Smart Money: Documented earnings needed for Roth IRA contributions

Bruce Williams is a national radio talk show host and syndicated columnist

Dear Bruce: I have two teen-age children who work: My daughter baby sits and my son mows lawns. I would like to get them started on a lifetime savings plan. I found an Internet site that showed how saving $2,000 from age 15 to 22 would produce $1 million at age 65 (at 7.5 percent interest).

I was thinking of starting IRAs for them now. I cannot contribute to an IRA myself, because my wife and I make too much money. Can I open IRAs in my children's names even though they are still dependents and only receive cash payments from the people they perform services for? I prefer a Roth IRA. Am I right? R.H., Salinas, Calif.

Dear R.H.: This is one of those situations where you can't have it both ways. The kids are earning money in cash, which puts them in the "underground economy." In order to open an IRA, one has to have documented earnings. In the case of the Roth IRA, they are "after tax" earnings. The likelihood is that the kids wouldn't owe any taxes if this money is declared, but they would be responsible for the self-employed Social Security "contribution." If their earnings are declared, up to $3,000 could be put into a Roth IRA because they earned the money. If that money were left to compound until they reach retirement age, it could easily exceed $1 million. Furthermore, under the current law, the proceeds would be totally tax free.

Dear Bruce: I have about $200,000 in cash and securities, a $200,000 home with an $80,000 mortgage and a business debt of about $200,000. I'm considering gold as an investment. What are your thoughts? F.B., via e-mail

Dear F.B.: One doesn't invest in metals, one speculates. Metals do not pay interest. They generally have to be stored in some secure place at some cost. Investing in rare coins is not an investment in gold, but rather in numismatic rarities. A rare $20 gold piece has a very modest amount of gold, but can be worth a great deal of money. Bullion is yet another story, but it should be assayed at the time of purchase.

In general, the holding of metals is not a worthwhile proposition. If you wish to invest in gold, consider stocks in gold producing or manufacturing firms. Coins are quite a different matter and provide their own share of risks.

Dear Bruce: What do you have to say about viaticals? C.C., Pahrump, Nev.

Dear C.C.: Viaticals certainly have their place in the investment spectrum. They are simply a method whereby someone, diagnosed with a terminal condition and expected to live a relatively short period of time, has access to the proceeds of their own life insurance, which, under ordinary circumstances, would not be available to them. Simply put, the investor in viaticals posts a percentage of the death benefit and then agrees to pay the premium on the life insurance until such time as the person dies. The individual or company posting the money then becomes the beneficiary. The investor is reimbursed for their monies from the policy upon death. The idea is sound and certainly benefits a number of people. The problem is that, like many enterprises, some rascals have invaded the viatical industry, and you must be extremely careful with whom you deal.

Dear Bruce: Can you please tell us how to handle this: We have $10,500 in credit-card debt. We bring home $2,700 a month. Should we continue to do as we have been doing, paying them off on a monthly basis, or should we get a home equity loan, which can we use on taxes? The only other debt that we have is the house, which is $53,000. R.K. via e-mail

Dear R.K.: Ordinarily, I have little enthusiasm for taking on mortgage debt to pay off credit cards. The reason that this distresses me is that it tends to stretch out the payments on a credit card over many years. If you have the discipline to pay this off quickly, the idea of the tax deductibility has some attraction. If you can retire the obligation in something on the order of 36 months, I have no problem. If you are tempted to make the payments over five or 10 years, I believe that this is short-term relief that is not in your best interest.

Dear Bruce: My father-in-law owns commercial property in New York. He wants to conduct a 1031 exchange for property in Colorado where my wife and I live. He then wants to deed the property over to my wife. Properly conducted, the 1031 should allow him to avoid capital gains tax for the exchange. What happens when he gives the property to my wife? Does this action result in gift tax? Is there a better way to conduct this transaction? M.C., Parker, Colo.

Dear M.C.: I suspect your father-in-law is trying to gift your wife property that is in her neighborhood where she can look after it. To that extent I would agree with that arrangement. However, if it's just for tax purposes, then why doesn't he just sell the property in New York and gift the money to your wife, which she can invest as she wishes?

Before you do anything, talk with a competent accountant who specializes in tax matters. At first glance, it seems that there will be a gift tax due by your father-in-law, unless he claims against his lifetime estate, which he has every right to do. No matter how it's sliced, it would seem to me that unless your father-in-law takes advantage of the lifetime exemption, there would be a taxable event when this happens.

Dear Bruce: My pension now is $63,000, but in 2006 at age 62, it will be $53,000, which won't inflate. Plus I have $17,500 in Social Security that should increase if the government sees fit. My wife and I also have a 401(k), IRAs and other assets that have shrunk to about $450,000. Hopefully we can reverse that trend. With this scenario, do we need long-term care insurance? L.M., via e-mail

Dear L.M.: In round numbers you will have, at a minimum, $70,000 in pension and Social Security. Your $450,000 investment should generate at least another $20,000 for a total of $90,000 a year. The one thing you haven't shared with me is how much of your pension, if any, will be available to your wife if you pass away. Even with no pension, her income should run somewhere in the area of $35,000. Perhaps a very small long-term care policy on her may be in order. If a reasonable portion of your pension continues until her death, I see no compelling reason for you to carry insurance, unless you are concerned about leaving a lot of money to an heir.

Dear Bruce: Recently, in response to a request for CD alternatives, you mentioned to look in local newspapers to find FDIC-insured savings that would give you about a 5 percent return or better. Where are these accounts? Do we have to lock in the CDs for three to five years to get more than 5 percent? S.A., via e-mail

Dear S.A.: Absolutely. The short-term CDs are going to be paying a far lower percentage. If you're willing to lock in for 60 months, there are FDIC-insured institutions across our country that are prepared to pay 5 percent, possibly even a fraction more. Ordinarily, in most financial sections of newspapers, the highest-paying CD-issuing institutions are published. You should have no trouble locating them. It doesn't matter if the bank is in your town or your state, as long as it is FDIC-insured.

Dear Bruce: I'm an 83-year-old widow; my husband passed away in 2000. We had our money in CDs. Their value now is $216,000, and I have them at one institution. I am told that they are only insured for $100,000. How can I be assured that my money is safe? M.L., Holton, Kan.

Dear M.L.: The reality is that most institutions are not going anywhere, and the possibility of them going down is relatively remote. For your peace of mind, you could open three accounts covering your $216,000 in three different institutions that are all FDIC-insured. However, if you went to branch A, B and C of the same bank, the $100,000 limit would apply. For the sake of simplicity, why not open one other account for about $100,000 or $110,000.