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If You Made Less Than $63,000 Last Year, Read this Before You File

It’s becoming increasingly difficult for low to middle-income families to save; however, the IRS allows a Saver’s Credit that could mean a $2,000 tax credit per family. Of course, it depends on the tax filer’s status as well as their adjusted gross income, or AGI.  The tax benefit is to increase the incentive for lower income families to put money away for retirement.  Every family that qualifies should be taking advantage of this bonus tax credit.

To be eligible for the Saver’s Credit…

  1. You must be 18 years or older
  2. You must not have been a full time student (you can be a part-time student)
  3. You must not be claimed as a dependent on another person’s tax return.
  4. Your Adjusted Gross Income (AGI) must be below $63,000 (married filing jointly), or $31,500 (single).

How it works…

In 2018, if your tax status is married filing jointly and your AGI is not more than $38,000, and you meet the other requirements, then you qualify for an additional 50% tax credit.  If you are above that income level it goes to a 20% tax credit from $38k up to $41k. Then it is a 10% tax credit from $41k until you are phased out above the $63,000 threshold.

Let’s say that you earned $38,000 for all of 2018, and your spouse was unemployed for the entire year. If you made a $2,000 contribution to your Qualified Plan (ie IRA, Roth IRA, 401K, 403B) for 2016, then you can receive that 50% tax credit which in this case is $1000 against any taxes owing or to add to your refund.  On top of that you can contribute $2000 to your spouses Qualified Plan and get an addition $1000.   That is $2000 cash money in your pocket for contributing $4000 into a retirement account.  $2000 is the maximum tax credit any family can receive.

This tax credit is in addition to the tax benefit you get within the IRA such as being able to deduct from your income all contributions to a Traditional IRA.

Don’t miss out on this too little known tax credit that can save you big money on your taxes this year.

Also, if you don’t have any investment account currently, and you know you qualify for this credit, why would you forego getting 50 cents cash back for every dollar invested.  And at the same time you are putting money into a growing retirement account. A win win for sure.  You can open up an IRA and contribute to it for tax year 2018 up until April 15th  and still get the credit this year.  Give us a call and we can get you set up with a Roth IRA or similar,  no upfront costs.

By Jimmy Hancock

References

  1. IRS. “Retirement Savings Contributions Credit (Saver’s Credit).” Retirement Savings Contributions Credit (Saver’s Credit). IRS, 13 Dec. 2018. Web. 4 Feb. 2019. <https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Savings-Contributions-Savers-Credit>.
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3 Tips for Millennial’s Looking to Invest

When it comes to Millennial’s and their money, most would rather sit on a boat load of cash. They have a sinking feeling that investing in the stock market is like boarding the Titanic. According to a recent Bankrate.com study cited by a recent The Street article, 1.  younger people prefer bank accounts over stock investments. Of course, cash is a low-yielding investment that’s better reserved for retirees who just want don’t want any risk. How does a young person get over his or her aversion to the stock market?

1. Investing instead of trading

One way a young investor can get over their fear of losing money in the stock market is by taking a long-term approach. Trading stocks is not the same as investing in the market. Most of the horror stories of people who lost fortunes occurred because they either “bet” money on a penny stock, or sold out of a crashing market and never got back in for the big run up that always occurs after crashes.  Smart investors contribute a certain amount of money on a regular basis so that they build up shares in diversified mutual funds over time.

2. Not worrying about an immediate reward

A lot of younger people are used to experience immediate gratification because of our highly technical world and consumer-driven society. But investing in stocks can be frustrating in the short term if the market is not climbing at that particular time.  Focus on the long term not the immediate reward.  If you can be patient, there is a huge reward for investing long term in stocks.

3. Diversifying from the start

When trying to figure out how to invest their money, some young people are lost. Their default option is a savings account or possibly certificate of deposits at a bank.  These should not be your default option as they give you very low returns long term.  One way to have a diversified portfolio is by choosing a mutual fund that already includes a variety of different stocks in different sectors and countries and also short term bonds. You can hold highly diversified mutual funds within a 401(k), Roth IRA or many other retirement or regular investment accounts.  With our company there is no minimums to start an investment, and we offer extremely diversified mutual funds, which means you can own over 12,000 stocks as a beginning investor with just a little money to start putting away.

