Converting from a traditional to a Roth IRA is a hot topic this year, for a couple of reasons. Two significant barriers - income and filing status - have been removed. And, tax rates will be changing in 2011, making 2010 tax rates look like a good deal. Over the next few days, I'm going to try to pull together all the pieces of information you might need to evaluate whether a Roth conversion makes sense for you. Today, we're going to start by learning the rules about conversions. Hold onto your hat, because some of these are more complicated than the news media has led you to believe.

Rules for Roth Conversions:

Beginning this year (2010), anyone can convert money from a traditional IRA, SEP IRA, or a SIMPLE IRA to a Roth IRA.

• Restrictions based on income or tax filing status have been removed.
• You can also convert money from an employer plan [401(k), 403(b), 457, and profit sharing plans] to a Roth IRA.
• Special rule for SIMPLE plans: In the first two years of participation in a SIMPLE plan, rollover to an account other than another SIMPLE plan is prohibited.

You will owe tax on the amount converted, at your marginal tax rate.

In 2010, you can choose whether to recognize the income and pay the tax in 2010, or whether to spread the income between your 2011 and 2012 tax years and pay the tax at the rates in effect in those years.

Unless new legislation is passed, tax rates will increase in 2011. The laws which reduced tax rates to their current level will expire, and most tax brackets will go up 3% or more.

If you have made non-deductible contributions to an IRA, those amounts will be converted tax-free. However, you cannot convert just the non-deductible contributions. You must add together the balances in all of your traditional IRA accounts (including SEP and SIMPLE IRAs), and calculate the proportion of that total that is from nondeductible contributions.

You can do a conversion at any age. Taxes will apply, but there are no early distribution penalties if you are not yet age 59 ½. If you have a required minimum distribution for the year of the conversion, you must still take that distribution: it cannot be converted.

Conversions can be un-done, or recharacterized, as late as the due date (including extensions) for the tax return for the year in which you did the conversion. So you could have until Oct. 15, 2011 to change your mind about a conversion done in 2010 and put the money back into a Traditional IRA.

Converted amounts on which you pay tax at conversion must be held in the Roth account for five years before distribution. Otherwise, those amounts may be subject to a 10% early distribution penalty. There are exceptions to the 10% penalty. Exceptions include being aged 59½ or older, disabled, a beneficiary rather than the original account owner, and several others. You can find the details about exceptions to the early distribution penalty in Taking Distributions from Tax-Deferred Retirement Plans.

You may need to make estimated tax payments or increase your withholding for the years in which you will recognize the income from the conversion, to avoid penalties for underpaying your taxes.

There are no required minimum distributions from a Roth IRA for the original owner, or for a beneficiary spouse who re-titles the account in his/her own name. There are required minimum distributions for beneficiaries other than a spouse, and for a spouse who leave the account in the name of the deceased.

The conversion can be done by

• trustee-to-trustee transfer,
• converting with the same trustee,
• or a rollover, meaning that you receive the funds and are responsible for depositing them in the new account within 60 days. With a rollover, the original custodian will be required to withhold 20% for taxes. If you want to convert the full balance of the traditional IRA, you will have to make up the difference with other funds.

Now that we've got the rules under our belts, we'll next tackle how to go about deciding whether converting is the right thing for you. So make sure to watch for my next post, which I plan to have up in a couple of days.

If you have questions about Roth conversions that you'd like to have answered, please click on my name below and send me an email. I'll try to address those in a future post.

Don't put all your eggs in one basket. While this might make sense if you're a farmer, why would you care? The mental image of losing all your eggs when you trip over a running chicken can help you remember the importance of diversification with your investment portfolio.

Diversification is an important investment strategy; it helps us manage business and market risk. Let's suppose that Susie Q wants to invest in technology. Clearly choosing to invest in only one tech company would not be a diversified portfolio. If something bad happens to this company (for example, poor management leads to the company failing), then Susie Q would lose all of her investments. To help manage business risk, people choose to invest in more than one company.

What if Susie Q invests in several tech companies such as Dell, Apple and Sony. Does she now have a diversified investment portfolio? No – if something happens to this market sector, and tech stocks as a group lose value, her portfolio will suffer significantly.

To have a diversified stock portfolio, Susie Q will invest in a variety of businesses types such as stocks in pharmaceticul, agribusiness, aerospace, automanufacturing and technology. (Caveat: this is a hypothetical situation; this does not mean you should run out and buy stock in any of these sectors today.) Mutual funds can help people diversify their investments by investing in many companies in different market sectors.

To summarize, diversification in your investment portfolio can help you manage the risk of one company failing (business risk) and the risk of a particular industry doing badly (market risk). To learn more about diversification, visit the "Choosing Investments" section of the Plan Well, Retire Well website.

