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Your money avoiding panic from roth conversion glitch


taxes due on your 2010 Roth conversion from the Internal Revenue Service? Don't worry, you are not alone - and you likely do not actually owe any extra cash. Thousands of these frightening notices went out this spring to taxpayers who converted tax-deferred retirement money from a traditional IRA to a Roth IRA, in which income taxes are paid upfront and not owed later. The problem stems from the complexities of the 2010 Roth conversion - in which for one special year only, taxpayers could choose to spread the taxes due over two years, rather than paying them all at once. Add to that a glitch between some of the tax software programs and the IRS. It adds up to a lot of taxpayers who converted their traditional IRAs to Roths in 2010 receiving IRS notices that they owed more taxes (and penalties). If you received one this spring, you do need to respond, but it is not a reason to panic."People freak out about anything they get from the IRS," says Bill Fleming, of PwC's private company services practice. He says he has received a number of these notices for clients. "The software providers and the IRS had a disconnect."

With a traditional IRA, you pay taxes when you withdraw money, but with a Roth you pay the tax when the money goes in and then do not owe income tax again. So if you converted a traditional IRA to a Roth - a move that had been restricted but was opened up to taxpayers at all income levels in 2010 - you had to pay taxes on the conversion. While most Americans have long since moved on from thinking about tax year 2010, the IRS is only now sorting its way through the massive volume of 2010 returns and trying to find discrepancies that resulted in taxpayers not paying what they owed. Its computer system tries to match documents in the more than 100 million individual tax returns to find errors, and when it discovers a discrepancy it sends a notice to the taxpayers."They are running a regular matching for 2010, and they don't know it's a Roth conversion. They are just looking for a distribution from a retirement account. For whatever reason, they are not picking up," PwC's Fleming says. "They are saying, 'Oh, there's a massive under-reporting of IRA distributions. There must be a problem.'"Details of any Roth conversion appear on Form 8606, rather than on the main 1040 return, making it more difficult to match the information, Fleming notes. A glitch in the e-filing systems of some of the large tax software firms meant some data about these Roth conversions never made it to the IRS.

CCH Inc, one of the large professional tax software firms, sent a note to clients about the issue, noting that some electronic returns were missing page 2 of Form 8606."CCH alerted the IRS to the issue and has been working with them on a resolution," according to the notice, which adds that the erroneous notices were halted in late April. Thomson Reuters Corp, the global information company, another provider of professional tax software, had a similar issue: Its GoSystem Tax product did not signify taxpayers' intent to defer the tax on the 2010 Roth conversions, as permitted for that year only, on returns filed electronically."When the IRS later ran validation checks, these e-files were flagged and the affected taxpayers were sent notices," said David Wilkins, a spokesman for the tax and accounting business of Thomson Reuters. "We resolved the issue. Also, the amount of tax owed by these taxpayers was not affected and they were not required to pay penalties."

It is unclear whether consumer tax software was also affected by glitches, or whether most people who did Roth conversions chose to seek out accountants - and thus relied on the professional software - for help. H&R Block Inc spokesman Gene King said that his firm had not seen or heard of the problem in its consumer tax software. A TurboTax spokeswoman did not respond to requests for comment. The IRS did not respond to a request for comment. TAXPAYER RESPONSE This all may sound technical, and it is, but for taxpayers receiving the notices about large phantom tax bills, it is also a big deal. On the Bogleheads.org online investing advice forum, posters have been freaking out about dunning notices that sometimes reached into the tens of thousands of dollars. If you are among the taxpayers who received one of these notices, and you did everything right on your Roth conversion, you shouldn't worry. However, you cannot just ignore the notice and hope it goes away. Instead, you will need to respond (or have your accountant do so) and mail Form 8606 to the IRS. Doing so "resolves the notice and closes the matter without further action or impact to the taxpayer," the CCH notice states. Of course, none of this means you avoid paying the regular taxes that you do owe in 2011 and 2012 on those Roth conversions done in 2010. If you converted a traditional IRA to a Roth in 2011, you also owed tax on that this year; and if you do a conversion this year, you will owe the tax on it next April. That all means that you will want to run the numbers closely - especially if you are paying quarterly estimated taxes - so that you are not surprised by the tax hit when it comes due.