Saving money through a bank account is the equivalent of putting cash under the mattress or burying it in your backyard. Millennial’s are too smart not to find better ways to invest their money.

By Jimmy Hancock



References

  1. O’connel, Brian. “Young Americans Prefer Bank Investments, Not Stock Market.” TheStreet. N.p., 23 July 2014. Web. 07 Mar. 2016.
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Quarter 3 Stock market Update

The following is from Matson Money Quarterly Statements.  It is a good reminder to focus on long term historical returns rather than panicking about short term returns.

“The 3rd quarter of 2018 saw domestic equity markets hit all-time highs, meanwhile outside of the U.S., the decline in international markets that persisted in the first two quarters of the year, stalled out and various  international asset classes achieved positive returns. U.S. stocks rose by 7.71% for the quarter as represented by the S&P 500 index, while  international stocks as measured by the MSCI World Ex-USA Index returned 1.31%. Large cap value stocks gained momentum, after going into negative territory earlier this year, and moved higher to the tune of 5.7% as measured  by the Russell 1000 Value Index.

2018 thus far has seen a divergence in the performance of domestic equities vs international stocks. While domestic equities are hitting all-time highs, international stocks have seen a decline from their performance in 2017. The  myopically focused nature of mainstream media and market watchers seem to just focus their attention on one index to represent the investment landscape, the S&P 500. In the good times, investors seem to compare their  diversified portfolios to the S&P 500 and get frustrated when they can’t keep up. You’re hearing stocks are at all-time highs so why isn’t your portfolios  at an all-time high as well? Its important for investors to understand this is an  apples to oranges comparison. A sound investment solution involves diversification and not just in the U.S. equity markets but international ones as  well. It involves owning stocks that have low correlation to one another so that when one goes down, another one does not go down as much. It’s not fair to  tell yourself, “if only I owned more U.S. Large Cap (S&P)” There are  many other asset classes in the world that have historically done better than the S&P 500, however they are not the ones being referenced on your nightly  news show.

To highlight the benefits of global diversification, let’s look back to 1970 and examine the relationship between U.S. stocks, as represented by the S&P 500 Index, and international stocks, represented by the MSCI EAFE Index. From 1970-1989, international stocks outperformed the U.S., then from 1990-1999, U.S. stocks outpaced international, then from 2000-2017, international stocks outdid the U.S. These decade-long tradeoffs in  performance is exactly why clients need to stay focused on their long-term investing goals and remain diversified. Developed countries have similar long- term expected returns, but as the data has shown, they achieve these returns at different times. Over the entire period, 1970-2017, the S&P 500 average annual return was 11.95%, while the MSCI EAFE index had an average annual  return of 11.78%. They each took different routes to get there, but in the end, they achieved a similar result.

In the end, choosing a wise financial strategy -and sticking to it -can have  tremendous impact on an investor’s long-term financial health. Chasing performance through buying and selling is a risky game. Historically speaking, it can reduce an investor’s real return. Relying on unbiased, non-emotional advice from a trusted investor coach to make good decisions can help an investor bridge that gap between what the average investor makes and the return of the market. ”

Reference

  1. Matson Money. “Account Statement.” Letter to James Hancock. 15 Oct. 2018. MS.

 

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Keep these 3 Rules and You Will Be a Successful Investor

Investing can be very complicated and confusing, but it also can be very simple.  Today I am going to try to simplify investing with these 3 rules.

1. Own Equities

Equities is just another word for stocks.  Why is this the first and most important rule?  Stocks have historically out performed fixed income (Bonds/Money Market/Savings Accounts) over the long term, and that is including the few crashes we have had.  In fact, that battle is not even close, especially now that fixed income has stayed so low the past few years.  Check out this chart which compares the annual return from 1926-2013 of the S&P 500 (Stocks) with Treasury Bills (Fixed Income).

stocks vs bonds

You can see Stocks have outperformed Fixed income by over 6% per year over the long term.  It is obvious to see the long term advantage of owning stocks in your retirement portfolio.