Bonus Question: If you own a significant amount of your company's stock in your investment portfolio, are you diversified? Think of it this way, if your company fails (which you likely think won't happen, but imagine that it does) and you lose your job AND your investment portfolio's value goes down, were you diversified?

In the wake of natural disasters such as the earthquake that hit Haiti last week, charitable giving is up. With so many organizations claiming to collect for relief efforts, how do you know whom to give your monies to? Through research, I found that there are a few key factors that might help you choose which efforts to support and which to stay away from. Here are a few points to consider when choosing a charity:

1. Find out the percentage of your donation that actually goes towards supporting victims. As a rule of thumb, reputable organizations will use most of your donation to aid victims or provide programs. If most of your donation goes toward administrative costs, the organization is probably one you would want to shy away from.

2. Steer clear of organizations that seem to appear overnight. Organizations which have been around for years and have recognizable names and reputations for helping are probably safer alternatives.

3. Look at the organization's Form 990. This IRS form is filed by organizations exempt from taxation. In addition, it provides financial information on how much the organization spent on administrative, program and fundraising costs.

4. Make sure the charity is legitimate. Don't be fooled by a charity having a similar name to one that you may have heard before. There are watchdog groups that track charitable organizations. Visit their websites to look up the charity you are considering. See the list below.

5. Give your time in lieu of money. If you want to learn more about a charity, volunteer some of your time. Firsthand experience with an organization allows you to get a better feel for who they are and what they do.

6. Avoid identity theft. Never give your credit card or personal information in response to phone, email or door-to-door solicitation. If you would like to give to an organization, visit their website for online giving or write a check. Never give cash.

For those that itemize, the IRS has made your charitable donations to support Haiti relief efforts immediately deductible on your tax return. For more information on this deduction, visit the IRS website.

If you would like to check out a charitable organization, visit one or more of these websites:

BBB Wise Giving Alliance

Charity Navigator

American Institute of Philanthropy

Guidestar

Until we talk again, have a happy new year.

It comes around every year, but it still catches many of us off guard: tax season. So it's time to pull together all the info that you or your tax preparer will need to complete your 1040, 1040A or 1040EZ.

If you find yourself scurrying each year to find records of your donations, business expenses, IRA contributions, or child care payments, this would be a great time to get prepared for NEXT year.

How big is the stack of documents that you use to compute your deductions and prepare your taxes? If your stack is just a few sheets of paper, all you need is a single file folder or envelope. Label it "Current Year Taxes" and put it somewhere handy, preferably close to where you open the mail

Also set up a file folder on your computer labeled the same, Current Year Taxes. Rather than printing documents that you might misplace, you can drag and drop them into their own place on your hard drive.

Throughout the year, whenever you receive a document you MIGHT need when you file your taxes, drop it into the Current Year Taxes folder.

If your situation is more complicated - maybe you have a home-based business or your have numerous investments that generate taxable income - you may need an accordian file or a directory on your computer. Look for natural groups of information to determine the labels for the divisions in your accordion file or your directory. Some might be:

• charitable donations
• investment income
• depreciation records
• utility bills (for a home-based business)
• college expenses

Once this year's taxes are done, move the electronic and paper files to a new folder labeled "Taxes 2010." Now, you're ready to put this year's documents into the Current Year Taxes folders. Next year, it will be a piece of cake.

Did you set any goals for the New Year? I find setting goals to be relatively easy -- it's reaching the goals that is difficult. Especially those goals that require repeating behaviors week after week like losing weight or saving money. Based upon the number of articles I've recently read, it seems I'm not the only one that has trouble staying focused on my goals!

Well, leave it to an economist to come up with a new way to motivate you. Dean Karlan, Economics Professor at Yale University, decided to apply behavioral economics research and help people reach their goals. With others, he formed a company, StickK.com -- a place where you can "put a contract on yourself."

According to the Stickk.com website, "We all need help to reach our goals - whether it's incentives, or support from others. Years of economic and behavioral research show that people who put stakes - either their money or their reputation - on the table are far more likely to actually achieve a goal they set for themselves."

Basically the idea is that you use a stick to motivate yourself to meet your goal. For example, at the website, I could set a financial goal to save 10% of my income in a retirement savings plan each paycheck. If I fail to meet my goal, a stick (of my choosing) would be applied: a donation to a charity would be made at my expense or, even worse, a donation to an anti-charity! An anti-charity is defined as "any organization whose views you strongly oppose, or one which promotes values that are most contrary to your own." The possibility of donating to an anti-charity would motivate me!

