Author Topic: Started investing late, not sure if able to lower MAGI for tIRA tax deduction  (Read 1205 times)

cliner

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AKA "Another Traditional Vs. Roth IRA Thread"

I understand the rationale behind this section in the Investment Order thread:

...         
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level            
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)            
...

But my specific situation is confusing to me. I've read tons of articles on "traditional vs roth IRA", but I'm still not confident in what to do. Here's my situation:

Estimating $85,000 gross for this year, but expecting a $5-7,000/yr raise, starting next week. Pay is variable from week to week, but $85,000 is probably pretty close to what I'll earn this year
Was in debt until recently, now contributing a little more to my 401(k) up to company match, and haven't increased it significantly because I'm trying to figure out what to do.
All debt recently paid off, so I'm saving 45-55% of my take-home pay to establish a $10,000 emergency fund. I'm at 7,000 for the emergency fund.
Once the emergency fund is complete, I'll continue investing at the same 45-55% rate

Now, the problem I'm having:
To qualify for the partial tIRA tax deduction, I would have to reduce my MAGI to <$72,000 by December 31, correct?
This year, I've contributed only $2,700 to my 401(k) (= MAGI $82,300)
I would need to contribute an additional >$10,300 to my 401(k) to lower my MAGI enough to qualify for the tIRA tax deduction, plus max out the tIRA ($5,500) to fully-use said benefit
That means I would want to raise my 401(k) contributions to 36% ($7,083 estimated gross monthly income *.37 = ~2,600... over 4 months = $10,400)

It seems like I'm cutting it way too close by starting out so late. I also might end up with a gross income of more than $85,000 if this raise ends up being more than expected. If I don't reduce my MAGI to <$72,000, then I don't qualify for a tIRA tax deduction at all, and therefore am missing out on the biggest benefit of a tIRA, correct? So in that case, I'd be better off just playing it safe & maxing out a Roth this year, then bumping up my 401(k) contributions to match the remaining 45-55% savings rate I'm at currently, and then switching my efforts to a tIRA next year when I know I can drop my MAGI down enough to qualify for the deduction? Or would tIRA still be the way to go for me for the rest of 2017 regardless of the deduction?

I'm probably making it more complicated than it is, but I just can't wrap my head around it. I would appreciate any input.

VoteCthulu

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Personally, I'd just max my 401k and then put 5500 onto a Roth IRA, in case I ended up over the limit. It might be slightly less optimal, but I don't think the difference is worth worrying about.

MDM

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To qualify for the partial tIRA tax deduction, I would have to reduce my MAGI to <$72,000 by December 31, correct?
Yes, but the word "partial" is important.

Quote
This year, I've contributed only $2,700 to my 401(k) (= MAGI $82,300)
I would need to contribute an additional >$10,300 to my 401(k) to lower my MAGI enough to qualify for the tIRA tax deduction, plus max out the tIRA ($5,500) to fully-use said benefit
Unfortunately it doesn't work that way.  You can't deduct any tIRA contribution if your MAGI is $72K or above.  You can deduct the full $5500 if your MAGI is $62K or below.  The amount you can deduct changes ~linearly for MAGIs between $62K and $72K.  E.g., if your MAGI is $71,900 you may deduct all of $60 in tIRA contributions.

Does that make things clearer or murkier?

cliner

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To qualify for the partial tIRA tax deduction, I would have to reduce my MAGI to <$72,000 by December 31, correct?
Yes, but the word "partial" is important.

Quote
This year, I've contributed only $2,700 to my 401(k) (= MAGI $82,300)
I would need to contribute an additional >$10,300 to my 401(k) to lower my MAGI enough to qualify for the tIRA tax deduction, plus max out the tIRA ($5,500) to fully-use said benefit
Unfortunately it doesn't work that way.  You can't deduct any tIRA contribution if your MAGI is $72K or above.  You can deduct the full $5500 if your MAGI is $62K or below.  The amount you can deduct changes ~linearly for MAGIs between $62K and $72K.  E.g., if your MAGI is $71,900 you may deduct all of $60 in tIRA contributions.

Does that make things clearer or murkier?

