Get With The Plan: July 12, 2009

71209Vin, 32, and Staci, 33, are financially stable but they are concerned about their retirement savings and education planning for their two children, ages 5 and 3. They’d consider buying a larger home, but their immediate concern is retirement savings.

“Our specific question is whether we should convert my rollover IRA into a Roth IRA once income restrictions are lifted in 2010,” said Vin.

The couple, whose names have been changed, have saved $42,108 in 401(k) plans, $42,108 in IRAs, $11,000 in a cash balance pension plan, $3,491 in college savings plans, $15,207 in savings and $1,971 in checking.

The Star-Ledger asked Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Management in Florham Park, to help the couple create a game plan.

Pallitto first addressed the IRA conversion question.

“Currently, the law does not permit conversions for taxpayers with income over $100,000, but in 2010 the $100,000 ceiling will be removed,” Pallitto said. “That allows all taxpayers to convert their IRAs into Roth IRAs, paying one half of the tax owed in 2011 and the other half in 2012, effectively giving you an interest-free loan on one half of the tax liability for one year.”

Vin is concerned about federal budget deficits, which also makes him concerned about the future of Roth IRAs. If the couple paid the tax on the conversion, Vin is worried that at some later date the government would need more money and attempt to tax Roth IRAs.

Pallitto said it would be unconstitutional to double-tax the converted amount down the road, but adds there is always a chance that a portion of the appreciation could be subject to tax in the future if changes are made.

“That is an extremely remote possibility and political suicide for whichever party attempted to pass that legislation, but it is a valid concern on his part,” Pallitto said. “However, we have to make a plan based on the current laws, and it would be prudent for them to convert their IRA in 2010.”

Pallitto said he doesn’t think the government will attempt to tax Roth IRAs, but he thinks tax rates on all other income will be going up in the future.

Vin and Staci, a stay-at-home mom, currently save 6 percent of Vin’s salary to his 401(k), which Vin thinks isn’t enough. But his company matches dollar-for-dollar up to 6 percent. Pallitto conservatively estimated that if Vin saves $12,000 a year, or $1,000 per month, between his contribution and his employer’s match, their retirement savings would grow to about $2 million, assuming an 8 percent return to age 60.

“Since he is saving the maximum amount for his employer’s match, I would rather see him and his wife continue to fund their Roth IRAs to enhance their retirement savings,” Pallitto said.
To reach the maximum allowed by law, the couple would set aside an additional $10,000 per year. Pallitto said instead of retirement, there’s another place the couple could save their money: college savings. They are currently saving $50 per month per child, but Pallitto recommends $250 per month per child. The remaining $5,200 per year should be used to increase their emergency and short- to mid-term savings, he said.

“They are both young and have many years ’til retirement, and although this may not be textbook financial planning, I do not want to see them tie up all of their money for retirement,” he said. “There will be things that will come up at a later stage of their life, but before retirement, that they will need to be prepared for.”

He’d like to see them save six months’ worth of living expenses in their emergency fund, then dollar-cost-average additional savings into mutual funds to meet their objectives.