NEW YORK – This week, Gail addresses Federal Government retirees' conversion dilemmas and gives some house-buying tips.
My wife will retire in December 2001 from the Federal Government. As a Federal Employees Retirement System (FERS) retiree, she has participated in the Thrift Savings Plan (TSP) with matching employer contributions. She will be 62 at retirement.
Upon retirement, the TSP contributions stop. Rather than leave the balance in TSP, would it be best to roll the entire amount into a Roth IRA? If so, should it be rolled in December 2001 or should she wait for the new tax year to begin in January 2002? There are no plans to withdraw any of these funds, at least for now, upon her retirement. We file a married joint return.
I will retire next year from the government as well. At retirement, our combined income will still not allow a deductible IRA. Would we be better served to each open separate Roth IRAs with the spouse the beneficiary rather than anything on a joint venture?
Thanks to the tax bill just passed by Congress, it is now possible to move the balance in one type of retirement plan — say, a 401(k) — into another type of retirement plan, such as a 403(b), when you change jobs. This is called "portability." It will make it a whole lot easier to manage your retirement accounts because you can now consolidate the money you have in different plans into one place. Of course, even before this legislation was enacted, most retirement plans could be moved into a traditional IRA when you left the job.
However, portability only goes so far. You cannot transfer money from a tax-deferred retirement plan, such as the government's FERS, directly into a Roth IRA because all contributions to a Roth are made with after-tax money. So, first you have to move your wife's FERS balance into a traditional IRA. Then you have to pay the income taxes on this money, which she's been (legally) postponing for years. After that, provided you do not exceed the income limits, you are free to move it into a Roth IRA. This is what's called a "conversion."
Only someone whose Modified Adjusted Gross Income (MAGI) is less than $100,000 is eligible to convert a traditional IRA into a Roth IRA. Unfortunately, this is one of the marriage penalties they did not address in the latest legislation: the income cap on Roth conversions is the same whether you file as a single taxpayer or jointly. I explained in detail how to compute your MAGI in my column dated May 12th, "The Grapes of Roth and Other IRA Matters." You can access this by clicking on "Money Matters Archive" at the top right corner of this page. Then scroll down to the appropriate column.
If you meet the income requirement, the next question is can you come up with the money to cover the income taxes you'll owe? Keep in mind, you don't have to covert all of the money you transfer into traditional IRA. Instead, you could convert to a Roth IRA only as much as you can afford to pay the taxes on. You can convert additional portions in later years as you accumulate the money to cover the taxes due.
But as many law-abiding citizens have found out, it gets a little tricky. You could convert now believing that your MAGI will be less than $100,000, and find out at the end of the year that it is actually above this amount. If that happens, you’ll have to RE-convert your account back to a regular IRA. Although it can be annoying, this isn't such a big a deal — provided the custodian for your IRA is knowledgeable about the regulations and can provide the forms you need.
If you think you'll be cutting it close, you might want to wait until December when you'll have a more accurate picture of your total 2001 income. On the other hand, postponing means you run the risk that your wife's account could go up in value, thanks to the investments it owns. In that case, the conversion would cost you more in taxes.
On a separate issue, once both of you are retired, you are no longer eligible to make a contribution to any type of IRA. That's because contributions can only be made if you have "earned" income, that is, income from a job. Investment income, rental income, etc. do not count.
As I've said here before, I really like Roth IRAs. The potential for tax-free growth is hard to turn down. But you've got to follow the rules or you'll run into trouble. Most mutual fund companies have a telephone number to call for information. In light of the hassles you can run into, you might also consider seeking the help of a professional financial advisor. You've got until the end of the year to make a 2001 conversion, so take your time.
My wife and I are debating whether to buy a house this summer or next.
The crux of the debate of course boils down to money. If we wait until next year, we will be able to afford a bigger place in a better location.
On the other hand, interest rates are favorable now, and a dramatic rise in the next year would offset any financial gains we are anticipating and thus we might as well buy this year.
What is your prediction for the path of interest rates in the next year?
If I had a way to accurately predict interest rates, I would not be writing this column!
Seriously, I have yet to come across an economist, Wall Street pundit, or soothsayer who can consistently and accurately forecast where the markets are going to be next month, let alone next year. There are just too many variables.
However, lenders have become extremely creative and have devised a lot of new ways to accommodate would-be homebuyers. Some will customize a borrowing plan to meet your specific needs. It really depends upon how much they want your business.
One option that comes to mind is a "balloon payment" loan. This type of loan generally has a low, fixed interest rate for several years, but then requires you to come up with a significant chunk of money at some point in the future when the loan terminates — anywhere from 3 to 10 years. This balloon payment amount could be $10,000, $20,000 or more, depending upon the terms of your loan.
Payments on a balloon mortgage usually cover just interest — no principal. That means you're not building up any equity in the home. But this type of loan enables you to keep your initial payments low and therefore you might qualify for more house than if you applied for a straight 30-year mortgage. If you're confident you'll be pulling in more income in a couple of years, look for a lender who will give you a balloon loan that matures in that timeframe. Typically, when the balloon payment comes due, people re-finance the entire amount. I can already hear your next question: "But what will interest rates be then?" Answer: see first paragraph.
There's also something called a "graduated payment mortgage," which starts out with low payments that rise over time. This type of loan is based on the assumption that your income will rise, making it possible for you to afford the higher monthly payments. Initially you pay less than the going rate of interest and in later years you pay more to make up the difference. But if your income doesn't keep pace, you could be in trouble.
Whatever mortgage you choose, make sure there is no penalty to pay it off early. This is your "escape clause" because if interest rates go even lower at some time in the future, you can replace your original loan with a less costly one.
The old-fashioned, 30-year fixed rate mortgage is more the exception than the rule these days. So shop around. And don't just visit the banks in your town. There are a number of great mortgage sites on the Internet. But read the fine print carefully, especially as it pertains to up-front costs.
In some cases, you might be able to wrangle a lower interest rate if you pay more initially. Pretty much everything is negotiable. If you feel like you're in over your head, consider an independent mortgage broker. Let him or her do the legwork. Sure, they get a fee for their services, but since they know the business (after all, they do this every day) they ought to know who's got the best deals and the terms that best fit your needs. After all, this is probably the single largest purchase you'll ever make, and getting some expert guidance could save you money in the long run.
Happy house hunting!
If you have a question for Gail Buckner and the Your $ Matters column, send them to firstname.lastname@example.org along with your name and phone number.
The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.