Moving to an IRA can give you more freedom with your investment options, as you’re not tied to only the stocks that your old employer offered.

Where to Move Your Money

One of the first questions you may have is deciding which brokerage to roll  your money into so you can get your IRA off to a good start. If you already have an IRA with someone you can easily roll it over there so you can maintain a simplified financial system. If you don’t have an IRA already opened or you’re not happy with your current brokerage, here are some things to consider to find the best option for you and your money.

When looking at brokerages, check their fees, including commissions. As you’re building your investments you don’t want fees eating up your returns.

Open a Traditional or Roth IRA?

The great thing about IRAs are the tax advantages associated with them. With Traditional IRAs you can deduct your contributions. With Roth IRAs, your withdrawals are usually tax-free. You have to decide what is best for your circumstances. For us, we decided to have Roth IRAs.

Currently annual contribution limits for either account are $5,500 if you’re under 50 and $6,500 if you’re older. That gives you a great opportunity to stash your money away over the years.

Using Index Funds for Your Portfolio

You don’t need much money to get started with investing. You also don’t need a complicated plan. There are many ways to diversify your portfolio easily. One way to do this is by investing in index funds.

Looking for low cost index funds and Exchange Traded Funds(ETFs) can be beneficial for your portfolio. These are funds and ETFs that track a market index such as the S&P 500.  Since they are typically not actively managed but automated you have much lower fees.

Building Your IRA

Now that you have gained control over your money and have it in an IRA it’s time to set up an easy to maintain system to grow your portfolio. The easiest way to stay on target for your investment goals is to go ahead and automate your IRA contributions. It has certainly helped us avoid skipping deposits.

You may have a fixed budget now, but if you simply increase your contribution every time you get a raise, you’ll be surprised at how quickly you build up your investments.

Thoughts on Rolling Over your Money

How many of you have money left in a 401(k) at an old job? Are you rolling it over to your current brokerage or will you start fresh?

No Money for Your IRA Contributions?

With those tax benefits, you’d think that most people would  be aggressively contributing to their IRAs. However how many people actually maximize their contributions (currently it’s $5000/year)? Why is that the case?

One of the biggest obstacles I hear from people about why they are not contributing money into an IRA is that they don’t have the extra money in their budget. With budgets already tight, they feel like retirement contributions are out of the question.

The good news is that you can make some adjustments to your budget that will help you save for later without drastically sacrificing your budget now.

Finding Money in Your Budget

If you’re looking to jump start or increase your retirement contributions, here are some big ways to find money in your budget.

• Proper Withholding on Paychecks: If you haven’t reviewed your w-4 in awhile, you may want to look at it again. When it comes to withholding on your wages, you could optimize your finances by simply adjusting to what could work best for you. For some, being conservative with their withholding means they can get a bigger refund come tax time, which they can immediately use to fund their IRAs in one swoop. For others, getting more money in their paychecks throughout the years can be the right choice as they set up automatic contributions to keep them on point.
• Take a Week to Shop Insurance: Sometimes we can get into a comfortable habit of staying with the same insurance company simply because we’re used to dealing with them. There’s nothing wrong with being loyal to a good company, just make sure you’re getting value for your loyalty. For us, switching car insurance has cut our premiums by almost half. For my mother, calling around got her current insurance company to lower her bill.
• Consolidate Student Loans: If you qualify for lower rates with a student loan consolidation, you should seriously check it out and run the numbers. The money saved can then be redirected towards your IRA.

None of these adjustments will hamper your budget now, yet they can save you a good amount of money. If possible, once you make the change set up an automatic contribution to your IRA so you can stay on target.

Thoughts on Funding an IRA

I’d love to hear from you about your retirement contributions. How did you find money to contribute to your IRA? What has been the easiest adjustment you’ve made? What has been the hardest?

Build Your Nest Egg and Save on Your Taxes

Don’t ignore the tax benefits of building a nest egg. A 401k and traditional IRA will give you a tax break today by allowing contributions to be considered tax deductions.

You may be getting ready to file your taxes before the April 15th deadline.  You can still make a contribution of up to $5,000 to your IRA ($6,000 if over 50) by the tax deadline and take a tax deduction for the contribution on your 2012 taxes.  You can build your nest egg and at the same time keep more of your hard-earned money.

If you opt for a Roth IRA you won’t see a tax break today, but qualified withdrawals in the future will come out tax free. If Uncle Sam is going to provide a benefit for saving money, take advantage of it.

Use Your Tax Refund to Build Your Nest Egg

After you file your taxes and find out you’re getting a tax refund, you can contribute some of your tax refund to your IRA and get a head start on tax savings for next tax year while growing your retirement.

Contribute a Little More

If you have a 401k at work or you opened up an IRA these vehicles are a great start, and if you’re already contributing something, that’s all the better. The thing is, you can always do more. Chances are you aren’t maxing out your 401k so there’s room for improvement.

You may be thinking that there’s simply no way you can afford to put more away, and it’s true that money is tight in this economy. But you don’t have to feel like you’re taking on another mortgage payment just to boost your retirement savings.

Start small. For example, if you’re currently contributing $200 a month, bump it up to $250. 50 extra dollars a month doesn’t seem like it will help, but over the long run it can be a big difference. Just the extra 50 bucks a month over the next 25 years tucked away in your retirement account will likely add up to $30,000 or more.

