Special Report: Converting to a Roth IRA

Links to Topics in the Special Report: Converting to a Roth IRA:

Converting From a Traditional IRA to a Roth: How Much?
Converting From a Traditional IRA to a Roth: Timing
Converting From a Traditional IRA to a Roth: How to Convert

Converting From a Traditional IRA to a Roth: How to Convert

You’ve decided converting or moving a portion of your Traditional IRA into your Roth IRA is the right thing to do. You’ve calculated how much to move and you know you want to do it now. So just do it.

What? You say you don’t know how? No problem. Just call your broker, mutual fund company or your discount broker’s customer service department and ask for their instructions.

My discount broker is USAA Investment Management Company. The first time I moved money from my IRA to my Roth I called USAA Customer Service; they guided me to the right place on their web site to download the proper form.

Next, I filled out the form specifying the precise securities I wanted to move and signed it.

Then I faxed the form to the phone number shown on the form. Daily for the next two days, I checked both accounts on-line – the transaction concluded on the second day.

The really good part came next. After establishing and documenting the process that first time, USAA has allowed me to give verbal instructions by telephone to their customer service representative. It’s really a snap.

When I move my wife’s money from her Traditional IRA to her Roth it’s a bit more complicated but not too much more. The first Roth conversion I did for Linda was identical to my own first conversion. I downloaded the form, filled it out and had Linda sign it. Then I faxed it to USAA. That was last year.

This year, after I instructed the customer service representative on making my Roth conversion I told her that I also wanted to make a conversion for my wife’s account. She told me she could do it over the phone if we could conference in Linda for a three-way call. I called Linda while the rep waited on the line and when Linda joined the called she told the representative that I was authorized to do the Roth conversion transaction for her.

Linda then dropped off the call and I instructed the USAA Customer Service Representative on which of Linda’s IRA securities we wanted to move to her Roth.

The next day it was done. Your broker or mutual fund company will have a different process and nobody beats USAA customer service. Nevertheless, your broker’s process will probably be similar.

Once you’ve decided to make the move and determined how much to move and then selected the specific securities to move – the mechanics of actually making the move are really pretty easy.

Link to Other topics in the Special Report: Converting to a Roth IRA

Converting From a Traditional IRA to a Roth: Timing

If you think, as I do, that your income tax rate may be higher after you retire, then you’re a candidate for converting a portion of your Traditional IRA into a Roth IRA.

In the previous post I discussed why you might want to move money from your Traditional IRA to your Roth and some considerations for determining the amount to move (convert).

When you move cash from your IRA to your Roth, timing is not a consideration. However, if you move securities you should know that your tax liability is determined by the value of the securities at the time of the move. Your cost basis (what you paid) is irrelevant; so is the price at which you eventually sell the stock.

Because of this feature, when I moved securities from my IRA to my Roth last year, I did it in the early Spring because the entire market was significantly down. This allowed me to move more shares for the same tax liability than if I’d made the move later in the year.

For example, suppose you held 100 shares of XYZ company in your IRA that you’d originally purchased for $10 per share. Your cost basis for this stock is 100 shares times $10 per share or $1,000. If today, the price of XYZ stock is $5 per share and you convert all 100 shares into your Roth, your tax liability is your tax rate on $500.
If later, the price of XYZ increases to $12 and the value of your holding in your Roth account becomes $1200, it doesn’t matter because your tax liability remains the tax on the $500 value at the time of conversion.

Last year, the situation was pretty clear. The market had crashed and everything was down. I had confidence that my stock would rise again although I didn’t know when. Today, in 2010, it’s a bit less certain. The market is up substantially from last March. Some people think we’re in a new bull market. Others expect another leg of recession. Still others think the market is simply overvalued right now and expect a correction.

I expect another leg down to match a “W” recession and an extended “L” shaped recovery after the second downturn. If I were certain in this opinion I’d wait to move shares to my Roth until after the next crash.

