Author Topic: IRA w/ low taxable income  (Read 1484 times)

jpdx

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IRA w/ low taxable income
« on: December 09, 2017, 10:17:51 PM »
My AGI is low this year and with itemized deductions I can zero out my federal income tax liability. Should I contribute to my traditional IRA or my Roth IRA?

With traditional, I get no immediate income tax advantage, but I do get a much larger ACA premium tax credit. A $11,000 IRA contribution gets me an additional $2,300 which is pretty nice.

What do you recommend?

MDM

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Re: IRA w/ low taxable income
« Reply #1 on: December 10, 2017, 12:35:57 AM »
My AGI is low this year and with itemized deductions I can zero out my federal income tax liability. Should I contribute to my traditional IRA or my Roth IRA?

With traditional, I get no immediate income tax advantage, but I do get a much larger ACA premium tax credit. A $11,000 IRA contribution gets me an additional $2,300 which is pretty nice.

What do you recommend?
This is analogous to the decision one has when maxing out your retirement account.  In your case (assuming no state tax effects, etc.) the "current marginal tax rate" is $2300/$11000 = 20.909%.

If (again assuming no state tax effects, etc.) you expect the money to be invested for ~30 years, and your federal marginal rate when withdrawing to be ~17.23% or lower, use traditional.  If the marginal rate on withdrawal will be >17.23%, use Roth.  See rows 146-160 on the 'Misc. calcs' tab of the case study spreadsheet if you'd like to change any assumptions.

Roth vs. Traditional
Extra fee in tax-advantaged0.0%
Return from dividends in taxable2.0%
Return from growth in taxable6.0%
Total return in tax advantaged8.0%
Tax rate on dividends15.0%
Taxable return, including dividend tax7.70%
Tax rate on capital gains15.0%
Effective cap. gain tax rate11.688%
Number of years invested30
Ratio for equal outcomes.824
Current marginal tax rate20.909%
Withdrawal breakeven rate17.230%<- prefer Roth if the marginal withdrawal rate will be greater than this.

jpdx

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Re: IRA w/ low taxable income
« Reply #2 on: December 10, 2017, 04:42:06 PM »
Thank you for the explanation and for the spreadsheet, which is an amazing resource!

I'm leaning towards traditional, for two reasons:

1. My ACA subsidy will actually be more significant than I thought, because of increase in fam size.
2. I currently live in a high income tax state, that's a certainty, but retirement location is TBD.

Is this reasoning sound?

MDM

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Re: IRA w/ low taxable income
« Reply #3 on: December 10, 2017, 05:27:22 PM »
Thank you for the explanation and for the spreadsheet, which is an amazing resource!

I'm leaning towards traditional, for two reasons:

1. My ACA subsidy will actually be more significant than I thought, because of increase in fam size.
2. I currently live in a high income tax state, that's a certainty, but retirement location is TBD.

Is this reasoning sound?
Those are both significant considerations in your decision.

Add in your expected marginal rate in retirement, and you should have enough to confirm or dispute your leaning.

TreeTired

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Re: IRA w/ low taxable income
« Reply #4 on: December 11, 2017, 08:20:44 PM »
Can you contribute $11,000 to an IRA?  I thought the limit was $5,500. (oh, are there 2 of you?  :) ) Also,  "Low" AGI  is a relative term. How low is low?  My son made around $20k last year.  I didn't even realize there was a retirement tax CREDIT for low income earners. Retirement Savings Contributions Credit, or "Saver's Credit"

If you qualify for the credit at all, it starts at 10% of your contribution, and there is a 20% level for lower income folks, and a 50% rate.  After playing around with the numbers, I advised my son to open a traditional IRA that brought his income down to the 50% level, so he qualified for the 50% tax credit. After that, he opened a Roth IRA so his total IRA contributions were $5,500.

For 2018, Married Filing Jointly, the 10% credit is for AGI of $41k - $63k, so if your traditional IRA contribution can get you below $63k,  or into the 20% or 50% bracket you should factor that into your decision.
« Last Edit: December 11, 2017, 08:23:17 PM by TreeTired »

jpdx

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Re: IRA w/ low taxable income
« Reply #5 on: December 12, 2017, 12:12:23 AM »
TreeTired: With itemized deductions and child tax credit, my income tax will be zero. I was eager to use the saver credit but it is not refundable so doesn't make a difference in this case.

