Roth vs Traditional

[Saving in Austin]

I'm think I'm about to invest in VTSAX and make our 2015 IRA contributions. I've read lots on the Roth vs Traditional issue and here is our situation. We expect to make around $120K combined and there are years where our income is closer to $175K.

We live in Texas and pay no state taxes. We may want to retire in California which would mean paying state taxes later. We may inherit around $400K in traditional IRA money around 10-20 years from now. We are not counting on it but it is a definite possibility.

We currently have $158K in Roth and $35K in Traditional. I guess I'm not sure if it better to invest in the Traditional for tax purposes in our situation.

[matchewed]

You can only work within the framework you know (the present). Reduce your taxes now with a traditional gives you a known more optimal saving by avoiding taxation in the now. You could just run numbers on the most likely scenario in the future as well to determine whether it's better in the now (traditional) vs. better in the future (Roth).

You can't rely on "mays" and "not counting ons". You need to go with your knowns and have an idea of future possibilities but not make hard commitments based on maybes.

[Saving in Austin]

Thanks. I wish I were better at running numbers for the future vs. the now.

One thing I know right now are current tax rates. Who knows what future rates will be.

You are probably right though. Anything may happen 10-20 years from now.

[dandarc]

Will your traditional contributions be fully deductible?  If you're making decent sized 401K contributions, or have other above-the-line deductions then probably if that 120K is a gross-income figure.  Or if you don't have access to workplace retirement plans.  But any tIRA contributions that are not deductible should definitely go to Roth.

Also - if you change your mind between now and April 15th (technically October 15th 2016, but that would require filing an amended return), you can recharacterize your contributions between Roth and Traditional for 2015, so don't let perfect get in the way of good - get the money working for you ASAP!

[Saving in Austin]

Thanks for this reply. The Traditional would be fully deductible. We are both self employed. I will also have SEP contributions but need to wait until the end of the year for our accountant to weigh in.

[matchewed]

Thanks. I wish I were better at running numbers for the future vs. the now.

One thing I know right now are current tax rates. Who knows what future rates will be.

You are probably right though. Anything may happen 10-20 years from now.

Frankly they're just math problems. You can anticipate your tax savings today via a traditional method; $1250 I believe if it's just your traditional IRA and filing jointly (.25*5000=1250) (also assuming a 25% tax bracket for your income filing jointly). Or it would cost you $6667 of gross income to put $5k into a Roth (.25*6667=5000). So you could in today's terms earn $6667 in order to put 5k into a Roth or you just earn $5000 and put it in a traditional, which saves you $1250 on taxes this year.

So you've got some baselines and then you just do an all other things being equal sort of analysis, these all other things would be taxes on "income" in the future, growth...etc. Since you can still save the 5k amount regardless of which method you choose you can easily see the difference. Added up over 10 years a traditional IRA will save you $12,500 in taxes that you don't have to pay. The Roth costs you $16,667 in additional income that you have to earn in order to pay taxes and still invest the same amount. Sure you have to pay taxes on the traditional when you FIRE you don't necessarily have to depending on your income and how you execute your plan. There are several ways to reduce your taxable income in the future.

Caveat on the whole back of the napkin math and the many assumptions behind it.

[Saving in Austin]

Thanks again. We will each be able to contribute $6500 this year (54 and 50 years old).

So $13,000 x .25 = $ 3,250