Author Topic: How much to open a Traditional IRA?  (Read 2089 times)

nessa

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How much to open a Traditional IRA?
« on: October 30, 2020, 10:11:09 AM »
Hey gang! I've been passively reading here since February, and actively participating in my MMM life and these forums (mostly focused on paying off my student loans in the Gauntlet thread). I've gone from huge debt and about $800 ER/savings to student loans only and $11,500 ER/savings to date.

I've been considering how much cash I need to have "on hand" for emergencies - including my line of overdraft protection and credit card lines of credit. I live well within my means (less than half my salary each month - the 'excess' goes to pay off the student loan and to buy myself some stuff to level up [I'm losing weight, need some interim clothes - stuff like that]), contribute to my 401k at work, and healthily save 500-700 each month.

I've decided I don't need such a huge 'cash cushion' as i can pull from a lot of areas to cover an emergency; so I'd like to open up a Traditional IRA with Vanguard. Minimum to open is 1k, and I know the max contribution for the year is 6k. I am very comfortable with having my money start "making me money" and not touching it.
 
Mustachian input: things to consider when deciding how much to put in the IRA account?

cool7hand

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Re: How much to open a Traditional IRA?
« Reply #1 on: October 30, 2020, 10:23:19 AM »
Welcome!

You should save as much as your budget allows. Here is a solid post on investment order: https://forum.mrmoneymustache.com/investor-alley/investment-order/. While many follow what this post advocates, there is no one right way to FIRE. If paying off low-interest debt is meaningful to you, maybe that's right for you.

secondcor521

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Re: How much to open a Traditional IRA?
« Reply #2 on: October 30, 2020, 11:58:25 AM »
Not the question you asked, but you probably want to evaluate if a traditional IRA or Roth IRA is better for you.  This is alluded to in the notes on the Investment Order thread that cool7hand pointed you to.

I have three young adults and they are all very lightly taxed because their incomes are low.  I've encouraged them to contribute to Roth IRAs, because avoiding 0% or 10% or even 12% taxation now with a traditional IRA is not that valuable, but avoiding 22% later is quite valuable.

If you have a medium to high income, also note that there are phase out ranges where the deductibility of a traditional IRA contribution may be limited or eliminated, and the ability to contribute to a Roth IRA may be restricted.  If this scenario applies to you then start looking at a backdoor Roth contribution.

Runrooster

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Re: How much to open a Traditional IRA?
« Reply #3 on: October 30, 2020, 06:20:03 PM »
How much is your annual spending? Or to put it another way, how many months is your Emergency Fund?
How much are you contributing to your 401k? Are you getting the full match? Is it a Traditional or Roth? Can you contribute more?
How old are you?  Do you have any long term goals like education, wedding, children, home?

My gut instinct is that 12k is a nice EF or beginning of a down payment. As we’ve seen during Covid, six months cash is good to have. 30 years is a long time to give up access to money.

draco44

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Re: How much to open a Traditional IRA?
« Reply #4 on: October 31, 2020, 07:51:37 PM »
Ideally you should put the maximum amount of money into your IRA or Roth IRA allowed every year. But remember you don't have to fill in up for the year in a single deposit. The opening deposit of $1000 is unavoidable if that's the rule for company and fund you want to invest in (and like many folks here, I am a huge Vanguard fan, so good choice). But after that you can deposit as you feel comfortable, with of course an eye to reaching whatever your annual goal is by the end of the year.  Maybe one month you add $200, maybe the next you deposit $800. Or set an auto-deposit that adds up to your annual goal.

Eventually you'll hopefully get to the point where you are financially stable enough to either fill the account entirely on Jan. 1, or set a weekly or monthly auto-deposit for (max $allowed that year/units of time in the year) without batting an eye, depending on your preference. But it sounds like you aren't there yet.

Starting out, I think the biggest hurdle is opening the account in the first place. Do that, then let your money sit for a few weeks without obsessively checking your account balance every day. See how you are feeling after those weeks, then decide what's a reasonable annual investment goal for you and figure out what you need to do each week/month to make that happen. Remember that by investing even $1 and having an investment account, you are doing better than last year.

nessa

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Re: How much to open a Traditional IRA?
« Reply #5 on: November 02, 2020, 07:08:05 AM »
Guys, thanks!

To answer the questions posted: 48/f/single (divorced); already have my education, own my home, car is paid off, not planning on EVER getting re-married (once was enough) or having kids. Annually I pull in $58k from my (stable) career, not planning on changing that until I FI"RE", RE being Recreational Employment starting in 2028 (my planned date, TBA).

