Should we switch from Roth IRA's to Traditional IRA's?

[$40Kby40]

We currently have Roth IRA's through Vanguard. It seemed to make sense because we never made that much $ and up until last year never owed any federal taxes. I went back to school, graduated last year, and moved from GA to CO for a job this year. My husband did not have a job lined up here and finally after 6 months of being un/underemployed, he's starting a new job today.

Looking at my 2014 tax return, our income was about $45,000 (we owed $300 to federal). I expect with us both working to make around $90,000 in 2016. I've been able to work overtime at my job so far and that may continue next year. If not, I'm thinking of working a prn job in addition to my full time job (work in healthcare 3 12 hr shifts/wk). If I worked an extra night/week, I would make about $1,000/month -bringing our income up to $100,000.

We've never made this much $ ( I know we're so far behind most on this board and have made a lot of mistakes),but would like to make better/smarter decisions now.

So, from what I've read in this forum, the idea is to get your taxable income down as low as possible in order to not owe on taxes and keep more of your $. I have a 403b through work and have been doing 3% to get the match. I just increased this to 6% once my husband got this new job. I do plan to increase this next year if that makes more sense than contributing more to an IRA? I also have an HSA, but only do $42/paycheck. I plan to increase this amount also. We spent a lot of $ moving to CO and then w/ my husband not making hardly anything the last 6 months, I couldn't do as much as I wanted to.

My husband will have a 401k and access to HSA account at his job, also. He has to work 1,000 hrs before he is eligible for the employer match. He will be automatically enrolled at 4% and then I will try to get him to increase that amount.

We have one child, but 2015 will be the last year we get the child tax credit (he turns 17 in 2016).

I appreciate any and all advice.

[Jack]

You should almost always assume traditional is best, then recharacterize all or part of it after you actually calculate your taxes for the year. I'll explain via example.

Next year, with income at $90k, and both eligible for 401ks, you should be contributing to the following (in this order):

• 401Ks to employer match
• max HSA
• max IRAs
• max 401Ks

Total: $53550, which means your gross income after investments is $36450. That's good, because it puts you just under the phase-out for the Saver's Credit (for married filing jointly).

Let's go through the 1040 (*note: using the 2015 1040 but 2016 retirement contribution limits, so some of this will be a little off):

Line 7 (gross wages): $54,000 ($90K - $36K; the 401K deductions don't even show up in the "wages" section of your W2)
Line 22 (total income): $54,000
Line 25 (HSA): $6550
Line 32 (IRA): $11000
Line 36 (sum of AGI-reducing deductions): $17550
Line 37 (AGI): $36450
Line 40 (standard deduction, MFJ): $12400
Line 42 (three exemptions): $11850
Line 43 (taxable income): $12200
Line 44 (tax): $1223
Line 51 (Saver's Credit): $2000
Line 55 (total credits): $2000
Line 56 (tax minus non-refundable credits): $0
Line 63 (total tax): $0

So, maxing out your traditional IRA (and your other tax-deferred accounts) would be enough to reduce your tax liability to $0 (give or take other "above the line" income or deductions). However, you're right at the edge of the Saver's Credit:

• If you made $90,051 and didn't change anything else, you'd owe $423 because you'd only be able to deduct $800 instead of $2000.
• If you made $90,000 but contributed to a Roth IRA instead of traditional, you'd owe $823 because you'd only be able to deduct $400. Edit: Whoops, I forgot to account for the difference in taxable income! You'd start out owing $2576 and only be able to deduct $400 of it, so you'd end up owing $2176.
• If you had less income (or more above-the-line deductions, such as tuition, student loan interest, or moving expenses) then you could "tune" your traditional and Roth IRA contribution (by recharacterizing part of it) to make your AGI exactly $36,499, contributing as much to your Roth IRA as possible (to save on future taxes) while still maintaining $0 tax liability now.
• Finally, if you failed to increase your contributions beyond what you're doing now ($42 per pay period to HSA and ~4% of gross wages to 401k), you'd pay a whopping $8,254 of tax!

Note that this did not consider state taxes, other pre-tax deductions from your salary (e.g. insurance premiums), and a bunch of other stuff like that, so YMMV.

[MDM]

With the large step income increase you have a great opportunity to invest most or all of that increase.  For retirement purposes, you should do all you can with tax-advantaged investments before putting anything into taxable accounts.

Whether to use Roth or traditional is less clear.  Jack's post does a good job explaining how Form 1040 works, and highlighting the opportunity for the saver's credit.  To get to the saver's credit, however, you will have to use a lot of 15% marginal rate money and even some 10% marginal rate on traditional accounts.

If you put $11K into traditional IRAs, and $6650 into an HSA, the $36K into a traditional 401k would save you ~17% on federal income tax.  That includes the saver's credit, and is subject to all the YMMV considerations Jack mentioned.  Calculations were done using the case study spreadsheet - you can download a template from http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-%27case-study%27-topic/msg274228/#msg274228 and run your own calculations.

The usual "Rule of thumb": use traditional if your current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between.
See http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/ for more details on that topic.
In short:
The more you put into traditional now the higher your marginal withdrawal rate - which favors Roth.
The more you put into Roth now the lower your marginal withdrawal rate - which favors traditional.
So, polish your crystal ball and good luck! 

Also, don't agonize over the traditional vs. Roth so much that you do nothing.  Take a quick look, then just pick one and go.  You'll have plenty more years to practice on this decision.

[$40Kby40]

• Finally, if you failed to increase your contributions beyond what you're doing now ($42 per pay period to HSA and ~4% of gross wages to 401k), you'd pay a whopping $8,254 of tax!

Thanks so much Jack for breaking it down like that for me. This "our income is going to double problem" is definitely a good one to have. I just wanted to make sure that we don't screw it up. I actually told my husband almost the exact same thing -regarding owing something like $8,000 if we don't put more into these retirement/hsa accounts.

MDM, I read through the second link you posted and I wish I could say it made the decision clearer, but maybe not...it gave me more to think about, though.
I completely agree with your last line about not agonizing so much that we do nothing. I'm going to look around on the Vanguard website now.
Thanks again.