WHEN REGULAR IS DEFINITELY BETTER THAN ROTH

by Andrew D. Schwartz, CPA

Each winter, when my staff and I meet with our clients to review their tax information, we get this question a lot,  "Should I go with the Roth version of my employer's 401(k) or 403(b) plan, or should I stick with the traditional version?"

Taxpayers first had the option of contributing money to a Roth account back in 1998.  Remember, when you contribute money to a Roth account, you elect to forego a current year tax break in exchange for a promise from the government that distributions taken from the Roth account down the road won't ever be taxed. 

Through 2005, the only access you had to these tax-free accounts was to contribute to a Roth IRA.  Many middle-income and high-income taxpayers never had the opportunity to contribute to a Roth IRA, however, since their incomes exceeded the relatively modest threshold based on their filing status.  (The Roth IRA threshold for 2012 is $125k for single individuals and $183k for married couples.)

Congress liked that people were giving up a current year tax break by opting to go with a Roth IRA instead of to a Traditional IRA, so decided to expand this opportunity to 401(k) plans and 403(b) plans. As we wrote in our October 2005 Newsletter in an article called The New Roth 401k and 403b, employers could begin to offer the Roth version of these plans as of January 1, 2006. 

What's the difference between the Traditional and Roth versions of these popular retirement savings plans?  With the traditional 401(k) or 403(b) plan, the salary deferrals you make reduce your taxable salary and grow tax deferred.  You will then owe income taxes on distributions taken from these accounts when you retire.

Let's say you earn $200k, and you max out your 403(b) salary deferrals for $17k during the year.  In this case, your W-2 will report taxable wages of $183k in Box 1.  Assuming you are in the 33% federal tax bracket, the $17k you contribute into your 403(b) plan saves you $6,667 in federal income taxes.  That's a pretty good tax break I would say.

What happens if you instead decide to go with the Roth version of the 403(b) plan for your salary deferrals?  When you contribute money to a Roth account, you forego a current year tax-break.  Your W-2, therefore, will report the full $200k as taxable wages in Box 1, instead of $183k that would be reported had you gone with the Traditional 403b.  The benefit of giving up this tax break is the tax-free treatment of the compounded growth on the $17k of salary deferrals. In other words, you won't owe any federal income taxes on the distributions taken from this account when you retire.      

The Max Factor:

When my clients ask me for advice about the Roth 401k or 403b plan, I immediately look at Box 12 of their W-2 forms to see how much they contributed in salary deferrals during the prior year.  According to the instructions of the W-2 form, here are the relevant codes that show up in Box 12 of the W-2 form:

Code D - Elective deferrals to a section 401(k) cash or deferred arrangement. Also includes deferrals under a SIMPLE retirement account that is part of a section 401(k) arrangement.

Code E - Elective deferrals under a section 403(b) salary reduction agreement

Code AA - Designated Roth contributions under a section 401(k) plan

Code BB - Designated Roth contributions under a section 403(b) plan

What I'm looking to see is whether this client is maxing out their salary deferrals during the year.  If a client is contributing to the Roth version of the 401k and 403b plan, and is falling short of the $17k max ($22.5k max if 50 or older), I strongly suggest that they consider contributing only to the Traditional version until they are able to max out their contributions. 

In my opinion, socking away as much money as possible each year into these tax-advantaged, creditor protected accounts takes priority over worrying about saving taxes later.  Remember, if money is tight, you have the choice of contributing $10,333 into a Roth 401k account, or taking advantage of the $6,667 tax break offered by traditional 401k plans and putting away the max of $17k into the Traditional 401k account. 

I think a financial planning twist on Alfred Lord Tennyson's poem about lost love sums this up best, "Tis better to save and be taxed than never to have saved at all."

TOP

REFINANCE YOUR MORTGAGE ON A DEVALUED HOME THANKS TO HARP 2.0

by Don Clark at LYC Mortgage LLC

On October 24, 2011, the Federal Housing Agency (FHA), together with Freddie Mac and Fannie Mae, issued a press release announcing a series of changes to the Home Affordable Refinance Program (HARP).  This program is designed for homeowners that are current on their mortgage but have been unable to refinance because of their reduced home value.  Finally, this program provides low risk borrowers the opportunity to capitalize on today's record low mortgage rates.

