Recharacterization from Roth to Trad IRA?

[jexy103]

DH and I just ran the numbers through H&R Block software, married filing jointly. Last year, we received a ~$2K refund, so we ran a W4 calculator and adjusted his withholdings by 1. This year, we currently owe $1,720... and also get hit with a $29 underpayment penalty. :-( Our taxable income increased about $8K, and everything else was largely the same. Like last year, we both maxed out our Roth IRAs and traditional 401(k)s (TSPs). (This is our fifth year of Roth contributions, so the plan was to switch to traditional this year anyway; when I started investing 5 years ago, I liked the Roth benefit of being able to withdraw contributions after five years as a backup emergency fund.) Our current AGI is about $68K, which means we're $7K too high to receive the Saver's Credit ($400) either (must be under $61,500 AGI). So we're considering recharacterizing both of our Roth IRA contributions ($11K total) to traditional to 1) get us under the $61K AGI to get the $400 Saver's Credit, and 2) receive a $330 refund instead of owing $1,720 (difference of $2,050).

Now, this would be a $2K difference this tax year, but how does that affect us in the future? It looks like we earned about $1,800 on our $11K of contributions, so that would also have to get recharacterized. That $1,800 invested at 8% over 33 years (now until 65) could come to about $22,400. Estimate 15% taxes on those gains when we withdraw at retirement age, and we're looking at $3,360. But that's future dollars (33 years out), which is less valuable than today's $2,050, right? Also, we plan to FIRE in about 10 years at 42 when DH hits his 20-year mark in the military. So at that point, we would likely do a Roth Conversion Ladder, which would decrease the amount of time/gains this money would have in the traditional account to be taxed.

So, the questions are- 1) Does my math look right? 2) Am I missing anything to consider? 3) What do the fine minds of the MMM community recommend (recharacterize both, neither, or one plus some to get under $61,500 AGI)? 4) Do we need to wait for the Vanguard recharacterization to be fully processed and receive the new forms before we file, or can we file as though we made the contributions to the Traditional and submit this weekend? We're expecting baby #1 in the next 1-3 weeks, so we want to file before she arrives and we become perpetually sleep deprived. :-) TIA!

[DavidAnnArbor]

Definitely recharacterize. You can do the Roth ladder in the future when you get to that bridge.

[jexy103]

David, thank you for your advice!

[moof]

Definitely do traditional IRA recharacterization, and put future contribution into a traditional IRA if you can.  In all likelihood you will make those withdrawals while in a pretty low tax bracket, so avoid taxes now if at all possible.

Roth is barely better than a taxable account if you are planning to live on <100k/year long term.  Roth is less flexible for taking money out and will avoid hardly any taxes if you have a short accumulation phase and a modest retirement.  Roth's only make more sense than traditional IRA's if you are in a very low tax bracket now, and expect to retire lavishly.  I intend to use mine only for "lumpy" expenses that would otherwise be hard to withdraw without getting pushed into a higher tax bracket.

Our priorities are:
1)  Max out 401k.
2)  Max out spousal IRA.
3)  Max out my Roth (too much income to qualify for traditional).
4)  Max out 529 (avoids 9% state income now, offsetting possible risk of possible 10% penalty later).
5)  Shovel anything else into taxable.

We have no HSA option, and we have no non-mortgage debt or those would be high on the list.