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Q: I would like to pay of my credit card debt (it's over $20,000 at a 16.99% interest rate). I am a retired teacher with a pension and 403(b). I am still substitute teaching. My home will be paid off in 2 years with a current interest rate of 4.62%. I have 1 child in college, 1 car note, and 1 equity line of credit. Should I get another low interest loan to pay off my credit card or transfer to lower rate credit card? We still use the card for monthly expenses? I prefer carrying a credit card instead of cash.
A: We all want to pay as little as possible on our debt; however, the bigger question for you is how are you accumulating the debt on your credit card to begin with? We would recommend creating a budget for all of your living expenses and trying to stick with it. Is it possible to pay off your credit card debt with your home equity line of credit? Also, try using a debit card instead of paying for everything with a credit card after you create your monthly budget.
Q: Our income is too high this year, so we can't do a Roth IRA. I heard that we can contribute to a non-deductible IRA, then convert to a Roth IRA (backdoor). My spouse and I currently have rollover IRAs with high balances, so when we convert to the Roth IRA we will be taxed on most of the $6500. Is this correct and would you recommend doing this? We are both 55 years old.
A: The IRS uses a pro-rata rule when calculating tax on Roth IRA conversions. As such, most of the conversion would be taxable if you already have a sizable IRA account. Also, if you are in a very high tax bracket relative to what your tax bracket will be in retirement, then the Roth IRA conversation doesn’t really make sense.
For example, if you pay 30% in taxes today, and in retirement you’ll be in a 10% bracket, then the Roth IRA doesn’t help nearly as much in the future.
So it boils down to taxes today versus taxes tomorrow. If your tax rate will be similar (or higher) in the future than the conversion then it might make sense. If your tax rate will drip in the future than the conversion may not be beneficial.
Q: In the book "You Can Retire Sooner Than You Think" there is a section on Roth IRAs that says, "Contributions are made with after-tax dollars and can be withdrawn at any time without penalty." Recently, I visited a Financial Advisor who told me there is a 10% penalty even for contributions. Can you tell me who is correct?
A: Distributions from Roth IRAs are designed to be tax-free in retirement. A distribution from a Roth IRA is not included in the owner’s gross income and is not subject to the 10 percent early withdrawal penalty if it is a “qualified distribution.” Distributions that do not meet the definition of a qualified distribution may be subject to income tax and the early withdrawal penalty.
Qualified Distributions – are distributions from a Roth IRA that satisfies both the following tests:
1. The distribution must be made after a five-taxable year period, and
2. The distribution satisfies one of the following four requirements:
a. Made on or after the date on which the owner attains the age of 59½
b. Made to the beneficiary or estate of the owner on or after the date of the owner’s death
c. Is attributable to the owner being disabled, or
d. For first time home purchase (lifetime cap of $10,000 for first time homebuyers)
Nonqualified Distributions – Any amount distributed from an individual’s Roth IRA that is not a qualified distribution is treated as made in the following order
· From regular contributions
· From conversion contributions on a first-in-first-out basis, and then
· From earnings
In the event a distribution is not a qualified distribution, the first layer will be return of adjusted basis (from after-tax contributions), followed by post-tax conversion contributions. Since these contributions have already been taxed there will be no income tax consequences (although there may be a penalty). The final layer consists of tax-deferred earnings on contributions and conversions within the Roth IRA, which will be subject to tax and penalty if the distribution is not a qualified distribution.
Distributions will generally not be taxable to the extent that total distributions do not exceed total contributions and conversions.
Q: I just rebalanced my Rollover IRA investments and I have my cash allocation sitting in a money market fund that has a very low return. Where can I invest that in a very low-risk fund (such as an ETF) to get a better return?
A: A lot of people have been searching for ways to increase the yield or interest they earn on their cash in this low-rate environment. The more yield investors stretch for, the more risk you take on. You might consider a short duration bond fund or something similar.