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2013 Tax changes

Hey it’s tax time again and here is a short summary of some of the recent changes that you should be aware of. With the exception of payroll tax, for most people their is little to no change in both tax rates and capital gain tax rates.

I recently read an article in Money Watch and according to Money Watch:

Tax rates on ordinary taxable income. For workers with taxable income below certain levels, their tax rates will remain at 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. For single filers with taxable income above $400,000, married filers with income over $450,000, married filing separately over $225,000 and heads of household with taxable income over $425,000, the new 39.6 percent rate will replace the 35 percent tax rate for income over these amounts. So a married couple with a taxable income of $650,000 will pay an additional $9,200 of income tax just due to this change.

Higher tax rates for long-term capital gains and dividend income. Like the income tax rates for people with incomes below certain levels, the tax rates that apply to their capital gains and dividends will remain the same. But for taxpayers with the higher incomes noted above, their rate increases from 15 percent to 20 percent. So a taxpayer with $10,000 in capital gains and $10,000 in dividend income would pay an additional $1,000 of income tax due to this change.

So I know after I read this, I had to ask myself, “Where’s the silver lining?” Even though Congress has ensured that workers will pay more in payroll taxes and some of us will pay more in income taxes, the good news is that many of these new tax rules that were put into place are to help avoid the “fiscal cliff” (or at least cushion the fall!) and they are permanent. This will give many of us business owners a welcome sense of stability which could open up a plethora of opportunities; whether it’s setting up a business in relation to tax implications or giving people more confidence in your current investment (or investing in general). These new tax laws may be just the push you need to apply more focus or stay focused on working your self-directed accounts (401Ks, IRAs, HSAs, Coverdale accounts) because your investments can grow tax-free or tax deferred. With the exception of Coverdale accounts, you still have until April 15th to put contributions in for both 2012 and 2013! So get your money moving, and happy filing!

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SIMPLE IRAs Explained

A SIMPLE IRA is an employer sponsored retirement plan offered within small businesses that have 100 or less employees. SIMPLE is an acronym for savings incentive match for employees. Small businesses may favor SIMPLE IRAs because they are a less expensive and less complicated alternative to a 401k plan.

With a SIMPLE IRA, the employer matching incentive is built in to the plan. The employer must either match the contributions employees make to their plan, up to 3% of salary. Or the employer can make contributions for employees of a flat 2% of salary, whether or not the employee chooses to participate in the plan. This differs from 401k plans. An employer offering a 401k plan can choose whether to match employee contributions. Many do, but in difficult economic times, matching programs can be among the first benefits cut. Employers who choose to offer SIMPLE IRAs are generally required to match, dollar for dollar, from 1% to 3% of the employee’s salary.

A SIMPLE IRA works a lot like a 401k plan. Contributions to the plan are made pre-tax, and the money in the plan accumulates tax-deferred until the money is withdrawn at retirement. If the money is withdrawn before age 59 1/2, you will pay a 10% penalty fee. Within a SIMPLE IRA, your employer will likely offer a wide variety of stock and bond mutual fund investment options. A SIMPLE IRA cannot be a Roth IRA.

If you are a small business employer, the decision to offer a SIMPLE IRA vs a 401k is often not so much about the size of your company or the number of employees, as it is about how much you as the owner want to put into the plan. The contribution limits for a SIMPLE IRA are different than 401k contribution limits. In 2012, employees can generally contribute $11,500 to a SIMPLE IRA. The catch-up contribution limit for 2012 is $2,500. That means if you are age 50 or older and your employer allows catch-up contributions, you can put an additional $2,500 into the IRA this year. If you have a SIMPLE IRA and you participate in any other type of employer retirement plan during the year such as a 401k, the limit on how much you can contribute to all of the plans is $17,000.

With a 401k, individuals can save $17,000 in 2012, or up to $22,500 with a catch-up contribution. So, you can see, there is a big difference in the amount you can sock away in 401k. Small-business owners who are highly paid professionals, such as doctors, dentists or attorneys, tend to favor solo 401k plans over SIMPLE IRAs because of the higher contribution limits offered with a 401k.

SIMPLE IRA rollovers are anything but simple if you have been invested in the plan for less than two years. If two years have passed since you’ve begun participating in the plan, you can move the money into a rollover IRA or new employer 401k. If you’ve participated for less than two years, you can only roll it into another SIMPLE IRA or leave the money in the former employer’s plan.

