This week, Gail counsels a reader who owns a SIMPLE plan, helps you calculate a partial contribution to a Roth IRA, and explains the benefits of leaving an IRA to charity.

 

Hello Gail,

I'd like to contribute to a Roth IRA for 2003. I'm single and it looks like my adjusted gross income will fall between $95,000 and $114,000, so I should qualify, right? After I calculate the AGI, and say I get a figure like $100,000, how do I calculate the partial contribution?

Thank you.

Sanford

 

Hi Sanford,

Thanks for bringing up IRAs. It gives me an opportunity to post an important reminder for all IRA contributors: No matter which type of IRA you have, the deadline for making your 2003 contribution is April 15, 2004. Let me state this another way:

You do not get an extension on contributing to your IRA even if you get an extension on filing your 2003 income tax return!

Back to your specific situation, Sanford. You've got the right idea, but your numbers are off a little. As a single taxpayer, you can contribute the full $3,000 to a Roth IRA provided your "Modified" Adjusted Gross Income (MAGI) is $95,000 or less. (*See below for the income limits that apply to married couples.)

To compute your Modified Adjusted Gross Income, start with your AGI on line 34 of the standard 1040 tax return. You'll need to add back some deductions you were allowed to this figure. They include foreign-earned income, student loan interest, deductible tuition and fees, and employer-paid adoption expenses.

(You'll find a thorough explanation of MAGI in IRS Publication 590, which contains a wealth of information about IRAs. On page 55 there's a short worksheet to calculate this. You can access it at: http://www.irs.gov. Enter "590" in the "Publication" box.)

Once your MAGI hits $110,000, you are no longer eligible to contribute to a Roth IRA. At that point, your only option is to make a non-deductible, after-tax contribution to a traditional IRA.

If, as in your case, your MAGI falls between $95,000 and $110,000, you can make a partial contribution to a Roth IRA. Here's how to calculate that number:

1. Subtract $95,000 from the amount of your MAGI.

2. Divide this number by $15,000 (the phaseout range).

3. Multiply the fraction you get by the maximum possible contribution ($3,000).

4. Subtract this amount from maximum contribution ($3,000).

5. The result is your reduced contribution. Round up to the nearest $10. If your total is between $0 and $200, you can contribute $200.

By the way, if you're age 50 or over, the maximum possible contribution for 2003 is increased to $3,500. Substitute $3,500 for $3,000 in steps 3 and 4 to figure your partial contribution based on this higher maximum amount.

Let's use your numbers in an actual example. I'm going to assume that your MAGI is $100,000 and that you're under age 50.

1. $100,000 - 95,000 = $5,000

2. $5,000/15,000 = 0.333

3. 0.333 x $3,000 = $999

4. $3,000 - 999 = $2001.

You're allowed to round up to nearest $10, so you are eligible to contribute $2,010 to a Roth IRA for 2003.

Hope this helps,

Gail

*For married couples, the ability to contribute to a Roth IRA begins to get phased out once your joint MAGI exceeds $150,000 and is completely eliminated once it hits $160,000.

In addition, in Step #2 above, you would use $10,000 instead of $15,000 when calculating your partial contribution.


 

Dear Gail,

I have a SIMPLE IRA with my old job. It is invested in the equivalent of a money market fund. Now I am working for a non-profit organization. Could I roll over my money from the simple IRA to a 403b? I can no longer contribute to the SIMPLE IRA again, so what should I do with this money (about $4,000)? Since I have to pay the service fee every year, if I am not doing anything now, after 20 years there will be nothing left on this simple IRA account.

Thank you.

Linda

 

Dear Linda,

"SIMPLE" stands for "Savings Incentive Match Plan." It's type of retirement plan only small businesses can offer their employees and as such, it has some unique characteristics.

First and foremost, as you mention, contributions made by you and or your employer go into an IRA account in your name, as opposed to the type of account you would have with, say, a 401(k).

The 2001 Tax Act made it much easier to move money from one retirement plan to another, but there is still a special restriction on SIMPLE IRAs: within the first two years after money has been contributed to your account, you cannot roll it anyplace except to another SIMPLE plan!

After your SIMPLE account is two years old, you can roll it into any other kind of retirement plan you want, including a 403(b) without penalty. However, this can only happen if your new employer's retirement plan is set up to accept this type of rollover. Many are not.

So your first step would be to check with your 403(b) plan and find out if it accepts rollovers from other retirement plans.

If it isn't, your best option, in my opinion, is to roll the money into an IRA. If you already have a traditional (tax-deductible IRA), you can simply have your SIMPLE account transferred into that. If you don't have an existing IRA, you can establish one with a mutual fund, bank, or brokerage firm. Once the account is open, your new IRA custodian will take care of having the money transferred. All you have to do is fill out a form authorizing the transaction.

You're smart to be concerned about the amount of the annual custodial fee that every IRA sponsor charges. So do some comparison shopping on the Internet. I think you'll be pleasantly surprised. I know for a fact that some companies are very affordable — in the neighborhood of $10/year.

But I have to be honest with you, the real issue isn't the annual fee, it's what your account is earning. According to Bankrate.com, the average rate on a money market fund right now is 1.4 percent. Based on your balance of $4,000, that's a return of just $56/year! If your money remains invested in a money market fund, you're right to think it's never going to amount to much.

Since your letter indicates you will not be using this money for 20 years, you need to invest it in something that has historically had a better rate of return than cash. And, of course, you want to be diversified. This prevents your whole portfolio from declining if a certain sector of the market— stocks, for instance — has a bad year.

If you're only working with $4,000, you're not going to achieve proper diversification by buying individual securities. That's why I like mutual funds. Every major mutual fund family offers what is called a "balanced" fund. They might put their own particular name on the fund, but it will own both U.S. stocks and bonds, generally in a mix (or "balance") of 60 percent stocks and 40 percent bonds. The stocks are from large companies and the bond component usually includes a healthy dose of U.S. government securities.

Or you could look into something called an "asset allocation" fund, which will give you even more diversification. These funds will include stocks and bonds issued by foreign corporations and governments, as well as small and mid-sized U.S. companies.

The nice thing about either a balanced or asset allocation fund is that you don't have to worry about re-balancing your portfolio to maintain the same mixture of securities. The mutual fund does it for you.

If your SIMPLE IRA account is not at least two years old, you'll have to wait until it is before you make a move.

Be careful!  If you simply take the money out of your SIMPLE plan within the first two years, you could be subject to a 25 percent penalty.

Take care

Gail

 

Gail, if you designate a charity as your beneficiary of an IRA, do THEY have to pay the taxes on it that you would if you withdrew the funds yourself?

Frederick

 

Dear Frederick —

It make a LOT of sense to leave your IRA and other retirement assets to charity. As you indicate, if you leave a retirement account to a person, they will have to pay income tax on withdrawals just as you would if you were alive.

The tax code calls this "income in respect of a decedent." It simply means that someone else is receiving this income on behalf of the person who died. And the tax consequences are the same: If you would have to pay income tax on it, so will your beneficiary.

However, charities are a special case. They are exempt from income tax. So any retirement assets you leave to charity pass income tax free.

In addition, assets you leave to charity provide a tax deduction to your estate, reducing the potential amount of estate tax owed upon your death.

In case you are thinking: "Leave my IRA to charity? I'd be cutting my kids out of their inheritance!" consider this strategy: purchase a life insurance policy equal to the value of, say, your IRA and name your children as the beneficiaries. Life insurance passes free of income tax to the beneficiaries. So, on an after-tax basis, your heirs will receive more money than they would if you left the IRA to them directly.

Best wishes —
Gail

  

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