Whether you bump up your contributions 20 dollars a month or 200 dollars a month, the idea is to make it a habit every year. When you make a small bump to your monthly contributions your budget won’t take a noticeable hit.

Sure, you might feel the pinch initially, but it doesn’t take long before your spending adjusts and you completely forget about the extra money you’re putting into your nest egg. Now, if you make the same small increase each year it won’t take long before you’re putting a lot of money away toward retirement and you don’t even realize it. You will be thanking yourself when it comes time to rely on that money.

If you aren’t currently building up your nest egg with a 401k, IRA, or even just a savings account, now is a perfect time to start. Just like the advice above about starting small, that’s probably how you’ll want to start for the first time.

If you can’t afford to max out an IRA right now that’s perfectly fine and nothing to be ashamed about. Start with 25 or 50 dollars a month. Sure, that alone won’t give you the retirement of your dreams, but we’re just trying to build a foundation and get into the habit of saving.

Over time you will increase your contributions and it all adds up. Remember, every day that passes is one less day you have to save. You can’t get that time back, so save something, anything, and it will pay big dividends and help you save on your taxes.

Investing has never been easier than today with all the options available for people to really use their savings to achieve the dreams and goals for the future. No savings to become a smart investor? Consider your tax refund to start investing in the stock market like a professional.

According to the IRS, the average tax refund in 2012 was about $2,803 and that is more than enough to open a brokerage account and start investing your savings for the future. In fact you can start investing with a lot less.

It is an interesting year for investors. After the Financial crisis of 2008 and 2009 the stock market has recovered and now we are in what experts call a “bull market”, a market in which prices of company’s stocks are rising and investors are encouraged to buy shares.

The performance of the stock market is remarkable. From the bottom of the market in March 2009 to February 2013, the price of stocks has risen 89% based on the S&P 500, the stock index composed by the leading 500 companies in the US. That represents an impressive average annual return of 17% in the last 4 years.

That return outperforms by far other investment alternatives such as bonds, money market funds, certificates of deposit or real estate. However, there is more risk involved when investing in the stock market. That means the returns change a lot from one month to the next or even from one day to the next.

But the stock market is a good alternative to achieve long term goals such as retirement when the risk is properly managed and balanced with your age and goals.

Your tax refund could be your pass to the world of investments:

-As soon as you get your tax refund this year, go to an investment brokerage firm or even your own bank and open an Individual Retirement account (IRA). An IRA is a vehicle in which you can invest your money and obtain a tax advantage: every dollar you put  in the IRA is reduces  your taxable income so you pay fewer taxes as you invest your savings.

-When you have your IRA, you can pick mutual funds to invest your money in. A mutual fund is a collection of stocks, bonds and cash alternatives. The Mutual Fund manages the money from many investors (hundreds or thousands) and that allows the small investor to have their money managed by professionals.

-You can pick among thousands of different funds with different objectives. There are funds for stocks, for bonds or funds that invest in a mix of stocks and bonds.

-Your selection of the fund depends on the risk you are willing to take with your money. For instance, stocks are riskier than bonds. However, in the long run the annual return for stocks tends to be higher. And you will need a higher return to achieve long term goals like retirement.

-How much risk can you take? It all depends on the time you have to achieve the goal. If you have 20 years for retirement, you can take a lot more risk than if you plan to retire next year.

-The tax refund is only the starting point. Once you open the IRA account you should sign up for automatic investments to contribute every month to the IRA account.

-Your finances are going to be transformed because you will be officially an investor with real long term goals.

- Haven’t filed your taxes yet?  Go online and file your taxes so that you can get your tax refund as soon as possible, make these smart investment moves with your tax refund, and keep more of your hard-earned money.

Invertir nunca había sido tan fácil como ahora gracias a todas las opciones disponibles para que la gente  realmente aproveche sus ahorros para lograr los sueños y metas para el futuro.

¿No puede ahorrar para convertirse en inversionista? Considere su devolución de impuestos para empezar a invertir en la bolsa como un profesional.

De acuerdo con el Servicio de Impuestos Internos (IRS), la devolución promedio de impuestos en 2012 fue de cerca de $2,803. Esa cifra es más que suficiente para abrir una cuenta de inversiones y empezar a invertir sus ahorros para el futuro. De hecho, es posible empezar a invertir con mucho menos.

Es un año interesante para los inversionistas. Después de la crisis financiera de 2008 y 2009, el mercado de acciones se ha recuperado y ahora estamos en lo que los expertos llaman un mercado en auge (“bull market”), un mercado en el que los precios de las acciones de las empresas están aumentando y los inversionistas están interesados en comprar las acciones.

El desempeño del mercado de acciones ha sido sobresaliente. Desde el punto más bajo del mercado en marzo de 2009 hasta febrero de 2013, el precio de las acciones aumentó 89% con base en el S&P 500, el índice de acciones  compuesto por las principales 500 empresas de Estados Unidos. Esto representa un impresionante rendimiento promedio anual de 17% en os últimos 4 años.

Este rendimiento supera de lejos a otras alternativas de inversión como bonos, fondos de mercado de dinero, certificados de depósito o inversiones inmobiliarias. Sin embargo, se asume más riesgo cuando se invierte en el mercado de acciones. Esto indica que la rentabilidad cambia mucho de un mes a otro e incluso entre un día y otro.