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What Is A Non-Deductible Traditional IRA?

Many people make too much money to contribute to an Roth. You can get around this problem. High earners can still take advantage of the Roth IRA by contributing to a nondeductible IRA and then converting to a Roth. A nondeductible IRA is simply a traditional IRA for which there is no tax deduction, and it is available to almost everyone with wages or self-employment income.

A non-deductible Traditional IRA is a Traditional IRA that consists of non-deductible contributions. In both Roth IRA and non-deductible Traditional IRA, contributions are non-deductible, meaning that you fund them with after-tax money. The major difference comes from the way earnings are taxed. Earnings are taxed as ordinary income if you withdraw them from a non-deductible Traditional IRA. In contrast, earnings are tax free if you withdraw them from a Roth IRA.

You make non-deductible contributions to a Traditional IRA by setting up and sending money to an IRA custodian of your choice. You do not need to notify the IRA custodian that you are making non-deductible contributions. However, you do need to notify IRS that you have made non-deductible contributions to a Traditional IRA with Form 8606 Nondeductible IRAs when you file your tax return. It is your responsibility to keep track of the basis, the amount of non-deductible contributions, in your Traditional IRA. You can then convert this non-deductible Traditional IRA to a Roth IRA but make sure you get professionals help.

Remember that the IRS treats all of your (but not your spouse’s) non-Roth IRAs as one giant IRA. When you make non-deductible contributions to a Traditional IRA, you’ll have the basis, the amount of non-deductible contributions, reported on Form 8606. When you convert a part or all of your Traditional IRA to a Roth IRA, the conversion amount must contain the non-deductible portion proportionally. For example, if 5% of your non-Roth IRA are non-deductible contributions, then 5% of the conversion amount must be non-deductible contributions, and the rest must come from the deductible contributions, including earnings and rollover contributions. Notice that you cannot just convert the non-deductible part to a Roth IRA.

There are a couple of ways to work around this problem. The proportionate allocation rule does not apply to rollovers from an IRA to a QRP (Qualified Retirement Plan like a 401k) or 403b plan. Instead, a distribution that is rolled from and IRA to a QRP or 403b plan is deemed to come entirely out of the taxable portion of the IRA. This exception is necessary because the nontaxable portion of an IRA cannot be rolled into a QRP or 403b plan. You might therefore consider a rollover from your Traditional and non-traditional IRA back to a 401k or if you qualify as a self-employed business owner who can open a solo 401k, you might rollover your Traditional and non-traditional IRA to a solo 401k.

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Who Is Eligible For A Spousal IRA?

If you are a spouse that stays at home, it seems unfair that you can’t build up a retirement account in your name. After all, one of the requirements of opening an Individual Retirement Account (IRA) is that you need earned income. The truth is that the IRS makes an exception for married couples that want to boost their household retirement savings while providing a stay at home spouse the ability to build a nest egg. This arrangement is often referred to as a spousal IRA. There are eligibility requirements for these spousal IRAs.

Are You Eligible for a Spousal IRA? Many households have an arrangement in which one spouse stays at home to care for the home and children. In such cases, if you are the stay at home parent, you can open an IRA in your name. In fact, the spousal IRA is just a regular IRA. The name merely refers to the fact that the working spouse can make a contribution to an IRA held in the name of a non-working spouse.

The eligibility requirements for the spousal IRA are straightforward:

Marital Status: Married
Tax Filing Status: Married, filing jointly
Earnings: Contributing spouse must have compensation/earned income that amounts to at least the amount annually contributed to the non-working spouse’s IRA. If the contributing spouse also has an IRA, annual compensation/earned income must exceed the combined contributions the IRAs.
Age: The non-working spouse must be under 70 1/2 in the year of the contribution for a traditional IRA. There are no age restrictions on a Roth IRA for a non-working spouse.

Once you determine that you meet the eligibility requirements, it’s possible for you to open an IRA in your name and have your working spouse contribute to it. Understand that IRAs must be held separately, not jointly. This means that the non-working spouse owns the assets in the IRA. Once your working spouse contributes to the IRA, the money becomes yours. The IRA is in your name and opened with your social security number, and it remains yours even if you divorce.

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SEP IRA versus Solo 401k

A SEP IRA allows tax-deductible contributions and tax-deferred growth. Easy to set up at basically any broker. Very minimal paperwork involved. In a Solo 401k their are similar tax advantages as with the SEP, however with more paperwork, a more limited number of administrators, and higher contribution limits.