2. Diversify

Diversification, if done correctly, can increase return and decrease volatility (Risk).  Diversification in your investment portfolio is measured in part by the number of stocks you are invested in, as well as the different categories and countries those stocks are located in.   For example, if you invest in the S&P 500 Index, you are investing in 500 very large US companies.  You are not really diversified if you only invest in the S&P 500.

There are many different categories of stocks to invest in.  There is Micro cap (very small companies), Small Cap, Value, Growth, International.  Matson Money specifically invests our clients in over 12,000 stocks in all of those categories throughout the world.

The benefit of diversification is to lessen the risk that any one stock or group of stocks will crash, go bankrupt etc.   The standard deviation (volatility) of your portfolio can also be managed through proper diversification.

3. Rebalance

Rebalancing at a simple level is just buying low and selling high.  If your portfolio is 50% in Stocks and 50% in fixed, rebalancing would keep it that way through many different market swings.  If stocks go up faster than fixed, then you need to sell stocks (high) and buy fixed (low), and the other way around if the opposite happens.

Rebalancing most importantly keeps your portfolio at the risk preference that you choose, and especially helps to reduce risk in down markets.   It can also give your return a slight boost over the long term as well.

Now that you know the 3 rules of investing, you need an investment coach that understands and implements these rules as well.  If you can keep these 3 rules then your retirement portfolio will be in good shape over the long run.

By Jimmy Hancock



Reference

Matson Money. The Market Factor. Digital image. Matsonmoney.com. N.p., 23 July 2014. Web. 4 Nov. 2014. <https://www.matsonmoney.com/>.

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What are the Cost’s Associated with Investing?

There are many different ways in which costs are charged to your investment portfolio.   Many of these are hidden and are basically untraceable.  Today we are going to discuss a few of the hidden costs, and a few of the transparent costs.

Costs you should know about

Management Fee/Commission

Whoever your investment advisor is is making a percentage of their money from your portfolio.  This is necessary, but you need to make sure that the fee or commission you are being charged is not over the top. You will usually be charged just commissions or just a fee, not both.

If your working through an advisor that works on Commissions, then he legally cannot charge you more than 8.5% as a shave off the top of any new money coming in.  That is a big percentage.  For example, if you transfer in just $10,000 to an advisor that works on Commissions, they could take $850 out of the $10,000 thus lowering the value to $9,150 right off the bat.  Commissions are also dangerous because it makes the advisor more focused on the sale and initial transfer then he is on helping you ongoing.  He gets almost all his money upfront.

A management fee is a percentage charged each year as a much smaller percentage than commissions.   If your manager is trying to actively trade, he will usually charge a higher fee.  Management fees are based off of the total amount invested.

Mutual Fund Loads

A lot of mutual funds come with loads.  These are additional costs to you that are basically penalties.  They can be for different reasons, but many times it is to keep you from switching out of the fund.  They can either be front end loaded, or back end loaded, meaning the charge comes when you buy in, or when you sell out.  They also can charge you if you move your money out before a certain time frame.  Not all mutual charge a load, so make sure your funds are no load funds.

Hidden Costs

Trading Cost

One of the main hidden costs comes from the Bid Ask Spread.  The Bid Ask Spread is the difference between the buy price and sell price of a stock.  The guy on Wall Street who actually performs the trade gets paid the difference.  There is a cost to you every single time a stock is bought or sold by a fund.  If your mutual fund is being actively traded by a manager trying to beat the market, then more likely than not they are losing you money on the way.   If you are invested in institutional funds, aka passively managed funds like with Matson Money, then the trading cost you pay is minimal.

