Are we doing the right thing?

[Jules13]

It seems like I have read some negative comments about contributing to Roth IRAs lately?  Or maybe I misinterpreted something.  We currently max out my husband's 401k (I am a SAHM) and both of our Roth IRAs.  We don't contribute anything to my traditional IRA (rollover from previous working life 401k).

We also contribute some to a FSA account, but only what we know we will use.  We do most of our charitable contributions to various organizations through husband's work also, to further reduce taxable income.  He does not have an HSA available.

Are we doing the right thing?  Should we be doing anything differently? 

Thanks.

[catccc]

I believe the thinking is that if you are in a high tax bracket currently, you are better off contributing to a traditional IRA than a Roth IRA.  This happens to be the case for many mustachians, especially high income or dual earners.

In my case, because we are a one-income family, and in the same tax bracket that we expect to be in when we retire, contributing to a Roth makes sense.  We are forgoing the deduction that a traditional IRA would provide, but gaining the benefit of tax free earnings.  We expect to pay 15% on the contributions whether we contribute to the Roth or the traditional.

If we were currently in the 25% tax bracket, and expected to be in the 15% tax bracket during retirement, it might make sense to get the deduction now by contributing to a traditional IRA, and pay the 15% later at withdrawal.  The big question mark here would then be the gains, which will also come out at 15%- is 15% on the gains more or less than the 10% delta saved on the initial contribution?

I think that sums it up.  I'm sure there's some bit about the limitations on traditional IRA withdrawals (age related), but that's too much thinking for me right now.

[mom22boys]

Many people that post assume you can using the contribution to the tIRA to reduce their taxable income.  For some of us, we make too much money and can't use the contribution to the tIRA to reduce my taxable income.  This is my situation, so what I did was contribute to my tIRA, and did a backdoor conversion to a Roth IRA.  In my opinion that's better than the tIRA, and then paying tax on the earnings latter.  At least my earnings grow tax free now.

[PowerMustache]

Jules,

Around here many people plan to be in the 0% income tax bracket when they retire. This is very feasible if you don't work to make money and your income comes solely from dividends and capital gains.

If you retire with no income from working, then you can convert the money in your traditional IRA to a Roth IRA at a rate of about $10,000 per year per individual, depending also on some other factors. Then, you can use those funds converted to the Roth IRA without penalty after waiting 5 years. Thus, in the end, you will have paid NO taxes on that money from the traditional IRA. This is clearly better than directly contributing to the Roth IRA. Therefore, it is better to contribute to the traditional IRA if you plan to retire with very low income from working.

But, to be eligible for this option, you need to make sure you don't earn to much now. The cap on how much you can earn and still be eligible to contribute to the traditional IRA is LOWER than the cap on how much you can earn and still be eligible to contribute to the Roth IRA. For the Traditional IRA, you can only make around 60,000/year as an individual before the benefit starts to phase out. For the Roth IRA, you are allowed to make up to something like 100,000/year. So people with incomes higher than about 60,000 should contribute to Roth IRA because they can't contribute to traditional IRA.

[teen persuasion]

It depends on your taxes and marginal bracket.  DH contributes to his 401k and HSA and gets our taxable income down to zero, so we contribute to Roth IRAs.  There is  no further advantage to lowering our taxable income, and the disadvantage of RMDs and tax on tIRA withdrawals in retirement, so that is best FOR US.  Higher income couples or singles have a different tax scenario, so many opt for the current tax deduction instead, since that is more valuable FOR THEM.

  There is no one size fits all - evaluate what is best for you.

[Jules13]

We are in the 15% tax bracket now, though I'm surprised by that.  I guess because we reduce taxable income with 40k1 and charitable and FSA contributions.  But, my husband is up for a promotion so that might change. 

My tIRA is only about 16k.  It grows slowly but without any contributions, not much.  But, it was around 11k when I stopped working 10 years ago, so 6k for doing nothing isn't so bad. 