Pero el mercado de acciones es una buena alternativa para lograr metas de largo plazo como el retiro cuando el riesgo se administra adecuadamente de acuerdo a la edad y las metas del inversionista.

Su devolución de impuestos puede ser su entrada al mundo de las inversiones:

-Tan pronto como reciba su devolución de impuestos este año abra una cuenta de inversión en una firma de corretaje o en su propio banco. Abra una cuenta de retiro individual (IRA). El IRA es un vehículo en el que usted invierte su dinero y obtiene una ventaja de impuestos: Cada dólar que invierta en la cuenta IRA reduce su ingreso gravable y así paga menos impuestos mientras invierte sus ahorros.

-Cuando tenga una cuenta IRA, usted puede seleccionar fondos mutuos para invertir su dinero. El fondo mutuo invierte su dinero en acciones, bonos o alternativas de efectivo. El fondo mutuo administra el dinero de muchos inversionistas (cientos o miles). Esto permite que el dinero del pequeño inversionista sea gestionado por profesionales.

-Usted puede seleccionar entre miles de fondos diferentes con objetivos diversos. Hay fondos para acciones, para bonos, o fondos que invierten en una mezcla de acciones y bonos.

-Su selección del fondo depende el riesgo que esté dispuesto a asumir con su dinero. Por ejemplo, las acciones tienen más riesgo que los bonos. Sin embargo, a largo plazo el rendimiento de las acciones tiende a ser mayor. Y usted necesitará rendimientos más altos para lograr metas de largo plazo como la jubilación.

-¿Cuánto riesgo puede tomar? Todo depende del tiempo que tenga para alcanzar el logro. Si a usted le faltan 20 años para jubilarse, usted puede asumir mucho más riesgo que si planea retirarse el próximo año.

-La devolución de impuestos es sólo el punto de arranque. Una vez usted abre una cuenta IRA usted puede registrarse para realizar inversiones automáticas para aportar cada mes a su cuenta IRA.

-Sus finanzas se van a transformar porque usted empezará a ser un inversionista con metas de largo plazo.

-¿No ha presentado sus impuestos todavía? Puede ir a Internet y presentar sus impuestos para obtener su devolución de impuestos lo más rápido posible, empezar a invertir y hacer que su dinero rinda más.

Facebook

Well, I would be excited too. Many of the employees became instant millionaires as a result of Facebook going public since as part of the company’s incentive plan, they were given Restricted Stock Units.

What Does This Mean for Overnight Millionaires and Their Taxes?

If you are ever so lucky to receive Restricted Stock Units, they are a promise to grant shares of stock, which are granted on a vesting schedule or meeting of certain milestones by you or company.  When vesting occurs, the value of the stock is included in your income as ordinary income and the employer is required to withhold taxes as soon as the RSU is vested whether you sell your shares or not.  If you later sell the shares, the change in value is a capital gain or capital loss.

Employee Stock Purchase Plans, on the other hand, are shares that you buy at a discount so you don’t have to pay taxes until you sell the stock.  When you sell the stock, the discount you received when you bought the stock is generally considered additional compensation to you and will be taxed as regular income.  If you sell your stock in less than one year, your gains will be considered compensation and taxed as ordinary income.  If however, you sell your shares after one year, your profit will be taxed at the lower capital gains rate.

If you are lucky enough to become an instant millionaire and you receive Restricted Stock Units you may be subject to higher taxes than under an Employee Stock Purchase Plan. Either way cha-ching. I really don’t think this would be a bad problem to have.  Stock options give you a chance to make more than your salary and they also give you a sense of ownership in the company.

Have you ever received employee stock options?  What type were they?

A new tax law took effect on Jan. 1, 2011 as a part of the Emergency Economic Stabilization Act of 2008, and it requires brokerages to report certain cost basis information to the IRS. This is a good thing for investors because it makes tax preparation easier and places more responsibility on your brokerage to accurately track your cost basis.This tax legislation impacts your brokerage account in a number of ways, so check with your brokerage to find out more. For example, Scottrade streamlined their information into an easy-to-use online Cost Basis Education.

What is Cost Basis?

Let’s back up for a moment and define cost basis. Cost basis is the original value of an asset that is used to calculate gains and losses for tax purposes. For most positions, your cost basis will be the purchase price plus any commissions, and it will be adjusted for wash sales, corporate actions and/or return of capital during the time you hold it.

Cost Basis Reporting

The new legislation rolls out in phases. This tax year, your brokerage will report to the IRS the cost basis for all equities you acquired on or after Jan. 1, 2011. These are called “covered” positions. All your other investments, including equities purchased before 2011, are considered “non-covered” positions. Equities include stocks, American Depositary Receipts (ADRs) and Real Estate Investment Trusts (REITs).

Over the next two years, other types of investments will be covered:

Where Cost Basis is Reported

Your cost basis information will appear on your Form 1099. Keep in mind that not all brokerage accounts will receive a Form 1099. To learn more about the different tax forms generated for brokerage accounts, check out last month’s blog, What to Expect from Your Brokerage at Tax Time .

 Capital Gains & Losses

Cost basis information is used by your brokerage and the IRS to calculate capital gains or losses when you close a position. Some brokerages, like Scottrade, allow you to choose how your capital gains and losses are calculated.

