Archives for July 2010

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Roth IRA Conversion Deadline

I’ve recently gotten a few questions about the deadline for a Roth IRA conversion. The answer is that it depends on what, exactly, you want to know the deadline for.

The shortest answer is that, for any given year, the deadline for a Roth IRA conversion is December 31 of that year. (Note: This is different from IRA contributions, which can be made up until April 15 of the following year.)

There are a few other Roth conversion-related deadlines you may want to know about, though.

Income Limits Are Gone for Good

As of 2010, the income limits for Roth IRA conversions disappeared. They are not scheduled to come back. In other words, no matter your income level, Roth conversions are not “do it in 2010 or miss your chance.”

Why 2010 Is Special

December 31, 2010 is the deadline, however, for the special option to delay payment of the tax on a Roth conversion. That is, for 2010 Roth conversions, if you choose to do so, you can claim 50% of the converted amount as income in 2011 and the other 50% in 2012.

Beginning in 2011, Roth conversions will go back to working like normal — if you convert in a given year, you’ll have to claim the converted amount as income in that same year.

Roth Conversion Recharacterization Deadline

In case you’ve never run across the term before: A “Roth conversion recharacterization” is basically a do-over. If you convert an amount from a traditional IRA to a Roth IRA, you’re allowed to undo the whole thing as long as you don’t wait too long.

To do so, you’ll have to:

  1. Notify the custodian(s) of your traditional IRA and your Roth IRA of your intention to recharacterize the conversion,
  2. Transfer the amount in question from the Roth IRA back to the traditional IRA, and
  3. If you’ve already filed your tax return for the year of the conversion, you’ll have to amend that return.

The deadline for recharacterizing a Roth IRA conversion is October 15 of the year following the conversion.

Just Because You Can…

One last point: Just because you can convert your IRA to a Roth IRA doesn’t mean you should convert it.

Student IRA: Can a Student Open a Roth IRA?

For many tax breaks, a taxpayer is ineligible if he or she is claimed as a dependent on somebody else’s return. In other words, there are numerous tax breaks for which most students are ineligible.

Fortunately, IRAs and Roth IRAs don’t work that way.

As long as you have earned income, and your modified adjusted gross income is below a certain level (It changes every year, but most students needn’t worry — see here for Roth IRA rules.), you’re eligible to make contributions to an IRA.

Roth IRA or Traditional IRA?

The primary difference between a traditional IRA and a Roth IRA is that a traditional IRA gives you a tax break now (in the form of a deduction), while a Roth IRA gives you a tax break later (in the form of tax-free withdrawals from the account).

For the most part, students aren’t overly burdened with taxes. In fact, if your income is below the standard deduction amount, you’re not paying income taxes at all. As such, the deduction you could get from making traditional IRA contributions probably has little or no value.

Takeaway: A Roth IRA is the better choice for most students.

Where to Open an IRA?

People often ask which brokerage firm offers the best investment selection. In my opinion, investment selection isn’t all that important when choosing a brokerage firm.

It’s true that certain mutual funds are only available via specific brokerage firms. But every single brokerage firm will give you access to exchange traded funds (ETFs), which you can use to build a low-maintenance, diversified portfolio.

As a result, rather than focusing on investment selection, I’d suggest looking for a brokerage firm with low costs and good customer service. Fortunately, there are several such choices.

For example, each of the following brokerage firms are super low-cost:

  • Vanguard: $7.00 per stock or ETF trade, with free trades of Vanguard ETFs.
  • Fidelity: $7.95 per stock or ETF trade, with free trades of several iShares ETFs.
  • Schwab: $8.95 per stock or ETF trade, with free trades of Schwab ETFs.

Get Started!

When you’re first beginning to invest, how much you invest will have a far larger impact than how you invest. Rather than getting hung up on choosing the absolute best investments with the absolute best brokerage firm, I’d suggest just getting started:

  1. Open an IRA,
  2. Put together a low-cost, low-maintenance, diversified portfolio (see here for examples), and
  3. Work on contributing to that portfolio as much as you can, as often as you can.

HSA Contribution Limits: Health Savings Account Rules

Health Savings Accounts (HSAs) are a pretty nifty way to save money. In short, if you’re eligible, they allow you to use pre-tax money to pay for medical expenses. This is done in either of two ways:

  1. Through making (pre-tax) payroll deductions directly through your employer, or
  2. Through claiming an “above the line” deduction for the amount you contribute to your HSA.

HSA Contribution Limits

For 2010, HSA contribution limits are as follows:

  • $3,050 for a person with self-only coverage, or
  • $6,150 for family coverage.
  • Also, if you’re 55 or older, you’re allowed to make a catch-up contribution of $1,000.

