A year ago, when I met with my accountant, we spent some time talking about our retirement, our goals, and how we were going to reach them. In looking at our retirement accounts, I saw that the vast majority of our savings were in tax-deferred accounts like 401(k)s and Rollover IRAs. We only had a very small percentage in tax-free Roth IRA accounts, which I’ve always said was probably the best retirement account in existence. Where else can you invest in the stock market and have your gains be entirely tax free? Nowhere.

Right now, you can convert a traditional IRA to a Roth IRA as long as your adjusted gross income is under $100,000. The $100,000 limit applies whether you are single or married, tax filing classification wise, which makes it one of the few limits that is the same for both. So if your AGI is under $100,000, then you can convert today and you don’t have to wait for 2010.

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This Foundation post is dedicated to what I consider the best retirement weapon available – the Roth IRA account. The Roth IRA was championed by Senator William Roth of Delaware and created with the Taxpayer Relief Act of 1997, signed by President Clinton. The primary tax benefit of the Roth IRA, at least the one most lauded, is that your account’s appreciation and earnings are tax free. The tradeoff is in the contributions, which are not tax-deductible.

This is the biggest distinction between it and the Traditional IRA. On a traditional IRA, your contributions are tax-deductible but your earnings and appreciation are taxed as ordinary income when you start making regular disbursements in retirement.

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You can avoid costly mistakes if you understand the difference between tax-advantaged investments and tax-advantaged accounts.

What are tax-advantaged investments? Investments that people make specifically because of the tax advantages they provide are referred to as tax-advantaged investments. In fact, if not for the tax advantages, most people would not buy those particular investments. Tax-free bonds, fixed and variable annuities are examples.

Mutual funds offer tax benefits but they are not generally considered tax-advantaged because people don’t buy them specifically for the tax benefits. Real estate also has tax advantages but is also not generally included in this category. What’s important to keep in mind is that these investments have tax advantages regardless of what account you hold them in.

What are tax-advantaged accounts? Retirement accounts are tax-advantaged. Examples are IRA’s, 401(k)s, SEP IRA’s, ROTH IRAs etc. What’s critical to understand is that you can buy any investment you like within these accounts and the returns are tax-advantaged. The tax benefits don’t depend on the investments you make within these accounts.

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It’s April 15th, it’s getting late, and chances are you’re done with your taxes or getting ready to send it in. Here’s the best last minute tax tip you could possible get and you have until midnight tonight to get it done.

Lending Club, through EntrustCAMA, recently announced that they were going to offer self-directed IRAs. When you open an IRA with a brokerage firm, you can invest in stocks, bonds, and mutual funds. When you open a self-directed IRA, you can invest in pretty much anything as long as you follow a few rules. I won’t go into those rules, you can read about self-directed IRAs at the Motley Fool, but this is a savvy move by Lending Club but I think it’s a mistake for average investors to participate.

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Reader TTFK sent me an email this morning about the “Credit for Qualified Retirement Savings Contributions,” also known as the Saver’s Credit, claimed on Form 8880, a tax credit I haven’t covered recently. The Retirement Savings Contribution tax credit is a tax credit, up to $1,000 ($2,000 for joint filers), for contributions you make into qualified retirement accounts. It’s a great incentive for you to save towards your retirement if you’re able to and those who earn less than $26,500 ($53,000 married filing jointly) qualify for some of the tax credit. Unfortunately, if you earn more than that, you don’t qualify.

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One of the most frequent questions I get is “Where should I open an IRA?”

Short answer: Anywhere, just open one! If you want mutual funds, open an account with the company that offers the funds you want, like Vanguard, Fidelity, etc; because they will let you buy and sell the funds for free. If you want stocks, open an account with a company that offers the lowest fees.