The max for a SEP is up to 25% of compensation with a cap of $49,000 for 2011. Solo 401k allows profit sharing contributions of up to 25% of compensation plus tax-deductible salary deferrals to the plan of up to $16,500 for 2011 ($17,000 for 2012). The cap is now at $49,000 for 2011.

So while the caps are the same, you can make very little self-employed income and basically defer it all, which you can’t do with the SEP. This gives you that added flexibility which is especially beneficial for those who have some self-employed income as secondary income and want to get the most tax advantages.

For example, if you made $16,500 of eligible compensation, you could sock all $16,500 of it away with a Self-Employed 401k, but only $5,000 with a SEP. Of course, if your self-employed income is substantial and/or is your sole source of income, 25% may be plenty and I’d then go with the simplicity of the SEP.

One thing worth mentioning is that the SEP IRA is typically not the best vehicle if you are self-employed and don’t have W2 income. In this case, the SE 401K is almost always better, particularly since the Roth 401K is available as well. In the case of self-employment as a second income, with a 401K and W2 available, the self-employed 401K is not available, but the SEP-IRA is and is a good choice in this case.

A bit of digging revealed that employer SEP contributions don’t appear to count against your limit for Traditional or Roth IRA contributions (again, you’re your own employer, so you can make these contributions on your own behalf). Assuming this to be true, you can max out your regular IRA and contribute to a SEP. In addition, you can also rollover your SEP into your Traditional or Roth IRA. Thus, you can take advantage of the SEP without having to keep track of an extra account over the long term but instead you can open your SEP account, fund it, roll it over into your Traditional or Roth IRA, and then close it. While it’s a bit of extra work, it might be a good way of supercharging your retirement savings if you have any self-employment income lying around.

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Tax Liens In Your Self Directed IRA

One investment that fits very well into your Self-Directed IRA are tax lien certificates. They are reasonably simple to understand and with a modest amount of research you can purchase certificates that will provide you with safety and a very attractive rate of return. Approximately half of the states are tax deed states, which means the actual property is auctioned off at a county place of location, and half of the states are tax lien states, meaning you can purchase and become holder of a tax-lien certificate.

A tax lien is a lien on a property for not paying taxes. Every year owners of real estate have a financial obligation to pay taxes on their real estate. If they are not paid, the county government will either auction a tax lien certificate or it can be purchased over the counter for the property. The winning bidder is in essence paying the taxes on behalf of the real estate owner and receives a tax lien certificate as proof of purchase. By paying these taxes, you are also helping the county as this money is used for roads, education, fire, and police. The benefit to you is you hold first position lien on the property above all other lien holders.

As the owner of the certificate, you can expect one of two possible outcomes. One, the owner will redeem his property by paying you, the lien holder, all the back taxes plus interest and fees, or two, if the owner does not pay you, since you are in first position on the lien, the bank holding the mortgage then has the option to pay you or relinquish the land or home to you as payment for the back taxes. Due process of foreclosure is required.

After purchasing the tax lien certificate, you wait for the redemption period if the state has one, which is typically one year (some state are more and some are less), or until the property owner pays the back property taxes owed. If the property owner decides to pay their tax obligation, he or she must pay a visit to the county tax collectors office where they will repay what you paid to acquire that tax lien certificate plus a pre-determined amount of interest. The interest rate is subject to state requirements. The county government will contact you, ask you to return the certificate, and upon receipt of the certificate, the county will generate a check in the amount you paid to acquire the tax lien certificate plus interest.

This can be a very safe and lucrative investment. Your interaction is with the county not the homeowner and your investment is backed by real estate or land. Tax Liens fit very nicely inside your Self-Directed IRA. As with any investment, be sure to do all of your research. You want to learn all you can about the property. It is imperative to do a proper title and bankruptcy search on the property. A certificate holder does not have priority over creditors and the Internal Revenue Service in a bankruptcy situation. This could eliminate the value of your tax lien certificate. Once you have checked out the financial and title situation of the property, you or someone on your behalf, should visit the property. There is a potential risk in purchasing a property, note or tax lien certificate sight unseen. Know what you are buying and how much you are willing to pay for it.

Look at each scenario and decide what your strategy would be if that scenario came to pass. Could you make money if you had to foreclose? Would you want to own the property? What would you do with the property if you did have to foreclose? Is the property going to need repairs?