Note: Any contributions made by your employer count toward the annual contribution limit, thereby reducing the contribution that you can make.

Contributions for each year can be made up until April 15 of the following year.

HSA Eligibility

In order to be eligible to make contributions to an HSA, you must be covered by a high-deductible health plan (HDHP) with an annual deductible of at least $1,200 ($2,400 if it’s family coverage). The plan must also have maximum out-of-pocket expenses of less than $5,950 ($11,900 if it’s family coverage).

Also, you must:

  • Not be enrolled in Medicare,
  • Not be claimed as a dependent on somebody else’s return, and
  • Not have other health care coverage (with a few exceptions).


Health Savings Accounts (HSAs) are often confused with Flexible Spending Accounts (FSAs). The primary difference between the two is that money contributed to an HSA rolls over to the following year if unused. In contrast, FSAs are “use it or lose it.” Any money left unspent in an FSA disappears at the end of the year.

The takeaway is that with an HSA you don’t have to play the game of guessing how much you’re going to face in medical expenses each year. For example, if your 2010 HSA contributions exceed your medical costs, that’s no problem. You’ll be able to use the remaining money from your 2010 contributions to pay medical costs in 2011 — or 2012, 2013, etc.

HSA Withdrawals

Money can be withdrawn from an HSA at any time, for any reason. However, unless the money is either a) spent on qualified medical expenses or b) used to reimburse you for qualified medical expenses, it will be subject to income taxes and a 10% penalty.

  • Exception: If you’re age 65 or over, or have become disabled, the 10% penalty is waived, though regular income taxes will still apply.

Qualified medical expenses include those that would qualify for the Medical and Dental Expenses deduction, as well as non-prescription medicines.

Update: Beginning in 2011, over-the-counter drugs will not be eligible unless you have a prescription.

Investing within an HSA

Funds within and HSA can be invested in much the same way as within an IRA (though your investment options will be limited to whatever the HSA administrator chooses to offer). Of course, at any given point, it’s likely you’ll be spending the money within your HSA in the near future, so it’s usually a good idea to keep it invested in something very low-risk.

Earnings and growth within an HSA are not taxable — though again, if you take money out for something other than qualifying medical expenses, the entire distribution is taxable and potentially subject to a 10% penalty.

For More Information, See My Related Book:


Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Tax Considerations for Unmarried or Same-Sex Couples

As complex and intimidating as taxation can be for most people, it’s even trickier for unmarried and same-sex couples, as there are additional pitfalls to look out for.

Estate Tax and Gift Tax

Property that passes from one spouse to another is not subject to estate or gift taxes. Unfortunately, for couples the IRS considers to be unmarried, when one partner inherits property from the other, the unlimited marital deduction does not apply.

The takeaway: For unmarried or same-sex couples with assets beyond the exemption amount, efforts to minimize estate taxes become even more important than they are for other couples.

Inheriting an IRA or 401k

The rules for an inherited IRA are different for a spouse beneficiary than for a non-spouse beneficiary.

Specifically, as a non-spouse beneficiary, you have to begin taking required minimum distributions (RMDs) in the year following the death of the original account owner — no matter how old you are. (In contrast, spouse beneficiaries can simply roll the inherited IRA into their own IRA and treat it as if they were the original owner all along.)

Takeaway: Don’t forget to take RMDs from an inherited IRA.

Early IRA Withdrawals

The rules for withdrawals from an IRA allow you to avoid the 10% penalty if you’re using the money to pay for higher education expenses or unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. And, for most couples, the same exception applies if you’re withdrawing money to pay for your spouse’s medical or education expenses.

But again, because same-sex couples are not considered married, any IRA distributions used to pay for your partner’s expenses will be subject to the 10% penalty (unless, of course, you meet some other exception).

Takeaway: If you need to withdraw money from an IRA to pay for such expenses, be sure to take it out of the right partner’s IRA!

Have a Will, and Name Your Beneficiaries

This last point isn’t exactly a tax consideration so much as a general estate planning consideration. In short, for same-sex or other unmarried couples, a will becomes absolutely essential — even more so than for other couples.

The reason is that (in most cases) if somebody dies without a will, his or her assets pass on to his closest relatives. And, therefore, if your state doesn’t consider you to be married, your partner could inherit nothing if you die without a will, as everything will pass to your blood relatives.

Similarly, be sure to name your partner as the beneficiary for your IRA or retirement plan at work if you want to ensure that he or she will inherit those assets when you pass on.

