get 37.5% of your benefits if you retire early and 50% at your normal retirement age.

Remember that the normal retirement age is no longer necessarily 65.  The full retirement age is increasing gradually to age 67 by the year 2027. Looking at your various retirement benefits, you can figure out the best time for you to start taking Social Security.

Third, decide how much you want to rely on Social Security. The younger you are, the more likely it is that your benefits will be less than projected. As a safety measure, you might assume your actual annual benefit would be 75% of current estimates. Whatever your method, plug that Social Security number into your retirement needs analysis to see how much you will have to save on your own to provide the income you want. Then make a plan to save even more than that, if you can.

Don’t Pick Up That Phone
One final tip: When you deal with the Social Security Administration, do it in writing. If doing so is impossible, go to a Social Security office. Use the telephone as a last resort. Whether in person or by phone, take copious notes, and get the employee’s name and ID number with whom you are dealing.

You won’t be penalized if you receive incorrect information from the employee and you have proof. If you are not happy with the Social Security Administration's decision about your situation, you can file a “reconsideration.” You can also ask to have any deadlines waived until your problems are resolved.

It’s Your Money
Social Security was never designed to pay for a life of luxury, but even with its current fiscal woes, you can probably count on something when you retire.

There are several "rescue" plans on the table now, allowing workers to invest some of their Social Security contributions themselves, allowing the federal government to invest some of the programs' billions in the stock market, and making other massive changes to the system. Whatever the outcome, it’s clear that the days of guaranteed, steadily increasing benefits are over.

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Several different types of retirement plan — 401(k), defined benefit, profit-sharing — can be made to suit a prosperous small business or professional practice. But if yours is a really small business — home-based, a start-up, a sideline — maybe you should consider adopting a SIMPLE plan.

SIMPLE is a type of retirement plan specifically designed for small business. SIMPLE is the somewhat strained acronym for "Savings Incentive Match Plans for Employees." As you guessed, they thought of the SIMPLE acronym first, and built the official name later.

SIMPLEs are intended to encourage small business employers to offer retirement coverage to their employees, and some have done so. But SIMPLE features work well for self-employed persons without employees. Here's what can be good for you about them — and what's not so good.

SIMPLEs contemplate contributions in two steps: first by the employee out of salary, and then by the employer, as a "matching" contribution (which can be less than the employee contribution). Where SIMPLEs are used by self-employed persons without employees — as IRS expressly allows — the self-employed person is contributing both as employee and employer, with both contributions made from self-employment earnings. (One form of SIMPLE allows employer contributions without employee contributions. The ceiling on contributions in this case makes this SIMPLE option unattractive for self-employeds without employees.)

How Much You Can Put in and Deduct

Those with relatively modest earnings will find that a SIMPLE lets them contribute (invest) and deduct more than other plans. With a SIMPLE, you can put in and deduct some or all of your self-employed business earnings. The limit on this "elective deferral" is $10,500 in 2007, after which it can rise further with the cost of living.

If your earnings exceed that limit, you could make a modest further deductible contribution--specifically, your matching contribution as employer. Your employer contribution would be 3% of your self-employment earnings, up to a maximum of the elective deferral limit for the year. So employee and employer contributions for 2007 can't total more than $21,000.

Catch up. Owner-employees age 50 or over can make a further deductible "catch up" contribution as employee. This is $2,500 in 2006 and 2007.

Example: An owner-employee age 50 or over in 2007 with self-employment earnings of $40,000 could contribute and deduct $10,500 as employee plus a further $2,500 employee catch up contribution, plus $1,200 (3% of $40,000) employer match, or a total of $14,200.

Low-income owner-employees in SIMPLEs may also be allowed a tax credit up to $1,000.

SIMPLE is good for the home-based business and can be ideal for the moonlighter — the full-time employee, or the homemaker, with modest income from a sideline self-employment business. With living expenses covered by your day job (or your spouse's job), you could be free to put all your sideline earnings, up to the ceiling, into SIMPLE retirement investments.

Keogh plans could allow you to contribute more, often much more, than SIMPLEs. For example, if you are under 50 with $50,000 of self-employment earnings in 2007, you could contribute $10,500 as employee to your SIMPLE plus a further 3% of $50,000 as an employer contribution, for a total of $12,000. A Keogh 401(k) plan would allow a $25,500 contribution.