The other comments from teen persuasion and powermustache literary made my eyes blur.  Might need more coffee and read again to understand. 

Thanks!

[teen persuasion]

Basic pros and cons of IRAs:

  tIRA - current tax deduction, but must pay tax on future withdrawals
  Roth IRA - tax free growth and withdrawals, but no current tax deduction

You could broadly divide employed taxpayers into 3 groups:
 
  Income low enough that taxable income is 0
  Income high enough that ineligible for tIRA tax deduction
  Everyone in between

The first and second group can't benefit from the main advantage of a tIRA, so going Roth is obvious.  Everyone in between needs to dig deeper to compare the costs of paying the tax now vs paying it later, in retirement.  If tax rates are the same, it is a wash - no advantage either way.  If you can tip the scales, though, say thru converting tIRA funds to Roth while low income (after FIRE) in that zero tax bracket each year, you can get the best of both forms: upfront tax deduction, and tax free withdrawals later.

You have to predict and plan where you will be post FIRE, tax and incomewise.

[Valetta]

We each do both - max out 401ks and max out Roth IRAs. If we had to choose between the two, we would do the 401ks first but because we save so much, we can do both. We are getting to the point income wise where we may not be able to do the Roths anymore though. I think a lot of the advice is for people that don't have the $23,500 to max both out.

It sounds like you are maxing out both, which I don't think is a bad thing. I would certainly put money into a Roth before I would put it into any taxable accounts (we do that too, after maxing out the first two options).

We don't have an HSA available to us either although when we did, we maxed that out as well.

[Jules13]

Okay, couple of questions. 

What does this statement mean? 

I think a lot of the advice is for people that don't have the $23,500 to max both out.

We are maxing out 401k for my husband and Roth IRAs for both of us. 

I'm wondering should we be contributing to my tIRA instead?  But, can I even do that?

And I don't even understand getting taxable income down to "0".  How does that even work?  What does it have to get down to in order for it not to be taxable?

Thanks for all the responses.  Some of my confusion in replies is with the abbreviations, but I'm figuring them out.

[teen persuasion]

Getting our taxable income down to zero involves the standard deduction and personal exemptions.

For example, if our income is $50k, and DH maxes his 401k ($18k), then our AGI is $32k.  Once you subtract the standard deduction for MFJ ($12,600) and 5 exemptions for 2 adults plus 3 kids ($4k each, total $20k) you can see that our taxable income is zero.  So our federal tax is zero.  There is no point to putting contributions into a tIRA, to lower our AGI further below zero, so we contribute to Roth IRAs instead (tax free going in, tax free coming out).

Whether you can get your taxable income down to zero depends on your details: gross income, 401k deductions, HSA deductions, payroll deductions for things like health insurance, dental, etc., size of family (number of dependents), filing status, itemized vs standard deduction.  Then there are credits, some refundable, some not.  Nonrefundable credits can only wipe out your tax due, while refundable credits can actually be returned to you if you owe no tax.  The refundable credits are what I actually use to fund our Roth IRAs (fully some years, partially now).

You can fund either a Roth IRA, or a traditional one, or any partial combination of both up to a max total of $5500, as long as you are eligible.  If you have no income of your own, it is a spousal IRA using your spouse's income.  The question is which is better for your tax situation.


The comment about $23,500 to max both out is referring to maxing a 401k @ $18k plus an IRA @ $5500.

[Jules13]

Ahhhh....thanks so much for the clarification. 

[PowerMustache]

Great explanations, teen persuasion! Very helpful and succinct.

Jules, I encourage you to keep researching and asking about those parts you don't understand, just like you are already doing in this thread. The IRA/401k rules are overwhelming at first and it's true there are many details, but once you learn a few core facts it will be easier and more fun to learn those details. My previous comment jumped ahead past the basics to a particular strategy, one that is probably not right for your situation, so feel free to ignore me and focus on teen persuasions good explanations!