Your money me and my money jack bogle


NEW YORK, Sept 11 For a guy who helped create the modern investment-management industry as the founder of Vanguard Group, John "Jack" Bogle has an interesting relationship with money: He hates to use it. Bogle doesn't care for the fancy things people often buy, and he sure doesn't like how it has corrupted the financial system. He thinks that everyone should save for the future, of course, but he can't stand to spend on himself. He is happiest when he is at the family getaway in the Adirondacks with his wife, six kids and 12 grandchildren. Or at the office, where he still works at the age of 83. Bogle's famously hard-working and thrifty outlook is present in his new book "The Clash of the Cultures: Investment vs. Speculation," a scathing indictment of an economy that serves to enrich Wall Street types at the expense of Main Street shareholders. Bogle's own net worth is somewhere in the low eight figures, he estimates. So what exactly does he do with it - and what advice does he have for the rest of us? We sat down with him to find out. Q: Can we assume you're all in Vanguard funds? A: One hundred percent. My personal, non-retirement accounts are about 80 percent bonds and 20 percent stocks, reflecting my old rule of thumb that your bond allocation should roughly equal your age. It's spread across different bond funds, like the Vanguard Intermediate-Term Tax-Exempt (VWITX). I'm a pretty conservative guy. My retirement accounts are more like a 50-50 split between stocks and bonds, because of a longer time horizon and because yields on bonds are extremely unattractive right now. The equity side is mostly in Total Stock Market Index (VTSMX), but I still have a little bit in the Wellington Fund (VWELX), which I've been investing in for many decades. I don't ever want to sever that relationship. Bonds in my retirement accounts are about 30 percent Treasuries and 70 percent investment-grade corporates, like the Vanguard Intermediate-Term Corporate Bond Index (VICBX). Q: How about investments in other areas of your life, like real estate? A: My wife and I downsized our home in Bryn Mawr, Pennsylvania, as we got older. About five years ago we moved into a place that's about a third smaller and with much less property. I didn't take out a mortgage for it because at this point I don't have to borrow money, and I don't like to. We also have what I call our "big old Adirondack barn," which is a place that's been in my wife's family for more than 50 years. It's for ourselves and our six children and our 12 grandchildren; it's a nice refuge for them. Q: Do you set a little aside for those grandkids in 529 college-savings plans? (Vanguard has about $40 billion in assets in 27 state 529 plans.) A: I don't really like the idea of tying up your money in 529 plans, because of all the restrictions on withdrawals. I'm not against them, I just like having more flexibility than being required to use those funds specifically for educational purposes. We do save a little money for all my grandkids every year, but we just chose the Vanguard Balanced Index Fund (VBINX). It's about 60 percent stocks, 40 percent bonds, and it's been wonderful. We give them what we can within annual gift-tax limitations, and put it all into that very tax-efficient fund. Q: Have you had any medical expenses in recent years, resulting from your health scares? A: Thankfully, we have terrific health coverage here at Vanguard, and I've definitely used it in my 83 years. Because of my heart transplant 16 years ago and use of anti-rejection drugs, they estimated about a 50 percent fatality rate. I've been lucky enough to be in the good half. Anyone who's been given an extra 16 years of life, there's no point in going around bitching about anything. Q: Where do you like to give back? A: I tend to give to those who have helped me along the road of life: Blair Academy, Princeton University, our church, and several hospitals that got me here in one piece. On the community side, I've always been a big supporter of the United Way. The best rule for philanthropy is to give until it hurts, as much as you can, because none of us can get through life all by ourselves. As John Dunne wrote, 'No man is an island, entire of itself.' Q: Do you have any extravagances? A: Every winter my wife and I take a week off and go to a resort in Florida. But I really can't stand spending money on myself. I don't like going into stores, I don't like the whole process of buying things. I have everything I could possibly need. I grew up in a certain way. My father's money vanished in the Great Depression, and he had trouble keeping a job. So they were tough times, and I started working when I was 10 years old, delivering papers and eventually becoming a waiter. I learned you work for what you get, and I feel sorry for people who haven't had that upbringing. Q: Any advice for people about where they should invest going forward? A: Stock returns basically come down to dividend yield plus earnings growth. If you have a dividend yield of 2 percent, plus earnings growth of 5 percent, I think a 7 percent annual gain is a rational expectation for stocks. I think it's unwise to get out of the stock market, or the bond market, even though the economy is uncertain. The market is often stupid, but you can't focus on that. Focus on the underlying value of dividends and earnings. Invest as efficiently as you can, using low-cost funds that can be bought and held for a lifetime. Don't go chasing past performance, but buy broad stock index and bond index funds, with your bond percentage roughly equaling your age. Most of all, you have to be disciplined and you have to save, even if you hate our current financial system. Because if you don't save, then you're guaranteed to end up with nothing.