Stricter Rules for Gifting

If you give money or non-cash donations to charity, you’ll be interested in some of the provisions of the new Pension Protection Act.

There are two changes affecting charity:  the first is that you are now required to maintain written documents for any cash gifts in order to claim a deduction.  Most churches will send you a statement at the end of the year, if you use the envelopes provided, or write a check.  But gone are the days of dropping cash into the collection plate or the Salvation Army bucket.

Second, if your donated non-cash items aren’t in "good" condition, you won’t get a deduction.  This is to keep people from taking large deductions for items that really belong in the trash.  Of course, no-one has defined what "good" condition is yet, so use your common sense when donating items.

Resources:
New pension law closes loopholes in charity deductions – LA Times
The Pension Protection Act of 2006 offers retirement tax breaks, tough rules on charity – About.com

Are ETFs Right for You?

Exchange traded funds (ETFs) are gaining in popularity, but are they right for you?

ETFs are similar to index funds, but they trade like a stock, meaning they can be bought and sold throughout the day instead of just once a day.

Advantages:

Low cost – ETFs have a lower annual expense than most mutual funds, including most index funds.  According to Morningstar, the average expense ratio for ETFs is 0.30%, compared to 0.35% for no-load index funds, and 0.96% for all mutual funds.

Tax efficient – ETFs don’t have to sell stock positions to meet shareholder redemptions, which cuts down on taxable transactions.  Also, redemptions by large shareholders are paid in kind, protecting investors from unnecessary taxable events.

Disadvantages:

The main disadvantage of ETFs is that they can only be bought through a broker, which means you will pay transaction costs each time you purchase an ETF. 

Conclusion:  ETFs can be a great way to diversify your portfolio, especially if you are making a one-time purchase.  But if you make regular purchases, such as with dollar cost averaging, the transaction costs can end up costing you more than if you had purchased an index mutual fund.

To learn more about ETFs, check out the Exchange Traded Funds Center at Morningstar.  In addition, you can read more about iShare ETFs managed by Barclays Global Investors, or Vanguard’s ETFs.

Deducting Roth IRA Losses

Recently, someone asked me if they could deduct losses they incurred in their Roth IRA.  Here’s my response…

You can deduct losses in a Roth IRA, but the rules and treatment are different than you might expect.  First, in order to claim a loss in any IRA investment, you must withdraw the entire balance from all of your IRAs of the same type.  So, if you have a loss in your Roth IRA, you must liquidate all of your Roth IRAs in order to deduct the loss on your tax return.

Second, your basis in your Roth IRA includes your contributions plus conversions (from a traditional IRA) less any withdrawals you have previously taken from your Roth.  Form 8606, Non-Deductible IRAs, is used to determine the basis in your account and to

report withdrawals.  Note that reinvested dividends and capital gains are not part of your basis in a Roth IRA.

Finally, losses in a Roth IRA are deducted on Schedule A – Itemized Deductions, rather than on Schedule D – Capital Gains and Losses, which is where most people would expect to report the loss.  Roth IRA losses are a miscellaneous deduction, subject to a 2% floor.  This means that the deduction is only available if you itemize your deductions, and only the amount greater than 2% of your adjusted gross income (AGI) is deductible.  In addition, miscellaneous deductions are not allowed for purposes of the alternative minimum tax (AMT), so you could lose the benefit of the deduction if you are subject to AMT taxes.

Whether it makes sense to liquidate your Roth IRA to claim the loss will depend on several factors, such as whether you itemize or not, how large the loss is compared to 2% of your AGI, whether you’re subject to AMT tax, and other factors.  You should also consider how much will you lose in potential earnings if you liquidate your Roth IRA.  You may want to consult with your tax advisor and financial planner to determine the best decision for you at this time.

Put Your Finances on Auto Pilot

I was at a conference recently, and learned a great tip to automate many of my email communications.  After I implemented this tip, I started thinking about all the ways you can automate your finances to help achieve your financial goals. 

So… this week’s tip is a list of ways to put your finances on autopilot:

1.    Invest in your company’s retirement plan.  This is the easiest way to put your savings on autopilot, by far.  And many companies provide a matching contribution, so there’s free money involved as well!

2.    If you don’t have a company retirement plan, setup your own retirement plan (IRA, Roth IRA, SEP IRA and many others) and establish an automatic withdrawal from your bank account to your retirement plan.

3.    Setup an automatic withdrawal from your checking to your savings account to save for emergencies, rainy days, vacations or other short term financial goals.

4.    Setup automatic withdrawals to pay for recurring bills.  This way you won’t ever miss a due date.

5.    Setup automatic withdrawals to pay the minimum on your credit card.  There’s nothing worse than paying a late fee because you didn’t get your credit card payment in on time.  This tip will make sure you always get at least the minimum payment in on time each month.  You can always send in extra money when you want to.

6.    If you’re self employed, transfer a specified amount each month to a savings account until it’s time to send in your quarterly tax payment.  This will be much less painful than coming up with 3 months of estimated taxes at one time.

7.    Adding onto #6, if you’re self employed, consider incorporating your business and putting yourself on the payroll.  Then you will be required to withhold taxes and submit them periodically.

There are many more ways to put your finances on autopilot, but these will get you started.  The important thing is to make it automatic, and painless, so you’ll never miss the money.