Author: desola

Meredith Dietz
October 31, 2023

New FAFSA rules will simplify the form and help more aid go to those who need it most.

The Free Application for Federal Student Aid (FAFSA) determines your eligibility for need-based financial aid for college. In previous years, the FAFSA asked families about the amount they contributed to employer-sponsored retirement accounts like 401(k)s each year, and factored it into households’ overall yearly income, reducing their eligibility for need-based aid.

That’s changing: Under a new rule for the FAFSA form, pre-tax contributions to workplace retirement plans will no longer count as income, which means the potential for greater financial aid. Here’s how families can use this change to prioritize both their retirement savings and budgeting for college costs.

How the new FAFSA rule will impact your retirement planning

In previous years, the FAFSA asked families to report their retirement contributions, which would factor into their total income. That meant those dollars would reduce their chances for need-based aid. That’s all set to change with a redesigned FAFSA, in which questions about untaxed payments to tax-deferred pension and retirement-savings plans have been removed. These changes are part of the FAFSA Simplification Act passed back in 2020.

This change means that with proper planning, a 401(k) can now provide both retirement security and help increase your eligibility for financial aid, since saving pre-tax through your employer will be a viable way to reduce your total income as reported on the FAFSA. In other words, you may no longer be faced with the strict “either/or” decision to invest in your child’s college or your retirement plan. While some colleges and universities use alternatives to FAFSA, this change will open up more options for many families hoping to strategically leverage their retirement savings.

One way the FAFSA process will be simplified is by drawing more information directly from tax documents. However, the FAFSA collects that tax information from two years prior to the application, so contributing more to retirement accounts this year won’t have an impact on the financial aid awarded for 2024-25 school year—but it will for the 2025-26 year.

The redesigned FAFSA is expected to launch in December 2023 for the 2024-25 academic year. Here’s how you can start prepping now to apply for federal student aid in December.

BY ANGELICA LEICHT

OCTOBER 20, 2023 / 3:32 PM EDT / CBS NEWS

Life insurance is a financial product that can offer invaluable protection and peace of mind for you and your loved ones. However, this type of coverage comes at an extra cost, so it’s crucial to do your homework and make an informed decision before purchasing a policy. Otherwise, you could pay out of pocket for a policy that doesn’t offer the coverage that you need or want.

And, to make sure the policy you’re purchasing is the right one, it can be helpful to ask questions — and in some cases, a lot of them. That way, you’ll know exactly what you’re getting into with any potential life insurance policy — and can be sure that you’re picking the right option before signing on the dotted line.  

10 important questions to ask before buying a life insurance policy

Be sure to ask these crucial questions as part of your search for the right life insurance policy:

What is my primary reason for buying life insurance?

Before delving into the details of life insurance policies, it’s essential to establish your objectives. Are you purchasing life insurance to provide financial security for your family, cover funeral expenses, pay off debts or as an investment tool? Understanding your goals will guide you in selecting the right type and amount of coverage.

What type of life insurance is best for me?

Life insurance comes in various forms, with the two most common being term life and whole life (or permanent) insurance. Term life offers coverage for a specified period, while whole life provides lifelong coverage — typically with a savings or cash value component. The coverage length, amount and other factors can vary between the two, so make sure you know which works best. And, your choice should align with your financial goals and budget, too.

How much coverage do I need?

Determining the appropriate coverage amount is vital. It should be enough to replace your income, pay off debts and cover future expenses, such as your children’s education or your spouse’s retirement. A common rule of thumb is to aim for coverage that’s 10 to 15 times your annual income, but in some cases, you could need a lot more (or less).

How much can I afford?

Your budget plays a significant role in selecting a life insurance policy. Consider what you can comfortably afford while maintaining your other financial goals, such as saving for retirement or emergencies. Balancing cost with coverage is essential.

What is the insurance company’s financial stability?

It’s important to choose an insurance company with a strong financial track record. Research ratings from agencies like A.M. Best, Moody’s and Standard & Poor’s to ensure the company is financially stable and capable of meeting its obligations. 

Are there any exclusions or limitations in the policy?

Be sure to read the policy documents carefully. Life insurance policies may contain exclusions or limitations related to pre-existing conditions, suicide and certain activities or occupations. Understanding these terms will prevent any surprises when you need to file a claim.

