Author Topic: 401k / IRA questions  (Read 885 times)

COEE

  • Bristles
  • ***
  • Posts: 323
401k / IRA questions
« on: November 06, 2017, 10:17:30 AM »
So, I was laid off earlier this year.  I plan to start my new job next Monday (just in time for the holidays!  Yay!).  Meaning that this is a great opportunity for me to contribute to roth 401k because I will be solidly in the 15% tax bracket for the last year ever probably.  I do have a little in roth at this point in my life... but it's not a large part of my assets something like 8-9% of my NW.  I contributed it the first two years after school while my income was low.

However, next year I will be solidly in the 25% tax bracket.  Meaning t401k will be my best option next year.  I will also be phased out completely from the a tIRA, meaning that all of my contributions henceforth with be to rIRA until I phase out of that.  My wife will have access to tIRA next year (no job based 401k). 

So what makes more sense for my IRA contributions this year?  I could put them in rIRA at a 15% tax hit, but starting next year I'll be force into rIRA for a 25% tax hit and will continue funding the rIRA at this level for some period of time.  I could put them into my tIRA though because it may be the last time I ever get to contribute to my tIRA, but this only saves me a few bucks ($825) today, and I'll have to pay taxes later.

I expect to be in the 15% tax bracket when I retire.  Meaning my gains will be taxed at 0% anyway, right?  So that logic has me putting everything into tIRAs, right?  This is where I get a bit confused.

terran

  • Pencil Stache
  • ****
  • Posts: 805
Re: 401k / IRA questions
« Reply #1 on: November 06, 2017, 01:14:53 PM »
Withdrawals from from your t.IRA or traditional 401k will be taxes as regular income, so if you're in the 15% bracket in retirement you will pay 15% tax on those withdrawals. Roth withdrawals will be tax free.

The 0% capital gains bracket applies to brokerage accounts, not IRAs of any kind.

If your marginal tax rate now and in retirement is the same then it's a wash -- doesn't really matter whether you contribute to roth or traditional. It sounds like this is likely to be the case this year. If you expect to move to a state with lower taxes in retirement you might want to go with traditional this year. Another factor would be if you can stay under $37k AGI you can pay no federal tax thanks to the savers tax credit.

If you expect to be other the roth IRA contribution limits someday you may want to avoid putting money in a t.IRA, and even consider converting any existing t.IRA balances to roth this year while your marginal tax rate is low as t.IRA balances will mess up your ability to make a backdoor roth contribution. You may be able to roll your t.IRA into your 401k instead, which would also fix this issue, so check on that.

If you expect tax rates in general to be higher by the time your retire that would be a vote in favor of roth and vice versa in favor of traditional.

Personally, I would probably contribute as much as you can to your traditional 401k, convert t.IRA to r.IRA and contribute to r.IRA to the extent possible while still staying under whatever the lowest savers tax credit limit you can get to. So if you make anything under $37k limit + $18k 401k limit + $5.5k t.IRA limit + $5.5k spousal t.IRA limit = $66k, then contribute that amount to roth and the rest to traditional. If you make less than $55k then you can also convert some of your existing t.IRA to roth and still stay under the limit. Remember that deductions like health insurance will also generally lower your AGI.

COEE

  • Bristles
  • ***
  • Posts: 323
Re: 401k / IRA questions
« Reply #2 on: November 06, 2017, 03:31:24 PM »
If your marginal tax rate now and in retirement is the same then it's a wash -- doesn't really matter whether you contribute to roth or traditional. It sounds like this is likely to be the case this year. If you expect to move to a state with lower taxes in retirement you might want to go with traditional this year. Another factor would be if you can stay under $37k AGI you can pay no federal tax thanks to the savers tax credit.

Oh wow - I didn't realize this was even a thing.  I'll look into it.  Keeping my AGI that low will be very tough. - if even possible.  Although, I might be able to qualify for the 10% credit - better than a poke in the eye! 10% of 27k is $2.7k!  That's a huge tax CREDIT - nearly all of my estimated taxes for the year if I'm sheltering 27k in traditional accounts!

Thanks for the tip!

terran

  • Pencil Stache
  • ****
  • Posts: 805
Re: 401k / IRA questions
« Reply #3 on: November 06, 2017, 03:50:52 PM »
If your marginal tax rate now and in retirement is the same then it's a wash -- doesn't really matter whether you contribute to roth or traditional. It sounds like this is likely to be the case this year. If you expect to move to a state with lower taxes in retirement you might want to go with traditional this year. Another factor would be if you can stay under $37k AGI you can pay no federal tax thanks to the savers tax credit.

