Roth vs. Traditional for me
by Pondo33 » Sun Jun 16, 2013 10:17 pm
I am trying to figure out whether I should contribute to a Roth or Traditional IRA.
I know the rule of thumb is that if you're in a high tax bracket today than you expect to be in the future, you should consider a traditional ira because at some point in the future you will be taxed at a lower rate and you can take the tax deduction now. This is my situation: I expect to be in a lower tax bracket in the future. However, I question whether I should be in a traditional ira now. The reason I doubt this is that while it's true that I will likely be taxed at a lower rate in the future, I feel I can absorb the tax easier now- I would feel it less today than even a lower tax rate later if I am earning less.
Also, isn't it true that the tax deduction is not available if one's taxable income is above a certain amount per year for a couple? If so, and I can't take the tax deduction that normally comes with a traditional ira, then the Roth makes even more sense.
Both of these ideas lead me to the conclusion that I should contribute to a traditional then convert to a Roth right away. Is my thinking correct? Does it make sense?
I know the rule of thumb is that if you're in a high tax bracket today than you expect to be in the future, you should consider a traditional ira because at some point in the future you will be taxed at a lower rate and you can take the tax deduction now. This is my situation: I expect to be in a lower tax bracket in the future. However, I question whether I should be in a traditional ira now. The reason I doubt this is that while it's true that I will likely be taxed at a lower rate in the future, I feel I can absorb the tax easier now- I would feel it less today than even a lower tax rate later if I am earning less.
Also, isn't it true that the tax deduction is not available if one's taxable income is above a certain amount per year for a couple? If so, and I can't take the tax deduction that normally comes with a traditional ira, then the Roth makes even more sense.
Both of these ideas lead me to the conclusion that I should contribute to a traditional then convert to a Roth right away. Is my thinking correct? Does it make sense?
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Re: Roth vs. Traditional for me
by livesoft » Sun Jun 16, 2013 10:22 pm
You haven't given much to go on. Age? Other opportunities? Years to retirement? Other investments? Maybe they all don't matter though.
I don't see why you cannot do traditional plus put the taxes you would pay if you did a Roth into an investment account.
I don't understand the difference between (a) contribute to Roth now versus (b) contribute to traditional then convert to Roth right away.
I don't see why you cannot do traditional plus put the taxes you would pay if you did a Roth into an investment account.
I don't understand the difference between (a) contribute to Roth now versus (b) contribute to traditional then convert to Roth right away.
This information has been prepared without taking into account the Sequestration, investment objectives, financial situation and particular needs of any particular person or company.
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Re: Roth vs. Traditional for me
by Pondo33 » Sun Jun 16, 2013 10:43 pmlivesoft wrote:You haven't given much to go on. Age? Other opportunities? Years to retirement? Other investments? Maybe they all don't matter though.
I don't see why you cannot do traditional plus put the taxes you would pay if you did a Roth into an investment account.
I don't understand the difference between (a) contribute to Roth now versus (b) contribute to traditional then convert to Roth right away.
Two things:
First, let me fill in some blanks. I did not originally include it because I didn't know it was necessary to address the question. I am forty years old and married. My wife is 36 years old. We file jointly, have no kids, our marginal tax rate is 28% and our state tax is 5%. Combined we earn about $250k per year. We have a $50k emergency fund and about $10K in a separate cash account. We maintain our checking account at $4k. We own a house worth about $180k. We own 2 cars with no payments. I own an airplane worth about $40k. We have $155k in a traditional ira and $15K in a roth, both of which were rolled over from a 401K at my wife's last job. She just started a new job with a 401K available and she will contribute at the maximum rate. I just made a $5,500 contribution to a traditional ira. We are ready to make my wife's annual contribution. We have no debt at all.
Secondly, as to your last point: I believe the difference between contributing to a roth now versus contributing to a traditional then converting to a roth is that because of our income, we cannot contribute direclty to a roth. Am I right about that?
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Re: Roth vs. Traditional for me
by grabiner » Sun Jun 16, 2013 10:58 pmPondo33 wrote:I know the rule of thumb is that if you're in a high tax bracket today than you expect to be in the future, you should consider a traditional ira because at some point in the future you will be taxed at a lower rate and you can take the tax deduction now. This is my situation: I expect to be in a lower tax bracket in the future. However, I question whether I should be in a traditional ira now. The reason I doubt this is that while it's true that I will likely be taxed at a lower rate in the future, I feel I can absorb the tax easier now- I would feel it less today than even a lower tax rate later if I am earning less.
It makes more sense to compare the out-of-pocket investment. If you are in the 25% tax bracket, you can put $5500 in a Roth, or $5500 in a Traditional IRA and then invest the $1375 tax savings in a taxable account. Even given the tax loss from investing the $1375, you'll come out ahead if you retire in a 15% bracket.