For example, Scottrade’s default calculation method is first-in, first-out (FIFO), which means the first shares you acquired will be the first sold. Think of it like the milk aisle at a large grocery store – the shelf is loaded back-to-front from the refrigerated room in back, so the first gallon of milk that the grocer slides into the shelf is the first one a customer sees. The first gallon of milk put in is the first gallon of milk that is taken out.

Shares of stock can work the same way. Here’s an example:

Monday:         Buy 50 shares XYZ @ $9 ($450 total)

Wednesday:   Buy 50 shares XYZ @ $11 ($550 total)

Thursday:      Buy 50 shares XYZ @ $10 ($500 total)

Friday:            Sell 50 shares XYZ @ $10 (500 total)

With FIFO, your total realized gain would be $50. The first shares you bought (50 @ $9 on Monday) would be the first shares sold. Subtract your investment of $450 from your sale price of $500, and you gained $50 on the transaction.

FIFO is one of several calculation methods your brokerage can use. Check with your brokerage to find out more about the methods available and how to set a tax strategy in your account.

To learn more about cost basis, visit Scottrade’s Cost Basis Education.

Scottrade does not provide tax advice. The material provided in this article is for informational purposes only and Scottrade is not responsible for any errors or omissions. Please consult your tax software or tax/legal advisor(s) for questions concerning your personal tax or financial situation.

Jaci Devine is a free-lance writer with experience in the financial services industry who specializes in investment education.

What to Expect from Your Brokerage at Tax Time

As the number of envelopes labeled “Important Tax Information” pile up in your mailbox, it’s easy to get overwhelmed. Rather than getting discouraged this year, take control of your taxes. When you know what to expect in those envelopes, you can make sure you get the information you need.

Scottrade offers customers several in-person and online educational opportunities to learn more about their tax forms, and the information presented is useful for all investors, no matter which brokerage you’re with.

Form 1099

If you have one or more brokerage accounts, you may be receiving a variety of forms. The most common one is your Form 1099. At Scottrade, the following types of brokerage accounts will typically receive the Form 1099:

• Individual or Joint Brokerage Accounts
• Retirement Accounts (IRAs and Roth IRAs)
• Trusts and Estate Accounts
• Investment Club Accounts
• Partnership Accounts
• Sole Proprietorship and LLC Partnership Accounts
• Custodian Accounts

Reportable Transactions

Keep in mind that even if you have one of these accounts, you will only be issued a Form 1099 if you had reportable transactions in your account in 2011. For non-IRA accounts, reportable transactions include:

• Closing a tax lot (selling a long position or buying to close a short position)
• Interest and dividends
• Taxable corporate actions (e.g., tenders, mergers, cash in lieu of fractional shares)
• Royalty trust income
• Brokered CD sales, and CD redemptions if the certificate matured more than one year after it was issued
• Principal interest on unit trusts and corporate bonds
• Original issue discounts (OID)
• Bond redemptions

If you had one of these reportable transactions in your account, but the aggregate proceeds were less than $10, the proceeds are not reportable, and your brokerage typically will not issue you a Form 1099.

Composite 1099

The Form 1099 is actually a composite form made up of several subsets that each address a specific type of reportable information.

Here is a breakdown of the components of the Composite 1099:

Retirement & Education Savings Accounts

If you have an individual retirement account (IRA), a Roth IRA or a Coverdell Education Savings Account, you will be issued different variations of the Form 1099.

IRAs and Roth IRAs:

• Form 1099-R – Reports distributions, including conversions and recharacterizations
• Form 5498 – Reports contributions, fair market value (FMV)as of Dec. 31, 2011, and required minimum distributions

Coverdell ESAs:

• Form 1099-Q – Reports distributions, transfers out and fair market value as of Dec. 31, 2011
• Form 5498ESA – Reports contributions and transfers in

Mailing Dates

Even though you may want to get an early start on your taxes, keep in mind that brokerages mail your 1099s and other forms on different schedules, depending on IRS mailing dates and information availability. Check with your brokerage for their tax form mailing calendar.

Take Control

When those tax forms start to pile up, don’t just set them aside this year. Armed with the right information about what you should receive from your brokerage firm, you can take control of your taxes and get the information you need.

To learn more brokerage-specific information about your taxes, visit Scottrade’s Tax Guide.

Scottrade does not provide tax advice. The material provided in this article is for informational purposes only and Scottrade is not responsible for any errors or omissions. Please consult your tax software or tax or legal advisor(s) for questions concerning your personal tax or financial situation.

Jaci Devine is a free-lance writer with experience in the financial services industry who specializes in investment education.

IRAs

IRAs can be a powerful tool that can help you build your finances, prepare for a better retirement, and get a hefty savings at tax time. However, some people are confused on what they are, how much they can contribute, and the deadline for their contributions. I’ll answer some common questions to help you feel more comfortable using them.

Max Out Your IRA Contributions

When should you start investing in an IRA? As soon as you can, provided that you have an emergency fund in place and don’t have any high interest (>12%) debts.

How much can you contribute to your IRA? For 2011, you can contribute $5,000/year or the amount of your taxable compensation. If you’re over 50, you get an additional $1,000 added to your contribution ($6,000/year). Don’t forget that these are for individuals, so a couple younger than 50 can contribute $10,000 into IRAs ($5,000 each). If you can max out your contributions, then please do so.