Oh wow - I didn't realize this was even a thing.  I'll look into it.  Keeping my AGI that low will be very tough. - if even possible.  Although, I might be able to qualify for the 10% credit - better than a poke in the eye! 10% of 27k is $2.7k!  That's a huge tax CREDIT - nearly all of my estimated taxes for the year if I'm sheltering 27k in traditional accounts!

Thanks for the tip!

Careful, it's not that good -- you need to read the fine print. The credit is figured on a max contribution of $2k per person, so $4k as long as your wife also contributes to her IRA. So the 50% credit is "worth$2k, but since you won't have a $2k tax liability with a $37k AGI and the credit is non-refundable you won't get the full $2k. Completely eliminating your federal tax liability is pretty cool though.

COEE

  • Bristles
  • ***
  • Posts: 323
Re: 401k / IRA questions
« Reply #4 on: November 06, 2017, 03:57:09 PM »
terran.  Wow.  I think you just saved me almost $5k in taxes... big thank you!  I had no idea that credit even existed!  Looks like I'll be able to stay under the 62k AGI threshold to get the 10% credit.  So I'll get about 2.5k credit between my wife and I and my tax burden will be decreased by another 2.5k due to lowering my AGI with traditional contributions.  I think I've done this right.

FYI, I have not contributed to my IRA traditional or otherwise yet this year.  I haven't done that this year because I lost my job around tax time, so I wanted to make sure I stayed as liquid as possible until I got a job.  But I have been putting the money aside each month to fully fund the IRA's if I had the opportunity.  I should be able to play the game to get me just into the 10% credit, and still put some into the rIRA.

This will put my federal taxes at about 1% of my gross this year if I've done everything right.  Kick ass.  Thanks again!

terran

  • Pencil Stache
  • ****
  • Posts: 805
Re: 401k / IRA questions
« Reply #5 on: November 06, 2017, 04:08:03 PM »
terran.  Wow.  I think you just saved me almost $5k in taxes... big thank you!  I had no idea that credit even existed!  Looks like I'll be able to stay under the 62k AGI threshold to get the 10% credit.  So I'll get about 2.5k credit between my wife and I and my tax burden will be decreased by another 2.5k due to lowering my AGI with traditional contributions.  I think I've done this right.

FYI, I have not contributed to my IRA traditional or otherwise yet this year.  I haven't done that this year because I lost my job around tax time, so I wanted to make sure I stayed as liquid as possible until I got a job.  But I have been putting the money aside each month to fully fund the IRA's if I had the opportunity.  I should be able to play the game to get me just into the 10% credit, and still put some into the rIRA.

This will put my federal taxes at about 1% of my gross this year if I've done everything right.  Kick ass.  Thanks again!

Just in case you missed my followup post, sorry for the bad news, but the credit only looks at $2k of contributions per person, so as long as your wife and you contribute at least $2k each and you can get under the $62k limit you'll "only" get a $400 credit. Still a pretty nice little bump on top of the marginal tax rate savings, but not nearly as nice as if you could count all contributions. If only!

COEE

  • Bristles
  • ***
  • Posts: 323
Re: 401k / IRA questions
« Reply #6 on: November 06, 2017, 04:10:44 PM »
Doh, okay... So it will be $400 between me and my wife... I saw it worded differently... but I see that's not the case... Tricky, tricky.  I don't think there's any way I get down to the 50% or even the 20%...
« Last Edit: November 06, 2017, 04:13:29 PM by COEE »

COEE

  • Bristles
  • ***
  • Posts: 323
Re: 401k / IRA questions
« Reply #7 on: November 06, 2017, 04:35:25 PM »
So I guess now I'm going back to, I could save about $3k in taxes now, but is that worth it to me in the long run to get the money out tax free in the future?  I don't think it is. 

The 17kish I plan to put in a today will generate ~14k in the next 10 years assuming 6% APY.  For a total of 31k.

Assuming I am still in the 15% tax bracket when I withdraw my funds...
In a traditional, I will have to pay $4.65k to get my money out in 10 years.   31k-4.5K=27.5k
In a roth, I will not pay anything, but I will have paid $3k to put it in.              31k-3k= 28k

Seems to me the best solution is to contribute to roth.  Chances are this money will sit longer than 10 years making the numbers point even more to the Roth working out better for me.  Am I missing something?

terran

  • Pencil Stache
  • ****
  • Posts: 805
Re: 401k / IRA questions
« Reply #8 on: November 06, 2017, 07:11:44 PM »
I think you're saying you "somehow" come up with the money to pay the tax on the roth and still contribute $17k, in which case you should be able to contribute that extra to traditional. Also, I think you're mixing present and future value by subtracting the $3k at the end of instead of the beginning.

