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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Lady SA on October 23, 2015, 09:44:39 PM

Title: Help me understand Roth IRA vs trad IRA with a higher income
Post by: Lady SA on October 23, 2015, 09:44:39 PM
I have a question regarding IRAs. I know advice really depends on specific situations, so I'm including our financial picture for you below.

Life Situation:
Tax status: MFJ
My DH and I (for clarity I’ll be LLB) are both 23
DINKs

Salaries:
LLB: $72800/year
DH: $78000/year
Total income (before tax): $150800
Monthly income (before tax): ~$12,500

Pre-tax deductions:
LLB 401k: Max ($18000), employer match up to 5%
DH 401k: Max ($18000), employer match up to 5%
Health Ins premiums: ~$150/mo
DH HSA: $50/mo (DH's health ins - it was cheaper to be insured individually. I have a different individual plan to address my health problems)
Bus passes x2: $140 (pre-tax bus passes through employer)

After tax savings/investments
Max monthly contribution into 3% savings account for emergency fund: $500
DH Roth IRA: $150

Other info that may or may not be relevant:
Total monthly expenses: $6,445 (this includes $3k/mo student loan payment)
Debts: $-127k in student loans (ouch) – I got some great advice on how to handle this a few weeks ago, should be paid off in 4-5 years

DH has a roth IRA that he and his father set up a few years ago. There isn’t much in it. DH wants to roll this IRA plus a few of his other investments (not totaling more than $3000) into a vanguard IRA. This consolidated IRA account would get a very small contribution each month – our budget supports maxing 401ks plus extra loan payments while also putting $150 in this account. For this consolidated account, he is currently leaning towards opening another Roth.

Obviously, with our high income, our first priority should be reducing our taxable income/liability - even with the huge loans hanging over our heads. We've gotten at least that far in our mustachian training! :)

My specific questions are:

1.   We want to set up IRAs now. For our high income and based on the fact we want to retire well before traditional retirement age (our goal is age 40, likely less), which IRA plan (traditional or Roth) makes sense? On one hand, if we do traditional IRAs, we will have much lower income after we FIRE, plus we can do the roth conversion ladder (or is that only 401ks you can convert? See, I’m totally oblivious to so much financial stuff haha). On the other, if we have roths, we don't have to pay taxes on gains. One thing to note, we wont be able to come close to maxing these accounts until our student loans are paid off in 4-5 years.
2.   Stupid question, I know… but both DH and I should get separate IRAs, correct? Like we can’t “combine forces” into one? Its pretty obvious because the name is an individual retirement account, but I thought I would check - especially since we wouldnt be able to put much into two IRAs for a few years.
3.   Just thought of this – if we both have IRAs, should they both be traditional, both be roth, or one of each? I’m not even sure how to think about this!

To me, based on what I’ve been reading, it looks like traditional IRAs are our best bet – our retirement spending will be at mustachian levels, and paying taxes up-front into a roth while we have much higher income and consequently much higher rate… seems silly. The trouble is convincing DH - he is stuck on "but with a roth we will never pay taxes on the gains!” and “its better to pay taxes now, because when we withdraw, tax rates as a whole will be higher”. Is that a concern if our financial circumstances will be vastly different? Any ideas or advice on how to talk about this with him? He is a little dubious about the math behind FIRE, particularly with regards to FIRE strategy (accounts, taxes, etc). I think both of us are just overwhelmed by what we don’t understand. And since I’m not very confident in my financial know-how, I’m not a very good “guide”! So any advice is very helpful.

Thanks for all your help!
Title: Re: Help me understand Roth IRA vs trad IRA with a higher income
Post by: cincystache on October 23, 2015, 10:05:41 PM
http://www.madfientist.com/traditional-ira-vs-roth-ira/

Read this, it pretty much answers all of your questions.

To summarize;
1. Traditional IRAs for both of you. Max out the IRAs before you put extra toward student loans unless your interest rate is above 6-7%. For early FI you are better off filling your tax-deferred buckets as much and as early as possible. You can still get the loans paid off well before you retire. Do the math, you will come out ahead in the long run paying the loans off slower and maxing out all of your tax-advantaged accounts first (including the HSA)

2. Yes, separate IRAs. Again, I strongly encourage maxing out the IRAs ASAP instead of paying off the student loans early.

3. Both Traditional. Get the tax benefit while your income is high and then do the conversion ladder when your tax rate drops in early retirement.

Great job! Keep up the good work.
Title: Re: Help me understand Roth IRA vs trad IRA with a higher income
Post by: MDM on October 24, 2015, 12:54:07 AM
http://www.madfientist.com/traditional-ira-vs-roth-ira/

Read this, it pretty much answers all of your questions.

To summarize;
1. Traditional IRAs for both of you. Max out the IRAs before you put extra toward student loans unless your interest rate is above 6-7%. For early FI you are better off filling your tax-deferred buckets as much and as early as possible. You can still get the loans paid off well before you retire. Do the math, you will come out ahead in the long run paying the loans off slower and maxing out all of your tax-advantaged accounts first (including the HSA)

2. Yes, separate IRAs. Again, I strongly encourage maxing out the IRAs ASAP instead of paying off the student loans early.

3. Both Traditional. Get the tax benefit while your income is high and then do the conversion ladder when your tax rate drops in early retirement.

Great job! Keep up the good work.
^Pretty much this, at least in theory.

In practice, you will not be able to take the full $11K tIRA deduction because you make too much.  See http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits.

Separate IRAs are a good idea, primarily because you have to do it that way by law.  They are Individual Retirement Arrangements.  Not going to re-litigate the agreement you and DH have (http://forum.mrmoneymustache.com/ask-a-mustachian/investmax-401ks-vs-student-loan-payoff-strategy/msg841270/#msg841270) on the SL trade-off. ;)

Yes, as cincystache suggests, traditional appears best from what is in your OP.

The table below is from the case study spreadsheet (http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-%27case-study%27-topic/msg274228/#msg274228), showing $4,010 is the maximum (see cell I40) you could deduct for a tIRA contribution, given the other numbers.  Note that by increasing the HSA contributions you would lower your MAGI and thus be eligible to deduct even more in a tIRA - maybe ~$5,520 total.
CategoryMonthly
Comments
Annual
Salary/Wages for earner #1$6,067$72,800
Salary/Wages for earner #2$6,500$78,000
Pretax Health Ins.$150$1,800
Employer-sponsored HSA$50$600
Pretax Commuter costs$140$1,680
FICA base salary/wages$12,227$146,720
Traditional IRA$334At maximum$4,010
401(k) / 403(b) / TSP / etc.$3,000At maximum$36,000