However, I’m not certain. So today I moved a portion of my planned 2010 conversion and I’ll wait and see what the next six months brings before I move the rest.

The next post will address the mechanics of Roth IRA conversion.

Link to Other topics in the Special Report: Converting to a Roth IRA

Converting From a Traditional IRA to a Roth: How Much?

I believe income taxes across the board will probably be higher by the time I retire. If I’m right (I hope I’m wrong!) Linda and I will be better off with more retirement assets in tax-free Roth IRA’s instead of in tax-deferred Traditional IRA’s.

Recently, I’ve read articles describing the new for 2010 rules on who can contribute to a Roth IRA and articles describing the special (2010 only) rules for converting a traditional IRA into a Roth. The new and special rules don’t apply to me – I don’t make that much money. Still, converting (moving) some assets from a traditional IRA to a Roth is something I do every year.

All new IRA contributions go into a Roth. However, I’ve changed jobs a few times in my life and each job change ended up increasing my Traditional IRA account balance when my 401k account with my former employer was rolled into my Traditional IRA.

Since allowable 401k contributions are significantly higher than IRA contributions the amounts rolled over into my Traditional IRA drove it higher than my Roth; Even though I contribute the maximum allowed to my Roth each year.

Because I believe my income taxes will be higher after I retire – an arguable belief I know – I want to move as much money as I can afford from the Traditional IRA to the Roth. Now then, how much can I afford?

The problem is the value of the assets moved becomes taxable income for the year in which the move occurs. If you move $1,000 to your Roth and your income tax rate is 25% then your income tax for the year increases by $250. This can be a very expensive proposition if you convert tens of thousands of dollars. It can also be very expensive if you have no money budgeted to pay taxes other than your withheld wages.

I fall into the second category. I don’t want to write a check on income tax day. On the other hand, I don’t mind reducing my refund from Uncle Sam in exchange for moving retirement money to my Roth. So, I estimate what my refund might be and then conservatively calculate the amount I might safely move to a Roth.

Then, I split the difference and move the same amount from Linda’s Traditional IRA to her Roth as I move between my own accounts.

Timing considerations and the actual mechanics of the conversion (move) will be the topics of future posts.

Link to Other topics in the Special Report: Converting to a Roth IRA

Diversification & Warren Buffet

Warren Buffet famously said, "Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing." And, “Wide diversification is only required when investors do not understand what they are doing.”

Although Warren Buffet speaks in favor of learning everything you can about prospective investments and only putting your money on your best ideas. Mr Buffet reads annual reports for pleasure. He walks his talk and he is the most successful investor in history.

However, his current stock portfolio consists of the following stock investments – not counting Berkshire-Hathaway’s wholly-owned subsidiaries:


Thirty companies from fifteen industries are represented in this list. It looks pretty diversified to me.

Mr Buffet has a problem that I don’t have though. He has too much money. He must find a place to put billions of dollars; A place that will earn a good return and also not drive the price out of sight by the shear size of his buy order.

I could, if I chose, put every last cent I own into one stock – and no one would notice. Poor Warren just can’t do that. He often buys companies outright – taking them private – because he can’t make a significant (to Berkshire) investment in their stock without taking them over. Right now he is in the process of swallowing Burlington Northern (BNI) whole.

So, it may be that Mr Buffet has inadvertently ended up with a diversified portfolio. But, I doubt it. Warren Buffet is an excellent stock picker. He picks for the Berkshire
If you pick the best company in every industry – you inevitably create a nearly perfectly diversified portfolio. Not a bad approach, if I do say so myself.

Would that I could emulate his results.

Timeshare Sales Pitch Weekends

Linda and I have taken a couple of weekend get-a-ways where the bulk of the cost was borne by one of several timeshare marketing companies.

Generally, timeshare companies cover lodging and some meals but not transportation. But, TNSTAAFL, there’s no such thing as a free lunch – the cost of a timeshare subsidized weekend includes sitting through a high pressure tag team sales event. These are usually advertised as 90 minutes long, but in my experience you rarely escape before three hours have passed.