With IRA contributions, there are guidelines for the deduction and contribution limits.  If you contribute to your traditional IRA by April 17th, you may be able to claim a tax deduction on your tax return for the amount contributed.  Roth IRA contributions, however are not tax deductible since the qualified distributions are tax-free.

You can contribute to your Roth IRA if your modified AGI is less than:

• $179,000 for married filing jointly or qualifying widow(er),
• $122,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year, and
• $10,000 for married filing separately and you lived with your spouse at any time during the year.

For your traditional IRA, if you or your spouse is covered by a retirement plan at work, your deduction may be limited.

Don’t worry about figuring out these limitations.  TurboTax easily guides you through the necessary entries and gives you the appropriate tax deduction to maximize your tax refund.

Make it Easy to Contribute

The easiest way to stay on target for your investment goals is to go ahead and automate your IRA contributions. It can be as small as $25/week; the important part if getting you into the habit of saving up for your retirement.

You can also set aside a chunk of any bonuses or windfalls you get this year to deposit into your IRA.

Deadlines for Contributing to Your IRA

2011 is over, but you still have until April 17th to make a tax deductible contribution to your traditional IRA and reap the benefits of a bigger tax refund.

Thoughts on Your IRA

How many of you have continued to contribute your IRA? How has it been doing this year?

Retirement

On the road to retirement, there are some decisions you’ll have which can impact your taxes along the way. Your 401(k) and IRA accounts – should you choose the traditional pre-tax flavor or Roth?  The Roth plan requires post-tax contributions, but allows tax free growth and distribution, in most cases.  If the distribution is the result of a conversion or certain rollover in under 5 years after conversion and you are under 59-1/2, you may have to pay an additional 10% tax penalty.  With pre-tax plans, you contribute to the plans with your funds without any taxes deducted so the distributions are taxable.  So which one do you choose?

One approach to consider is to look at your marginal tax rate, and see how far into that bracket you are. For example, a single filer will be in the 15% bracket from $8,500 of taxable income right until $34,500. If you find that after deductions, exemptions, credits, etc, your taxable income is $38,000, it may not make sense to be in pre-tax retirement accounts for all your retirement savings. Since only the amount above $34,500 is taxed at 25%, by putting exactly $3,500 into a pretax 401(k) or IRA, you’ll reduce your taxable income so the last dollar is taxed at 15%, and none at 25%.

If your company offers a 401(k) with a company match, see if they also offer a Roth 401(k). If not, at least be sure to deposit enough to get the match, and then use a Roth IRA to top off your savings. If the Roth 401(k) is an option, you are usually able to change between this and the standard pre-tax 401(k) on a pay cycle adjustment. The process can be fine tuned a bit by using a traditional IRA and converting some of it to Roth, as needed. A bit of attention to your taxable income and your paystubs and you should be able to take advantage of the difference between these two tax rates.

On the retiring side, you can implement a similar strategy. As a single retiree, finding yourself with a mix of pre and post tax investment accounts, by choosing the pre-tax 401(k) and IRA to make withdrawals right up to the taxable income of $34,500, and Roth or other post tax money for anything above this, you can aim to live right on the edge of 15% through retirement.

With the 2011 standard deduction ($5800) and exemption ($3700) adding to $9500 right off the top, this is about all the median earner needs at retirement. If your withdrawals are a bit lower than this, consider the strategy of converting just enough IRA money to top off that 15% bracket.

It’s not as difficult as it might appear. By looking at last year’s return and adjusting slightly for this year’s numbers, you should have a good idea where 2011 will put your taxable income. Underestimate a bit, and convert just enough IRA money to Roth to hit your goal.

If in April, your return tells you went over, just recharacterize enough to get the taxable income number dead on. This strategy for the just-retired person will help bring that IRA balance down over time to avoid some potentially large RMDs (Required Minimum Distributions) after reaching 70-1/2.  Please note: once you make contributions to a designated Roth account, you cannot later change to a pre-tax account.

Note – the rates I discussed are for the single filer. Take a peek at the page I linked above for the tax table for other filing status, the idea works the same with the numbers adjusted for status.

As long as an individual meets certain criteria laid out by the IRS, this strategy will offer hefty tax savings for individuals and much-needed cash for numerous charitable organizations.

Qualified Charitable Distribution

Tax Law Timeline

The Pension Protection Act of 2006 allowed taxpayers age 70 1/2 and older to exclude from their gross income what would otherwise be taxable distributions from their IRA if they were paid directly to a charity.

This law has been extended for the last 4 years, and is currently extended through December 2011 by the Tax Relief Act of 2010.

This tax legislation extends Qualified Charitable Distributions – an IRA distribution paid directly to a charitable organization from IRAs – through the end of this year. QCDs are excluded from the taxpayer’s gross income for federal tax purposes and may be counted toward an individual’s Required Minimum Distribution (RMD) if those minimums have not yet been satisfied.

