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Tax Time 2008: Retirement Savings Contributions Credit and IRAs

Now that we’re in 2009, it’s not a bad idea to start thinking about 2008 taxes. I don’t expect anything to be drastically different this year, but there are a few things I’m going to be looking at this year.

Credit for Qualified Retirement Savings Contributions
Form 8880 – TurboTax filled this in for me last year and I didn’t even know about it until I read more about it this year. In 2008, if you are filing jointly and have an Adjusted Gross Income (AGI) of less than $53,000 then you can receive a tax credit on a portion of your contributions to an IRA or retirement plan. Last year we were low enough to get the 10% credit on up to $2,000 of our contributions. Lower incomes receive a higher percentage back. Remember, tax credits > deductions.

Doesn’t sound like a big deal, but it’s actually a pretty good deal for those with lower incomes since the credit is a straight up reduction of your total tax bill. If you contribute to a Traditional IRA, you get the deduction there that brings your AGI down and then on top of that you get anywhere from $200-$1,000 back. The income limit for the 50% credit is low ($16k single, $32k joint), but if your income is in that range then you’d definetely want to contribute $2,000 to a Traditional IRA before April 15, the deadline for making 2008 IRA contributions. If you were in that situation you’d be able to put $2,000 away for retirement, reduce your AGI by $2,000 and get $1,000 slashed off your tax bill. I could see people in that situation paying $0 in Federal taxes when combined with other deductions and credits.

IRA Rollovers
I never rolled my SIMPLE IRA (money market funds) from my old job over to Vanguard and now would be a great time to do it considering equity prices are down. If I rollover into a Roth IRA then I pay taxes on the whole thing. I’ll only do that if we’re over the $53,000 limit for the Savings Credit and I can’t get my AGI under that with contributions to Sarah’s Traditional IRA. If I roll into my Roth I’ll eat the taxes this year and then roll Sarah’s into a Roth next year and be done with Traditional IRA’s for the foreseable future.

Traditional IRA deduction limits
And the reason I’m moving away from Traditional IRAs is the fact that we’ll eventually both be participating in employer sponsored retirement plans. If we are both active in an employer plan, then the Traditional IRA deduction starts to phase out at a modified AGI of $83,000. Once that phase out hits it makes sense to put money into a Roth IRA because of tax advantages and the fact that non-deductible contributions in a Traditional IRA really complicates things. Remember, Roth IRA contributions > Non-deductible Traditional IRA contributions.

So that’s just some of the stuff I’m going to be dealing with this year. I’ve still got a lot to learn, but it is nice to finally learn the ropes and be more aware throughout the year of things that affect our taxes. This year I’m getting the wife involved and she will be sitting down in front of TurboTax and filling out our return with my help. What do you think, should I add tax geek to my list of geekdoms?

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Simple IRA rollover

My old employer offered an IRA through Fidelity and I just passed the 2 year maturity date on that account. With Simple IRAs you have to wait 2 years before the funds are available to rollover. I’m sure regular investment accounts at Fidelity are fine, but this IRA was an “Advisor” account and I didn’t really have much control over it and the investment options were limited. Some of the fees are a little steep considering how much I have in the account. I think I just have a money market fund in it that hasn’t done much, but I did double my investment from the employer match.

The Fidelity IRA will be rolled over to a Traditional IRA at Vanguard and I’m contemplating putting the money into the Total International Stock Index Fund. I’ve got the Target Retirement 2045 in my Roth which is heavy in domestic large caps and only has 18% of its holdings in international stocks. I’d be willing to go a little higher than that, maybe 30-35% international. My rollover just barely meets the minimum $3000 in the international fund and maxing out my Roth IRA for 2008 would put my portfolio at 39% international. Next year I’ll buy more of the 2045 fund and bring that percent down.

If anybody is interested I put together a little spreadsheet to help calculate asset allocation based on a fund’s holdings. With funds of funds, this can be tough to figure out, especially if you have overlap in different funds. Since I’m in broad market index funds I don’t have to worry about being too heavy in a certain sector or single company.

Yeah yeah I know, index fund blah blah blah, asset allocation blah blah blah.

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Putting my money where my mouth is: opened a Roth IRA

I’ve been blabbing on about finances for a little bit now and up to this point I haven’t been very aggressive about saving for retirement. Saving for retirement is good and dandy, but right now is the most important time for us to put away money (if you are wondering why see this post on compound interest). Both of us have a little money in SIMPLE IRAs, I pay 5% into LACERA (county pension) and get 3% matched going into a 457(b). Not enough to meet our goals, but definitely better than 0%.

For over a year now I’ve been talking about starting a Roth IRA and never did. With April 15th just a few days away, I went ahead and started a Roth IRA at Vanguard. What’s important about April 15th besides taxes being due? It’s the last day to make IRA contributions for 2007. I maxed out my 2007 contributions which leaves me another year to work towards maxing out my 2008 contributions.

My entire investment strategy revolves around starting young and investing for the long term (30 years). I also wanted a strategy that would require very little effort on my part. I knew index funds were the way to go, but there are ton out there and needed to narrow it down. I was also taking asset allocation and fees into consideration.

After some research I found Vanguard’s Target Retirement Funds. They are funds of funds and include indexes of US and international markets along with bonds. The 2045 Retirement Fund has an asset allocation of about 90% stocks and 10% bonds right now and will gradually reverse those numbers as 2045 grows closer. Since I’m starting young I’m comfortable with an aggressive allocation and the automatic reallocation will save me time down the road. The expense ratio is a low .25% which can really impact savings over the long term.

Opening the account was really easy and everything is done online. Funds were transferred straight out of my checking account and I avoided a $20 annual maintenance fee by opting for paperless statements. I also like the fact that Vanguard is client-owned and is there to serve the investor, not outside shareholders. You’ll never see TV ads for Vanguard since that’s money coming out of their investors pockets. With $1.3 trillion in holdings they must be doing something right.

My strategy will probably evolve as our income and tax situation change, but the essential idea is to put away a steady amount over the years in tax advantaged accounts and let compound interest do its job.