The multiple and continuous sales pitches can be frustrating and irritating, especially when they delay giving you the premiums you were promised until seemingly every sales person and manager in the place has had an opportunity to work on you.

The stakes are high for the sales team. Their commissions are high but their marketing expenses are high as well. They need to sell some minimum number of time shares per session to recoup their marketing expenses and pay their sales commissions. So, they push hard.

If you can’t take the hard sell for an extended period of time without caving; stay out of the situation. Pass on the timeshare weekend. Actually buying a timeshare could make this weekend the most expensive vacation of your life.

Linda and I have stood up to the test, but the fact that timeshare companies continue to offer weekend vacations in their marketing mix is testimony that someone’s been buying under the pressure. Don’t let it be you.

Link to Other Topics in the Special Report: Cutting Expenses

Merry Christmas

I'm taking the week off to celebrate Christmas. I wish you all a very merry one.

Paying Less for Books: Part 2 – Money Saving Tactics

I am a bibliophile. I prefer holding a book in my hand while I read. I like to own books. I like to look at them on my shelves and recall their main points or stories.

Because it’s important to minimize the cost of the books I buy, I’ve developed a strategy and tactics to substantially reduce the price I pay. The strategy is patience. I put books I’m interested in on a list and wait.

Several good tactics are based on the strategy of patience.

First:
As time passes I validate my interest in the books on my list. About half of them I eventually delete from the list without buying; I’ve lost interest in them or my interest is insufficient to justify the money or the time to read them

Second:
I wait for the mass-market paperback edition. I use this tactic for most of the novels on my list. A typical hardback novel lists for around $30. The mass-market paperback typically lists for around $8.

Third:
I have a Barnes & Noble membership providing a 10% minimum discount on any B&N paperback or a 20% minimum discount on hardbacks. As a member, Barnes & Noble sends me a discount coupon at least once a month for an additional discount on anything in the store. The additional discount ranges from 10% to 25% with 15% discount coupons being normal.

The B&N discounts are cumulative not additive. That is, they take the 10% membership discount and then they take the 15% coupon discount on the balance; instead of adding the 10% and 15% coupons and taking a 25% discount once. This process reduces the total savings, but it’s still a good deal.

Fourth:
I shop the remainders. Book sellers, including B&N, deeply discount books that fail to meet their sales expectations or to make room on their shelves for newer issues. Sometimes, books on my list show up on the discount displays. When they do I snap them up and still take the 10% B&N membership discount. On those occasions when I buy books on impulse, they’re almost always on the discount shelves.

Fifth:
I shop the used books on Amazon.com. When the mass-market paperback edition is published, the remaining hardbacks are discounted, especially by the used book sellers on Amazon. Even with a $4 typical shipping & handling fee, the total discounted cost of used books on Amazon often drops below the $8 price of the paperback edition. I’ve bought several books at a discounted price of $0.01 plus the $4 shipping & handling.

The combination of these tactics – based on the strategy of patience – enables me to buy the books that I really want without busting the budget.

Link to Other Topics in the Special Report: Cutting Expenses

Paying Less for Books: Part 1 – Patience and Making a List

I am a bibliophile. I read – a lot. And I prefer holding a book in my hand while I read. Oh, I read email and email newsletters and articles and blogs on the internet. But, when I hold a good book in my hands my attention span is much better than when I read from a computer screen.

I like to own books. I like to look at them on my book shelves and recall their main points or their stories. Because I like to own books it’s important for me to minimize their cost and so, I’ve developed a strategy that substantially reduces the price I pay for most books.

The key to my strategy for paying less for books is patience. I rarely buy books impulsively. I keep a list of desirable books on my pocket computer with a duplicate of the list set up as a “Wish List” in Amazon.

When I discover a book I’m interested in I add the title and author to my list. Then I wait. Right now my list contains 83 titles; evenly split between fiction and non-fiction.