Informally known as HARP 2.0, this new program updates and removes many of the previous regulations which kept good borrowers at bay.  With HARP 2.0, homeowners who lost value in their home (pushing their loan-to-values over 80%) or who previously were obstructed from refinancing because of mortgage-insurance coverage requirements or condominium project approvals are now eligible for HARP refinancing.   

While some restrictions still surround HARP 2.0, this is likely the only opportunity millions of homeowners living in devalued homes, with good credit and a solid payment history, have at refinancing their original mortgages.  Also, with mortgage rates making history in the past month for shattering all-time lows, timing could not be more perfect.  Unfortunately, this program will only be around for a limited time as it’s scheduled to expire in 2013.

To qualify for this program, general eligibility requirements require that the current mortgage be a conventional first lien owned or securitized by Freddie Mac or Fannie Mae and has been owned by them prior to May 31, 2009.  That would mean that your mortgage had to be obtained prior to that date to qualify.

If this situation applies to you, the first step is to determine if your mortgage is owned or securitized by Freddie Mac or Fannie Mae .  If you are unsure, you can check both Fannie Mae and Freddie Mac’s websites or you can call their toll-free number for confirmation.

• Fannie Mae: www.fanniemae.com/loanlookup 1-800-7FANNIE (8 am to 8 pm ET)
• Freddie Mac: ww3.freddiemac.com/corporaterate 1-800-FREDDIE (8 am to 8 pm ET)

A short HARP eligibly questionnaire is available by contacting LYC Mortgage by email or phone (781-303-2620).  If your home has decreased in value, this might be your only option to refinance with mortgages at today's historically low rates.  Don’t miss out.

This article was provided by Don Clark at LYC Mortgage LLC, headquartered in Wellesley, MA.  To contact Don Clark directly, please call 781-303-2620 or email dclark@lyccpa.com.  You should also check out LYC's state licenses before contacting them.

 TOP

EMPLOYEE  VERSUS INDEPENDENT CONTRACTOR

Wondering if you should be classified as an employee or an independent contractor?  Or, do you have someone working for you, and you're not sure how that person should be classified?   Well, believe it or not, the IRS has a form for that.

According to our friends at the IRS:

In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

Common Law Rules

Facts that provide evidence of the degree of control and independence fall into three categories:

1. Behavioral - Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial - Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship - Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Form SS-8

After reviewing the three categories of evidence, if you are still unsure if a worker is an employee or an independent contractor, the business can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take up to six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form Form SS-8 (PDF).

Plan B: Complete For Your Records Only

Instead of sending this form to the IRS and then waiting six months to hear back, it's not uncommon for people to complete the Form SS-8 as a way to facilitate a conversation between the employer and the worker, and help both parties decide how to most appropriately classify the worker. 

Form 8919

If you feel that you should have been paid as an employee versus a contractor, there is a second option available to you.  You can complete and attach a Form 8919 to your federal tax return.  You should be aware that submitting a Form 8919 with your taxes will most likely cause the IRS to contact your employer.  According to the instructions:

 TOP

2011 & 2012 TAX FACTS

• For 2011, the standard deduction for a single individual is $5,800 and for a married couple is $11,600. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.
• For 2011, the personal exemption is $3,700. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  
• The maximum earnings subject to social security taxes is $110,100 for 2012, up from $106,800 in 2011.
  
• The standard mileage rate is $.555 per business mile as of July 1, 2011, up from $.51 per mile for the first six months of 2011.
  
• The maximum annual contribution into a 401(k) plan or a 403(b) plan is $17,000 in 2012, up from $16,500 in 2011.  And if you'll be 50 or older by December 31st, you can contribute an extra $5,500 into your 401(k) or 403(b) account that year.
• The maximum annual contribution to your IRA is $5,000 for 2012.  And if you turn 50 by December 31st, you can contribute an extra $1,000 that year.  You have until April 15, 2013 to make your 2012 IRA contributions. 

TOP