Guidelines to Determine Qualified Charitable Distributions

• Individuals must be 70 1/2 years of age or older when the contribution is made.
• Contributions must come from traditional or Roth IRAs. According to the IRS, QCDs cannot be made from employer-sponsored IRAs (Simplified Employee Pensions; SEP-IRAs), Savings Incentive Match Plans for Employees (SIMPLE-IRAs), or from defined contribution retirement plans (for example, 401(k) plans or 403(b) plans).
• Charities receiving the contribution must be eligible to receive tax-deductible charitable contributions; 501(c)(3) organizations. This seems rather obvious, but you need to be smart and research the charity prior to your donation.
• The maximum QCD is $100,000; however, a spouse can also make a $100,000 qualified charitable distribution within the same year if the couple files a joint income tax return.
• The $100,000 max limit doesn’t apply to the overall charitable deduction limit. Therefore, individuals are able to make charitable contributions in excess of 50% of their adjusted gross income.
• The distribution must be a “trustee-to-trustee transfer”. This means that the money doesn’t touch your bank account; instead, it goes directly from your IRA account to the charity that you have chosen. A distribution to a recipient other than a charity will not be tax free, even if that recipient donates the money to a charity.
• Qualified distributions for 2011 must be made by December 31, 2011.

Benefits of This Extension

There are three major areas of benefit when dealing with this tax-free extension.

First, the extension gives an incentive for individuals over 70-1/2 to donate. These incentives could possibly be a deciding factor for many people considering what to do with their IRA distributions.

Although the individuals get a tax break, extending this tax legislation benefits charities who are in need of donations by making it easier and cheaper for donors to give. Remember, charities need funds to continue doing good work around the country and around the world.

Second, the tax relief extension benefits the donor by allowing the exclusion of up to $100,000 of the the QCDs from their gross income in 2011. This is the tax-break highlight of the program extension, especially for this last month of the year.

Third, for those of you who have Required Minimum Distributions, QCDs satisfy RMDs that you would normally be forced to receive from your IRA, just as if you had received an actual distribution from the plan. This means your RMD will satisfy your required distribution amounts as well as give you all of the tax benefits of a qualified charitable distribution.

However, you do not get to deduct QCDs as a charitable contribution on your federal income tax return. That’s double dipping.

Why This Extension Is Important To You

Typically, deductions for charitable cash contributions are limited to 50% of a taxpayer’s AGI. Individuals who want to make a large charitable donations above that limitation are able to do so under this extension.

This is an important tool because the QCD’s exclusion from an individual’s gross income provides a solution for making charitable deductions for taxpayers who are not able to itemize their deductions (i.e. they take the standard deduction).  If you are a taxpayer over 70-1/2, who is lucky enough to have a paid off mortgage, you may not be lucky enough to itemize your deductions since mortgage interest usually plays a big part in you being able to itemize deductions.  If this is the case, paying qualified charitable distributions directly from your required minimum distribution(tax-free) will greatly help your tax situation.

Other areas of importance are that the extension makes this process less time consuming and less expensive. Without utilizing this tax-free extension, an individual would see an increase in paperwork and a decrease in benefits.

Who Should Make Qualified Charitable Distributions?

Typically, there is a limit of 50% of an individual’s Adjusted Gross Income that is available for charitable deductions. Taxpayers who want to make a large charitable donation above that limitation are ideal candidates to benefit from the QCD extension.

Another possible candidate might be someone who desires to make a large charitable donation, but their only financial vehicle is a large IRA balance. In this situation, if the individual took a normal IRA distribution outside of the tax-free QCD extension, they would be subject to fees, taxes, and a litany of other possible consequences (including an increase in taxable Social Security income or a rise in Medicare Part B Premiums).

Other individuals might simply want to donate their entire RMD and still enjoy the tax benefits by making the contribution through the tax-free QCD.

Remember, qualified charitable distributions for 2011 must be made by December 31, 2011.  If you decided to make this thoughtful charitable contribution, it will be indicated on your Form 1099-R.  Don’t worry,  TurboTax will easily guide you to enter the necessary information from your qualified charitable distribution.

Year End Tax Tip

Why It Looks Attractive

In a time of stock market volatility, you might have seen your retirement investment returns diminish – and even go negative – it might be tempting to put that money to better use by paying off debt and getting rid of the interest payments. On top of that, there is fact that when you borrow from your retirement plan, you are borrowing from yourself. So, you pay off your credit card debt, but you still need to repay your 401(k) loan. You make payments plus interest back into your account, so you are paying yourself the interest, rather than giving it to the credit card companies.

This seems like a great idea, especially since, if it is a loan from your retirement account, you won’t be charged the 10% penalty (this is on top of your tax rate) for withdrawing before reaching the age of 59-1/2, and you won’t have to report the money as income.

Why You Shouldn’t Do It

Of course, there are downsides to using retirement account money to pay off your credit card debt. First of all, if you withdraw the money outright, without using a loan, you will have to pay a penalty of 10% of the amount, if you aren’t 59-1/2. Plus, the withdrawal amount will be added to your income, and you will have to pay income tax on it.

Even if you go the loan route instead, there are definite downsides to using retirement money to pay off credit card debt. You will have to pay a loan fee and you will have missed opportunities. Without that money sitting in your retirement account, working for you, you won’t have as much later. Yes, you are putting the money back as you repay your loan, but for a time, the capital was missing from your account, and you missed out on compound interest. That will result in a smaller nest egg over time.

