The Early Show

Your Money Matters

November 12, 2009 / 8:58 AM EST / CBS

In the series "Ask It Early," "Early Show" money maven Ray Martin answered questions submitted by viewers, and he provides the answers in this column.

Question from Dave in Kingston, N.Y.:

"I'll be switching jobs in the near future, and I would like to move my 401K over without losing any contributions. How can I go about doing that the best way?"

Ray's Answer:

You can move your 401K plan. Most new employers plans allow you to roll over your 401K from your old employer into your new employer's plan, you just got to get the instructions from your new employer's plan, find out where they need to receive the money, call up your old plan's record keeper and say, "I want to roll over to my new employer's 401K," fill out some forms and paperwork.

They wire the money or they'll send you a check payable to your 401K plan, which you then send in to your new employer's plan tax-free, and then you continue your contributions into your new employer's 401K, and you've already got a head start because you got your old balance in there.

Have a question for Ray? E-mail him!

Question from Ann, of Shokan, N.Y.:

Ann and her husband received a large tax refund (over $5,000) and want to use it as an emergency fund, but still invest it wisely. They want it to be liquid, but still pay a decent return.

Ray's answer:

Let's assume for the sake of this question that you have been a good doobie and already have these bases covered:

1) A EMERGENCY FUND of cash in bank accounts equal to at least six months living expenses, and
2) NO CREDIT CARD OR OTHER HIGH INTEREST RATE DEBT and
3) MAXIMIZING MATCH AND CONTRIBUTIONS TO RETIREMENT PLANS.

So what to do with an extra $5,000? I'd suggest opening and funding a ROTH IRA. Here's why:

1) TAX AND PENALTY FREE WITHDRAWALS:

Distributions of Roth IRA assets from your contributions and from nontaxable conversions of Traditional IRA can be taken at anytime, tax and penalty free - that is, if the distribution is in line with the rules that exempt assets from income tax and early-distribution penalties. So your contributions can be withdrawn tax and penalty free, but you'll just have to leave your earnings in the account.

2) INVESTMENT FLEXIBILITY:

When you open a brokerage account titled as a Roth IRA, you can invest in virtually any listed stock, bond, mutual fund and even CDs issued by FDIC insured banks. Choose an investment that meets your objectives for safety, risk, growth and time frame.

3) ROTH IRA TAX BENEFITS:

If you open a Roth IRA and invest in a few funds, etc., and you do not need to use the money until after retirement all of your withdrawals after age 65 - contributions and earnings -- are tax free. Better yet, you are NOT required to take any minimum distributions from your Roth IRA after age 70.5, so you can leave the account to grow for a very long time.

The annual amount you can contribute to a Roth IRA in 2009 is $5,000 and $6,000 for anyone who is 50 or older.

Who is eligible to open a Roth IRA?

The eligibility rules are pretty simple -- anyone can contribute to a Roth IRA, regardless of age. All you need to be eligible for a Roth IRA contribution is some amount of taxable compensation. Compensation includes salaries, wages, tips, bonuses, fees, and any other amount you've received for providing a service to others.

The annual amount you can contribute to a Roth IRA in 2009 is $5,000 and $6,000 for anyone who is 50 or older.

To be eligible to make a Roth IRA contribution in a given calendar year, there is a income limit. If your adjusted gross income exceeds these limits, then you are no longer eligible to contribute to a Roth IRA.

In 2009, the adjusted gross income limits are:

Single filers, Head of Household or Married Filing Separately (and you did not live with your spouse during the year) with modified adjusted gross income up to $105,000 can make a full contribution. Contributions are phased out starting at $105,000 and you cannot make a contribution if your adjusted gross income is in excess of $120,000.

Joint filers with modified adjusted gross income up to $166,000 can make a full contribution. Once again, this contribution is phased out starting at $166,000 and you cannot make a contribution if your adjusted gross income is in excess of $176,000.

If your tax filing status is Married Filing Separately (and you live with your spouse) you cannot make a Roth IRA contribution if your AGI is in excess of $10,000.

Question from Julie, of New York, N.Y.:

My sister and I are giving money to my mom to help her pay for her assisted living facility costs. What's the best way to do this for tax purposes?"

Ray's answer:

You are part of a growing generation of adults -- nearly a quarter of the adult population -- who provide care for older or sick family members and friends. These numbers are likely to grow as the population ages and more people live longer.

