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Volume 15, Issue 2

Is a Roth 401(k) Right for You?

Since it first became available in 2006, many employers have added the Roth 401(k) to their benefits packages as a retirement savings option. A Roth option, which is available for Individual Retirement Accounts (IRAs), as well as sponsoring 401(k) and 403(b) accounts, may be appropriate for some individuals, depending on their circumstances. So, is a Roth 401(k) right for you? Let’s take a closer look.

To Roth or Not to Roth

In order to decide whether the Roth 401(k) option has a place in your retirement plan, it is important to weigh the advantages and disadvantages of both types of 401(k)s. With a traditional 401(k), you make contributions on a pre-tax basis, which lowers your current taxable income, and earnings are tax-deferred. However, your retirement distributions will be subject to ordinary income tax. With a Roth 401(k), your contributions are not tax deductible, but earnings and distributions are tax free, provided you have held the account for at least five years and are at least 591⁄2 years old. Is it better to pay taxes on your retirement funds now or later? The best choice for you depends on your current tax situation and your long-term financial goals.

It is important to keep in mind that the 401(k) annual deferral limits—$ 16,500 for taxpayers under the age of 50 and $22,000 for those over age 50 in 2009—apply to all 401(k) contributions, regardless of whether they are made on a pre-tax or after-tax basis. If you contribute to a Roth 401(k), you may have to reduce or discontinue your contributions to your employer’s conventional 401(k) plan to avoid exceeding these limits. However, you may contribute to both types of 401(k) plans.

Also, matching contributions made by employers must be invested in a traditional 401(k), not a Roth account. So, even if you make contributions exclusively to a Roth 401(k) account, you will still owe tax in retirement on withdrawals from funds contributed on a pre-tax basis by your employer.

What about the Roth IRA?

The Roth 401(k) is only available through an employer-sponsored plan, whereas the Roth IRA is available to all taxpayers (with income limitations). How do the two Roth options compare? First, you can save more money in a Roth 401(k) than in a Roth IRA. The 2009 annual contribution limits for IRAs of all kinds are set at $5,000 for taxpayers under the age of 50 and $6,000 for older workers. The Roth 401(k) is subject to the more generous elective salary deferral limits that apply to conventional 401(k)s—$16,500 or $22,000 for those over age 50 in 2009.

Furthermore, the Roth IRA is subject to adjusted gross income (AGI) limits; only those with AGIs below $120,000 for single filers and $176,000 for joint filers are eligible to contribute after-tax dollars to a Roth IRA in 2009. These income limits do not apply to Roth 401(k)s.

In addition, contributions to a Roth 401(k) can be made through payroll deductions, which puts retirement saving on autopilot. To participate,an employee who is currently contributing to a traditional 401(k) plan could, for example, opt to have his or her contributions diverted to a Roth version of the same plan. Unlike the Roth IRA, however, you will be required to begin taking distributions from a Roth 401(k) after the age of 701⁄2. The Worker, Retiree, and Employee Recovery Act of 2008 temporarily waives required minimum distributions (RMDs) for 2009 only.

If a Roth 401(k) makes sense for you,ask your company’s benefits administrator if the feature is available for your retirement plan. If it is not already in place, expressing interest in the Roth feature may increase the likelihood that your company will adopt the option.

Tax Benefits of Donating Used Vehicles to Charity

Donating a used car or other vehicle to charity is a great way to support the nonprofit of your choice, while also allowing you to claim a deduction on your federal income tax return. But the rules governing vehicle donations have tightened in recent years. Consequently, it is important to be aware of the process involved in donating a car and the procedures that must be followed when claiming the deduction.

Many charities, both large and small, now accept vehicle donations. The types of vehicles that qualify for the tax deduction include all privately owned automobiles manufactured primarily for use on public roads, as well as boats and airplanes. In order to claim a deduction, however, the charity that receives the gift must be recognized by the Internal Revenue Service (IRS) as a 501(c)(3) organization .Available online and at most public libraries, IRS Publication 78 includes an annually updated list of qualified charities.

Prior to a change in rules in 2005, taxpayers were permitted to write off the fair market value of the donated vehicle. But under current law, you are only allowed to deduct automatically the good faith fair market value of the car if the estimated amount does not exceed $500.

The IRS defines fair market value as the price a willing buyer would pay and a willing seller would accept for the vehicle when neither party is compelled to buy or sell and both parties have reasonable knowledge of the relevant facts. When assessing the value of the vehicle, use a pricing guide based on make, model, year, options, and accessories, as well as the condition of the car.

If the vehicle is assessed at a value between $500 and $5,000, the size of the deduction depends upon what happens to the vehicle after the charity has received it. If the charity sells the car, your deduction is limited to the exact amount of the sale price. Different rules apply, however, if the charity makes what the IRS calls “significant intervening use” of the vehicle before it is sold or otherwise disposed of. If, for example, a donated car with a fair market value of $1,500 is used by the charity for several months for pickups and deliveries before it is sold at auction for $1,200, the donor would nonetheless be permitted to claim a deduction of $1,500.

The donor may also claim the fair market value, rather than the sale price, if the charity sold the car to a “needy individual” at a much lower price than the actual value or if the organization makes a “material improvement”— generally, reconditioning work that is more than routine or cosmetic—before selling the vehicle. If, however, the vehicle is ultimately sold for less than $500, the taxpayer may claim a deduction for the lesser of the vehicle’s fair market value on the date of the contribution or $500.

