After tax IRA contribution, Roth or Traditional, all while overseas

[Adventcloud]

Hi guys, the names Advent. I just recently got started with trying to create a path to financial independence all while traveling the world. I left for Australia in December of last year and it's been liberating. I'm 24 years old and I want to not only travel for the rest of my life(or till I feel I want to settle) but I also want to be financially independent. I've been devouring information the last month or so and I'm slowly getting a grasp on how to do it. I do however have a question that may be rather simple for you guys, but I've had an issue finding a clear answer.

I filed my taxes earlier this month, however I've decided I want to get started investing into an IRA. I am highly leaning towards a Roth IRA since I'm in the 10% tax bracket now and I plan on having quite a few business, so If all goes as planned I will be in a higher tax bracket when I retire. Simple sounding right. Well I've also noted something called an IRA conversion ladder which seems it may seem possible to get the best of both worlds. So now I'm stumped which one I should start with. Next since I've already filed my taxes it seems as though I don't have to file an amended return if I fund a Roth IRA; however if I fund a Traditional it seems as though I have to file an amended return. I do not want to file an amended return while overseas it just will end up being a pain and I would only get less then $100 back since I already received almost all of my taxes back with being in such a low bracket. Last but not least I plan on opening an account with Vanguard to fund my IRA. How do I make it clear that either of these contributions is for 2015 and not 2016? Any advice? Thanks in advance.

[etselec]

Go ahead and fund the Roth. I'm not an expert on conversion ladders, but I think they require having extremely low-income years when you retire and it doesn't sound like that's your plan.

If you fund before April 15 (or 18 this year? not sure) Vanguard will ask which year you'd like the contributions to be applied to.

[seattlecyclone]

The basic rule is to go Roth when you expect your tax bracket to be higher in retirement and traditional when you expect your tax bracket to be lower.

The IRA conversion ladder is good if you have traditional IRA assets that you want to withdraw prior to standard retirement age. But if you're going with Roth to start with that isn't a major concern.

[Adventcloud]

Thanks for the information guys. It definitely makes sense. I do have two further questions however. My current income is quite low and will probably stay that way for the next couple of years. Wouldn't it be possible to convert during these couple of years in order to not have to pay any taxes on the IRA? Sorry if it's a dumb question a lot off this is quite new to me. Also would anyone be able to confirm my thoughts on having to file a tax return if I funded a traditional IRA over a Roth?

[beltim]

Are you a US citizen?  I'm going to assume so based on your question.

Is your income from the US or Australia?  If Australia, and you claim the foreign earned income exclusion, you are not able to contribute to an IRA using any money excluded from your taxes.  Also, as a US citizen living abroad, I think you need to file a tax return even if you have no tax liability.

[Adventcloud]

I am a US citizen, It's self employed income, so I have to to pay tax either way. I'm not claiming the foreign earned income so that I can contribute to the IRA even if I had income out here. Whether I have to file the return or not isn't my question though. I already filed my return, my question is if I contribute to an IRA now will I have to file an amended return? Based on my research it seems if I contribute to a Roth IRA I'm fine and don't have to file an amended return because it's after tax contribution. I would like a confirmation though and also I would like to know if I contribute to a Traditional IRA would I have to file an amended return unlike the Roth? Last but not least I would also like to know that since I make under 15k is it better to contribute to a traditional then convert If I'm able to make sure that I stay in the 10-15% bracket? Sorry I know it's quite a lot, but I really do appreciate the help. I may create a new thread outlining my full situation in the future.

[beltim]

I am a US citizen, It's self employed income, so I have to to pay tax either way. I'm not claiming the foreign earned income so that I can contribute to the IRA even if I had income out here.

Okay, good.  A lot of people who ask a question like this make that mistake.

Whether I have to file the return or not isn't my question though. I already filed my return, my question is if I contribute to an IRA now will I have to file an amended return? Based on my research it seems if I contribute to a Roth IRA I'm fine and don't have to file an amended return because it's after tax contribution. I would like a confirmation though and also I would like to know if I contribute to a Traditional IRA would I have to file an amended return unlike the Roth? Last but not least I would also like to know that since I make under 15k is it better to contribute to a traditional then convert If I'm able to make sure that I stay in the 10-15% bracket? Sorry I know it's quite a lot, but I really do appreciate the help. I may create a new thread outlining my full situation in the future.

Yes, you're correct: if you contribute to a Roth IRA, you don't need to file any tax forms.  If you contribute to a traditional IRA, you would need to file an amended return in order to take the tax deduction.

I will add that there's no difference between contributing to a Roth IRA and contributing to a traditional IRA then converting it in the same year, so you shouldn't do that. 

