Author Topic: Traditional IRA question  (Read 2160 times)

aalferez

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Traditional IRA question
« on: July 19, 2017, 10:15:23 AM »
Hi everyone.
So I noticed that I am doing wrong the investments: I max out my Roth IRA when I should be doing a Traditional IRA

I make 100K a year, I max out my 401K and this year I maxed out my Roth IRA too. I started reading about MMM on Feb this year.
So for next year I should max out a new Traditional IRA that I have to create, I guess with  Betterment since I have with them my Roth IRA and my taxable personal investment account.

But my question is: Money that goes to the Traditional IRA is PRE-tax, so when I do a transfer to this account, I'm putting after-tax money.
So does this have to be set up to be transferred with payroll on my company? What if I want to max it out right away instead of putting a little every month?

Thank you

dandarc

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Re: Traditional IRA question
« Reply #1 on: July 19, 2017, 10:25:10 AM »
You deduct it on your tax return.  Which saves you taxes, which means you'll get a bigger refund or owe less when you file taxes.

Are you sure that your traditional IRA will be deductible?  If you're single, there needs to be quite a lot more than $18K to the 401K to get your MAGI under $62k for a tIRA contribution to be fully deductible.

aalferez

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Re: Traditional IRA question
« Reply #2 on: July 19, 2017, 12:48:27 PM »
Oh I had no idea that in order to deduct that amount of money for the tIRA I need a MAGI of <66K.
Crap.

Thanks for the info though

bryan995

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Re: Traditional IRA question
« Reply #3 on: July 19, 2017, 01:23:02 PM »
Yeap, since you cannot deduct your tIRA, you should instead just put this into a ROTH IRA.

At some point, you will no longer be allowed to contribute to a roth (income limit).
My income is over the limit for eligibility to contribute to ROTH, so instead, I take my after tax money ($5500 x 2) and invest into a traditional IRA on Jan1, and then on Jan2, I initiate a traditional->ROTH conversion.  Roth is nice because once the money is >5 years seasoned, the principal can be withdrawn.  I plan to use a ROTH ladder during my first 5 years of retirement.

Aggie1999

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Re: Traditional IRA question
« Reply #4 on: July 20, 2017, 09:14:39 AM »
Yeap, since you cannot deduct your tIRA, you should instead just put this into a ROTH IRA.

At some point, you will no longer be allowed to contribute to a roth (income limit).
My income is over the limit for eligibility to contribute to ROTH, so instead, I take my after tax money ($5500 x 2) and invest into a traditional IRA on Jan1, and then on Jan2, I initiate a traditional->ROTH conversion.  Roth is nice because once the money is >5 years seasoned, the principal can be withdrawn.  I plan to use a ROTH ladder during my first 5 years of retirement.

On the traditional -> Roth conversion does the 5 year rule apply when the principal was originally put in the tIRA from after tax dollars? Seems like it shouldn't since taxes were paid on that money.

dandarc

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Re: Traditional IRA question
« Reply #5 on: July 20, 2017, 09:41:58 AM »
Yeap, since you cannot deduct your tIRA, you should instead just put this into a ROTH IRA.

At some point, you will no longer be allowed to contribute to a roth (income limit).
My income is over the limit for eligibility to contribute to ROTH, so instead, I take my after tax money ($5500 x 2) and invest into a traditional IRA on Jan1, and then on Jan2, I initiate a traditional->ROTH conversion.  Roth is nice because once the money is >5 years seasoned, the principal can be withdrawn.  I plan to use a ROTH ladder during my first 5 years of retirement.

On the traditional -> Roth conversion does the 5 year rule apply when the principal was originally put in the tIRA from after tax dollars? Seems like it shouldn't since taxes were paid on that money.
If you do the backdoor Roth conversion as illustrated, then while the 5-year rule on the conversion does apply, it only matters in terms of filling out the forms - significant tax and penalty won't be owed, regardless of when the conversion amount is withdrawn.

Due to ordering rules on unqualified distributions from a Roth IRA which are as follows:

1.  Regular contributions
2.  Conversions in chronological order
     a.  Taxable portion of each conversion first
     b.  Non-taxable portion on each conversion second
3.  Earnings

If the conversion is done quickly as bryan995 illustrates, the taxable portion of the conversion will be very low - most likely 0.  So as you're withdrawing, you've burned off the regular contribution amounts and you're on this conversion - 2a is 0, so your withdrawal is 2b.  The additional tax is only due on the taxable portion, so you've got no income tax, nor any penalty to pay.

Still need to keep good records of course, because you may need to prove all of this to the IRS down the road.

robartsd

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Re: Traditional IRA question
« Reply #6 on: July 20, 2017, 10:41:09 AM »
The 5 year rule applies to traditional -> Roth conversions and is based on the tax year of the conversion. Regular Roth contributions are not subject to waiting.