Expense Ratio

The expense ratio is how the mutual fund company pays for their operational costs.  Operating expenses are taken out of a mutual fund’s assets and in turn lower the return to the fund’s investors.   Usually retail mutual funds that are popular due to advertising have very high expense ratio’s.  This is another cost that comes to you in the form of a lower return.  The actual amount that it is costing you is very hard to quantify.   You want to invest in funds with very low expense ratios.

There are a few other costs involved as well, but are only for specific accounts and situations.  These costs are not necessarily a bad thing as long as they are kept low, and reasonable.  Even with these costs, investing in stocks is the greatest wealth creation tool on the planet.  To limit you costs you need to avoid actively traded funds and managers, and invest in a diversified efficient portfolio.

We try to keep our costs low by not charging any commissions, and instead charging an annual management fee based on the total amount invested.  We don’t charge to meet or set up new or additional accounts.   We also keep costs lower by avoiding actively trading within clients accounts.

By Jimmy Hancock

References

1.Bold, Adam. “4 Hidden Costs in Investing – US News.” US News RSS. US News and World Report, 8 Feb. 2011. Web. 22 Sept. 2014. <http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2011/02/08/4-hidden-costs-in-investing>.

2.”Expense Ratio Definition | Investopedia.” Investopedia. Investopedia US, n.d. Web. 24 Sept. 2014. <http://www.investopedia.com/terms/e/expenseratio.asp>.

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The Advantage of Rebalancing

balanceToday we are going to discuss the topic of Rebalancing your portfolio and why it is so important.  I will explain to you how a continuously rebalanced portfolio is one that is constantly buying low and selling high.

“Rebalancing -The process of realigning the weightings of one’s portfolio of assets. Rebalancing involves periodically buying or selling assets in your portfolio to maintain your original desired level of asset allocation.”

Rebalancing for Dummies

Rebalancing can be very complex and confusing, but I will give a simple example to explain some of the benefits.

For example, lets say you have a retirement portfolio with $50,000 invested in stocks, and $50,000 invested in bonds. This is the 50/50 portfolio which is pretty safe and best for those closer to retirement.  So you let it go 1 year and lets say it was like 2017 and stocks had a great year.   After 1 year you now have $65,000 in stocks and $51,000 in the fixed portion.  You are no longer invested like you wanted to be, and are opening yourself up to way more risk than you originally planned on.   Rebalancing is then needed to sell off what is high, which is stocks, and buy into what is low, bonds.  The beautiful thing about it is, there is never a time when rebalancing forces you to buy high, or sell low.

Why doesn’t everyone rebalance?

Rebalancing never seems like the right thing to do at the time.  For example in 2008 when stocks were plummeting, rebalancing would have been to sell safe fixed income to buy stocks.  If you think about it though, you are buying low and selling high.  During these times you need an investment coach to keep you off the ledge.

So by rebalancing a portfolio, what you are really doing is lowering the risk and keeping to your individual risk preferences.  That is really the main goal of rebalancing, but an added benefit is being able to consistently buy low and sell high.  This can help over the long term to increase your return as well.

The Proof

Take a look at this chart by Forbes which visually explains all of this.

 

Rebalancing chart forbes

 

You can see from the chart that rebalancing really does its work when the downturns in the market come.  The chart shows that the rebalanced portfolio made more than the portfolio that was left alone, and with much lower risk.

Make sure that your money is invested with an investment coach that has a scientific and predetermined way for rebalancing your hard earned money.

By Jimmy Hancock

 

References

1.”Rebalancing Definition | Investopedia.” Investopedia. Investopedia US, n.d. Web. 17 Sept. 2014. <http://www.investopedia.com/terms/r/rebalancing.asp>.

2. Brown, Janet. The Impact of Rebalancing. Digital image. Forbes.com. Forbes, 16 Nov. 2011. Web. 17 Sept. 2014. <http://www.forbes.com/sites/investor/2011/11/16/does-portfolio-rebalancing-work/>.