Since you're in the 10% tax bracket this year, I think it's a no-brainer to contribute to the Roth IRA, since you anticipate being in a higher tax bracket in retirement.

[robartsd]

Amounts contributed to a traditional retirement accounts are deducted from income for taxes (to be tax as income when withdrawn). In a Roth conversion, the money from the traditional account is counted as income and taxed then placed in a Roth account to be withdrawn tax free during retirement. The loophole for early retirees is that after 5 years in the Roth, the converted funds can be withdrawn penalty free just like regular Roth contributions can at any time. I agree with others, that since you expect to be in a higher tax bracket at retirement, Roth may be the better choice right now.

BTW, if your 2015 income is low enough, it may save you a bit of money filing an amended return after funding a Roth if you can claim Saver's Tax Credit.

[beltim]

BTW, if your 2015 income is low enough, it may save you a bit of money filing an amended return after funding a Roth if you can claim Saver's Tax Credit.

This is a very good point.  For a single earner the cutoff for the Retirement Savings Contribution Credit is adjusted gross income of $30,500:
https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Savings-Contributions-Savers-Credit

[Adventcloud]

Thanks guys, I really appreciate the help. I'm only 24 so I'm not eligible for the savers credit till next year. You've made my decision much clearer at least for this year. I guess I misunderstood the conversion. I thought that If you contribute to the Traditional then converted to the Roth as long as you were currently in a low tax bracket you could do the conversion completely tax free. I didn't know that it involved a 5 year wait.

[robartsd]

Thanks guys, I really appreciate the help. I'm only 24 so I'm not eligible for the savers credit till next year. You've made my decision much clearer at least for this year. I guess I misunderstood the conversion. I thought that If you contribute to the Traditional then converted to the Roth as long as you were currently in a low tax bracket you could do the conversion completely tax free. I didn't know that it involved a 5 year wait.

The conversion is taxed at whatever your marginal tax rate is (so if you're in the 0% tax bracket after adding the converted amount to your income, it is tax free). The 5 year wait is for taking the funds out of the Roth to prevent people from using the conversion as a backdoor to take the funds out immediately. Your age doesn't disqualify you for saver's credit, but I'm assuming that your parents are still claiming you as a dependent. If provided for more than half your needs, then they are entitled to claim you. If your parents provided support but not a full half, I'd have a discussion with them about how claiming yourself would affect your taxes (and how not claiming you would affect theirs) to come up with the best overall strategy as you transition away from dependency on them.

[lpb0306]

Thanks guys, I really appreciate the help. I'm only 24 so I'm not eligible for the savers credit till next year. You've made my decision much clearer at least for this year. I guess I misunderstood the conversion. I thought that If you contribute to the Traditional then converted to the Roth as long as you were currently in a low tax bracket you could do the conversion completely tax free. I didn't know that it involved a 5 year wait.

You qualify for the savers credit; you don't qualify for the Earned Income Credit, but for the savers credit you just have to be 18 or older (I'm 24 as well, and my husband and I qualified this past year for $200 each off our federal return)

[Adventcloud]

Oh wow thanks guys for pointing that out. I was completely confusing the Savers Credit for the Earned Income credit. I also thought that I didn't qualify because I was using Turbo Tax and I never got a credit. Honestly I'm still confused why turbo tax wont apply the credit to me either. Does this credit apply to a personal Roth IRA as well or just a Retirement account via employment?

My parents aren't claiming me either nor are they supporting me. I'm just trying to figure all this out on my own and what the best strategies would be. As I said I'm traveling the world and no longer live at home. Once I figure out the basics I'll probably write a case study up which people may find interesting.

In terms of doing the conversion I think I'm finally getting a grasp on it. The reason you can do the conversion in retirement is because with deductions your earned income becomes $0 however if I attempted to do that while self-employed I would actually hurt myself because with earned income at $0 I could no longer put money into a Roth or Traditional IRA? Am I correct or miles away?

Update: After reading a bit more the reason I don't qualify for the Savers credit is because the only taxes being taken out via self employment are the SS and Medicare taxes. Because my taxable income is technically $0 I don't qualify.

[robartsd]

Does this credit apply to a personal Roth IRA as well or just a Retirement account via employment?

It applies to IRAs (traditional or Roth) as well as elective contributions to employer programs (any required contribution to the employer program does not count).

Update: After reading a bit more the reason I don't qualify for the Savers credit is because the only taxes being taken out via self employment are the SS and Medicare taxes. Because my taxable income is technically $0 I don't qualify.

Since you're in the 0% tax bracket, the Roth vs. traditional decision is easy - Roth. You may have additional options for optimizing taxes due to your income being self-employment.