Can I customize my policy?

Many insurance policies can be tailored to your specific needs. Ask about the possibility of adding riders or endorsements, which can provide additional coverage for specific situations, such as critical illness, accidental death or disability.

How will inflation affect my coverage?

Consider how inflation will impact your coverage amount over time. You may need to periodically review and adjust your policy to ensure it remains adequate to meet your financial needs in the future.

What is the process for filing a claim?

Understanding the claims process is crucial. It’s essential to know what your beneficiaries will need to do to initiate a claim, what documentation is required and how long it typically takes for a claim to be processed and paid.

Can I change my policy in the future?

Life circumstances change, so it’s important to know whether you can adjust your policy if your needs evolve. Some policies offer flexibility through options like converting term insurance to whole life or increasing coverage amounts without the need for a medical exam, but not all will, so be sure you know how any potential life insurance policy functions before purchasing it.

The bottom line

Purchasing a life insurance policy is a significant decision that can have a lasting impact on your financial security and the well-being of your loved ones. By asking these important questions and thoroughly researching your options, you can make an informed choice that aligns with your financial goals and provides the protection you need for the future. Remember that life insurance is not a one-size-fits-all solution, though, so take your time and consider consulting with a trusted financial advisor to find the policy that’s right for you.

By Joy Taylor
Published October 21st, 2023

Older adults who want to make charitable gifts can get a tax break by making a qualified charitable distribution from an IRA.

Many Americans donate to charity each year. Knowing that the money can help an organization that is near and dear to your heart helps you feel warm and fuzzy inside. Getting a federal tax break for the contribution might be an added bonus. 

However, these days, most people who donate can’t write off their gifts. That’s because only individuals who itemize deductions on Schedule A of Form 1040 can deduct charitable contributions. And fewer people are itemizing each year because of higher standard deductions. Only 11.6% of federal tax returns for 2021 claimed itemized deductions.

For IRA owners who are 70½ or older, one of the easiest ways to make a charitable donation and get a tax break is by making a qualified charitable distribution from a traditional IRA. For 2023, you can transfer up to $100,000 directly from your traditional IRA to charity. If you have more than one IRA, the $100,000 cap applies per account owner, not per IRA. 

The amount next year will be a bit higher because the Secure Act 2.0 retirement law provides for annual inflation indexing of the $100,000 cap. Qualified charitable distributions are not permitted from employer plans, such as 401(k)s. The tax break applies only if you are 70½ or older on the date of the charitable transfer. 

If you are married, you and your spouse can each potentially give up to $100,000 in 2023 from your separate IRAs, provided each of you has a substantial amount in your IRA. But let’s say you have a $70,000 balance in your IRA, and your wife has an IRA worth $1.2 million. In this situation, your qualified charitable distribution cap is limited to $70,000 and your wife’s is limited to $100,000. Your wife won’t be able to make a distribution of $130,000 to make up for your lower gift. 

There are three main tax benefits of qualified charitable distributions. They are not taxable. They are not added to your adjusted gross income, which can help you mitigate surcharges on your 2025 Medicare premiums. And they can count toward your annual required minimum distributions. (Note: The first dollars out of your IRA are considered to be required minimum distributions, so if you want to do a qualified charitable distribution that will count toward your required payout, give money to the charity before you take money for yourself.) 

But you can’t deduct the qualified charitable distribution on Schedule A. That would be double-dipping.

Only transfers from your IRA directly to charity are considered qualified charitable distributions. Most IRA custodians will require you to fill out a form requesting the charitable payout. The custodian will then either send a check directly to the charity or make a check out to the charity and send it to you to mail to the organization. In either circumstance, get a receipt from the charity to substantiate the donation. 

Also, give a heads up to the charity if the check is being sent to it from the custodian. Let the charity know the money will be arriving, and give your name and address for an acknowledgement receipt for your tax records. If you have check-writing privileges on your IRA account, your custodian might let you write the check to charity yourself, but first ask if that’s OK. 

Don’t wait until the last minute in 2023 to do a qualified charitable distribution. It can take some time for the money to go from the IRA to the charity, particularly if an investment needs to be sold for cash, and the charity must receive the money by Dec. 31 for your contribution to count for that year.