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Stock Market Recap after the First Quarter

From what you heard on news you might think the stock market had a horrible first quarter.  With 3 individual trading days that had very large drops, that seemed to be the big news in the stock market.  But in reality the market didn’t really do too bad in the first quarter.  The following is an excerpt from the Matson Money quarterly statement.

“The 1st quarter of 2018 saw a reversal in course in broad equity markets, with both domestic and international equities declining. U.S. stocks fell by 0.76% as represented by the S&P 500 index, while international stocks also weakened, with the MSCI World Ex-USA Index declining 2.04% for the quarter. In unusual fashion, fixed income also finished mostly negative over the quarter. As a result of increasing interest rates, the Bloomberg Barclays U.S. Intermediate Government/Credit Bond Index lost 0.98%.

In the previous quarterly letter, we mentioned how the S&P 500 Index was on a run of 14 consecutive positive quarters. It was noted that although this can give investors a euphoric feeling, it can be dangerous because it can lure them into believing that volatility and downside risk are no longer a reality in equity investing. Stephen King has a succinct yet profound quote in the book The Colorado Kid that states “Sooner or later, everything old is new again”

This quote is applicable in many disciplines, but can be especially useful when applied to investing. When returns are negative, it can feel like they will never turn around. Conversely, in times where returns have been positive for an extended period, it can feel like they’ll go up forever. But inevitably, downward volatility will return to the market, and periods of negative returns will show up again. This is what we have experienced over this past quarter, downward volatility returned, equity returns turned negative. What was old is new again.

Why is this an important concept to remember? Because so many investors react on emotion to what is occurring in the present moment, which can undermine their long-term investing success as a result. Each year Dalbar Inc. puts out a comprehensive study titled “2018 QAIB Report” which looks at the individual investor return of all mutual fund investors in the U.S. In this study, they show that the average equity fund investor only received an annualized average return of 5.29% over the 20-year period ending 12/2017, compared to 7.20% for the S&P 500 Index. One of the main contributors to their underperformance is the fact that the average investor had a retention rate of only 4.03 years. What this means is that every 4 years they decided to change the course of their current investment strategy and go in a different direction.

One can surmise that many of these investment changes result from an emotional reaction to the current market conditions. While the difference between 7.20% and 5.29% may not seem that large, over that 20-year period, the average investor would have received over $120,000 LESS than the S&P 500 on a $100,000 initial investment.

We know the historically these cycles of volatility come and go, and that bear markets follow bull markets and vice versa. But over long periods of time, if an investor remained disciplined and consistent with their investment philosophy, they could have been rewarded with generous market returns. The ability to ignore the noise and keep a long-term focus is an extremely important component for an investor, and as the Dalbar data reveals, can also be extremely difficult.

In the end, choosing a wise financial strategy – and sticking to it  – can have tremendous impact on an investor’s long term financial health. Chasing performance through buying and selling is a risky game. Historically speaking, it will only reduce an investor’s real return. Relying on unbiased, non-emotional advice from a trusted investor coach to make good decisions can help an investor bridge that gap between what the average investor makes and the return of the market.”

References

  1. Matson Money. “Account Statement.” Letter to James Hancock. 15 Apr. 2018. MS.
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Should You Be Dollar Cost Averaging?

Today we are going to discuss dollar cost averaging (DCA) and how it is most likely helping your retirement portfolio.

“Dollar Cost Averaging-  The technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high.”  1.

Dollar Cost Averaging for Dummies

So to put it more simply, dollar cost averaging is when you are investing in a type of investment that has shares (stocks or mutual funds) and you are putting in new money on a consistent basis.  You are investing the same amount of money each time, but buying a different amount of shares, due to the fluctuation of share price of a stock or mutual fund.

The Benefit of Dollar Cost Averaging

As it works out over time, because you are able to buy more shares in lower prices, the average price you pay is always lower than the average price of the stock/mutual fund.   It is hard to wrap my mind around it, but whether the price is going up, down or both, you will get your stocks at a discount using Dollar Cost Averaging.

