This month’s guest post is courtesy of Bill Hughes, a Professional College Planner located in Lake Wylie, SC.

The parent who believes that the college admissions process is a game is intent on figuring out first the rules, then the unwritten rules, and especially the deep secrets of this new game – and then mastering them.  Game-playing parents range in style from the athletic through the compulsive gambler type and finally to the organized-crime-connected politician.

The athletic parent rises to the challenge of mastering the new sport.  I have a  friend who always gets lessons when he does a sport; the moment something goes wrong with his golf game he’s back to consult his pro.  He takes windsurfing lessons, skiing lessons, he consults with experts before he hikes.  So when his son, who was a good student in public school, got to spring of his junior year, the father hired an outside educational counselor.

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Rising gas prices may capture headlines, but today’s soaring health care costs are an even more consistent financial threat. The National Coalition on Health Care reports that in 2006, the average family health insurance premium topped $1,200 per month. That’s more than the average family’s mortgage—and health care costs are rising faster than interest rates!

Raising your health insurance deductible just a few thousand dollars can cut your premium by up to half. But that leaves you responsible for out-of-pocket costs. And even if you itemize, those are deductible only to the extent they exceed 7.5% of your adjusted gross income. Is there a way to capture premium savings from high-deductible insurance and tax savings for out-of-pocket expenses?

If you have self-employment income, even from a startup or sideline business, you can take advantage of a little-known tax break to save a bundle on your family’s health care costs. Medical expense reimbursement plans (“MERPs”) let you reimburse your employees, their spouses, and their dependents for uninsured medical costs. Plan benefits are deductible by the business, and nontaxable to the employee. Here’s how they work:

• You have to establish the plan for employees. If you operate as a proprietorship, partnership, LLC, or “S” corporation, you’re considered “self-employed,” and not eligible. If you’re single, you can establish a C corporation and pay benefits to yourself as an employee. If you’re married, you can hire your spouse and pay benefits to them. (If you operate as an S corporation, you and your spouse are both considered self-employed. In that case, segregate part of your income through a proprietorship or C corporation and pay benefits through that entity.)
• You have to offer benefits to all employees. However, you can exclude those under age 25; those who regularly work less than 35 hours per week; those who work less than nine months out of the year; and those who have worked for you for less than three years.
• You’ll need a written plan document. No special IRS filings are required for plans with less than 100 employees. You’ll deduct benefits as “employee benefits” on your business return, which may also lower self-employment tax bill.

Example: You’re self-employed as a real estate agent. You hire your spouse to provide marketing support, and establish a MERP for his or her benefit. The plan covers your employee, their spouse (meaning you!) and your dependents.

Once you’ve established the plan, you can still deduct 100% of your health insurance costs. This includes major medical and supplemental coverage, Medicare Parts A and B coverage, qualified long-term care, and “Medigap” coverage. You can even reimburse your spouse for any after-tax premiums they pay through their employer.

You can also write off 100% of your out-of-pocket costs and bypass the 7.5% floor for itemized deductions. This includes routine expenses such as co-pays, deductibles, and prescriptions; occasional expenses such as eyeglasses, teeth cleaning, and chiropractic care; and  big-ticket items like orthodontics, fertility treatments, and schools for learning-disabled children. It also includes nonprescription medicines and health-care supplies. You can reimburse your employee, or you can use business dollars to pay health-care providers directly. For more information, see our office.

MERPs won’t make your visit to the doctor less painful. But they may be the best kind of tax strategies because they give you new deductions for money you’re already spending. Enjoy them in good health!

This is final part of a five part series of posts related to Roth IRA Conversions and the rule changes that go into effect on January 1, 2010. As mentioned in prior posts in this series regarding Roth IRA Conversions, I will explain the rules around Roth IRAs, as well as what the recent changes in the law means. I will also provide you with some reasons to convert, as well as some reasons not to convert. In addition, my final post will include some tax planning tips around the Roth IRA.

For other posts in this series, please visit:

Part I: What is a Roth IRA? What is changing about Roth IRA Rules?
Part II: Reasons to Convert to a Roth IRA.
Part III: Reasons NOT to Convert to a Roth IRA.
Part IV: Planning Ideas around Converting to a Roth IRA
Part V: Planning Ideas – What is the Pro-Rata Rule?