You also can’t discount the problems that can come with a retirement account loan if you are laid off. If you lose your job while you have a loan outstanding, most plans require that you repay the remainder of the balance within 60 days. If you default on your 401(k) loan, you won’t see a ding on your credit report, but your loan will be reported as a distribution, and you will then be subject to penalties and taxes.

In many cases, taking money out of your retirement account has the potential to cost a great deal. Consider the viability of putting together a debt reduction plan before you withdraw money from your retirement account. If you do decide to take the money from your account, make sure you repay it as quickly as you can, and try to avoid penalties and taxes.

Capital Gains Tax

A capital gain is the profit made when you sell an investment for more than what you bought it for. If your investments sell for less than you bought them for, then you
are entitled to claim a capital loss. If you have incurred capital gains this year, and you have some losing investments in your portfolio, consider harvesting some of those losses to offset the gains so you won’t owe taxes on the capital gain income. Here’s where to start:

Compute the gains on assets you’ve already sold.  Make a list of your sales of stocks, bonds and real estate during the year, and add expected capital gain dividends on mutual funds.

Offset any losses you have already realized this year. That includes the stock you purchased when it was high and you thought it would go higher, but you finally sold when it dropped well below what you paid for it. Don’t forget loss carryovers from prior years – you can spot carryovers on page 2 of last year’s Schedule D of your personal income tax return.

If the gains exceed the losses, look for unrealized losses to offset those gains.  You may be holding onto a stock that has dropped, hoping it will regain its value. This may be a good time to sell the stock and put that loss to work.

Check your income tax bracket.  Before taking the step to sell a stock that has dropped in value, also see if you can take advantage of lower capital gains rates, which were extended until the end of 2012.  The maximum capital gains rate for most people with long-term capital gains is 15%.  If you have income lower than $34,500 ($69,000 for married filing jointly), capital gains and dividends may be taxed at 0% depending on the type of net capital gain!

Beware of the wash sale rule.  You cannot deduct losses from sales in a wash sale.  A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale, you buy substantially identical stock, acquire identical stock or securities in a fully taxable trade, acquire an option to buy substantially identical stock, or acquire substantially identical stock for your IRA.

Tip:  If you have a disallowed loss from a wash sale, add the disallowed loss to the cost of the new stock or securities.  The result will increase the cost basis of your new stock and decrease your gain on the sale of the new stock.

Don’t harvest too many losses.  Once you have offset your losses against your gains, excess losses can reduce up to $3,000 of ordinary income from employment or other sources. If your losses are greater than that, the excess can be carried over to the next year.

TurboTax easily guides you through the necessary interview questions and accurately makes the behind the scene calculations for your capital transactions.  You can also use tax calculators to help you plan and work through various tax scenarios.

Reconsider Withholding

If you’ve filed your taxes and ended up with a large refund or had to cut Uncle Sam a check, it’s time to address your withholding. If you owed money it’s a no-brainer that you want to adjust your withholding so more money is set aside for taxes so that you don’t have a bill next April. But having a large refund can be just as bad. In fact, the average refund this year is a little over $3,000. That means most people are letting Uncle Sam hold a few thousand dollars hostage for 11 months of the year when it could probably be put to better use immediately. Think about it—a $3,000 refund works out to an extra $250 a month of added cash flow. If money is tight you can see how helpful having that money each month would be. By adjusting your W-4 you can have a little less money withheld and put more money in your pocket with every paycheck. TurboTax makes it easy to adjust Form W-4.

Check Your Investments

Now is a good time to check your investments. That’s because the past two years have been two of the best consecutive years in the history of the stock market. If you’ve been invested during this time and saw some of these rapid gains your portfolio is probably a little out of whack. You should have a target asset allocation you try to remain at, but the gains in the market could have skewed your allocation heavily toward stocks if you haven’t rebalanced in a while. If that is the case you are likely more exposed to risk than you realize, so it’s time to check your investments and rebalance your portfolio to get you back on track.

Automate Your Finances

If your finances are in pretty good order and you’re still looking for a change that can help your finances, consider automating everything. Technology is a wonderful thing and these days you can virtually put your entire finances on autopilot. From automatic bill pay to retirement contributions, these days you don’t have to think twice about things.

Start with your savings goals. If you have a 401(k) that’s obviously automatic already, but if you have an IRA or other investment account you can set it up to make regular and automatic contributions on the interval you choose. The same can be said for even a regular savings account. Why wait to make a one-time transfer from checking to savings when you can set it up so that a little bit goes into your savings account with each paycheck? Once it’s automatic you never have to think about it or worry about spending the money before it gets deposited. Finally, the most obvious choice is automating bills. The fewer checks you have to write and accounts to login to, the easier your life will be. Why spend an hour or two each week paying bills when you can pay them without thinking twice about it? Not only will you have more free time on your hands, but you may even save some money by making it automatic.

Length of Retirement

The first thing you’ll need to consider is how long you expect to rely on retirement income. Time plays one of the largest roles in determining the size of your nest egg. Somebody working until they are 70 needs far less in the bank than somebody planning to retire early at age 60. Not only that, but early retirees may not have the benefit of receiving Social Security or Medicare for a few years which can significantly increase the amount of money needed.

So, take a look at what you plan on doing. Things may change, but you have to start with some sort of expectations. If you’re assuming you’ll retire at age 65 and plan on living to 85 that will at least give you a starting point. Now you know that at the very least your nest egg should cover about twenty years of income.