The easiest way the list saves me money is when, after some time has past, I realize that a particular title doesn’t interest nearly as much anymore. It no longer seems worth the money to buy it or the time required to read it. And so, I delete it from my list.

This is the ultimate fate of half of the books I capture on my “Wish List”.

The passing of time also permits other money-saving tactics to come to fruition. Tactics to be discussed in future posts.

Link to Other Topics in the Special Report: Cutting Expenses

Covered Call Options: Part 3 – How to Analyze a Covered Call Option

Writing a covered call option is the least mysterious and arcane black magic technique of options investing. It’s simple enough that I’ve done it myself and made a few bucks.

My analysis for writing (selling) a covered call goes like this:

1. Select a stock with at least 100 shares in my portfolio that has active options trading; for example Southern Copper – ticker symbol PCU.

2. Determine the minimum price I would be willing to sell PCU if my covered call is exercised.

3. Go to my on-line broker’s web site and look up the “options chain” for the stock – PCU.

4. Choose a selection of PCU call options at acceptable striking prices and several expiration dates (near term, three months out, and six months out).

5. Get the price quotes (bid price or last price paid) for each option.

6. Calculate the profitability of each option applying my broker’s option commission structure. I use an Excel spreadsheet for this analysis.

7. Choose the most profitable option in the selection.

8. Final gut check on the striking price and the price for which I’m willing to sell the option.

9. If I decide to set a price for my covered call option different from the price quotes used in my analysis then plug my price into my analysis model to check its profit.

10. Place the trade order thru my on-line broker.

After that, you wait for the call to sell. If it sells, you wait for it to expire or be exercised. If it expires, you can start the process over and sell another call. If it’s exercised then you have just sold your stock at the option striking price.

After you place the sell order for the covered call you will either sell the call earning the exact profit you calculated or you will not sell the call - you will have lost or gained nothing.

If you sell the call the only risk you take is the possibility of having to sell your stock for a price less than the market price at the time the call is exercised. If you chose a striking price that gives you an acceptable return then the worst case is you miss making a bonus profit on the sale of the stock.

Here is an analysis of a real selection of PCU call options:

My broker’s commission structure is as follows. A $9.20 commission is charged per trade or transaction. In addition, $0.75 is charged for each contract. In this example all of the potential trades analyzed are for one contract so the total commission in each case is $9.95.

The price is the price per share so 100 shares at $0.65 per share is $65.00 – this is the amount the buyer will pay me for selling the PCU AH call. $65 less the $9.95 commission yields my profit of $55.05. If the market price rises above the $40 striking price per share then the option would probably get exercised. Since my current cost basis (the average price I paid for my PCU shares) is $21.04 per share, I stand to make a profit of $18.96 per share or $1,896 for my 100 shares - less my broker’s commission on the stock sale of $5.95.

I chose these specific call options because their striking prices are above the current $36.40 market price for PCU and, since I’m not really interested in selling my PCU shares, I want to reduce the probability of being forced to sell the stock. I also want to ensure that if I’m forced to sell I get a price I’ll be happy with.

The number of contracts offered makes a difference to the profitability of covered calls because of the option commission structure. The same analysis is shown below using four contracts per transaction.
On the PCU AI call you see the difference in profitability due to the increased number of contracts. When one contract is sold the profit is $0.05 but when four contracts are sold the profit jumps to $27.80 – considerably more than four times the original profit.

You also see that a more profitable single contract is less affected by the commission structure when the number of contracts increases.

Another consideration is the expiration date. The more time allowed before the expiration date the higher the probability the stock price will rise above the striking price. Of course, if the stock goes down the option will expire. If you want to sell the underlying stock before the option expires, you will need to buy the option back at the current market price.

Writing covered call options allows you to lock in a profit with the risk of possibly missing out on some bonus profit if the underlying stock goes up above the option striking price.

Links to Other Topics in the Special Report: Covered Call Options

Covered Call Options: Part 2 - Definitions of Option Terms