That helps a lot. I'm going to work toward maxing my 401(k). I think I can do it, since I'm saving @ 45-55%. I'm also saving for a wedding in late April, but, well, that's in April.

Personally, I'd just max my 401k and then put 5500 onto a Roth IRA, in case I ended up over the limit. It might be slightly less optimal, but I don't think the difference is worth worrying about.

If I max my 401(k), then I'll almost certainly qualify for a partial tIRA deduction (and possibly a full deduction if, for whatever reason, I gross less than 85,000). Wouldn't I then want to put it into a tIRA instead of a Roth for the tax benefit? Or am I misunderstanding?

GizmoTX

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I don't think you can contribute to a tIRA if you max your contribution to a t401K. Together they cannot exceed $18K/year.
A t401K has a higher contribution limit than a tIRA to lower your MAGI.



MDM

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I don't think you can contribute to a tIRA if you max your contribution to a t401K. Together they cannot exceed $18K/year.
Contributions to a tIRA are completely independent of contributions to a 401k.

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A t401K has a higher contribution limit than a tIRA...
True.

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...to lower your MAGI.
A tIRA contribution has no effect on the MAGI for tIRA deductibility.  A t401k contribution will reduce that MAGI.

PDXTabs

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Don't forget that all of your pre-tax benefits lower your AGI (and thus, MAGI):
http://www.healthreformbeyondthebasics.org/key-facts-income-definitions-for-marketplace-and-medicaid-coverage/

DavidAnnArbor

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You should definitely max out your contributions to the 401k plan in the remaining months of the year, and then lower your MAGI down enough and get yet more tax savings by fully funding your tIRA if it's within your grasp. Even a partial tIRA is worth it, and then the balance you can then drop into your Roth IRA.
Find out if you're eligible for a health savings account, which is more tax savings.

Rubic

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I don't think you can contribute to a tIRA if you max your contribution to a t401K. Together they cannot exceed $18K/year.
Contributions to a tIRA are completely independent of contributions to a 401k.

Here's an article which I think explains the concept with examples:

https://www.personalcapital.com/blog/retirement-planning/can-contribute-401k-ira/

Aside from the minor adjustment to 2017 contribution limits for 401K plan,
($18,000 / $24,000 > 50 yr old), it appears the article is accurate.  I'm sure
MDM will indicate if otherwise.  ;-)


MDM

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Here's an article which I think explains the concept with examples:
https://www.personalcapital.com/blog/retirement-planning/can-contribute-401k-ira/
Yes, looks good in general. 

One line that may mislead folks: "Remember that contribution limits apply to the total of your contributions to all of your retirement accounts, either IRA or 401k." 

It's accurate, but at a quick glance one might think that applies to the combined total of IRAs and 401ks.  What it does mean is that the IRA limit applies to the annual total for all IRA accounts, and the 401k limit applies to the annual total for all 401k accounts.

DavidAnnArbor

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #10 on: September 02, 2017, 02:02:21 PM »
401k limit applies to the annual total for all 401k accounts.

Actually each employer 401k has a separate limit: although the employEE limit is per taxpayer, the employER contribution is per 401k plan.

MDM

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #11 on: September 02, 2017, 05:25:46 PM »
401k limit applies to the annual total for all 401k accounts.

Actually each employer 401k has a separate limit: although the employEE limit is per taxpayer, the employER contribution is per 401k plan.
Yes, that's the grad level - just trying to get through IRA/401k 101 first ;)

cliner

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #12 on: September 03, 2017, 11:41:58 AM »
OK all, I'm going to shoot for maxing my 401(k) before end of year. Will y'all confirm my math is correct?

Typical estimated weekly pay (gross): $1,700
Employer match: 50% of contributions up to 6%
Current contributions for the year: $4,075

Assuming average employer contribution of ~$50 for the remaining 16 weeks, I would need to contribute a little over $13,000 or 800/wk by the end of the year.

