Ask Julie

“Julie knows just about everything when it comes to personal finance – I have yet to see her get stumped.” – Cheryl D.


There are so many choices and so much information available on how to spend, save, and invest your money it can be hard to wade through all you see. If you have questions, please send me a note. I’ll reply to you directly, and post your questions and the answers here for others to see, unless, of course, you’d prefer I didn’t.

Here are a few questions I’ve received recently.

Question:  “I’ve maxed out my 401(k). Now what? I don’t meet the income requirements for a Roth IRA.”

Answer: Even if your company offers a 401(k), or other retirement savings option, you can still save in a traditional IRA. Current contribution limits are $5,500 for those under the age of fifty, and $6,500 for those fifty and over. Your contributions are after tax, but your earnings grow tax free until withdrawn. Your after tax contributions are not taxable at the time of withdrawal, but your earnings are.

That isn’t quite as good a deal as you get with a Roth IRA. There all your earnings are also tax free if you wait to withdraw them until after you turn 59 1/2.

There is a way to save in a Roth IRA, even if your income is above the Roth limit. You can contribute to a traditional IRA and immediately convert your contribution to a Roth IRA. Since there are no earnings on the traditional IRA, the conversion is tax free.

However, be careful. If you already have traditional IRA savings, due to previous 401(k) rollovers or your past contributions, this “back-door” Roth contribution probably won’t work for you. That is because, the IRS lumps all your traditional IRA holdings together, and will tax your current contribution according to the proportion of the balance that hasn’t already been taxed. This article explains the issue.

Congratulations on your savings, and remember, any savings are good savings, even if you have to pay a little tax in the future.

Question: “I’m transferring my IRA to a new financial institution, and they are asking me whether I have an option contract at my current institution. How do I know?

Answer: An option contract is a contract that allows you to purchase a company’s stock in the future for a given price, called the exercise price. In order to use this investment strategy, your financial institution will set up an account that allows you to do that. Ordinary accounts are not allowed to invest in option contracts.

You have to fill out forms and jump through some hoops to have an option contract, so if you don’t remember doing that, you almost certainly do not have any.

Question: “My company has given me a choice between receiving restricted stock units (RSU) or company stock options. Which should I take.”

Answer: Here are the pros and cons of each:

RSUs:

  • The primary advantage of RSUs is you have something that very likely will have some value in the future.
  • The tax treatment of RSUs is also simpler that with options. The award of RSUs is taxed as income in the year in which you receive them. In the future, when you sell your shares, you will incur capital gains tax if they are worth more than when they were awarded.
  • On the negative side, you are taxed on your award as income in the current year, which could boost you up into a higher tax bracket.
  • If you leave the company before they vest, your award will have no value.

Options:

  • With options, there are no immediate tax consequences to the award. You will be taxed when you exercise them.
  • The tax treatment is more complex. When you do exercise your options, the number of shares times the exercise price will be taxed as income, and the difference between the market value at the time and the exercise price will be taxed as a capital gain. There will be no losses, since you wouldn’t exercise the options if the stock value was less than the exercise price.
  • With options, there is a chance your award will be worthless. If the stock value remains below the exercise price between the time the options are vested and the expiration date, your award will have no value.
  • If you leave the company before the options are vested, your award will have no value. You may also be required to exercise any options that have vested within a short amount of time after leaving the company.

Usually, companies set up these awards so that RSUs and options are equally attractive at the time of the award. The main difference that could make one more attractive than the other is if they have different vesting schedules. Earlier vesting is better.

Congratulations on your award!

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Photo by Heidi Sandstrom on Unsplash
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