Here is a very basic example.  If you put in $100 a month to a mutual fund priced at $10 per share the first month you would buy 10 shares for that price.  Let’s say the price goes up to $20 per share the second month, so your $100 would buy 5 shares.  So with dollar cost averaging you would have 15 shares after 2 months.  At the same average share price of $15, if you invested the same $200 you would only have 13.3 shares.

So most individual investors saving for retirement use DCA as they invest a monthly amount into their retirement account.   This makes sense and is obviously a good way to invest.  Much better than to try and time the market and only put money in when you feel the market is safe or poised to have a big run up.   It is also a way to put investing for retirement on the monthly budget and plan it in instead of having to make room for it.

Is Dollar Cost Averaging ever bad?

There is only one situation in which Dollar Cost Averaging is not the best option.    If you have a lump sum from receiving an inheritance, bonus,  or are just starting to invest, it is almost always best to invest the lump sum rather than putting it in slowly over time.   Let me explain.

Throughout history the market has ALWAYS gone up over the long term, meaning 10, 20, 30 years.  There has never been a 20 year period where there has been  a loss in the market.  So the more shares you can buy now, usually the better you are.  If you wait to invest, odds are you are going to be buying at a higher price then you could have earlier.   Going back 88 years, 66 of those years have been up markets.  Going forward there is no way for us to know when the market will be up or down.

So the main reason people would rather use Dollar Cost Averaging over contributing a Lump Sum is FEAR.  They are scared the market will crash or take a big drop, because that is what they say on the news almost every single day.  They have been saying it ever since the market bounced back in 2009.   We should not let fear control our investment decisions.

For the average investor saving for retirement, consistent monthly contributions are the way to go, but if you ever do come across a lump sum of money that you want to invest, don’t wait to invest it.

By Jimmy Hancock



References

1. Investopedia. “Dollar-Cost Averaging (DCA) Definition | Investopedia.” Investopedia. Investopedia US, n.d. Web. 04 Sept. 2014. <http://www.investopedia.com/terms/d/dollarcostaveraging.asp>.

2. Miller, Steve. “Dollar Cost Averaging EP 265 08192014.” Livestream. Matson Money, 19 Aug. 2014. Web. 04 Sept. 2014. <http://www.livestream.com/markmatson/video?clipId=pla_0a3928e4-319d-4575-9297-eac738bffcd7&utm_source=lslibrary&utm_medium=ui-thumb>.

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What to do During a Stock Market Crash

So the stock market has officially had a “correction” over the last few weeks which is a 10% drop from the previous high.  And many people are panicked!  But panicking after a big drop in the market can be very bad for your long term retirement account.  Especially if that panic involved pulling your money (10% less than you had 4 weeks ago) out of the stock market.

This might sound weird but I actually got excited when the stock market took it’s big tumbles over the last few weeks.  I have been waiting for a good opportunity to “buy low” in the stock market.   Yes, now is the best time to put extra money into your retirement investment account.   Buying shares in a time like this is like when your favorite store has a 10% off your entire purchase sale!  Basically, you get the same items for a lower cost.

There are a few reason why I don’t panic when the stock market goes down.

First, I understand that the stock market has always come back from corrections and crashes to reach new highs.   Along with that, I know that the stock market as tracked by the S&P 500 has made over 10% per year on average over the last 30 years.   I often get asked by people, what if it just keeps going down and I lose all my money?   Investing in a diversified mix of over 12,000 stocks makes it very unlikely for you to lose all of your money.  What are the odds that 12,000 companies across the world in different sectors providing different products all go bankrupt at the same time?

Second, I know I am in this for the long haul.  Every investor is at a different place and will use their money for different things.  If you are needing the money you have invested in the next few years, you should definitely not have a vast majority of your money in stocks.  But either way, you can be invested for the long haul.  Even throughout retirement, yes have a big chunk of your money in bonds, but why wouldn’t you stay invested and give your money a chance to grow and keep up with inflation.  Smart people look at investing as a lifelong thing.