My current cushion covers 8 months of living expenses; again I'm fairly stable for the first time in my life so I am very comfortable locking away some of this cushion. I am contributing to my 401k to get the company match (6% gives me 3% match) and I'll be fully vested in 2024; its in a Vanguard Targeted account right now but that's changing as my company is moving to Fidelity next year. When I leave my job I'll be rolling it over into a Roth IRA (I think I can do that?)

My understanding of IRAs is that Traditional is the best choice based on my earning/tax bracket, since I'll pay less taxes when I withdraw the money? over a Roth. But like I said I'm new, and just starting to figure this all out.

@cool7hand: I've been making notes this year as I've been reading and digesting FI info; I have a list of how to funnel my money, turns out it is the link you posted! So my plan has been debt/emergency > 401k > IRA > (max 401k). I'm also healthily saving for some short and medium term purchasing goals, and aggressively paying off my remaining student loans because that will feel better to me once I am "free and clear" of that obligation.

Any other input is welcome! Thank you all so much!

secondcor521

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Re: How much to open a Traditional IRA?
« Reply #6 on: November 02, 2020, 11:19:16 AM »
[1] I am contributing to my 401k to get the company match (6% gives me 3% match) and I'll be fully vested in 2024; its in a Vanguard Targeted account right now but that's changing as my company is moving to Fidelity next year. When I leave my job I'll be rolling it over into a Roth IRA (I think I can do that?)

[2] My understanding of IRAs is that Traditional is the best choice based on my earning/tax bracket, since I'll pay less taxes when I withdraw the money? over a Roth. But like I said I'm new, and just starting to figure this all out.

[3] I'm also healthily saving for some short and medium term purchasing goals, and aggressively paying off my remaining student loans because that will feel better to me once I am "free and clear" of that obligation.

Any other input is welcome! Thank you all so much!

Clipped some text and added numbers for reference.

1.  Is your 401(k) a Roth 401(k)?  If so, you'll be able to roll it over to a Roth IRA - your contributions and earnings anyway.  Your employer match will go into a traditional 401(k); if you roll that portion over to a Roth IRA *or* if you've been contributing to a traditional 401(k), then you'd owe ordinary income taxes on any amounts rolled over to a Roth IRA in the year of the rollover, which is something you'd probably want to think carefully about especially if it happens in a high income year (say, your last year of working for example).

2.  You could read up on the Investment Order thread, especially MDM's post (here:  https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153).  Depending on whether your $58K is gross or take home, and whether your 401(k) is traditional or Roth, and other aspects of your tax situation, you're somewhere near the border between the 12% and 22% tax brackets.  At 12%, I'd do a Roth; at 22% I'd do a traditional (but see MDM's post for even more detailed suggestions).  If you wanted to get fancy (probably not yet), you could do a traditional IRA contribution for whatever portion of your income was in the 22% bracket, and Roth IRA the rest.

3.  If your student loan interest rates are high (>5%), I'd agree with you.  If they're low, then paying the minimum and doing something else with the excess might be better (as long as the psychological aspects aren't too much).  Again, see the Investment Order thread for details.

draco44

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Re: How much to open a Traditional IRA?
« Reply #7 on: November 02, 2020, 03:45:29 PM »
My understanding of IRAs is that Traditional is the best choice based on my earning/tax bracket, since I'll pay less taxes when I withdraw the money? over a Roth. But like I said I'm new, and just starting to figure this all out.

Maybe this is something you already know, but in case not, with a Roth IRA, you don't pay taxes on withdrawals because you invest in a Roth IRA with post-tax dollars. With a traditional IRA, you invest pre-tax dollars, and they get taxed when you withdraw. So it's not so much more or less taxes later, but whether you think you will be in a higher tax bracket later vs. now.

Here's part of the Vanguard website on Roth vs. traditional IRAs (https://investor.vanguard.com/ira/roth-vs-traditional-ira)
Will I pay taxes on withdrawals?
Roth: You'll never pay taxes on withdrawals of your Roth IRA contributions. And you won't pay taxes on withdrawals of your earnings as long as you take them after you've reached age 59˝ and you've met the 5-year-holding-period requirement.
Traditional: You'll pay ordinary income tax on withdrawals of all traditional IRA earnings and on any contributions you originally deducted on your taxes.

Is there a penalty for withdrawals taken before age 59˝?
Roth: There are no penalties on withdrawals of Roth IRA contributions. But there's a 10% federal penalty tax on withdrawals of earnings.
Traditional: With a traditional IRA, there's a 10% federal penalty tax on withdrawals of both contributions and earnings.