Assuming you have an extra $17k now to make contributions and pay taxes:

Traditional: $17k contribution, 6% return for 10 years = $30,444.41 - $4,566.66 tax = 25,877.75
Roth: $17k - $2,550 taxes = $14,450 contribution, 6% return for 10 years = $25,877.75

If the $17k gets you under the 62K limit the math actually gets a little better in favor of traditional in that it become $17400 contribution, 6% return for 10 years = 31,160.75 - $4,674.11 tax = $26,486.64, or $608.89 additional at retirement.

COEE

  • Bristles
  • ***
  • Posts: 323
Re: 401k / IRA questions
« Reply #9 on: November 06, 2017, 08:59:52 PM »
I'm thinking either way I'm going to contribute 17k... in a traditional I'm going to contribute 17k and 'pocket' 3k in reduced taxes (not investing the 3k immediately, probably).  In a Roth, I have to come up with 20k to contribute the 17k and pay 3k in taxes.  So I guess I start with 20k in both scenarios.

Traditional: $17k contribution, 6% return for 10 years = $30,444.41 - $4,566.66 tax = $25,877.75 + $3k savings from the first year = $28,877.75
Roth: $20k - $3k taxes = $17k contribution, 6% return for 10 years = $30,444.41

I think this is getting down to favor Roth in the long term - at least for me - since 10 years about the pay-off point.  But the money will probably sit there much longer (I like my job, and will probably live off of brokerage accounts when I first retire anyway).  Although, at the end of the day - what really matters is that I've saved something and that I sleep at night.  Talking with my dad, I know it's good to have a nice mix of both, and I certainly have that already, and will continue to have that as my income grows because I won't be able to contribute to tIRA starting next year.

I'm actually very much on the fence with this now.  I get your reasoning, but I also get mine.  I'm not sure what I want to do.  I feel like it's a bit of a tossup, and I'd sure like to be a bit more liquid for a while due to my recent employment situation so traditional is more tempting from that perspective, but stashing roth money while I'm in a low tax bracket is also tempting.  Six-of-one....

terran

  • Pencil Stache
  • ****
  • Posts: 805
Re: 401k / IRA questions
« Reply #10 on: November 06, 2017, 09:31:11 PM »
Now you're adding the $3k at the wrong end since if you invested it (either inside or outside the IRA/401k) it would grow to more than $3K at retirement. No matter how you cut it, if you invest the same amount in traditional vs roth minus taxes and assume the same rate of return and taxes now and at withdrawal, then you have the same amount to spend in the end. That's just how the math works. The only way to make it so don't have the same amount to spend in the end is to change one of those assumptions: for example by putting the same amount in traditional vs roth and spending the tax savings under the traditional scenario, or by assuming different marginal tax rates now vs retirement.

It doesn't matter how long a time frame you're looking at. There is no break even point as the math always works out the same.

As far as being on the fence, I really wouldn't worry about it too much. If you can get under the savers tax credit limit that slightly favors traditional, but otherwise they really are exactly the same, so it doesn't really matter. You're right that having a mix is probably a good idea, and the only way to make the roth actually worse is have a lower tax bracket in retirement (either from lower income or a change in tax law). If it weren't for the savers tax credit I would probably agree that going with roth would be the better choice in the interest of tax diversification, which is why I suggested only contributing to traditional up to the point of qualifying for the lowest savers tax credit threshold you can reach then going with roth the rest of the way. 

MDM

  • Walrus Stache
  • *******
  • Posts: 7187
Re: 401k / IRA questions
« Reply #11 on: November 07, 2017, 12:53:39 AM »
I'm thinking either way I'm going to contribute 17k... in a traditional I'm going to contribute 17k and 'pocket' 3k in reduced taxes (not investing the 3k immediately, probably).
If that is what you will do, Roth will be better.

In general, the commutative property of multiplication means that, for equal contribution and withdrawal tax rates, traditional and Roth give identical results.

When the pre-tax amount you can contribute to the Roth exceeds the IRS maximum for the traditional, for apples to apples one should invest the amount "left over" on the traditional side into a taxable account.  See Maxing out your retirement accounts in the same wiki article linked above.

COEE

  • Bristles
  • ***
  • Posts: 323
Re: 401k / IRA questions
« Reply #12 on: November 12, 2017, 09:08:20 AM »
I sincerely appreciate the input from MDM and terran.