In this post, I will review a few more tax planning considerations related to Roth IRAs. It is important to keep in mind that everyone’s situation is different and that these ideas may or may not apply to you. You should sit down with your tax professional and do proactive tax planning prior to doing anything.

Can’t Afford to Convert?  If you are like many taxpayers, you look at the cost of conversion and it is overwhelming.  The good news is that you don’t have to do the entire conversion all at once.  You can convert a small portion of your IRA each year over a several year period – depending upon what you can afford to pay in additional taxes for the year of conversion.  In addition, this allows you to sit down with your tax planner and find out the magic amount that you can convert this year without being pushed into a higher tax bracket.  By planning this conversion out over several years, you may be able to lower the taxes that you pay on the conversion, as well as spread it out over many years.

The Pro-Rata Rule.  Wouldn’t it be great if you could choose to convert your nondeductible contributions and keep the contributions that you deducted as traditional IRAs – thus paying very little, if any tax?  Sorry, but that is where the Pro-Rata Rule comes into play.  When determining the amount of your conversion that was from deductible contributions and the amount that was from non-deductible contributions, the IRS looks at all of your IRAs.  You must add the value of all of them together, then divide by the nondeductible contributions, and this will give you the percentage of any conversion that you make that is tax- free.    This prevents you from converting only your nondeductible contributions.  The good news is that you may be able to use a loophole – the 401(k) loophole below.

401K Considerations.  Balances in 401(k) accounts are not included in the calculations for the Pro-Rata Rules.  In addition, some employer 401(k) plans allow you to rollover your traditional IRA into the plan.  By doing so, it can allow the taxpayer to exclude some or all of their deductible contributions from the calculation.  This will result in a higher percentage that can be converted to a Roth IRA tax free.  In the event that a taxpayer that plans to do a conversion has already rolled their 401(k) into a traditional IRA, they may wish to consider rolling it back to a 401(k) if their employer plan allows.

Due to this Pro-Rata Rule, it is not usually recommended that you convert your 401(k) to a traditional IRA until after you are through with any Roth IRA conversions that you plan to do.  The exception to that would be if you wanted to convert the 401(k) balance to a Roth IRA as well.  Even if you do, it is probably a good idea to sit down with your tax planner to make sure that you structure the timing of the conversions in a manner that will maximize your tax savings.

Minimum Distributions.   As mentioned several times during this series of post, if you are over the age of 70 1/2 and you are taking Required Minimum Distributions (RMDs) from your traditional IRA or workplace plan, you can not include the current years RMD in the conversion amount.  You must pay the necessary tax on that RMD, and then you can convert the remaining balance.  (Note:  There are no RMDs for 2009 because Congress passed legislation to waive them due to the down market – fearing that they would wipe out many peoples retirement accounts.  RMDs are scheduled to resume in 2010.)

This is forth part of a five part series of posts related to Roth IRA Conversions and the rule changes that go into effect on January 1, 2010.  As mentioned in prior posts in this series regarding Roth IRA Conversions, I will explain the rules around Roth IRAs, as well as what the recent changes in the law means. I will also provide you with some reasons to convert, as well as some reasons not to convert. In addition, my final post will include some tax planning tips around the Roth IRA.

For other posts in this series, please visit:
Part I:  What is a Roth IRA? What is changing about Roth IRA Rules?
Part II:  Reasons to Convert to a Roth IRA. 
Part III:  Reasons NOT to Convert to a Roth IRA.
Part IV:  Planning Ideas around Converting to a Roth IRA.
Part V:  Planning Ideas – What is the Pro-Rata Rule?

In this post, I will review some tax planning ideas.  It is important to keep in mind that everyone’s situation is different and that these ideas may or may not apply to you.  You should sit down with your tax professional and do proactive tax planning prior to doing anything. 

Local Taxes.  Have you thought about where you plan to live when you retire?  Where you plan to retire could be a major factor in deciding whether or not to do a conversion – especially if you are close to retirement age.  If you are living in a high tax locale, such as New York, and you are planning to retire in one of the states that currently have no income tax (such as Florida), it may not make sense to convert.  If you convert while still living in the high tax state, you will have to pay a tax when you convert, when you would not be subject to that state income tax when you are in retirement.

