G is for Gross Income - Retirement Planning

We continue our look at some of the important factors of a good retirement plan. This alphabetical look at what you need to know continues with a look at gross income.

In Retirement Planning, G is for Gross Income

There are very few downsides to owning a Roth IRA. Of course there is the tax advantage. After five years, the money can be withdrawn tax-free. Unlike a traditional IRA, all of the withdrawals are taxed at your regular income. (The reason for this difference is based on whether the money was taxed prior to deposit – traditional IRA deposits were a deduction from taxes whereas a Roth IRA is funded with after tax contributions.)

A traditional IRA requires you to take withdraws by age 70 ½ (actually the date is April 1st in the year following your 70 ½ birthday). A Roth does not have any such requirements, allowing you to keep the money invested until you need it – if ever. And that “if ever” allows you to pass the Roth IRA on to your heirs who, although they would be required to take distributions, would find the added income from the inherited Roth IRA would be tax-free.

While there is no guarantee that your Roth IRA will grow without set-backs – what you pick for your investments determines the portfolio’s possibilities, the ability to save more is restricted not only by age but by gross income.

Age and Income

Your contributions before you reach fifty-years-old are limited in both the Roth IRA and the traditional IRA to $5,000. But after fifty, the annual contribution jumps to $6,000 with adjustments being made thereafter based on inflation.

But gross income also plays a role in how much you can contribute. More specifically, modified gross income. If you are single, that income cannot exceed $101,000 and if you are married, filing jointly, the income limit is set at $159,000. Modified gross income is calculated using IRS publication 590 (turn to page 61) and does not include any Roth conversions you may have made in the current tax year.

What if you make too much? It is a nice problem to have but to avoid not investing at all, the IRS allows you to make non-deductible IRA contributions. Conversions have income limits as well ($100,000 a year for individual or joint filers – sorry, married filers filing separately re not allowed to convert). But hold onto the non-deductible IRA until 2010 and convert without penalty.

There are still taxes to be paid on the conversion however but they can be spread over the following years (2011 and 2012).

A is for Asset Allocation

B is for Balance

C is for Continuity

D is for Diversity

E is for (Tracking) Errors

F is for Free-Float

Retirement Planning - B is for Balance

As we continue our alphabetical look at the wide variety of investment terms that are thrown about - in such a way as to generally assume you know what is being spoken or written - we will look at balance.

B is for Balance

There has been entirely too much emphasis placed on the need for balance. I firmly believe that in order for each part of your plan to work, it needs to have time to develop. Few people are willing to ride market unrest out, constantly tweaking their portfolio of mutual funds to get the same return, quarter over quarter, year over year.

Not only is this difficult for professional money managers, it is nearly impossible for the average investor to do.

There are far more important things to “waste” our time doing. If you follow some basic rules, you will be fine.

Ask The Right Questions

Among the first things you should ask yourself is “why did I buy this fund?” If it was because you found the long-term returns to be in line with your goals, then let the fund manager work out any kinks the market might throw his/her way. Check the fund each quarter but focus on the yearly prospectus. You should also keep those dollars invested. A down market is a buying opportunity for investors who use dollar cost averaging.

What is DCA?

Dollar cost averaging or DCA is one of the single most important ways to build a retirement portfolio. The method invests money each month directed to your defined contribution plan in equal amounts. This allows you to buy more shares of your mutual fund when the price is low and less when the price is high. It employs one of the basic market principles better than most investors would and does it with no effort.

There are several reasons that this works. Suppose the mutual fund you purchased was selling shares for $5. For each $5 you invested, you received a share in the fund. The market, doing what it does best changes based on an innumerable amount of factors. In some instances, this makes the share appreciate, increasing the price and in others, the price goes down.

When the price increases to $7, your designated investment dollars does not see that as a buying opportunity. Your five dollars instead buys only a portion of a share, in this case, only about three quarter of a share. In this instance, it keeps you from buying shares that might be overpriced.

But if the market goes down and the share price decreases to $2.50, your five-dollar investment has bought a share and a half. Investors have a difficult time controlling the desire to buy more when the markets are on the way up and selling when they are declining in value. DCA solves this.

In your Retirement Plan

The idea behind it is simple and is employed with great success in your company-sponsored plan. In those plans, money is automatically taken from your paycheck. If you are using a traditional 401(k), it is done before taxes are taken from your paycheck. If you are participating in a Roth 401(k) it is taken from after-tax dollars.

In both plans, a steady stream of cash is invested for your future. IRA users have some different challenges facing their use of DCA to its best advantage. Often, IRA investors opt for sending their mutual funds a check each month. This allows them to act based on current headlines.

If this sounds like something you are doing, set-up your contribution to be done automatically and write that amount in your budget. This will give you the opportunity to take advantage of all of the magic the DCA offers.

Previously: A is for Asset Allocation