The best way to provide financial assistance to your mom is to have your sister give you her contributions and to have you PAY THE MONEY DIRECTLY TO THE ALF/NURSING HOME/CARE PROVIDER. When you do this you qualify for three tax savings opportunities:

1) DIRECT PAYMENTS TO MEDICAL CARE PROVIDER ARE TAX FREE

When you pay money directly to a qualified medical care provider, which includes assisted living facilities, all amounts you pay are exempt from gift taxes and are not taxable as income to your mom.

2) GAIN ADDITIONAL ITEMIZED DEDUCTIONS FOR YOU

The costs YOU PAY for your and others qualified medical expenses may be deductible as an itemized deduction on your tax return…while only the amounts paid that exceed 7.5 percent of your adjusted gross income will be deductible, given the considerable amount of the costs involved in your situation and the fact that you income in retirement is lower, you could get a very nice tax deduction here.

3)CLAIM PARENT AS A DEPENDENT ON YOUR TAX RETURN

In some cases, adult children may also benefit from the tax deduction if their parent qualifies as their dependent. To qualify, you will need to provide at least 50 percent of the parent's financial support, including the assisted living monthly service fee. Also the older parents/dependents income cannot exceed the $3,650 exemption amount.

Here are the details covering how this works:

Direct payments to medical care providers exempt for gift and income taxes:
Under Section 2503(e) of the Internal Revenue Code (the "Code"), tuition payments made directly to an educational organization on behalf of a person, and payments for a person's medical care made directly to the provider are not treated as taxable gifts. This can be an important exclusion for planning purposes. For example, grandparents who already take full advantage of the annual exclusion for gifts to grandchildren can make additional tax-free transfers by paying their grandchildren's tuition for private school or college. Alternatively, adult children who pay for the medical care expenses for their parents can do so without incurring any gift or income taxes.

Tax Exempt Payment of Qualified Medical Expenses:

Qualifying medical expenses are defined by reference to Code Section 213(d). See IRC § 2503(e)(2)(B).

The exclusion applies to payments for (i) the diagnosis, cure, mitigation, treatment or prevention of disease, (ii) the purpose of affecting any structure or function of the body, or (iii) transportation primary for and essential to medical care. Treas. Reg. § 25.2503-6(b)(3). Payments for medical insurance are covered. The Section 213(d) definition of medical care is extremely broad. It also covers long-term care services, such as the costs of nursing homes or assisted living facilities, if provided by a licensed health care provider. The most notable area it does not cover is cosmetic surgery, unless to correct a birth defect or disfigurement from injury or disease. See IRC § 213(d)(9)(A).

Payments must be made directly to the health care provider.

In some cases, adult children may also benefit from the tax deduction if their parent qualifies as their dependent. That means that the adult children are providing at least 50 percent of the parent's financial support, including the assisted living monthly service fee. Check with your accountant and IRS Publication 502 for other specific qualifying details.

Itemized Deductions for Costs of Qualified Medical Expenses:
The IRS Publication 502 also advises the taxpayer how the medical tax deduction works:

"You can deduct only the amount of medical and dental expenses that you pay that is more than 7.5 percent of your adjusted gross income (Form 1040, line 37). In this publication, the term "7.5 percent limit" is used to refer to 7.5 percent of your adjusted gross income. The phrase "subject to the 7.5 percent limit" is also used. This phrase means that you must subtract 7.5 percent (.075) of your adjusted gross income from your medical expenses to figure your medical expense deduction." Many income-qualified seniors are already at or near that 7.5 percent threshold deduction level due to their current medical expense deductions (prescription drugs, medical co-payments, etc.).

Claiming a Parent as a Dependent:

Also the older parents/dependents income cannot exceed the $3,650 exemption amount. You must be able to prove that you are financially responsible for at least 50 percent of your parents' expenses, including lodging, utilities, food, clothing and medical costs over and above what Medicare and supplemental Medigap insurance covers.

Meeting this dependent test is a condition for claiming any tax relief for helping your parents. Their gross income may exclude all or most of their Social Security, plus tax-free income from municipal bonds.

When adding your costs, check your parents' medical bills, including premiums for Medigap and long-term care insurance, too. Their bills could push your qualified medical costs over the threshold for deducting medical expenses, which must exceed 7.5 percent of your adjusted gross income. To benefit from these deductions, your itemized deductions will need to total to an amount that is greater than the pre-set standard deduction, which is $5,700 for singles, $11,400 for couples and $8,350 for household heads for 2009, otherwise, if the standard deduction is higher, you'll just claim that amount.

Finally, when several adult children are each contributing financially towards a parents medical and living costs, it may make sense tax wise to alternate who will be collecting all siblings contributions and paying the parents costs -- doing so will allow each adult child to enjoy the tax benefits of doing this in the year they are making the payments.

For more information, visit the IRS Web site.