The money must generally go to a section 501(c)(3) organization. However, there is now a limited exception to this rule. IRA owners can do a one-time qualified charitable distribution of up to $50,000 through a charitable gift annuity, charitable remainder unitrust or a charitable remainder annuity trust. Many private colleges have charitable gift annuity programs. If you’re an alumnus, you may hear about this from your alma mater. 

Reporting on your Form 1040 

The Form 1099-R that you will get early next year won’t reflect the qualified charitable distribution. The 1099-R will show only the total amount of distributions made from the IRA for 2023. 

When filling out your 2023 Form 1040 or 1040-SR, you would include the total distribution amount on line 4a of the 1040. Then subtract the qualified charitable distribution and report the remainder, even if $0, on line 4b. Write “QCD” next to line 4b. If filing electronically, a drop-down box for line 4 should give you a choice to click QCD.

BY JOY TAYLOR

It’s finally fall. Leaves are changing color. Children and some adults are awaiting trick-or-treat. And student loan payments have resumed putting a dent in a lot of people’s wallets after a three-year halt on repaying college debt ended. But these tax breaks can help ease the pain. 

1. There’s a deduction for student loan interest

Taxpayers needn’t itemize on Schedule A of the Form 1040 to take this write-off.

• Up to $2,500 of student loan interest paid each year can be claimed as a deduction on Schedule 1 of the Form 1040
• For 2023, the break begins to phase out for single filers with modified adjusted gross incomes above $75,000 and for joint filers with modified AGIs over $155,000. It ends for taxpayers with modified AGIs over $90,000 and $185,000, respectively
• Parents who help a child repay student loans generally can’t take the write-off unless they are also legally liable on the loans. But, even if a parent paid the loan and can’t take the write-off, a child who meets the modified AGI limits can still take the interest deduction, provided he or she isn’t eligible to be claimed as a dependent on the parents’ return. The IRS treats this as if the parent gifted money to the child, who then paid the debt

2. Most student loan debt forgiven in 2021 through 2025 is tax-free for federal income tax purposes

This relief, enacted in the March 2021 stimulus law, is an exception to the general rule that cancellation of indebtedness is taxable. IRS has instructed lenders and loan servicers to not issue Form 1099-C to borrowers whose student loans are forgiven during this time period, and the discharged debt is excluded from income. Some states have different tax rules, which can be confusing. 

3. Up to $10,000 from 529 accounts can be used to help pay off college debt of the account beneficiary without having to pay income tax on the withdrawals

It’s important to note that this $10,000 is a lifetime limit, not an annual limit. 529 distributions for student loan repayments that exceed $10,000 are taxable in part to the extent of the excess and are also subject to a 10% penalty. 

4. Employers that offer qualified educational assistance programs can help

These programs can be used to pay down up to $5,250 of an employee’s college loans each year through 2025. The payments are excluded from workers’ wages for tax purposes. 

5. Relief can be offered through workplace retirement plans, starting in 2024

A new law will allow employer 401(k) matches conditioned on student loan repayments made by employees. 

The IRS blessed such a program in a 2018 private letter ruling. In that situation, the firm contributed to its 401(k) plan on behalf of employees paying down their college debt. The employer matches took place regardless of whether employees also paid in. Participation was voluntary, and employees had to elect to enroll in the program. Employers have been lobbying Congress for years to enact a statute to allow them to do this without seeking a private ruling from the IRS, and lawmakers obliged them last year in the SECURE 2.0 law.

Bob Haegele
October 19, 2023

As inflation lingers, the Social Security Administration (SSA) is boosting its cost of living adjustment (COLA) for benefit checks in 2024. It’s just one of many changes announced by Social Security recently.

Here are some key changes to Social Security happening next year – and what you need to know.

Watch for these 5 changes to Social Security in 2024

More than 71 million people depend on one of Social Security’s benefit programs, so annual changes to the program and its payouts are always highly anticipated. While this year’s cost-of-living-adjustment is down substantially from last year’s 8.7 percent increase — the biggest boost in over 40 years — any extra income is welcome news for beneficiaries on fixed incomes.

1. Cost of living adjustment (COLA) rises

The SSA has announced that benefit checks will rise 3.2 percent in 2024. The 3.2 percent adjustment will amount to a $59 increase in monthly benefits for the average retired worker on Social Security, beginning in January.