There are tremendous opportunities with tax lien certificates. Be cautious, be smart, and find tax lien certificates that will enhance your portfolio.

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Options For Old 401k Money

You have to make a decision about what to do with the money you’ve accumulated in your 401k or 403b retirement plan when you leave your job—whether you’re laid off, find a better job with a different company, or quit to go back to school or start a business. Many people don’t know they have choices. Here are some options on what you can do with old retirement investment accounts:

Roll your 401k into a self-directed individual retirement account (IRA). This choice is usually the best move because you’ll have more control over your investments. Like a 401k, a self-directed IRA is a tax-deferred account unless your roll it to a Roth IRA and pay the taxes. However, most IRA providers offer an unlimited number of investment choices, rather than the small list of funds an employer provides. So if your situation changes, you’ll be able to choose any investment that’s best suited for your needs. In addition, if you want help from a financial adviser, you can choose any adviser rather than being restricted to services offered by the 401(k) plan. If you still have a few retirement plan accounts at former employers, those can be consolidated into one self-directed IRA. Any qualified retirement plan assets can be moved into the same IRA without a tax hit when you leave your job in the future. In the end, transferring your 401k into an IRA makes the most financial sense.

You could leave the money behind in the prior employers plan. You can keep your 401k with your former employer without getting hit with taxes or penalties, however most 401k plans limit the number of funds you can choose from, so leaving your money behind perpetuates the problem of having limited investment choices. Also remember when you leave your job, you might not be eligible for any financial advisory services offered by the company. This means that your 401k assets will probably not be managed, so as time goes on, you may not own the right mix of investments as your goals and needs change.

If you are getting another job, you could roll your 401k into your new employer’s retirement plan. You’ll probably encounter the same problems as the previous choice, because your new employer’s 401k plan is also likely to offer a limited number of investment choices. Also, once you roll over your money into the new 401k, you can’t undo it. Your money has to stay with your new employer’s retirement plan until you leave the company. But at least you preserve the tax-free status of your retirement money.

A bad idea (but I am putting all on the table) is to take your 401k money in cash. If you cash out your 401k plan, you’ll have to pay taxes. If you’re under age 59 1/2, you’ll also have to pay a 10 percent early withdrawal penalty. As a result, you would lose close to half of your 401k money to the penalty and taxes. In addition, your retirement money will not be compounding any more. For these reasons, cashing out is a terrible idea. Despite the costs, a majority of people take the cash. According to a 2010 study by Hewitt Associates, 46 percent of employees took a cash distribution from their 401k plan when they left a company. I understand the allure of cashing a check for thousands of dollars, but it has a terrible impact on your retirement savings.

Instead, you need to take the money, no matter how small amount, and start a self directed IRA where you can invest in assets you understand like real estate, notes, gold, business, etc.

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Wise Women Radio Talks About Importance Of Self Directed IRAs

Check Out This Radio Interview Concerning Self Directed IRA Investing For Women

Please be patient when waiting for the Blog Talk Radio interview to load (takes 20-30 seconds)

Listen to internet radio with wisewomenradio on Blog Talk Radio
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Differences Between Roth IRA and Roth 401k

The first difference that comes to mind when comparing Roth IRA to a Roth 401k is the contribution amounts. For the Roth IRA you can contribute up to $5,000 to your plan and for workers over 50 may contribute an additional $1,000 per year (i.e. $6,000/yr total). The Roth 401k plan has higher contribution limits, allowing employees to save up to $16,500 per year. For workers over 50, the limit is $22,000. Therefore, the contribution limits for a 401(k) are roughly three times higher than that of an IRA. For the Roth 401k plans, the contribution limits are the same as the traditional 401k limits, so this is a definite benefit.

The next big benefit is the income limits. The higher earners can convert to a Roth IRA from a traditional IRA, but they won’t be able to make contributions if they make over a certain income (see my prior blog post for details). Not so for a Roth 401k, in which there are no such restrictions. For example, Roth IRA contributions are off-limits if your modified adjusted gross income in 2011 is higher than $179,000 for married couples filing jointly or $122,000 for single filers. So for some people the Roth 401k is the only way to go or forfeit any government sponsored savings plan.