For More Information, See My Related Book:


Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Calculating Real Estate Investment Return

Many people refer to their home as their “best investment.” Others argue that a home isn’t an investment at all because it may not go up in price or because you may never sell it.

In my opinion, anything that has a calculable (usually positive) rate of return is an investment. And it’s worth noting that buying a home can yield a positive rate of return even if the home never increases in value. (Conversely, it can have a negative rate of return even if the home does increase in value.)

Rate of Return Involves More than Home Value

The rate of return on a home purchase involves more than just the home’s market value. If you only consider the change in home value, you’re leaving out:

  1. Part of the price of the investment — maintenance costs and property taxes,
  2. The biggest part of the payoff — the fact that it replaces your rent, and
  3. The fact that the investment was probably leveraged (i.e., paid for using a loan).

I think it’s easier to first look at the purchase as if you were buying the home with cash. That way, it’s easy to calculate the expected return on the purchase:

Expected Real Return = D + G – C, where

D = imputed rental dividend (calculated as the size of the annual rent bill that you’d eliminate by owning instead of renting, divided by the purchase price of the home),
G = inflation-adjusted growth in home value, and
C = costs (insurance, property taxes, and maintenance), expressed as a percentage of the purchase price.

For example, if you’re currently paying $1,000 in rent per month, and you buy a home for $180,000, your imputed rental dividend would be 6.67% ($12,000 ÷ $180,000). From that, add the inflation-adjusted rate at which you expect the home to appreciate, and subtract any non-mortgage costs of owning the home.

Then you can determine how your return would be affected by using borrowed money for the purchase. (In short: It only makes sense to borrow if you expect a return greater than the interest rate you’d have to pay on the loan.)

Rate of Return When Prepaying a Mortgage

A recent Get Rich Slowly post asked whether it’s better to prepay a mortgage or invest elsewhere. In the comments, several people asked questions to this effect:

“Isn’t it risky to put a bunch of money into prepaying your mortgage? After all, we’ve seen in the last few years that home prices don’t always go up.”

It’s true that home prices don’t always go up. But if you own a home, you’re already exposed to that risk — whether you decide to prepay your mortgage or not. The rate of return you get when you prepay your mortgage is simply equal to the interest rate on the mortgage. It’s got nothing to do with changes in the market value of the home.

Why I’m Not Buying a House (and Likely Never Will)

For many people, owning a home provides an emotional benefit, so they’re happy to buy a home even with an expected return that’s somewhat less than the return they could get with other investments.

I find myself in the opposite boat. From where I’m standing, owning a home looks to be:

  1. A huge pain in the butt,
  2. Illiquid, and
  3. Extremely undiversified.

…whereas putting money into an ETF portfolio is the opposite. It’s easy. It’s liquid. And it’s diversified. As a result, I’m only going to be interested in buying a home if it appears that the expected return is significantly greater than that of other investments.

Of course, given that there are so many people willing to accept a lower return (i.e., pay more for the home), that may never happen.

How to Calculate Amortization Expense

The following is an excerpt from Accounting Made Simple: Accounting Explained in 100 Pages or Less.

Intangible assets are real, identifiable assets that are not physical objects. Common intangible assets include patents, copyrights, and trademarks.

Amortization is the process—very analogous to depreciation—in which an intangible asset’s cost is spread out over the asset’s life. Generally, intangible assets are amortized using the straight-line method over the shorter of:

  • The asset’s expected useful life, or
  • The asset’s legal life.

Example: Kurt runs a business making components for wireless routers. In 2008, he spends $60,000 obtaining a patent for a new method of production that he has recently developed. The patent will expire in 2022.

Even though the patent’s legal life is 14 years, its useful life is likely to be much shorter, as it’s a near certainty that this method will become obsolete in well under 14 years, given the rapid rate of innovation in the technology industry. As such, Kurt will amortize the patent over what he projects to be its useful life: four years.

Each year, the following entry will be made:

Amortization Expense 15,000
Accumulated Amortization 15,000

Simple Summary

  • Amortization is the process in which an intangible asset’s cost is spread out over the asset’s life.
  • The time period used for amortizing an intangible asset is generally the lesser of the asset’s legal life or expected useful life.

To Learn More, Check Out the Book:


Accounting Made Simple: Accounting Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to read and prepare financial statements
  • Preparing journal entries with debits and credits
  • Cash method vs. accrual method
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"A quick tour of the ins and outs of accounting. Great introduction on the basics and keeps it simple. Short enough to be read in a day. I highly recommend this to any one looking for a crash course in accounting. "
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