Giant Pool of Money

published February, 2009

I heard a rebroadcast of a good radio show on “This American Life” describing how the mortgage crisis occurred—which tied into and reinforced what I had already figured out, but is very understandable and includes crying marines, remorseless mortgage ‘bundlers’ and the French word “tranche’ which translates to slice.

The Giant Pool of Money — We listen back to a special program about the housing crisis produced in collaboration with NPR News. This program originally aired in May, 2008. What does the housing crisis have to do with the turmoil on Wall Street? Why did banks make half-million dollar loans to people without jobs or income? And why is everyone talking so much about the 1930s? It all comes back to the giant pool of money.

If you follow the link, you can ‘listen now’ to the show named The Giant Pool of Money—I would have named it differently, but they didn’t ask me.

Traditional/Roth IRA Conversions

published September, 2007

I got a question last month about converting a traditional IRA to a Roth IRA. It’s somewhat complex, but it can be done. If you want to do it, it’s better if your income is “low” to avoid paying a 10% penalty on top of the tax. I like the Roth, but it isn’t for everyone.

The difference between the traditional and Roth has two parts, the timing of the tax paid on the original principal, and the tax on the gain on the principal.

All your income is taxed, but the traditional IRA allows the deferral of that tax on the principal amount contributed to the IRA until you take the money out at 65. (The withdrawal date is really 59 1/2, but let’s just say 65). The idea is that the un-taxed money can grow tax deferred, and that you’re expecting to make less money at retirement, putting you in a lower tax bracket. You pay tax on the money plus any gain you withdraw. I, of course, would like to believe that my income bracket will be higher at retirement (whatever that might be!) than it is now, plus I have my suspicions about how Medicare and Social Security will be funded in the future.

The Roth IRA offers no current tax deduction, but the growth is tax-free—you’ve already paid tax on the “principal” and the gain is tax-free. Did I mention that the gain is not taxed?

The limit on new contributions for either IRA for 2007 will be $4,000 or $5,000 if you are 50 or older. There are some additional limitations on contributions, particularly if you’re participating in another retirement plan, like a 401(k). For the Roth only, if your MFJ modified AGI income is $156k or more ($99k single), you contribution will be limited; it will not be allowed at all if your income was over $166k ($114k single).

If you withdraw money from either IRA before it’s time, you’ll pay tax on whatever income you deferred, plus a hefty penalty. You’ve got to really need this money to justify withdrawing from an IRA before its time. ‘Once in a lifetime’ you can avoid the penalty on $10,000 if you purchase a home with the money. You still have to pay tax on the withdrawal (remember you deferred paying tax when the money went in), you just avoid the 10% penalty if this applies to you.

There is one other common case where you can avoid the 10% penalty for “early withdrawal” of funds: if you withdraw the money from a traditional IRA and put it into a Roth IRA. The restrictions on this include:

  1. Your “modified Adjusted Gross Income must be $100,000 or less (until 2010 when this limitation is removed). 
  2. If you’re married, you have to file a joint return (also removed for 2010), and the amount must meet the definition of a “qualified rollover contribution. 
  3. If the IRA is inherited, you can’t roll it over. 

For more info, see IRS Code Section 96.4 and Section 408

The income limit to convert is the year the money comes out, not the year the money goes into the Roth. The income limit does not include the money out of the traditional IRA (only for purposes of determining the AGI limit—you still have to pay the tax on the distribution from the traditional IRA!). If you’re married filing jointly, it is your combined income. If you’re already 70 1/2, you can’t do the conversion. It is very messy if you have traditional IRA’s which had deductible and non-deductible contributions. Expect that you’ll pay me the 10% penalty instead of paying the IRS if I have to figure this out!

You can’t keep the money out more than 60 days in between funds. I had a lawyer client who had won his case, but needed funds until he collected. He cashed in his IRA, hoping the settlement would arrive before 60 days so he could call it a “rollover.” It was 65 days until the settlement showed up, so he paid the 10% penalty.

I tell my clients to send the money directly from institution to institution so they never receive the money in the first place. In 2010 you’ll be able to report the income on the funds withdrawn over 2 years (2010 and 2011) instead of being required to report all the rollover income in the year of withdrawal. 

If you know your income will be low this year, or perhaps even a loss, it might be a “planning opportunity” to take the income from a conversion now, using up your loss against the income you would have had to report otherwise! If you’re in real estate and ‘having a bad year’ in 2007, the income limits shouldn’t bother you and you should not delay ‘till 2010 if you want to make this conversion.

Once you make a conversion, you must leave the money in the Roth for 5 years, or pay the 10% penalty as if you took it out early from the traditional IRA.

If you have a loss on your Roth IRA, you can take it once all the money comes out as a Schedule A, subject to 2% deduction. So keep track of what you put into a Roth—basically forever or until you use it up.

For more information, take a look at IRS Publication 590 or