Any chance anyone else wants to weigh in - maybe persuade me one way or another?

teen persuasion

  • Pencil Stache
  • ****
  • Posts: 971
Re: 401k / IRA questions
« Reply #13 on: November 13, 2017, 06:46:22 PM »
So, I was laid off earlier this year.  I plan to start my new job next Monday (just in time for the holidays!  Yay!).  Meaning that this is a great opportunity for me to contribute to roth 401k because I will be solidly in the 15% tax bracket for the last year ever probably.  I do have a little in roth at this point in my life... but it's not a large part of my assets something like 8-9% of my NW.  I contributed it the first two years after school while my income was low.

However, next year I will be solidly in the 25% tax bracket.  Meaning t401k will be my best option next year.  I will also be phased out completely from the a tIRA, meaning that all of my contributions henceforth with be to rIRA until I phase out of that.  My wife will have access to tIRA next year (no job based 401k). 

So what makes more sense for my IRA contributions this year?  I could put them in rIRA at a 15% tax hit, but starting next year I'll be force into rIRA for a 25% tax hit and will continue funding the rIRA at this level for some period of time.  I could put them into my tIRA though because it may be the last time I ever get to contribute to my tIRA, but this only saves me a few bucks ($825) today, and I'll have to pay taxes later.

I expect to be in the 15% tax bracket when I retire.  Meaning my gains will be taxed at 0% anyway, right?  So that logic has me putting everything into tIRAs, right?  This is where I get a bit confused.

Did I miss something?  Your IRA limit would be $5500 (or $6500 if > 50). You can't contribute $17k to your IRA this year.  You could contribute that much to a 401k, if you are already eligible at your new job, and will have enough income before 12/31/17.

MMbergmann

  • 5 O'Clock Shadow
  • *
  • Posts: 28
Re: 401k / IRA questions
« Reply #14 on: November 13, 2017, 08:27:06 PM »
So, I was laid off earlier this year.  I plan to start my new job next Monday (just in time for the holidays!  Yay!).  Meaning that this is a great opportunity for me to contribute to roth 401k because I will be solidly in the 15% tax bracket for the last year ever probably.  I do have a little in roth at this point in my life... but it's not a large part of my assets something like 8-9% of my NW.  I contributed it the first two years after school while my income was low.

However, next year I will be solidly in the 25% tax bracket.  Meaning t401k will be my best option next year.  I will also be phased out completely from the a tIRA, meaning that all of my contributions henceforth with be to rIRA until I phase out of that.  My wife will have access to tIRA next year (no job based 401k). 

So what makes more sense for my IRA contributions this year?  I could put them in rIRA at a 15% tax hit, but starting next year I'll be force into rIRA for a 25% tax hit and will continue funding the rIRA at this level for some period of time.  I could put them into my tIRA though because it may be the last time I ever get to contribute to my tIRA, but this only saves me a few bucks ($825) today, and I'll have to pay taxes later.

I expect to be in the 15% tax bracket when I retire.  Meaning my gains will be taxed at 0% anyway, right?  So that logic has me putting everything into tIRAs, right?  This is where I get a bit confused.

Did I miss something?  Your IRA limit would be $5500 (or $6500 if > 50). You can't contribute $17k to your IRA this year.  You could contribute that much to a 401k, if you are already eligible at your new job, and will have enough income before 12/31/17.

I think his point was he is in the 15 percent bracket this year so what's the point.

COEE

  • Bristles
  • ***
  • Posts: 323
Re: 401k / IRA questions
« Reply #15 on: November 14, 2017, 12:06:32 AM »
Did I miss something?  Your IRA limit would be $5500 (or $6500 if > 50).

Yes, so would it be wiser for me to contribute that $5500 to a roth or traditional IRA while I am in a 15% tax bracket?

teen persuasion

  • Pencil Stache
  • ****
  • Posts: 971
Re: 401k / IRA questions
« Reply #16 on: November 14, 2017, 07:11:06 AM »
It really depends on your details.  You mentioned next year you wouldn't be eligible for deductible tIRA contributions, so Roth IRA would be it.  What about further into the future?  Do you expect to eventually be ineligible for direct Roth IRA contributions, too?  If so, you can switch to backdoor Roth IRA contributions, but then you'd want need $0 in tIRA.  Thus don't even consider tIRA now, it'll just get in the way later.

Another way to consider the options:  If you will definitely go Roth IRA next year at 25%, why would you forego it at 15% this year?  Unless tIRA contributions could squeak you below a cliff, like the Retirement Saver's credit, or ACA subsidies, or 0% LTCG, then at least some tIRA makes sense.

Personally, with kids and eligibility for EITC, we go heavily into traditional 401k to reduce our AGI and wages to increase the credit as much as possible.  Then we put those refundable credits into Roth IRAs, because there's no additional benefit to using tIRAs for us.  EITC is quirky, in that 401k contributions affect it, but IRA contributions do not.  We stack the deck in the best way for us and our circumstances.   YMMV.