Tradition -> Roth conversions are subject to tax proportional to the part of the balance of all the individuals Traditional IRAs combined which is based on tax deductible contributions and earnings. For this reason, to efficiently conduct backdoor Roth contributions, you do not want to have any other funds in any Traditional IRA.

dandarc

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Re: Traditional IRA question
« Reply #7 on: July 20, 2017, 10:58:37 AM »
None of this backdoor Roth discussion matters for OP, at least immediately, since income puts aalferez well within Roth IRA income limits.

But we've got a lot of things brought up, that matter for overall planning.

1.  Regular Roth contributions can be withdrawn at any time, tax and penalty-free.
2.  Backdoor Roth (contribute to traditional IRA, don't deduct, immediately convert to Roth) is screwed up if you have any regular tIRA money at the time of the conversion as rbartsd illustrates.  Note that SEP-IRA and SIMPLE-IRA balances count here if you have any of them, so gotcha's abound.  The typical way to deal with this is to transfer your tIRA balance to a 401K or 403B before doing the backdoor Roth.
3.  Backdoor Roth is a conversion, and is treated as such - 5 year rules and penalties and such.  But it turns out that doesn't matter unless you have regular Roth conversions (meaning the whole amount was taxable) that were done earlier than the backdoor Roth conversions to consider.
4.  Roth ladder was mentioned - the 5 year rule on conversions matters since these are regular conversions where the whole amount is taxable, and therefore you'll have penalty to pay if you don't wait long enough.  This is typically a withdrawal-phase strategy, so usually doesn't collide with backdoor Roth contributions.

dandarc

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Re: Traditional IRA question
« Reply #8 on: July 20, 2017, 11:07:12 AM »
One more thing -

OP might be wondering, what if I had made tIRA contributions, only to find I couldn't deduct them later?  But I could have made Roth IRA contributions.  What do I do?

This comes up all the time.  People's incomes change mid-year, and so on.  Luckily, you don't have to guess right.  You can recharacterize from traditional to Roth or back up to your tax filing deadline, and it is just as if you had made the other type of contribution all along.  You can even partially recharacterize - this is great if you find yourself in the phase-out range for a traditional IRA deduction, you just call up your broker and recharacterize so that you have just enough traditional to deduct, and the rest is Roth.

If it turns out you weren't eligible even for Roth contributions, you request a return of excess contributions.  You pay tax on any earnings, but there is no penalty if you catch and correct it yourself.

aalferez

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Re: Traditional IRA question
« Reply #9 on: July 20, 2017, 01:16:33 PM »
I didnt even look at the Roth IRA income limits.
I'm not there yet but it's good to know; if I get a raise or new position I might be right there.

So is the tIRA->ROTH IRA the best solution to the extra after tax money if I cannot deduct it from taxes?

What other options do I have? Which one would be the best?

dandarc

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Re: Traditional IRA question
« Reply #10 on: July 20, 2017, 01:29:54 PM »
At 100K income, just put the money in Roth.  You don't need to do any gymnastics - you know that you can't deduct the tIRA and that you are eligible for the Roth, so put it in Roth from the get-go.

If your income goes up, you may get to a point where you can't just put the money into the Roth IRA due to the income limit.  The backdoor Roth IRA (non-deductible tIRA converted to Roth IRA ) gets you around the income limit, because there is no limit for conversions.  You don't have a need for that yet.

JanF

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Re: Traditional IRA question
« Reply #11 on: July 21, 2017, 12:41:42 PM »
You deduct it on your tax return.  Which saves you taxes, which means you'll get a bigger refund or owe less when you file taxes.

Are you sure that your traditional IRA will be deductible?  If you're single, there needs to be quite a lot more than $18K to the 401K to get your MAGI under $62k for a tIRA contribution to be fully deductible.

Can you explain more? I'm trying to set my husband up with T or Roth IRA (his work doesn't offer any retirement benefits). Our combine income is around 75K

dandarc

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Re: Traditional IRA question
« Reply #12 on: July 21, 2017, 12:51:11 PM »
JanF - assuming you file jointly, you've got nothing to worry about - your income is well below the cutoff for a traditional IRA deduction for Married Filing Jointly.  Put money into traditional IRA if you think your marginal income tax rate will be lower when you withdraw than it is today.  Roth if you think your tax rate will be higher.

All you do is set up the IRA at Vanguard (or whatever broker you choose) and send them the money.  Assuming you went traditional, when you fill out your taxes, one of your deductions (above the line - you don't have to itemize to get this deduction) will be the tIRA contribution.