Specifically, the average check for retired workers will increase from $1,848 to $1,907. For a couple with both partners receiving benefits, the estimated payment will increase from $2,939 to $3,033, a rise of $94.

Since 1975, the SSA has tied cost of living adjustments to the Consumer Price Index for urban wage earners and clerical workers (CPI-W). The SSA compares the third-quarter CPI-W for the prior year to the third-quarter CPI-W in the current year to determine the COLA. It then adjusts the COLA based on the difference in CPI-W from one year to the next.

2. Maximum taxable earnings going up

In 2023, the maximum earnings subject to Social Security taxes was $160,200. That is, workers paying into the system are taxed on wages up to this amount, typically at the 6.2 percent rate. In 2024, the maximum earnings will increase to $168,600, meaning more of a worker’s income will be subject to the tax. This adjustment is due to an increase in average wages in the U.S.

3. Maximum Social Security benefit also set to increase

As expected, the maximum Social Security benefit for a worker retiring at full retirement age will also increase in 2024, from $3,627 to $3,822. It’s important to note that this maximum applies to those retiring at the full retirement age, which is 67 for anyone born after 1960.

The maximum will be different for those who retire before the full retirement age, because benefits are reduced in that situation. The same applies for those who retire after the full retirement age, a strategy that can max out your benefit check.

4. Average benefit for spouses and disabled workers is increasing, too

The average benefit will increase across the board in 2024, and that includes benefits for people such as widows, widowers and the disabled. Here’s how those figures break out:

The SSA says the average widowed mother with two children will see an increase from $3,540 to $3,653.
Aged widows and widowers living alone will see their benefits increase from $1,718 to $1,773.
The benefit will increase for a disabled worker with a spouse and one or more children from $2,636 to $2,720.
Of course, those are averages, and individual circumstances will vary.

5. Social Security adjusts earnings test exempt amounts

If you claim your retirement benefits before you hit full retirement age, Social Security will withhold some benefits from your check above certain levels of income. It’s what the program calls the retirement earnings test exempt amounts, and it can claim a serious chunk of your benefits if you’re still working. Here’s how it will work in 2024.

If you start collecting Social Security before full retirement age, you can earn up to $1,860 per month ($22,320 per year) in 2024 before the SSA will start withholding benefits, at the rate of $1 in benefits for every $2 above the limit. In 2023, the maximum exempt earnings were $1,770 per month ($21,240 per year).

In the year you reach full retirement age, this rule still applies, but only up until the month you hit full retirement age and with much more forgiving terms. In 2024, you can earn up to $4,960 per month ($59,520$ per year) before benefits are withheld, at the rate of $1 in benefits for every $3 earned above the limit (instead of every $2). In 2023, the threshold was $4,710 per month ($56,520 per year).

Medicare Part B premiums increase

While Social Security and Medicare are different programs, most retirees participate in both, and many have their Medicare Part B premium automatically deducted from their Social Security check.

Monthly Medicare Part B premiums will rise from $164.90 in 2023 to $174.70 in 2024. The annual Part B deductible is also rising next year, from $226 in 2023 to $240 in 2024, or a $14 increase.

Bottom line

The 2024 Social Security COLA offers retirees and others a better-than-average boost to their benefits as inflation lingers. But that’s not the only change to the program, as other levels and thresholds have been adjusted to account for on-going inflation, too.

Key takeaways

Just like buckling your seatbelt whenever you drive, it makes sense to take some regular precautions in navigating the digital world.

Even if you feel confident in your ability to spot a scam, it’s important to stay vigilant against phishing attempts in your daily life.

Increasingly, your phone service has become a master key to accessing your digital information. So take steps to protect and monitor it.

Stay up to date with the latest levels of protection available on your accounts and devices.

We all take calculated risks every day in our lives. Hop in the car and you’re at risk of an accident. Step out for a walk and you might risk tripping on a sidewalk, or (depending on where you live) getting bitten by a tick.

We don’t see these risks as reasons to hide in our homes all day. Instead, we take reasonable precautions—like wearing a seatbelt, putting on bug repellent, and staying aware of our surroundings—and then go out into the world to live our lives.

Similarly, there are ever-present risks in the digital world. Short of living “off the grid,” it would be nearly impossible to avoid all digital risk. But it is possible, with some precautions and awareness, to greatly reduce your exposure to these risks, and to limit the potential damage that could be done to your life and finances.