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Five years, on the first day of my first “real” job, the HR administrator of my company handed me a folder labeled XYZ Company Pension & Retirement Plan. Inside the folder was a description of the company’s pension and 401(k) package, two “things” that meant almost nothing to me. I knew what a pension was but had no clue was a 401(k) was, but the folder seemed to have enough information in it to help me start my own 401(k) company if I wanted to. I made some good decisions about my 401(k), mostly by luck (I put 40% of my money into emerging markets, which was a good choice but I did it for a bad reason – I had no reason!), but you shouldn’t have to.

Retirement investing is not rocket science, it’s just confusing with all the acronyms and the taxability and everything else. The basics, which we’ll cover in this Foundation series article, once you unravel the confusion, are fairly straightforward.

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Popular Mechanics created a list of 100 Skills Every man Should Know, which naturally gravitated towards DIY/physical skills like jump starting a car and split firewood. The Frisky listed 30 Skills Every Woman Should Have Before Turning 30, which actually touched on more than physical skills (though #12 is physical ), with a handful of financial skills (#17 – #20).

This isn’t a checklist of things you need to necessarily do in your life, it’s just a list of things that you should know how to do (in case the need arises).

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In mathematics, there’s a concept known as a step-wise function. Its namesake is owed to what the function looks like when you graph it, it looks like steps or stairs (this is sort of what it looks like).

As you slide across the X-axis, the Y doesn’t jump up until after a certain amount. It’s at those boundaries, where the tiers shift up (or down), that you need to pay the most attention. Why is this little trip down memory lane important? Many things in personal finance are step-wise functions and it’s important to understand them because it can save you a lot of money.

When I discussed the impact of your credit score on your loan interest rates, I listed a table of scores and rates. If you remember the chart, everyone with a credit score between 760 and 850 would paid an interest rate of 5.766% on a 30 year fixed loan. Someone with a credit score of 759, just a sniff away from 760, would have to pay 5.988% – or 0.222%. One hard inquiry can shift you from one category to another and cost you a few thousand dollars. That one inquiry can take you from step to another and cost you thousands of dollars.

What other personal finance “functions” are tiers?

• IRA contributions (this explanation is for the Roth): Your contribution limit is affected by your adjusted gross income but it’s not perfectly linear. The range for a single filer for 2008 is $101,000 to $116,000. You figure out how far through the limit you are, then you calculate how much you can contribute but you always round up your contribution limit to the nearest $10. Also, if you calculate your limit to be under $200, you can round up to $200. This means if you can get your AGI from 116,001 to 115,999 – you go from being ineligible to contribute to a Roth IRA to being able to contribute $200. Here’s more information about Roth IRA contribution limits.
• Eligibility for Medical Expense Deductions: You’re able to deduct your medial expenses on your tax return if they are more than 7.5% of your adjusted gross income. It’s one of those ON-OFF situations where if it’s above 7.5% you’re eligible, if it’s under, you’re not. The nice thing about this tier is that there are two sides you can play with, either increase your medical expenses by paying for or purchasing things early or lower your AGI. (Update: I made an error in the original, it turns out you can only deduct the medical expenses that exceed the 7.5%, Thanks Fred!)
• Income tax underpayment penalty: This doesn’t happen often but if you have any large capital gains, usually from the sale of stock or your home, you need to be aware of the underpayment penalty rules regarding “safe harbor.” Safe harbor means that if you follow the safe harbor rules, you won’t be subject to underpayment penalties. How do you follow them? First, if you received a refund last year then you are safe this year. If you didn’t, then you have to be sure that you pay either at least 100% of your tax owed last year or pay within 90% of what you owe this year. If you fail to do that, then you will be penalized on the underpayment. If you follow those rules, you are safe. (states have similar rules too but they may be different, in Maryland the safe harbor rule requires payment of 110% of last year’s tax owed, which is 10% more than the federal rule)

Here’s a more comprehensive list of tax phaseouts if you want to dig a little further into those.

If you can think of anymore of these types of “money tiers,” please let me know in the comments.