Previously I've used the carrot approach to my New Year's Resolutions -- visualizing myself slim in the summer or enjoying a vacation using money saved. But this year, I think I'll try the stick approach and see how that works for me. Of course, you don't have to use a website like StickK.com or one of the many other similar websites that are springing up. Publically declaring your intentions (to a friend or family member) may work as well for you. The embarrassment of not reaching your goals is a stick too.

Here's one other tip for reaching your goals. Be sure you set SMART goals. SMART goals are goals which are:

S -- specific (for example, how much money saved?)

M -- measurable (a way to tell if you are succeeding)

A -- agreed upon (by family members or others affected by the goal)

R -- reasonable (reach high but don't set a goal that you can't achieve)

T -- timed (set a date to achieve your goal or steps to your goal)

The calculators at the Plan Well, Retire Well website may help you set your SMART financial goals.

And, let me know -- does a stick or a carrot help you achieve your financial goals? Click on my name below to send me a note.

On this blog we discuss the importance of saving money, how to invest money wisely, and how to plan for long-term goals such as retirement. We write about these things because we all believe in the value of saving and investing. What we don't tend to talk about is enjoying our money. However, I think it's also important to splurge once in awhile and spend money just for the fun of it!

In the next few days, I wish everyone time to pause from working for money, to be with friends and families, and to enjoy some of the things that we do with our money as well -- whether it's eating, traveling, giving gifts, or whatever you like!

New Year's Resolutions will soon be here again. Have you thought about what yours will be for 2010! The same old ones come to my mind; lose weight, exercise more, take time for myself, help others in need. I always start out with the best ideas; but usually by February 1^st I become so busy with my daily routine that my resolutions are out the window.

So, this year I decided I will make my resolution something I do on an annual basis anyway and re-visit it again in six months for a status check. My resolution for 2010 is to make my annual net worth statement and plan my financial goals for the year. I will check my progress in July. I hope you will consider joining me in my resolution. I think this is one I can actually accomplish. And I know you can too.

Never made a net worth statement? Well here is a quick way to get started, visit the Plan Well, Retire Well website for a quick worksheet. At the website, login and then paste this url http://www.retirewell.uiuc.edu/PWRW/WrkSheets.aspx?WrkShtID=1 into your browser to go directly to the worksheet.

List all your financial assets and debts. Examine the statement carefully. Think about the following questions; compared with last year, have your assets grown and your debts decreased? Are you setting money aside for emergencies? Are you contributing to your retirement plan?

Use your net worth statement as a guide to set financial goals for the year. Questions I am considering; can I increase contributions to my retirement plan this year because I have finally paid off my student loan? Do I have enough set aside for emergencies? Will I be able to take a family vacation this year? Net worth statements and financial goals are different for each of us. Each of us has different resources and values; however, a net worth statement allows you to see the big picture of where you have been and where you are going. I like to think of it as a "reality check", because you can see the actual numbers and plan accordingly.

Remember working toward financial goals is a process. Case in point – it took me 10 years to pay off my student loans so that I now have extra money to invest; but now I don't miss the money so I am putting that towards retirement.

I will check in with you about your progress in July 2010. Make 2010 a year you keep your resolution!

Do you overshop? I came back from the Association for Financial Planning and Counseling Education's conference energized and excited about everything I learned. One of the best presentations was about stopping overshopping. Dr. April Lane Benson spoke about the difficulties people have with overshopping. With the holiday season upon us, now is good time for us all to think about what drives our shopping behaviors. Being conscious of how and why we shop can help us change our behavior.

In a recent Psychology Today blog, Dr. Benson suggests that people who are trying to change their shopping behavior carry a card with them and answer these six questions before any purchase:

1. Why am I here?
2. How do I feel?
3. Do I need this?
4. What if I wait?
5. How will I pay for it?
6. Where will I put it?

For some people, shopping is an addiction. More and more people are recognizing this, and professional help is available.

While I am not addicted to shopping, at the holidays I find it hard to not overspend. My personal action plan as a result of Dr. Benson's message is to:

1) Know how much I want to spend before I go shopping.

2) Happily enjoy spending this money without any guilt as it will be money I know I can afford to spend.

3) Avoid purchasing those "extras" for myself while I'm out shopping. This tends to be my downfall during the holidays!

What steps do you use to manage your holiday shopping? Send a comment by clicking on my name below.

The holiday season is upon us. Believe it or not, Thanksgiving is here and Christmas, Hanukkah, and Kwanzaa are right around the corner. This is usually the time that some of the most sensible people throw caution to the wind and charge it! Amidst all the joyous festivities, many unfortunately rack up a ton of debt. In case you didn't know, on average it takes about nine years to pay off a $1000 balance at 18% interest. That's 2018! Is the sweater really that cute?