Here are 4 ways to protect yourself against scams and identity theft.

1. Stay vigilant against phishing

Phishing is a technique criminals may use to try to trick you into giving them your personal information—information that they may then use to try to steal your identity. They often do this by impersonating a company or institution, and then asking you to click on a link, open an attachment, or to “confirm” your date of birth, Social Security number, or account credentials.

Even if you feel confident in your ability to spot a scam, it’s important to stay vigilant in your daily life. Most phishing attempts are carried out by email, text message, or phone. Here are several warning signs that should raise suspicion:

Warning signs of phishing attempts

• Someone contacting you to say that you have won an award or freebie.

• Someone contacting you with a deal that sounds too good to be true.

• Phone calls, emails, or texts that claim to be from the IRS.

• Unusual communication from someone asking for help.

• Unusual communication (that may sound legitimate) claiming to be from a company you work with.

• Communication from an unfamiliar email address or phone number.

Remember that phishers may use urgent-sounding language to try to get you to click on a link or attachment right away—before you have time to think it through. To create this sense of urgency, they might claim that something very good has happened (like you’ve won some money), or that something very bad has happened (like you’re in debt with the IRS). Be suspicious anytime you receive an out-of-the-ordinary text, call, or email that makes such claims.

Here’s how you can protect yourself, particularly if you’ve received a suspicious or unexpected communication:

Protecting yourself against phishing attempts

• Stop communication with the phisher immediately.

• Hang up the phone, or ignore the suspicious email or text.

• Do not click on any links or download any attachments.

• Do not provide or “confirm” any of your personally identifying information.

• If you think the communication could be a legitimate request from a company you do business with, hang up and then call the company directly.

• Never grant remote access to your computer or read back a one-time security password (unless you have initiated the service call to a company’s official phone number).

2. Protect your phone service

Think of how protective you are with something like your Social Security number. You know that if a criminal were to obtain it, they might be able to take out a credit card in your name, obtain your tax refund, or even worse.

Increasingly, your cell phone account is becoming something you need to protect just as diligently. If criminals can gain access to your phone calls and text messages, they can potentially steal one-time passcodes and break into your accounts.

For example, one way they may do so is with “SIM swapping.” (A SIM card is a small plastic card that stores identifying information on your cell phone, and that allows you to make and receive calls.) With this scam, a fraudster may call your cell phone provider pretending to be you, saying that you have a new SIM card to activate. If the scammer already has some of your personal information (like the last 4 digits of your Social Security number, your date of birth, or your password for your mobile provider account), they might be able to convince the cell phone carrier that they are you and get your phone number reassigned to their SIM card.

Here are several warning signs not to ignore:

Warning signs that your phone has been compromised

• You stop receiving phone calls and text messages.

• Your phone says “no service” or “emergency calls only.”

• Restarting your phone does not restore service.

• You receive emails from your cell phone provider about changes to your account.

If you notice any of these warning signs, contact your provider right away to see if your account has been compromised. You can also take some proactive steps to help better protect your cell account:

Protecting your cell phone against hackers

• Set up a PIN on your mobile account.

• If you believe your PIN has been compromised, reset it.

• Secure your cell phone and internet service accounts, like by setting up multi-factor authentication.

• Ask your cell provider about additional ways to secure your account.

3. Strengthen your account security

Many companies, including Fidelity, go to great lengths to safeguard customers’ information and accounts, and are continually working to build new and enhanced layers of protection.

You can help reinforce those safeguards by being cautious with your passwords, opting in for new security measures, and making sure the companies you work with know how to reach you if they ever need to.

Here are some proactive steps you can take to strengthen security for your accounts:

Protecting your financial and other accounts

• Set up online access for your accounts, if you haven’t already.

• Sign up for multi-factor authentication, when available.

• Use complex passwords, and change them if you believe they’ve been compromised.

• Don’t use the same password for multiple accounts.

• Make sure your institutions have up-to-date phone and email contact information for you.

• Sign up for automated alerts of suspicious account activity, when available.

• Monitor your accounts.