Keep in mind that writing off your car donation is only possible if you itemize your deductions. To claim a vehicle deduction above $500, the receiving charity must provide you with a written acknowledgement of receipt that includes detailed information about the intended use and sale of the vehicle. The charity is required to provide you with substantiation of the donation within 30 days of the date when you signed over the automobile or, if the car is sold, within 30 days of the sale. A copy of the receipt must be filed with the tax return, along with IRS Form 8283, “Noncash Charitable Contributions.” If the vehicle is worth more than $5,000, you must also attach documentation from a qualified appraiser. If the donated car is worth between $250 and $500, obtain a written acknowledgement of the contribution from the charity for your records. You are not required to attach the acknowledgement to your tax return.

When donating a vehicle, steer clear of for-profit intermediaries that advertise offers to help you manage your charitable donation, as these middlemen often keep the bulk of the proceeds from the sales of donated cars. If possible, give the vehicle to a charity with a donation program that enables them to accept the vehicles directly. You should also consider avoiding charities that do not allow you to re-title the car when turning it over to them, as this leaves you vulnerable to liability.

If you’re considering the donation of a used vehicle to charity, you may qualify for a federal income tax deduction. For more information, consult your tax professional.

Prepay Your Mortgage: Save Interest

When you tally up the numbers behind your mortgage, you will probably discover that you will be paying a great amount of interest over the life of your loan. As a result, you may choose to prepay a portion of your mortgage loan. Prepayment can save you a considerable amount, particularly if you plan to reside in your home throughout the life of your loan.

Getting Down to Basics

Assuming you have a $200,000 mortgage at 7% for 30 years, your ordinary monthly payment (excluding real estate tax) is about $1,331, payable for a total of 360 months. The mortgage will ultimately cost you an estimated $479,022, which includes $279,022 in interest.

If you pay $50 extra per month (about $1.64 a day) toward that mortgage, you will cut your total interest payment to approximately $242,597, and you will own your home without a mortgage three years and three months sooner. In other words, the extra money you pay out at the rate of $50 a month will save you an estimated $36,425 in interest.

Obviously, the more money you pre-pay, the greater your savings. For homeowners who have adjustable rate mortgages (ARMs), the practice of prepaying is especially wise when interest rates are low. Prepaying reduces your debt load if rates go up later, since interest payments are highest and principal payments are lowest at the loan’s inception.

Things to Consider

Is there a downside to prepayment? It depends. Eventually you will eliminate the income tax deduction you receive from deductible interest paid. Depending on your tax bracket, the amount of money saved should be reduced accordingly. In addition, if you are sure the stay in your present home is only temporary, prepaying may not be as beneficial. It’s important to thoroughly analyze your options before you proceed.

Another area of concern can be prepayment penalties. While once common, they may be limited or nonexistent on relatively new mortgages. In addition, the competitive nature of lending has led banks, in some instances, to waive penalties and prepayment charges. In order to make prepayments, you can usually add the prepayment to your normal monthly mortgage payment.

Before proceeding with any type of plan, consult with your financial professional to ensure that your decisions are consistent with your overall financial goals and objectives.

Select Trustees with Care

If you are thinking about establishing a trust, you will need to select a trustee—someone who will administer the trust according to your wishes. Perhaps you are considering naming a family member, or maybe you are wondering whether it would be wiser to designate your attorney or another trusted professional. Choosing a trustee is an important decision that should be made with care.

A trustee’s role is to comply with the terms of the trust and fulfill its objectives. In selecting a trustee, you must weigh many personal, family, asset management, and business concerns. For instance, an important consideration is the size and complexity of the trust. Corporate and professional trustees often possess the accounting, tax planning, and money management experience necessary to administer large, complicated trusts. On the other hand, a small trust may not warrant professional management.

Duration is another significant concern. A trustee’s responsibilities often span one or more generations. Corporate fiduciaries may have the advantage of perpetual life (although the individuals administering the trust may change over the years). This longevity may also allow them to more easily fulfill the recordkeeping and reporting requirements of the supervising court, as well as Federal and state governments. If you have decided to appoint only individual trustees, you should be advised to consider designating co-trustees or successor trustees to address longevity concerns.

Advantages of Professional Trustees

Corporate trustees have other advantages, as well. For instance, they may be more impartial when considering beneficiaries’ needs than family members, who may face conflicts of interest. Also, corporate and professional trustees are held to a higher standard of professional conduct than nonprofessionals. Of course, professional service comes with a price. Many grantors of small trusts choose nonprofessional trustees to avoid high corporate fees.

Benefits of Family Members

When a personal touch is needed, family members, or other nonprofessionals who know the family, may offer special advantages as trustees. They generally have the sensitivity and flexibility required to support the special needs of a beneficiary. A family member or business associate may also be the preferred choice if you are leaving a business in trust. Corporate trustees generally do not run businesses.

Best of Both Worlds

Often, a combination of professional and nonprofessional trustees may work best. Corporate or professional trustees provide trust management expertise, while family members or other nonprofessionals respond to the changing needs and circumstances of beneficiaries.

Trusts are complex, varying by type and purpose, and are most likely to fulfill their objectives when responsibly administered. An inappropriate choice of trustee could invalidate a trust or have serious tax consequences. A qualified legal professional can help you make the most appropriate choice for your particular situation.

The information contained in this newsletter is not written or intended as tax, legal, or financial advice and may not be relied on for purposes of avoiding any Federal tax penalties. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.

The information contained in this newsletter is for general use and it is not intended to cover all aspects of a particular matter. While we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. Therefore, information should be relied upon only when coordinated with professional tax and financial advice. The publisher is not engaged in rendering legal, accounting, or financial advice. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any securities. This newsletter is written and published by Liberty Publishing, Inc., Beverly, MA, COPYRIGHT 2009.



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