The opposite is also true.  If you are currently living in a no state income tax-state such as Alaska, and plan to move to North Carolina for your retirement, it may make sense to convert while you are not subject to state taxation of those funds. 

Of course, as stated in prior post, we can not predict what the tax laws will be in the future.  This obviously applies to the individual states the same way it does to the federal government.  As most of the states are struggling to pay for hefty state employee pensions and Medicaid programs, there is a possibility of higher taxes at the state levels – as well as the implementation of income taxes in current no state income tax states.

Future Tax Rates.  What tax bracket are you going to be in during retirement?  Many individuals expect that their income to be lower during retirement, and thus have a lower marginal tax rate.  If this is the case, it may not make sense to convert.  Why pay tax at a high tax rate now, when you can pay a lower tax rate later? 

Conversely, other individuals may have higher income during retirement – especially once the required minimum distributions from retirement accounts kick in at age 70 1/2. 

Over the Income Limit.  Do you currently want to fund a Roth IRA, but are over the income limits for contributing to a Roth IRA?   You can open a traditional IRA, which is not subject to the income limits that a Roth IRA is, then contribute the maximum amount allowable and convert it to a Roth IRA in 2010.  Depending upon your individual tax situation, the contributions to the traditional IRA may or may not be deductible.  Just remember that if you can not deduct the contribution now, it will not be taxable upon conversion – although any earnings would be.   Many taxpayers have been maxing out their nondeductible contributions to traditional IRAs for several years now in anticipation of converting to a Roth IRA in 2010.

Protect Yourself Against Losses.  In future tax years, you can help to protect your account from losses or at least the taxes on money that you lose.   An individual can hold two Roth IRA accounts – one that is their “new” Roth IRA and one that is their “old’” Roth IRA.   Overtime, the individual will migrate all of the assets to the “old” Roth IRA.  Each year, contribute your funds to a traditional IRA (see “Over the Income Limit” above) and then subsequently convert that traditional IRA to the “new” Roth IRA.    The reason that you want to convert it to a “new” Roth IRA instead of just combining it into your “old” Roth IRA is that the tax law allows you to recharacterize a Roth IRA as a traditional IRA within certain time limits.  By doing this, if the investments in this “new” Roth IRA suffer a loss during the first year, you can recharacterize it as a traditional IRA and eliminate the taxes due from the conversion.  You can then reconvert the assets to a Roth again, at the deflated value, which would create a lower tax due.  This eliminates the possibility that you may have to pay taxes on value that no longer exists (See IRS Publication 590 for timing details surrounding your ability to recharacterize the IRAs).  In the event that the account increases in value, you could then transfer the assets to your “old” Roth after the time to recharacterize the account to a traditional IRA expires.  You can repeat this process each year that  you plan to make contributions. 

If that whole process was not enough pain for you, you can extend it even further to protect from losses in the investments.  You can open a separate Roth for each type of investment that you make with the converted money.  For instance, if you are investing the funds in three different investments, roll the funds into three separate Roth IRA accounts.  This way you can pick and choose which particular investments that you recharacterize – not just which Roth IRA account.  For example, if you had the following three investments:  Investment A that doubles in value during the year, Investment B that stays the same during the year, and Investment C that becomes worthless.    If all three of these investments were held in the same Roth IRA account, the total value would be the same and you would have to pay taxes on the converted amount as such.  If they are in separate accounts, you can pay the tax for the conversation of Investment A and Investment B, then recharacterize investment C as a traditional IRA – thus eliminating the taxes due on that portion of the conversion amount.

Estate Planning.  As discussed in Part III, Roth IRA’s do not have any required minimum distributions once they reach age 70 1/2 like they are required by traditional IRA’s.  If a retiree does not need the funds to live on, the earnings on their investments can continue to grow tax-free inside the Roth IRA.  Another advantage is that beneficiaries do not have to pay income tax on withdrawals that they make from an inherited Roth IRA.    Although, Roth IRA beneficiaries do have to take distributions across their life expectancies, Roth assets are still included in an estates value for Estate Tax purposes.