Conventional wisdom holds that a mortgage on the house you live in is a special kind of debt, one that, mostly because of favorable tax treatment, is so cheap that you should be in no particular hurry to pay it off.
But there is a popular heresy that opposes this firmly established orthodoxy. It holds that all debt is a bad idea, and paying 3X to the bank so you can save X on your taxes is loopy. Free Money Finance made this case recently. And Dave Ramsey is probably the high priest of this particular sect.
I have an instinctive contempt for orthodoxy and a sympathy for heresies of all kinds. But, alas, this is one of those cases where the conventional wisdom is spot on. Sad and boring, but true.
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March is just around the corner, which means we are entering the heart of tax season. Time to gather those 1099s, fire up the old TurboTax, and wonder how we can possibly pay Uncle Sam less money next time.
So ’tis the season to think about, and write about, schemes and tricks to minimize your tax bill. For example, the AP ran an item the other day discussing the rather unlikely maneuver of teenagers opening Roth IRAs.
It’s an idea with some intuitive appeal. As readers of this blog know, Roths are attractive if you believe that the tax rate paid today is likely to be lower than what will be paid when the money is withdrawn from the IRA. A teenager with a tiny income, and thus a low marginal tax rate, certainly qualifies.
And there is the tremendous emotional appeal of "the magic of compounding" that miracle of mathematics that will drastically increase the IRA balance during the very long journey to retirement. Even with only 5% annual return, after 50 years $1 would grow to $11.46. Imagine how grateful your child will be when they retire and realize the foresight you had in making them save way back in 2010.
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As all us personal finance geeks know, 2010 is a special year with regard to converting your traditional IRA to a Roth. For the benefit of non-geeks who have accidentally brought up this blog on their browser, it is worth explaining that there are actually two separate changes in the rules that kicked in on January 1, 2010.
The first is that from now on there is no income limit for doing a conversion. In the bad old days, to be eligible you needed to have an income of less than $100,000. Today anybody with a traditional IRA can convert it to a Roth, and this is true for all future years, not just 2010. (Unless, of course, Congress changes the rules again.)
The second IRA conversion change for 2010, and the one that makes 2010 "special" is that if you convert during 2010, and only during 2010, you have the option of deferring the income from the conversion to 2011 and 2012. So if you convert $100K from your traditional to Roth, you have the choice of either increasing your taxable income by $100K in 2010 or by $50K in both 2011 and 2012.
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As most of you know, 2010 is a special year for taxes. It is the last year covered by the Bush tax cuts which, as you may remember, were engineered as a package of temporary adjustments and deals rather than permanent changes. Most of it goes poof on December 31st of this year.
In the meantime, 2010 is a special year for converting traditional IRAs into Roths. When the Bush cuts were being constructed there was a need to find more government revenue, particularly at the end of the period covered by the law, i.e. 2010. IRA conversions fit the bill because, in the short run, they generate additional income tax revenue. (In the long run they do not, since conversions reduce income taxes paid in the future.)
So as of a few days ago, the income limitation on conversion to a Roth is gone. And just to get things started with a bang, for 2010 only, you have the option to defer the income tax bill on the conversion to 2011 and 2012. (That is, it is split between those two tax years.)
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There was a pretty good post over at WiseBread yesterday on how if a credit card company forgives some of what you owe, what was forgiven is income you have to pay taxes on.
On the one hand, this is a point worth repeating because it seems to surprise most people. On the other hand, the post neglects to mention an important exception, and, moreover, feeds into the belief that this is an irrational fluke of the tax code. It isn’t. It makes sense.
You owe Credit Card Corporation (CCC) $5000. Realizing you are unlikely to pay them back in full, and now regretting lending you the money to begin with, CCC agrees to settle the debt for $2000 cash. You sell your PEZ dispenser collection on eBay and send them a check.
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