Also, isn't it true that the tax deduction is not available if one's taxable income is above a certain amount per year for a couple? If so, and I can't take the tax deduction that normally comes with a traditional ira, then the Roth makes even more sense.
A Roth is always better than a non-deductible IRA, since both are taxed when you make the contribution, and Roth withdrawals are exempt from tax if you follow the rules.
If you are covered by an employer retirement plan, you can't deduct your traditional IRA if you are over the income limit. If you are not covered by an employer plan but your spouse is, then you have a much higher limit for deductibility. If neither of you is covered by an employer plan, then you can always contribute to deductible IRAs, regardless of your income.
Combined we earn about $250k per year. She just started a new job with a 401K available and she will contribute at the maximum rate. I just made a $5,500 contribution to a traditional ira. We are ready to make my wife's annual contribution. We have no debt at all.
The phase-out of deductible IRA contributions if your spouse is covered is $188K-198K, and I don't think you can get your $250K salary down to that range. Thus neither you nor your wife is eligible to contribute to a Roth IRA, and any Traditional IRA contribution either of you make will be non-deductible.
We have $155k in a traditional ira and $15K in a roth, both of which were rolled over from a 401K at my wife's last job
If that is your wife's Traditional IRA, then you can convert your Traditional IRA to a Roth IRA without a problem (this is known as a backdoor Roth IRA). However, your wife cannot use the backdoor Roth IRA, because conversions are prorated across all IRAs; if she contributes $5500, then 155,000/160,500 of any conversion will be taxed. If her new 401(k) accepts transfers from IRAs, she can transfer her existing IRA into the 401(k) to open the backdoor; I would only recommend this if the new 401(k) has very good options.
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Re: Roth vs. Traditional for me
by livesoft » Sun Jun 16, 2013 11:02 pm
So are you saying you have no 401(k), no 403(b), no self-employed retirement plan for yourself?
If your spouse contributes $5,500 to a traditional IRA, then converts $5,500 to a Roth IRA, then the taxes will be based on a $5,500/$160,500 conversion, so the taxes will be rather high. This is not quite the same as a back-door Roth where one might pay little to no additional income tax on the conversion.
I personally would not make anymore non-deductible traditional IRA contributions, but would instead put the money in a taxable account invested tax-efficiently. I now regret having made non-deductible traditional IRA contributions in the past.
If your spouse contributes $5,500 to a traditional IRA, then converts $5,500 to a Roth IRA, then the taxes will be based on a $5,500/$160,500 conversion, so the taxes will be rather high. This is not quite the same as a back-door Roth where one might pay little to no additional income tax on the conversion.
I personally would not make anymore non-deductible traditional IRA contributions, but would instead put the money in a taxable account invested tax-efficiently. I now regret having made non-deductible traditional IRA contributions in the past.
This information has been prepared without taking into account the Sequestration, investment objectives, financial situation and particular needs of any particular person or company.
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Re: Roth vs. Traditional for me
by damjam » Sun Jun 16, 2013 11:13 pm
If your income is too high to make a direct Roth contribution then generally it is also too high to make a deductibletraditional IRA contribution.
Roth IRA Income limits, Income limits for IRA deductability when you have a Retirement Plan at Work, Income limits for IRA Deductability when you do NOT have a Retirement Plan at Work.
You can still make a non-deductible traditional IRA contribution and then immediately convert to a Roth IRA. This is commonly referred to as a Backdoor Roth IRA.
However, in your wife's case that will be complicated by the fact that she has a traditional IRA already. The IRS considers all of a person's IRAs to be one big IRA, no matter how many accounts there are or how many institutions they are spread across. So when she converts part of her traditional IRA to Roth she will have to pay tax on the pro rata portion of the conversion that is taxable. If you don't have a traditional IRA you will be able to do the backdoor Roth easily.
Your wife may be able to rollover her traditional IRA into her new 401k plan. That will clear the way for her to do backdoor Roth conversions.
Roth IRA Income limits, Income limits for IRA deductability when you have a Retirement Plan at Work, Income limits for IRA Deductability when you do NOT have a Retirement Plan at Work.
You can still make a non-deductible traditional IRA contribution and then immediately convert to a Roth IRA. This is commonly referred to as a Backdoor Roth IRA.
However, in your wife's case that will be complicated by the fact that she has a traditional IRA already. The IRS considers all of a person's IRAs to be one big IRA, no matter how many accounts there are or how many institutions they are spread across. So when she converts part of her traditional IRA to Roth she will have to pay tax on the pro rata portion of the conversion that is taxable. If you don't have a traditional IRA you will be able to do the backdoor Roth easily.
Your wife may be able to rollover her traditional IRA into her new 401k plan. That will clear the way for her to do backdoor Roth conversions.
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