Runrooster

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Re: How much to open a Traditional IRA?
« Reply #8 on: November 03, 2020, 09:34:15 AM »
If by "own my home" you mean it is paid off, then that's a significant cushion right there. If not, I'd keep the 8 month EF, perhaps some of it in the stock market, but not tied up in a retirement fund.
Emergencies are real, and you can't pay your mortgage on your credit card.  No one is prepared to get laid off, and if you've never been stable before, it's still possible.  You should be able to float for up to two years which looking for a new job, bad economies happen, including credit cards, cash, unemployment.  It's not 6 months for all sources of money, 6 months in cash.  IMO.

nessa

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Re: How much to open a Traditional IRA?
« Reply #9 on: November 13, 2020, 09:53:44 AM »
I am learning so much. First off, thank you ALL for your responses. I really appreciate you taking the time to answer my questions and help me out!

Again in no particular order:

* My 401k is a Roth 401k (I don't know if I will have a roth when they switch to fidelity next year) So that means its a tax-advantaged account, and I can roll it into a RothIRA when I leave this job?

* 58k is my gross salary; I net around $3180 per month, my current spend rate is right around $1500 per month. I own my home free & clear, no mortgage, just my property taxes and homeowner's insurance (I'm paid bi-weekly so I get two "extra" paychecks a year and those go directly into a high-interest savings account online to pay taxes & insurance)

* I am absolutely set on wiping out my student debt next year, the psychological benefit will be worth it (I have a 3.125% interest rate so I know I can choose to pay it off slowly/per their timeline if I change my mind).

* I love the idea of six months cash-on-hand before I touch the credit-ways I can float an emergency (overdraft, credit card). At my current level that's $9k; which TODAY means I have $2k I can push somewhere to earn while I'm in my accumulation phase.

And now, MOAR questions: I theoretically understand "tax brackets" but have no idea what that means in relation to my income etc. I am assuming I will be below 12% when I start to draw from these accounts, so I think I would pay less tax when I'm 60 on a Traditional IRA withdrawal than the tax on the contributions to a Roth now? Does that make sense? I need to figure this out.

Any more input is greatly appreciated, researched, and considered!

secondcor521

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Re: How much to open a Traditional IRA?
« Reply #10 on: November 13, 2020, 10:56:40 AM »
I am learning so much. First off, thank you ALL for your responses. I really appreciate you taking the time to answer my questions and help me out!

Again in no particular order:

* My 401k is a Roth 401k (I don't know if I will have a roth when they switch to fidelity next year) So that means its a tax-advantaged account, and I can roll it into a RothIRA when I leave this job? [1]

* 58k is my gross salary; I net around $3180 per month, my current spend rate is right around $1500 per month. I own my home free & clear, no mortgage, just my property taxes and homeowner's insurance (I'm paid bi-weekly so I get two "extra" paychecks a year and those go directly into a high-interest savings account online to pay taxes & insurance)

* I am absolutely set on wiping out my student debt next year, the psychological benefit will be worth it (I have a 3.125% interest rate so I know I can choose to pay it off slowly/per their timeline if I change my mind).

* I love the idea of six months cash-on-hand before I touch the credit-ways I can float an emergency (overdraft, credit card). At my current level that's $9k; which TODAY means I have $2k I can push somewhere to earn while I'm in my accumulation phase.

And now, MOAR questions: I theoretically understand "tax brackets" but have no idea what that means in relation to my income etc. I am assuming I will be below 12% when I start to draw from these accounts, so I think I would pay less tax when I'm 60 on a Traditional IRA withdrawal than the tax on the contributions to a Roth now? [2] Does that make sense? I need to figure this out.

Any more input is greatly appreciated, researched, and considered!

[Numbers added for reference]

[1]  Yes.

[2]  You want to pay the taxes when they're the lowest.  If your tax rate will be lower in retirement, then you want to pay taxes then, not now.  So to the extent you're in the 22% bracket now and 12% bracket later, that would imply a traditional IRA, because it lets you avoid 22% now and pay 12% later.