Third, I don’t believe that me or anyone else can accurately predict the future.  This is a big one.  I get asked all the time innocent questions about investing and the stock market from clients and others that are all based around predicting the future.  Questions such as, is this going to end up being a crash?  Do you think stocks are overpriced?  How much do you think a diversified mix of stocks will make this year?  When I answer this question by saying I cannot predict the future, people are usually not satisfied.   The great thing about it is that you do not need a prediction about the future to be a successful investor and make money in the stock market.

Lastly, I believe in the phrase, buy low and sell high.  It is usually the hard thing to do at the time.  When the stock market is crashing down and you see the headlines say, this is the biggest drop in the Dow in its history, it isn’t necessarily an easy thing to buy stocks on that day.  On the opposite end, when the market is up for 2 straight years and the economy looks great and the headlines say, this is just the beginning for stocks, it isn’t easy to rebalance your portfolio and thus sell stocks and buy bonds.

Ultimately, we know there are going to be stock market ups and downs in the short term, but if you have a low cost diversified mix of stocks you will be doing alright in the long term.

By Jimmy Hancock

References

1. Matson Money. Separating Myths From Truths, The Story of Investing. N.p.: n.p., n.d. PPT.

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Why You Might Want to do a Roth Conversion in 2018

The new tax changes for 2018 have many people looking into Roth Contributions and Roth Conversions.  The main reason being, with lower tax brackets for the next several years, there is less of a reason for getting tax breaks now, and more of a reason to get tax free growth for the future.    No matter what your income or tax status is, you can take advantage as well.

What is a Roth Conversion?

A Roth conversion is when you convert money from a pre-tax account (Traditional IRA, 401k, 403B) to a Roth IRA.   By doing this you pay the taxes now on any money converted over, and get the benefit of never having to pay taxes on that money or its growth ever again.

Advantages of a Roth IRA

With a Roth IRA you have many tax advantages over a Traditional IRA.  The most obvious one is that any money you take out after age 59 1/2 and after having the account open for at least 5 years is 100% tax free.  As a part of this benefit is that there are no required minimum distributions at age 70 1/2, and your Roth money can go tax free to future generations at your passing.   Another advantage is that you can always take the total amount contributed to a Roth IRA out without any tax penalty, even if you are not 59 1/2.  It is just the growth on the account that would cause a penalty if taken out early.

Do I qualify for a Roth Conversion?

There are no income restrictions or limits for who can convert to a Roth IRA.  There are income limits for contributions to a Roth IRA, but not conversions.  Because of this anyone who wants to can take advantage of this possible huge tax saving trick.

What is a Backdoor Roth IRA?

A backdoor Roth IRA is for savers that don’t qualify to contribute to a Roth IRA because their income is too high(over $199,000 for married filing jointly)  There is a way for them to contribute to Roth IRA by first contributing to a Traditional IRA with after tax money and then immediately converting the money in the Traditional IRA to a Roth IRA.   Because there are no income limits on after tax Traditional IRA contributions this is legal, and can be very beneficial in terms of tax savings.

How much will it save me?

Just to show you the power of a Roth account vs a Pre-tax account, I will give you an example.  Elicia is 30 years old and plans to contribute $5500 a year into a Roth IRA until retirement at age 65.  Ryder is also 30 and plans to do the same but into a Traditional IRA.   In this example I will assume they both get exactly the same return(8% before retirement, 6% after), are in the same average tax brackets each year(30% before retirement, 15% after), and take the money out over a 25 year span in retirement.    During the working years Ryder would have saved $57,750 on taxes compared to Elicia’s $0 saved.   But as they took the money out in retirement Ryder will pay $250,667 to Uncle Sam while Elicia will pay $0.   In this example, a Roth IRA saved Elicia almost $200,000 in tax payments to the government.

Is a Roth Conversion for Everyone?

A Roth Conversion is not right for everyone.  There are a lot of things to consider depending on your age, tax bracket, and current investments.  A Roth Conversion may be very beneficial to you, especially in the long run, but you need the help and advise of a knowledgeable investment coach to decide if it is best in your situation.

By Jimmy Hancock