With $100,000 of earnings, it would be a total of $13,500 with a SIMPLE and $35,500 with a 401(k).

Withdrawal: Easy, but Taxable

There’s no legal barrier to withdrawing amounts from your SIMPLE, whenever you please. There can be a tax cost, though: Besides regular income tax, the 10% penalty tax on early withdrawal (generally, withdrawal before age 59 1/2) rises to 25% on withdrawals in the first two years the SIMPLE is in existence.

A Simple Plan

SIMPLE really is simpler to set up and operate than most other plans. Contributions go into an IRA you set up. Those familiar with IRA rules — in investment options, spousal rights, creditors' rights — don't have a lot new to learn.

Requirements for reporting to the IRS and other agencies are negligible, at least for you the self-employed person. (Your SIMPLE plan's trustee or custodian--typically an investment institution--has reporting duties.)

And the process for figuring the deductible contribution is a bit simpler than with other plans.

What's Not So Good about SIMPLEs

We've seen that other plans can do better than SIMPLE once self-employment earnings become significant. Other not-so-good features:

Because investments are through an IRA, you're not in direct control. You must work through a financial or other institution acting as trustee or custodian, and will in practice have fewer investment options than if you were your own trustee, as you could be in a Keogh. (For many self employeds, this won't be a big issue.) In this respect, a SIMPLE is like the SEP-IRA.

Other plans for self-employed persons allow a deduction for one year (say 2007) if the contribution is made the following year (2008) before the prior year's (2007) return is due (April 2008 or later extensions). This rule applies with SIMPLEs, for the matching (3% of earnings) contribution you make as employer. But there's no IRS pronouncement on when the employee's portion of the SIMPLE is due where the only employee is the self-employed person. Those who want to delay contribution would argue that they have as long as it takes to compute self-employment earnings for 2007 (though not beyond the 2007 return due date, with extensions).

Tip: The sooner your money goes in the plan, the longer it's working for you tax-free. So delaying your contribution isn't the wisest financial move.

It won't work to set up the SIMPLE plan after a year ends and still get a deduction that year, as is allowed with SEPs. Generally, to make a SIMPLE plan effective for a year it must be set up by October 1 of that year. A later date is allowed where the business is started after October 1; here the SIMPLE must be set up as soon thereafter as administratively feasible.

There's this problem if the SIMPLE is for a sideline business and you're in a 401(k) in another business or as an employee: The total amount you can put into the SIMPLE and the 401(k) combined can't be more than $15,500 (2007 amount)--$20,500 if catch up contributions are made to the 401(k) by one age 50 or over. So one under age 50 who puts $8,000 in her 401(k) can't put more than $7,500 in her SIMPLE, in 2007. The same limit applies if you have a SIMPLE while also contributing as an employee to a "403(b) annuity" (typically for government employees and teachers in public and private schools).

How to Get Started in a SIMPLE

You can set up a SIMPLE on your own by using IRS Form 5304-SIMPLE or 5305-SIMPLE, but most people turn to financial institutions. SIMPLES are offered by the same financial institutions that offer IRAs and Keogh master plans. Setting up a SIMPLE for your self-employed business is much like setting up a Keogh in a master plan. If anything, it’s, um, simpler — simpler because you have fewer choices than with a Keogh.

You can expect the institution to give you a plan document (approved by IRS or with approval pending) and an adoption agreement. In the adoption agreement you will choose an "effective date" — the beginning date for payments out of salary or business earnings. That date can't be later than October 1 of the year you adopt the plan, except for a business formed after October 1.

Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE. You need such an agreement even if you pay yourself business profits rather than salary.

Printed guidance on operating the SIMPLE may also be provided. You will also be establishing a SIMPLE IRA account for yourself as participant.

Keoghs, Seps and SIMPLES Compared

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Who is entitled to Social Security disability benefits?

An individual who is determined by the Social Security Administration to be "disabled" receives a Certificate of Award. This Certificate explains how much the disability benefit will be and when payments start. It also tells you when you can expect your condition to be reviewed to see if there has been any improvement.

If family members are eligible, they will receive a separate notice and a booklet about things they need to know.

Generally, a worker is entitled to disability if he or she is:

• insured for disability
• under age 65
• been disabled or expected to be disabled for at least 12 months
• has filed an application for benefits and
• completed a five month waiting period.

