Archives 2021

Whats the Right ROTH Conversion amount?

When it comes to retirement accounts in the US, there is no dearth of choices. They come in all flavors and each one brings its own merits and restrictions. If you are one of those investors, who have an IRA account in addition to a 401k account, you may have heard of discussions pertaining to converting your IRA to a Roth IRA. In this blog, we shall examine these two types of account and analyze whether it is advantageous to make the conversion from one type to another.

Rationale for Roth conversion

Individual Retirement Accounts [IRA], also known are Traditional IRAs are basically retirement savings accounts. Those with annual incomes up to $198k [MAGI] can contribute $6000/- per annum into their IRA accounts and get a tax deduction for their contributions. As these are paid with pre-tax dollars, all future earnings and withdrawals are taxed. If you are eligible to make a ROTH IRA contribution, these are made with post-tax dollars and hence future earnings and withdrawals are NOT taxed. Now, we shall see if you should convert your traditional IRA to a Roth IRA!

Generally tax saving on future earnings & incomes is touted as the primary reason for an IRA to Roth conversion. However, one needs to objectively assess the move in light of various aspects covered below:

  1. Let us say, presently you are in the 24% tax bracket ($171-$326k income for 2020). Do you expect to be in a higher tax bracket when you retire?
  2. Is the current Traditional IRA corpus solely from “Deductible IRA”? Or did you make any “Non-deductible” contributions?
  3. By converting even 20% of IRA funds to Roth, your income could jump from a lower 24% tax slab to a higher 32% slab. And that could significantly impact your tax liability – do you have the cash in hand to pay for this additional tax?
  4. Or do you have sufficient losses from other heads of income(s) to offset the tax liability that may arise from this Roth conversion?
  5. Is the market level right for you to convert a part of your IRA to Roth or should you wait for a deep correction in order to reap the disproportionate taxes incurred now as rewards / returns in future?
  6. Would you have other sources of income when you turn 70.5, that you do not need to withdraw the minimum sum from IRA under the RMD (Required Minimum Distribution) rule?

Once you have the answer to these questions, then it makes sense to do the math and see how much you stand to gain in taxes payable now (vs) taxes deferred to future. The other incentive to convert is to overcome a constraint introduced by the SECURE Act – whereby upon demise of the account holder (wef 1.Jan.2020), legal heirs (except surviving spouse) are mandated to withdraw inheriting IRA account balances in 10 years & pay higher taxes along with their then future income(s).

Important points to consider in your DECISION

  • It makes sense to convert only to the extent you remain within your current tax bracket
  • It would make for smart investing to convert amounts in excess of your retirement corpus
  • Any sum that you set aside in IRA to bequeath would largely benefit from the conversion

Do the Math with your financial advisor and understand the right amount to convert. It would help you optimize tax outgo NOW (vs) taxes payable from ages 59.5 or 70.5 depending on your annuity withdrawal age from IRA, happy planning!

Also read how good are 401k Target Year Retirement Funds!

Budget 2021 – Personal Finances

Overall this budget has not made major changes to personal taxation. However, few areas to take note are detailed below:

1. Wef 1.Apr.21, interest on EPF + VPF contributions in excess of Rs.2.5Lacs will be charged as interest income similar to FDs – further details are awaited as to whether only the first year’s interest is taxable or future interest that accrues/compounds from this excess contribution would also be taxable (in which case it could become an accounting nightmare for EPF).

Next step – A neater solution would be to prevent or cap employees’ contribution at Rs.2.5L in EPF/VPF each. Similar to government’s move last year that set an aggregate limit of Rs.7.5Lacs for employer contributions to EPF, National Pension System (NPS) and superannuation fund.

Rationale – About 1.1% of EPF account holders who also happen to be very high income earners are contributing lakhs and crores of their income(s) into their EPF & VPF accounts, to earn the highest 8.5% tax free interest. According to the government, this arbitrage is not fair to low income employees who are able to contribute only Rs.20833 p.m towards their retirement. Hence this tax measure does not impact 99% of EPF contributors.

2. All equity/stock market capital gains, interest & dividend income will be auto-populated in ITR forms for ease of tax compliance. The tax department collects data about all financial, real estate and gold investments made by individuals based on PAN numbers. This info would now be pre-filled in the assessees’ income tax returns to help with better tax compliance.

Rationale – A simple and effective way to curb under-reporting & non-reporting by use of technology. It also widens the tax base beyond the salaried class – whether they are from informal sector, self-employed, business owners or even rich agriculturalists.

3. ULIPs are now brought at par with equity mutual funds with regards to taxation, which was a long pending measure. Maturity proceeds from policies with premiums in excess of Rs.2.5Lacs will now be taxed as equity mutual funds (wef 1.Feb.21). This measure plugs the tax arbritrage of ULIPs and prevents mis-selling.

4. For pensioners above 75years of age, there is no need to file ITR – but tax will be deducted by bank. Need to see if the same would happen to all pensioners regardless of age. While this helps seniors from having to file their income tax returns, in case they employ any tax saving instruments under section 80C, they may still have to get help to file their returns and claim refunds.

The EPF tax proposal needs to be watched closely for amendments (or rollback) by 31.Mar.2021.

The Great Gold Rush 2020

Gold has been galloping and has returned 54% in INR absolute returns since jan/2019 and 38% since jan/2020. In fact it seems to be in a race with the stock market and has got a wide spectrum of investors puzzled and interested at the same time.

Gold comes with a long investing history and is often seen as a safe asset class in times of crisis. While trade war in 2019 created some to shift their investing to gold, the stock market plunge due to covid-19 caused gold price to spiral up 48% from $1281 (01/2019) to $1894 (01/2021).

Why the great rush?
Traditionally gold has an inverse correlation with the stock markets. When stocks are down, gold rises and vice versa. Gold is also known to have an inverse relationship with the USD. As gold itself is denominated and traded in USD, when USD strengthens, gold falls and vice versa.

However, since the GFC (Great Financial Crisis 2009) and the invention of money printing, the correlation between stocks and gold stands broken. This is due to cheap liquidity made available in plenty by the Fed ($7.24Tn) and other developed market central banks over the last decade (2010-2020).

Basic economics tells us that when demand rises without rise in supply, it results in a price rise. As more and more cheap cash chases fewer stocks in emerging market equities, it pushes up their prices and makes their valuations extremely high (Nifty P/E 38).

Domestically, whenever real interest rates turn negative, savers are disincentivized to save in cash assets such as fixed deposits and move to capital assets like stocks, or physical assets like gold and property. HNIs on the other hand move to exotic assets such as angel investing and cryptocurrencies, which explains the bubble in startups and bitcoins.

Did you miss out?
From a personal finance perspective, gold is just one among many types of assets held in an individual’s portfolio. It is quite similar to a plot of land in that it does not generate any passive income and may take long tenure to appreciate in value. Its price may rise/fall in the interim years depending on various factors such as real returns from other asset classes, political instability, social unrest, trade/currency/civil war and more importantly policies of central bankers.

Prior to 2013, long term return from gold over 20 years in rupee terms was 6% barely meeting inflation. Only post QE, return from gold is in the range of 10-12% p.a, very similar to returns from equity markets. And its outlook for 2021 is at $1900-$2300/oz. As long as you have a well diversified portfolio in different asset types, it would help you ride the upside and tide the downside – so that you could grow your portfolio and fulfill your personal financial goals.

Also read: Sovereign Gold Bonds