So I should up my contribution to 48% (1700 * .48)? I'm already saving 45-55% of my take-home pay, so this should be no problem at all. It's just a little intimidating.
« Last Edit: September 03, 2017, 11:44:16 AM by cliner »

PDXTabs

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #13 on: September 03, 2017, 11:50:23 AM »
The employer contribution doesn't count towards your AGI, has no affect on your tIRA eligibility, and does not count towards your $18K limit.

cliner

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #14 on: September 03, 2017, 11:54:44 AM »
The employer contribution doesn't count towards your AGI, has no affect on your tIRA eligibility, and does not count towards your $18K limit.

Thanks, I keep learning important stuff in this thread... So, to max 401(k) for the rest of the year I would have to bump my contributions up to 56%... I feel like that's pushing it. Am I over thinking it? Should I just relax, up my contributions to something more "reasonable" like 15-20%, and then start over in January, leave it at 20% and let it max out naturally throughout the year and consider 2017 a bust since I got started so late?

Rubic

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #15 on: September 03, 2017, 12:23:29 PM »
You should try to get your 2017 contribution up to $10,600 to maximize
your 50% employer match (if I've estimated your compensation correctly).  You
don't have to bump it up to 56% (though I'd recommend maxing it out if you can
afford it this year), but just somewhat higher than your current 15-20% rate.

MDM

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #16 on: September 03, 2017, 01:13:24 PM »
So, to max 401(k) for the rest of the year I would have to bump my contributions up to 56%... I feel like that's pushing it. Am I over thinking it?
Maybe underthinking it.  In other words, do at least some back-of-the-envelope calculations to see if you can handle the reduced monthly income a 56% contribution would cause, perhaps by drawing some from taxable savings.  There will be less tax due, so include that effect.

The answer may be that you obviously can or cannot, or it might be "maybe".  If it's a definite "no", then contribute what you can and wait until next year.  If it's a definite "yes", bump up to 56% and sleep well.  If it's "maybe", increase to, say, 40%, then recheck each month.

cliner

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #17 on: September 03, 2017, 01:54:53 PM »
So, to max 401(k) for the rest of the year I would have to bump my contributions up to 56%... I feel like that's pushing it. Am I over thinking it?
Maybe underthinking it.  In other words, do at least some back-of-the-envelope calculations to see if you can handle the reduced monthly income a 56% contribution would cause, perhaps by drawing some from taxable savings.  There will be less tax due, so include that effect.

The answer may be that you obviously can or cannot, or it might be "maybe".  If it's a definite "no", then contribute what you can and wait until next year.  If it's a definite "yes", bump up to 56% and sleep well.  If it's "maybe", increase to, say, 40%, then recheck each month.

Thanks, that's reassuring. I should be fine maxing it out, just wanted to make sure I wasn't missing something.

You should try to get your 2017 contribution up to $10,600 to maximize
your 50% employer match (if I've estimated your compensation correctly)

I don't think mine works that way. My plan says, "Matching contributions are calculated based on your pay and 401(k) elective deferrals for the payroll period."
Nevermind... I think I know what you were saying
« Last Edit: September 03, 2017, 02:07:09 PM by cliner »

MDM

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #18 on: September 03, 2017, 02:13:47 PM »
My plan says, "Matching contributions are calculated based on your pay and 401(k) elective deferrals for the payroll period."
Search "401k true-up" for something to consider next year.

PDXTabs

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #19 on: September 03, 2017, 10:16:39 PM »
Just save as much as you can and don't worry about it. When Jan 1 comes around remind yourself how much of a better position you are now in. With that said, because 401(k) contributions come out before payroll and income taxes, I think you are going to be surprised by how much you can stash given that you are currently saving 45%+ of your take-home pay.

cliner

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Re: Started investing late, not sure if able to lower MAGI for tIRA tax deduction
« Reply #20 on: September 04, 2017, 08:59:04 AM »
Just save as much as you can and don't worry about it. When Jan 1 comes around remind yourself how much of a better position you are now in. With that said, because 401(k) contributions come out before payroll and income taxes, I think you are going to be surprised by how much you can stash given that you are currently saving 45%+ of your take-home pay.

Thanks for the encouragement

My plan says, "Matching contributions are calculated based on your pay and 401(k) elective deferrals for the payroll period."
Search "401k true-up" for something to consider next year.

Thanks for the heads-up. I hadn't heard of this before.