Disability is generally defined as the inability to perform substantial gainful activity due to a medical or mental impairment. Meeting this definition under Social Security is difficult. Insured means that you have accumulated sufficient credits in the Social Security system. Visit the Social Security Administration's Website to apply for an estimate.

When do Social Security disability benefits begin?

If you are getting disability benefits on your own work record, or if you are a widow or widower getting benefits on a spouse's record, your payments cannot begin before the sixth full month of disability.

If the sixth month has passed, your first payment may include some back benefits. Your check should arrive on the third day of every month. If the third falls on a Saturday, Sunday, or legal holiday, you will receive your check on the last banking day before then. The check you receive is the benefit for the previous month.

Example: The check you receive dated July 3 is for June. Your benefit can either be mailed to you or be deposited directly into your bank account.

Are Social Security disability benefits taxable?

Some people who get Social Security have to pay taxes on their benefits. The rules are the same regardless as to whether Social Security benefits are received due to retirement or disability. You will be affected only if you have substantial income in addition to your Social Security benefits. If you are married and file a separate return, you probably will pay taxes on your benefits.

How long do Social Security disability payments continue?

Your disability benefits generally continue for as long as your impairment has not medically improved and you cannot work. They will not necessarily continue indefinitely, however.

Because of advances in medical science and rehabilitation techniques, an increasing number of people with disabilities recover from serious accidents and illnesses. Also, many individuals, through determination and effort, overcome serious conditions and return to work in spite of them.

What happens to Social Security disability benefits when I reach retirement age?

If you are still getting disability benefits when you turn 65, your benefits will be automatically changed to retirement benefits, generally in the same amount. You will then receive a new booklet explaining your rights and responsibilities as a retired person.

If you are a disabled widow or widower, your benefits will be changed to regular widow or widower benefits (at the same rate) at 60, and you will receive a new instruction booklet that explains the rights and responsibilities for people who get survivors benefits.

What happens if Social Security turn down my claim for disability benefits?

If you disagree with SSA’s decision, you can appeal it. You have 60 days to file a written appeal with any Social Security office. Generally, there are four levels to the appeals process. They are:

• Reconsideration. Your claim is reviewed by someone who did not take part in the first decision.
• Hearing Before an Administrative Law Judge. You can appear before a judge to present your case.
• Review by Appeals Council. If the Appeals Council decides your case should be reviewed, it will either decide your case or return it to the administrative law judge for further review.
• Federal District Court. If the Appeals Council decides not to review your case or if you disagree with its decision, you may file a lawsuit in a federal district court.

If you disagree with the decision at one level, you have 60 days to appeal to the next level until you are satisfied with the decision or have completed the last level of appeal.

You have two special appeal rights when a decision is made that you are no longer disabled.

They are as follows:

• Disability Hearing. As part of the reconsideration process, this hearing allows you to meet face-to-face with the person who is reconsidering your case to explain why you feel you are still disabled. You can submit new evidence or information and can bring someone who knows about your disability. This special hearing does not replace your right to also have a formal hearing before an administrative law judge (the second appeal step) if your reconsideration is denied. 
• Continuation of Benefits. While you are appealing your case, you can have your disability benefits and Medicare coverage (if you have it) continue until an administrative law judge makes his or her decision. However, you must request the continuation of your benefits during the first 10 days of the 60 days mentioned earlier. If your appeal is not successful, you may have to repay the benefits.

Will I receive Social Security when I retire?

Believe it or not, you will get Social Security when you retire. It's likely to replace a smaller percentage of your income than in the past, however, and you may end up having to work longer to get full benefits. To get the most from Social Security, make sure that you pay the required tax and that your account shows all your earnings. Then work as long as you can.

You can collect early retirement benefits at age 62, but you currently can't get full benefits until 65. Then you can collect additional benefits for every year you delay your retirement until age 70. After you begin to collect Social Security benefits, you will continue to receive them for life.

How can I find out what Social Security will pay me when I retire?

Request a Personal Earnings and Benefit Estimate Statement from the Social Security Administration. The PEBES contains your entire salary history, including the Social Security and Medicare taxes you have paid. It tells you what benefits you can expect, depending on when you retire. You can collect benefits as early as age 62, but benefits will be higher if you wait until your full retirement age, which ranges from 65, for those born before 1938, to 67, for people born after 1959. You get an even bigger check if you wait until 70 to retire. The statement also covers disability and survivor benefits for your family.