To figure out what your tax bracket is, you'd need to find out what your regular income is (easiest is probably box 1 of your W-2 from last year) plus any capital gains or qualified dividends that you know about, then plug those two pieces of data in here:  https://engaging-data.com/tax-brackets/

[The previous paragraph isn't 100% exactly correct, but it's mostly right and is a simplified version of the truth that will probably get you pretty close.  When you know enough to know what's wrong about it, you'll know enough to figure out your tax bracket :) ]

nessa

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Re: How much to open a Traditional IRA?
« Reply #11 on: November 16, 2020, 07:50:38 AM »
@secondcor521 thanks for the link! I ran my number (I have no capital gains so that was easy LOL) and I'm in the 22% marginal bracket.

secondcor521

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Re: How much to open a Traditional IRA?
« Reply #12 on: November 16, 2020, 01:10:33 PM »
OK, so then if you're sure you'll be in the 12% bracket when you're older, you'd want to try to contribute whatever amount is in that 22% bracket (the graphic should have an amount) to a traditional IRA.  You should confirm that you're under the AGI limit to qualify in order to deduct the contribution first - most people find non-deductible traditional IRA contributions to be pretty useless.  You're probably under the AGI limit.

Alternatively, if you can split your 401(k) contributions at work and you like your 401(k) investment options, you could put that 22% amount into your traditional 401(k) option at work.

If the 22% amount is significantly less than the amount that you qualify to contribute to an IRA for the year, then you could split it and do the 22% amount to a traditional IRA and the rest of the contribution to a Roth IRA or your 401(k) Roth option.

terran

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Re: How much to open a Traditional IRA?
« Reply #13 on: November 16, 2020, 08:53:01 PM »
If you can't afford to keep an emergency fund you're comfortable with, max out a 401(k) with good investment options (you might choose not to max it out if it doesn't have good options), and max out an IRA then you might consider https://www.bogleheads.org/wiki/Roth_IRA_as_an_emergency_fund

Since tax advantaged space is use it or lose is every year the worst case scenario is that you have an emergency and have to remove the contribution from the Roth IRA, and the best case is that you don't have an emergency and you end up with more money in tax advantaged accounts.

nessa

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Re: How much to open a Traditional IRA?
« Reply #14 on: November 20, 2020, 11:29:39 AM »
@terran thank you for that link! using a Roth IRA to hold my emergency fund makes sense, I'll add that to my possibly-to-do list. I definitely have no problem holding onto my emergency fund, and that's a great option for it to also grow me some 'stash while still being available.

You guys are great with the suggestions!

Ok, so I pulled the trigger. I opened my Vanguard account! However, I think my $ is just sitting there, I'm not sure how to invest it (? or allocate it? or whatever its called) into stocks/bonds.

Looking over my accounts I will move over the remaining funds that fall into the 22% bracket and then see how that affects my taxes in February.

secondcor521

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Re: How much to open a Traditional IRA?
« Reply #15 on: November 20, 2020, 11:43:56 AM »
Log into your Vanguard account.

At the top of the screen, click on "My Accounts", then click on "Account Overview" in the drop down box.

You should see your one Vanguard account.  It might be listed as "nessa - Roth IRA brokerage - 12345".  Click on the name of the account.  That will take you to a different screen.

Click on "Buy and Sell" under the name of the account.  You'll then pick the investment you want to buy (VTSAX for example) and the amount you want to purchase.  Click "Continue" then "Confirm".  Once you get a confirmation number, you've done it.

If you buy a mutual fund, the transaction will execute at the next close of the stock market.  So if you did it now the transaction would happen at 4pm EST today.  You'll be able to see the transaction in your account either later today or tomorrow, and Vanguard should email you a notice saying that your transaction has completed.

(Congratuations.)

terran

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Re: How much to open a Traditional IRA?
« Reply #16 on: November 20, 2020, 01:09:27 PM »
At Vanguard I would be investing in some combination of Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX), Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) and Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX).

Here's some good information that can give you some ways to think about what that mix/combination/allocation should be: https://www.bogleheads.org/wiki/Asset_allocation. I would consider anything from  0-40% bonds reasonable, and international stocks at 20-40% of total stocks, but there are people who would suggest both lower and higher amounts of international stock.

If the account you just opened is a taxable brokerage account, not an IRA, then you should consider https://www.bogleheads.org/wiki/Tax-efficient_fund_placement for how to split you allocation between your taxable account and tax advantaged. Broadly speaking, put bonds in 401(k)/IRA and stocks of either variety in taxable.

At lower tax brackets like yours (and mine) there's a slight advantage to putting international in taxable because while there will be more dividends (taxable) and fewer qualified dividends (lower tax) from an international stock fund, you get a foreign tax credit, which more than offsets the higher taxable income given your lower tax rates. There's a limit over which the foreign tax credit results in more complicated tax forms and a limited credit, but that doesn't happen until you have around $300k in a total foreign market stock fund last I checked, so you don't need to worry about that for awhile. So I'd probably suggest putting your foreign stocks in taxable, but putting US stocks there instead or as-well wouldn't be a big deal.