Fidelity offers a number of security-strengthening measures that customers should be aware of. For example, customers can turn on additional login security with multi-factor authentication. Customers can also use money transfer lockdown to block electronic money movement out of their accounts, if they believe or know they have recently been a victim of fraud or identity theft. Enrolling in Fidelity MyVoice® means that when you call Fidelity, you no longer have to enter a PIN or password, and your identity is instead verified using your voiceprint.

4. Secure your devices

Finally, any device you use that’s connected to the internet can become an avenue for cybercriminals to attack. Hackers may get in through newly discovered security holes in these devices and systems. From there, they may also be able to record your keystrokes, access your personal information, or even break into your accounts.

Here are some measures you can take to help secure your devices:

• Protecting your devices from hackers

• Change any default passwords when setting up your devices.

• Apply operating system and application patches as soon as the system maker releases them.

• Don’t download apps or games from companies you don’t know.

• Run antivirus and personal firewall software.

• Avoid conducting financial or other sensitive transactions using shared devices or unsecure networks.

• Avoid public Wi-Fi unless you are taking steps to encrypt and protect your activity.

In conclusion

Protecting your information and online accounts can help avoid the hassle and heartache of ID theft. Take advantage of all security measures offered—and remember that the best way to prevent theft and scams is with a strong defense.

If you believe you have been a victim of identity theft, a scam, or a cybercrime, there are government resources that may help you.

To report identify theft and establish a recovery plan, visit the Federal Trade Commission’s Identity Theft page
To report a scam, visit the Federal Trade Commission
To report a cybercrime, visit the FBI’s Internet Complaint Center

Source: https://www.fidelity.com/learning-center/personal-finance/family-financial-safety/4-ID-theft-protection-tips?ccsource=email_weekly_1005_1037578_64_0_CV2

Potentially higher tax rates in the future could be good for Roth conversions today.

Fidelity Viewpoints

Key takeaways

• Important tax provisions of the 2017 Tax Cuts and Jobs Act (TCJA) will sunset at the end of 2025, which may mean higher taxes on the horizon.

• If you convert traditional 401(k) or IRA assets to a Roth, you’ll owe taxes on the converted amount. But you won’t owe any taxes on qualified withdrawals in retirement.

• With Roth IRAs, there are no required minimum distributions during the life of the original owner and beneficiaries may be able to take withdrawals tax-free—making them valuable estate planning vehicles.

Converting money in a traditional 401(k) or IRA to a Roth 401(k) or Roth IRA has long had many potential advantages. Of course, you need to pay taxes on the converted amount. But once the money is in a Roth IRA, you don’t pay taxes on qualified withdrawals, giving you more flexibility to manage your taxes in retirement and boost after-tax income. Plus, there are no required minimum distributions (RMDs) on Roth IRAs during the lifetime of the original owner, allowing for continued tax-deferred growth and making them valuable vehicles for estate planning.

Note: RMDs are required for Roth 401(k)s in employer-sponsored retirement programs through 2023. However, RMDs for the original account owner will no longer be required for employer plans starting in the 2024 tax year.

One reason to consider a Roth conversion this year: Tax rates are set to rise in the future with the sunsetting of the 2017 Tax Cuts and Jobs Act, which expires at the end of 2025. That could mean some big changes in tax rates, unless there are other revisions to tax law. The top bracket could revert to 39.6% from 37%, and some of the lower brackets could increase by as much as 4 percentage points.

Intrigued? Here are answers to common Roth conversion questions. Always consult a tax advisor about your specific circumstances.

Can I convert money from a traditional 401(k) to a Roth 401(k)?

Yes, you can if your plan offers a Roth 401(k) feature and allows in-plan conversions. Of course, taxes may still apply, depending on the source of the balances converted.

Can I convert money from a traditional 401(k) to a Roth IRA?

Yes, once retired or while still working if your plan permits in-service withdrawals from your 401(k). You can convert your traditional 401(k) either through a direct rollover to a Roth IRA or by rolling funds over to a traditional IRA, and then converting to a Roth IRA.

Can I convert to a Roth IRA even if I earn too much to contribute?

Yes, there are no income limits on conversion. Also, if you and/or your spouse have high income levels and are not eligible to contribute directly to a Roth IRA, and you do not already have a traditional IRA, you may want to consider opening a traditional IRA and making a nondeductible contribution, then converting it to a Roth IRA. This strategy is sometimes called a back-door Roth contribution.