A nice benefit and advantage to a Roth IRA is that you don’t have to take distributions and essentially the account can exits forever without taking out any of the money. No RMD (required minimum distributions). The Roth IRA can be passed down to the next generation and provide tax-free earnings for that generation and the next. A Roth 401k, on the other hand, will require minimum distributions (RMD) starting at age 70½. If you need the money, you may not mind taking the distributions. But there is a way around it if you prefer to keep your savings working for you tax-free. You could roll the account over from a 401k directly to a Roth IRA but you would pay tax on any portion that was not Roth dollars.

On the flip side, an advantage of the Roth 401k is that the worker’s contributions can be matched by the employer up to a certain percentage. It’s essentially free money from the employer, on top of the employee’s elective deferrals. Just remember that the match portion of the contribution will be treated as a traditional 401k contribution since it goes in as pretax dollars. This is because the employer contribution can’t be taxed and in turn can’t be a Roth contribution. In other words, every Roth 401k has a Roth portion and a Traditional portion depending on where the dollars are coming from and what you elect.

If not in a self directed IRA or solo 401k plan that specifically allows alternative investments, your investment options would be more limited in a employer 401k since you are limited to the investment choices of that employer. On the other hand, a Roth IRA allows investors a great deal more control over their investment choices since they can choose from the wide range of investments for their own accounts. The best way to avoid the limited choices is to open a Self Directed Roth IRA or a Solo 401k Plan which essentially allows you to invest in anything allowed by the IRS. We will talk more about the Solo 401k in future blog posts.

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What Is A Self Directed Retirement Plan?

If you read the headlines and listening to the news you would think the world is coming to an end. Constant babble about how the economy is bad, unemployment is high, the cost of daily necessities such as food/clothing/gas are only going up, and that people are not saving enough for retirement.

Although many of these things are true at the surface, there are things you can control and actively participate in by educating yourself and getting a different perspective. One of those “things” is your retirement plan. When most people hear the words “retirement plan” they immediately think of stocks, bonds, mutual funds and CDs. They think of the 401k at their employer or an IRA and don’t feel like they have any control over the outcome of the retirement plans performance, even though they have chosen their own investments. Rightfully, most people think they just have to hope for the best since they really can’t do much about how the stock market performs and they only have a limited selection of investment choices.

Well I am here to say that the time for letting the market (or the fund manager) do the work for you is over. Most investors have a growing disillusionment of big financial wall street institutions and are looking to take control.

Remember it is Your Money, Your Future and Your Plan

American’s hold a vast majority of their money in stocks, bonds and mutual funds and in the recent financial crisis all three of these asset classes have lost value at the same time. Many individual investors and even some money management professionals, think that it may be quite awhile before these financial assets deliver the kind of steady, reliable growth that they have in the past. It may not happen in our lifetime, it is hard to tell.

All markets have cycles and at times they are booming and other times they go bust. In order to offset some of these swings, it is important that you put a portion of your money in alternative assets such as real estate, private lending, tax liens, precious metals, commodities, oil/gas, receivables, business LLC or C-Corporations, private equity investments, start ups companies, etc. This is true diversification, since diversifying into different securities is NOT diversification at all (unlike what most financial planners tell you).

Get Inspired

Most startup companies are initially funded by private placements and many times these original investments are originated from someone’s retirement account. In fact, some of the great tech companies that you reia about such as Google, Paypal, eBay, and Facebook were initially privately financed by angel investors and many of those investments may have been funded by someone’s IRA. As those companies grew to the giants they are today, many of these smart investors would have seen fantastic appreciation and growth their retirement account tax free.

Overall, you need to find investments that appeal to you based on your interest, experience and knowledge and those that meet your financial goals and risk tolerance.

Tax Protected Investing

No one likes to pay taxes, but many people invest and forego the opportunity to reduce their tax bill by utilizing government sponsored retirement plans outlined in this book. No matter what you invest in, you will always come out better when you have more money left over to live on in retirement if you make your investments in a tax deferred or tax free retirement plan. It is pretty easy to setup most of these plans and the time spent will be well worth the effort.

Take The Time To Get Educated

You really need to take the time to get educated about self directed investing and all the potential investment choices. This will help you be more confident and take action when an opportunity presents itself. There are so many ways to invest and get a better return that in the traditional type assets and I am not talking about just in a down market. Some of my favorite investments are real estate, private lending, tax liens, Forex and commodities (gold, silver, grains, oil, etc). I know real estate alone can conservatively return your retirement account double and even triple digit returns when done correctly.

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