Recently, I have received a lot of requests for credit management workshops. I normally talk about what a credit report is. I always jokingly say that a credit report is a "grown up report card." I usually get a lot of nodding heads and nervous laughs. I think most people know that it's true. We are judged based on our current and past credit history. I then ask why we need credit. Some of the responses I hear include: to buy a home, a car or get a job; all of these answers are correct. With the shortage of "good jobs", something like a blemish on your credit report could be the difference between getting the job and remaining unemployed.

Next, I normally talk about why everyone should check their report. I get a variety of answers. There are a number of reasons to check your credit report. The best reason I can think of is to make sure the information on the credit report is correct. Besides verifying accounts and balances on file, it is just as important to verify your name, date of birth, social security number, current and past addresses and employers. If any of this information is incorrect, it's probably a good idea to dig deeper and file a dispute, if necessary. I always suggest to workshop participants to get a free copy of their credit report from all three credit bureaus because there is always the possibility that the information is not the same. To obtain a free copy of your credit report, visit www.annualcreditreport.com.

Towards the end of the workshop, I usually talk about the components that make up the credit score such as payment history, amount owed, length of credit history, new credit, and types of credit. If you are holiday shopping and opening credit cards at every store you patronize to get the discount on your purchases, beware that it might cost you a dip in your credit score and inevitable a higher cost for borrowing money.

If you want to keep your spending under control during the holidays, consider establishing a holiday budget. The budget can include gifts, food, decorations and supplies, holiday cards, and other miscellaneous items. Lists will be an important part of creating your budget. Create a list for holiday gifts that include what you plan to purchase, the estimated cost and where you plan to purchase it, if possible. This will help you stay focused during your shopping trip. Your food list should include everything on your menu, including ingredients. Check your refrigerator and cabinets before your shopping trip so that ingredients are not purchased unnecessarily.

Finally, reflect on the year we have had. It's been a pretty rough time this year. We have worried about plummeting stock portfolios, foreclosures, and our healthcare coverage. Now, it's time for us to be thankful for the things that we have. If your 401(k) took a dive, be thankful you even had one; many employees don't. If your home went into foreclosure this year, be thankful you had somewhere else to go; someone ended up homeless. Finally, if your HMO or PPO wasn't the greatest, at least you had coverage; millions of Americans are without any coverage at all. During this holiday season, be thankful for the people and the things that are important to you. In the final analysis, that's what really matters. Have a wonderful Thanksgiving. Happy Holidays!!!

I've come across a couple of different articles this week about risk tolerance and risk capacity, after writing my blog post last week. (Maybe it's the same phenomenon as when you learn a new word that you think you've never heard before. But then you hear it 5 more times in the next week.)

The November issue of Money Magazine has an informative article, How Much Risk Can You Stand? by George Mannes. And through the end of November, they have arranged for readers to have free access to FinaMetrica's risk tolerance questionnaire, which the article says is one of better risk tools available.

One of the interesting points in the article is this: "Risk tolerance isn't about how much risk you ought to take when you invest; it's about how much you can take before you crack." Meaning, your risk tolerance (and the asset allocation that it would indicate) should provide an upper limit for the amount of risk (i.e., the amount of stocks) you could assume in your portfolio, rather than a target allocation.

The article also contends that a good risk tolerance assessment tool should limit itself to assessing your "appetite for risk" and not your risk capacity. I think it's important to assess both. But they are probably right that the two should be evaluated separately.

In an ideal world, your tolerance for risk, your capacity for risk, and the actual amount of risk in your portfolio should be in agreement. I have a target allocation for my household's investments; it is based largely on an assessment of our financial ability to withstand losses (risk capacity). I was curious whether it would also match up with my risk tolerance. So I took advantage of the free access to the FinaMetrica tool and got my risk tolerance score. While FinaMetrica does not provide advice about what an appropriate asset allocation would be for any given score, the Money Magazine article suggests a "comfortable ceiling in stocks" for various scores. I was very happy to see that my actual allocation was right in synch with the suggested stock allocation for my score.

But the thing I will take away is this: this number should probably be my maximum stock allocation, rather than my target. My husband and I stood firm with our investments over the past two years, other than doing some rebalancing which actually means we moved money from bonds funds into stock funds. So our risk tolerance was able to handle the craziness of the stock market during that time. But I need to keep a close eye on our allocation. If the stock market continues to make significant gains, we could quickly be over our upper limit for stocks and take on more risk than we want. If we scale back a bit on the stocks, we'll be less likely to exceed our level of risk tolerance before I get around to rebalancing again.