How can I estimate my tax liability on an IRA conversion?

Remember, all the traditional IRAs you own (with the exception of inherited traditional IRAs) are considered one traditional IRA for tax purposes, no matter how many accounts you have. Your tax liability is based on 2 things: the taxable income generated by the conversion and your applicable tax rate.

To figure out how much of a conversion from a traditional IRA to a Roth IRA may be taxable, you’ll need to know the types of contributions you made to all of your traditional IRAs (not just what’s being converted). There are 2 types of contributions.

1. Pre-tax, or deductible contributions. These are contributions that are deducted from your taxable income for the tax year in which the contributions were made.

2. After-tax, or nondeductible contributions. Any contribution for which you do not take a tax deduction is known as a nondeductible contribution. Such contributions create what is sometimes called “basis” in your traditional IRA. The amount of these contributions is not included in taxable income for the purposes of a Roth IRA conversion.

Estimating the taxable income from a conversion is straightforward if you’ve never made nondeductible contributions to any traditional IRA. If that is the case, whatever amount you convert will all be taxable income.

Note that earnings are always taxable when converted, whether they are attributable to deductible or nondeductible contributions, so for purposes of figuring out taxes on a conversion, you can think of your balances as falling into just 2 categories: (1) nondeductible contributions, and (2) everything else.

According to IRS rules, you cannot cherry-pick and convert just nondeductible contributions, leaving deductible contributions and earnings in the account, in order to avoid taxes. Instead, you must figure out the proportion of your total traditional IRA balances that is composed of nondeductible contributions, then use that percentage to find out how much of your conversion will not be taxable. Note that inherited IRAs are excluded in this calculation.

Keep state taxes in mind too. A Roth IRA conversion is a taxable event. If your state has an income tax, the conversion will generally be treated as taxable income by your state as well as by the federal government.

Tip: If your spouse has IRAs with mostly nondeductible contributions and you have IRAs with mostly deductible contributions, you might consider converting your spouse’s IRAs before yours to reduce the potential tax impact of conversion. The IRS views your IRA and your spouse’s independently for the above calculation.

How can I manage taxes on a Roth conversion?

Tax deductions can also help offset the tax cost of a Roth IRA conversion. For example, you may be able to take a tax deduction for donations to qualified charities. In general, by making charitable contributions with cash, you can deduct your charitable contribution up to 60% of your adjusted gross income (AGI) if you itemize. The deduction is usually limited to 30% of AGI for donations to some private foundations and some other organizations, as well as for contributions of noncash assets. Note, however, that if your itemized deductions—which include charitable contributions—do not exceed the standard deduction, there wouldn’t be any tax benefit from those charitable contributions. So be sure to consult with your tax advisor to plan your charitable strategy—there are techniques that can help ensure you enjoy the potential tax benefits of your charitable giving.

Does time of year matter?

Converting earlier in the year generally gives you more time to pay taxes. Taxes aren’t due until the tax deadline of the following year, so you may have more than 15 months to pay the taxes on your converted balances. (Note: If you pay estimated taxes, you may need to make some payments sooner.)

But there are also some advantages to converting later in the year:

• You can still start the clock on the 5-year rule as of the beginning of the year. This IRS rule requires a waiting period of 5 years before withdrawing converted balances or you may pay a 10% penalty. But the clock starts on January 1 of the year you do the conversion—no matter when during the year it actually happened. The 5-year rule is counted separately for each conversion.

• You’ll have more information about your income for the year. Since the amount you convert is considered taxable income, you may want to consider converting only the amount that would bring you to the top of your current tax bracket.

A conversion must be completed by December 31 to be included in that year’s taxable income. Managing the tax impact of a Roth IRA conversion requires careful analysis. A review with a financial or tax advisor is always a good idea.

If I want to keep a specific stock or asset in my IRA in my portfolio for the long term, can I keep that asset and convert it to a Roth IRA?

Yes. If you are holding investments in a traditional IRA—ones you want to keep for a number of years—and you think you may be in a lower tax bracket this year than you might be in the future, then a “focused conversion” may be a strategy to consider. With this strategy you move specific assets from a traditional IRA to a Roth IRA, rather than selling the assets first and then moving the resulting cash. In terms of the taxes, there is no difference between the 2 techniques.