Check Social Security Online or call 1-800-772-1213 for information on applying for the statement. You should ask for a PEBES every three years to make sure that the government has accurate information. By law, the Social Security Administration is under no obligation to correct mistakes after a little more than three years.

Can I count on Social Security being around when I retire?

With retirement on the horizon for hordes of baby boomers, you can bet there will be the political clout to keep Social Security going. However, the Social Security trust fund will be unable to pay benefit increases currently scheduled (which increase annually as the taxable wage base rises) without some kind of reform. A number of proposals have been offered to resolve the problem.

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Do you wonder how much you might receive in Social Security? Use this calculator to help you estimate your Social Security benefits.

Remember, this is only an estimate. Your actual benefits may vary depending on your actual work history and income.

There are ways to withdraw funds early from retirement plans like your 401(k) without getting hit with a tax penalty.

The rules are a bit rigid and, from a long-term perspective, you should think carefully before taking money out of your retirement plan until you're retired. In most cases, it's not the best strategy. Nonetheless, it can be done.

First, you need to know the rules. Distributions from employer-sponsored retirement plans and individual retirement accounts (IRAs) are subject to a 10% penalty if you start withdrawing the funds before you reach age 59 1/2.

Getting At The Cash, Avoiding The Pain
There are other options to get at your cash without getting penalized in the process:

1. Take the money as part of a series of substantially equal periodic payments over your estimated lifespan or the joint lives of you and your designated beneficiary. These payments must be made at least annually, and you base the payments on life expectancies from IRS tables. (See IRS Publication 939: General Rules for Pensions and Annuities.) If payments are from a qualified employee plan, they must begin after you have left the job.

    

   The payments must be made at least once each year until age 59 1/2, or for five years, whichever period is longer.

2. If you have extraordinary out-of-pocket medical expenses one year and your medical expenses exceed 7.5% of your adjusted gross income, you can withdraw funds to pay those expenses without paying a penalty. For example, if you had an adjusted gross income of $100,000 and medical expenses of $10,000, you could withdraw as much as $2,500 from your pension or IRA without incurring the 10% penalty tax.
3. An IRA distribution for first-time home purchases also escapes the penalty. You need to understand the government's definition of a "first time" home buyer. In this case, it's defined as someone who hasn't owned a home for the last two years prior to the date of the new acquisition. You could have owned five prior houses, but if you haven't owned one in at least two years, you qualify.

The "date of acquisition" is the day you sign the contract for purchase of an existing house or the day construction of your new principal residence begins. The amount withdrawn for the purchase of a home must be used within 120 days of withdrawal and the maximum lifetime withdrawal exemption is $10,000.

1. Distributions for qualified higher educational expenses also are exempt. Such expenses as tuition, room and board, fees, books, supplies and equipment required for enrollment are all covered. So, too, are expenses for graduate courses. This exception applies to expenses incurred by you, your spouse, children and grandchildren.
2. IRA distributions made to unemployed individuals (unemployed for more than 12 weeks) for health insurance premiums aren't subject to the 10% penalty tax.
3. If you receive a distribution due to "separation from service" (you're no longer at the job) in or after the year you reach age 55, you escape the penalty. This exception doesn't apply to distributions from IRAs or annuity or modified endowment contracts.
4. Distributions due to your death or due to total and permanent disability also avoid the 10% penalty tax. This is not a tax-planning strategy I personally advocate.

Remember that the above techniques avoid the 10% penalty tax, but they don't avoid the regular income tax that's owed when you start withdrawing funds from your retirement plans. Unless your money is parked in a Roth IRA -- which is after-tax contributions -- you're going to pay a tax.

Distributions rolled over into another retirement plan or arrangement however, escape both the regular income tax and the 10% penalty tax. Such rollovers should be made directly between your brokers. That way, you even escape the 20% withholding required on distributions that you touch.

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Contributing to a Traditional IRA can create a current tax deduction, plus it provides for tax deferred growth. While long term savings in a Roth IRA may produce better after tax returns, a Traditional IRA may be an excellent alternative if you qualify for the tax deduction.

Contributing to a Variable Annuity creates long term tax deferred growth. Use this calculator to see how a Variable Annuity might fit into your retirement plan.

What might it take to save one million dollars? This financial calculator helps you find out.

Enter in your current savings plan and graphically view your financial results for each year until you retire. Press the "View Report" button for a report that helps you see when you might hit your cool million - and what you might be able to do to possibly achieve this goal.