The Kind of Retirement

What you actually do in retirement will ultimately dictate how much money you need. If you will retire debt-free, no mortgage, and don’t plan on doing any traveling or buying a new home or anything, your retirement expenses may be very low. On the other hand, if your retirement vision consists of buying a new condo on the beach in Florida and traveling to Europe every summer, well, that’s another story.

You need to sit down and actually think about what you want to do in retirement so you can create a better picture of what your income needs will be. Obviously, the younger you are, the more these dreams and costs can change, but you can still create a ballpark figure by looking at what things cost now and adjusting for inflation. A good inflation rule of thumb is an average of 3 percent per year. Another way to think about it is the cost of something doubling every 25 years.  So, if your projected annual income in retirement would be about $30,000 in today’s dollars, know that in 25 years that means it will probably cost you roughly that.

Putting it All Together

After you’ve determined how much your annual retirement will cost and figured out roughly how many years you’ll need to rely on that money it’s time to create your magic number. Using the information above, let’s say I’m 30 years old today, plan on retiring at age 65, and expect my retirement income to be about $30,000 a year based on today’s dollars. Adjusted for inflation, that means my retirement expenses when I retire will likely be about $80,000. Then if I plan that money has to last another 20 years in retirement, I end up with a figure of $1.6 million.

Don’t be shocked at the number just yet. It may sound like a lot, but let’s look at how you can get there. In the same example, that leaves me 35 years to save up to this goal. So, utilizing my company 401(k) or IRA I can start putting money aside and let it grow. Remember, there are tax breaks here as well that will ease the pain. It won’t actually require putting aside the entire $1.6 million since we have time and compound interest on our side.

Assuming I already have $25,000 tucked away for retirement, I could reach my nest egg number by saving $12,000 per year and earning a somewhat conservative 6 percent average annually. Depending on your situation and how much you already have saved or need to save that may still seem like a lot, but remember that we’re basing it off of needing to fund our entire retirement ourselves. Whether you like the direction Social Security is headed or not, chances are you’re going to receive some retirement income there as well, and that will cut into how much of your personal money you need to use. But when planning, I feel it’s always best to plan for the worst and assume it won’t be there at all and if it is, that’s just a bonus.

Get Started Today

If this example has done anything, hopefully it illustrates the importance of saving for retirement. I know young people feel there’s no money to be saved and there’s plenty of time to catch up, but you really need to get started as soon as possible. Maybe you can’t put away enough each year right now to meet your goals, and that’s okay. As long as you’re saving something you’re on the right track. Besides, what seems like a lot of money today might feel like a drop in the bucket in 20 years and you may be able to comfortably save double or triple what you need to each year. So stop kicking the tires on your retirement plan and start putting some money away. A little bit goes a long way over time.

I’d like to see an article about the tax and long-term financial implications of using 401k loans or early withdrawals to pay off debts (credit cards, student loans, mortgage, etc.). Does it make sense to be paying a higher interest rate on debt than I’m making in my retirement investments?

Deciding to raid one’s retirement plan for debt repayment is not a decision to be taken lightly. I’m glad you took the time to ask for help before taking money from your future.

A 401(k) plan is a retirement plan and the government gives us some pretty big incentives to use it exclusively as one. Consequently, my bias is to avoid taking money from a 401(k) plan at all costs. Of the examples you mention, only the existence of significant high-interest credit cards would cause me to consider making an exception. (Student loans and home mortgages are “good debt” and are typically at a low cost. The negatives, discussed below, of pulling money out of your 401(k) greatly exceed the benefits of more aggressively reducing relatively low-cost “good debt.”)

On the other hand, credit card debt can be extremely expensive. For example, if you’re paying 20% or more APY on a sizable credit card balance, it might take you a very long time to pay back your debt. As such, if you could borrow from your 401(k) plan and pay off all (or nearly all) of your credit card debt, I’d consider it. Yet even in such a situation, it’s still not a no-brainer to do so to borrow from your 401(k) plan. Here’s why:

A 401(k) loan is risky. Should you terminate employment for any reason (e.g., lay-off, spouse gets a job in a different city, you get really irritated at your boss one day, etc.) your loan is typically due, in full, within 60 days. When you can’t pay it back (and you won’t be able to – if you could, you would have paid it back already), the entire outstanding loan is considered a distribution. As such, you’ll be subject to income taxes, plus a 10% early distribution penalty if you’re under 59 ½. This potentially large sum will be due no later than the following April 15. Will you have the money available? Unlikely, making matters even worse.

An outright distribution from a 401(k) plan is no better. After all, you permanently reduce the amount available to you at retirement.

Furthermore, keep in mind your retirement plan money is typically unavailable to debt collectors, even in bankruptcy. While I believe people should pay what they owe, one needs to be wise to all the angles.

Taking money from your 401(k) plan should be a last resort and, in my mind, done only a very specific situation: as a loan to immediately and aggressively attack high-interest credit card debt by a person with a good deal of job security who is willing to make the significant commitment necessary to ensure the debt does not recur once more credit is available. Otherwise, steer clear and pay off your debt the old fashioned way – by spending less than you earn and using the difference to pay down debt.

What do you think? Have you taken a 401(k) loan or distribution? Glad you did or still paying for it?