MDM

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Re: IRA w/ low taxable income
« Reply #6 on: December 12, 2017, 12:53:34 AM »
My AGI is low this year and with itemized deductions I can zero out my federal income tax liability.
TreeTired: With itemized deductions and child tax credit, my income tax will be zero. I was eager to use the saver credit but it is not refundable so doesn't make a difference in this case.
Ah, as Paul Harvey might say, we may need to know "the rest of the story."

Possibly a big difference between DINK w/ enough itemized deductions to get taxable income (Form 1040 line 43) to $0, vs. having kids and potentially eligible for saver's, child tax, and earned income credits.

Note that one gets to take the saver's credit before the non-refundable child tax credit.  If the saver's credit takes tax due to $0, one may then be able to use the refundable child tax credit.  And then maybe the earned income credit as well.

E.g., see below for what 1 earner, two kids, and the given income, insurance, and 401k contributions might do.

Paycheck frequency:AnnualAnnual
Paycheck ItemsEarner #1Earner #2Annual
Gross Salary/Wages
$52,100$0$52,100
Pretax Health/Dental/Vision Ins.$2,400$0$2,400
FICA base salary/wages
$49,700$0$49,700
401(k) / 403(b) / TSP / etc.$12,700$0$12,700
W-2 Box 1
$37,000$0$37,000
1040 AGI
$37,000
Payroll TaxesAnnualAnnualAnnual
Social Security$3,081$0$3,081
Medicare$721$0$721
Income Taxes
Federal tax-$4,8632017, MFJ, std., 4 ex.-$4,863
Total income taxes-$1,061-$1,061


Filing Status21=S, 2=MFJ, 3=HOH
# Exemptions4
# Children <172
# Children <132
# Children for EIC2
Adult #1Adult #2
Age3535
Full-time student?00
AGI$37,000
Std. Deduct.$12,700
Act. Deduct.$12,700
Exemption$16,200
Taxable$8,100
1040 Tax$810
Saver's credit$1,000
EIC$2,863
Child Tax Cred.$2,000
Net Tax-$4,863
VersionV9.10

« Last Edit: May 30, 2018, 09:51:05 PM by MDM »

teen persuasion

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Re: IRA w/ low taxable income
« Reply #7 on: December 12, 2017, 06:47:50 AM »
If you are eligible for EITC (or could be after traditional retirement contributions), payroll deductions to a 401k or equivalent is better than contributions to a traditional IRA.  EITC tests both line 7 wages AND AGI.  TIRA contributions only lower AGI, but payroll deductions to a 401k lower both, making you eligible for a larger EITC.

Does your state match CTC or EITC at all?  My state matches CTC at 33%, and EITC at 30%.

I put as much as possible into DH's 401k and HSA to maximize our refundable credits, and then use those refunds to fund Roth IRAs (no further advantage to traditional contributions).

jpdx

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Re: IRA w/ low taxable income
« Reply #8 on: December 13, 2017, 12:52:59 PM »
Thanks everyone.

I think I have too much investment income to qualify for the EITC.

1040 Line 44 "Tax" is already $0. So in this case I don't think I benefit from the saver credit. As MDM pointed out, I do receive the refundable "additional" child tax credit -- sweet!

jpdx

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Re: IRA w/ low taxable income
« Reply #9 on: December 13, 2017, 03:19:03 PM »
MDM, which rows do I need to adjust to account for state income tax effects?

MDM

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Re: IRA w/ low taxable income
« Reply #10 on: December 13, 2017, 03:33:45 PM »
MDM, which rows do I need to adjust to account for state income tax effects?
If you put the state postal abbreviation in cell H31, then change cell Q82 to =D65, the chart should show total marginal rate including federal, state, FICA, etc.

The federal tax calculation, AFAIK, is very good.  The state tax calculations are not as detailed, so may or may not be as accurate.

Does that answer work, or was it something else?

 

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