Author Topic: If you already owe $0 tax, Roth or Trad IRA?  (Read 4074 times)

caliq

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If you already owe $0 tax, Roth or Trad IRA?
« on: January 25, 2015, 09:49:39 AM »
So I'm trying to plan out 2015, and based on my annual cash flow spreadsheet, after I pay off all our consumer debt, I will most likely be able to max out my first IRA (I'm still in college).

My question is, if I have enough deductions and a low enough income to actually owe $0 in tax before considering retirement account deductions and credits, is there any other benefit to doing a Traditional IRA?  I understand the Roth conversion ladder, I just don't think it would be necessary since technically all of my income isn't taxed?  I don't think the Retirement Savings credit is refundable, and even if it is, I get the education credits/deductions so I don't think I'm eligible for it.  Based on what I've read, it seems like the Roth would be essentially the same as a Traditional in this case, except I wouldn't have to deal with the conversion ladder later on.  Am I understanding this correctly?

Secondly, I would be doing this before paying off some student loans that are at 6.8%.  My logic on this is that the loans are still under in school deferment, so even the ones that are currently earning interest haven't had the interest capitalize.  I'm going to be in school for the next 5 years (professional/graduate school), so it's not like they're going to capitalize this May.  Based on my spreadsheets, I should be able to pay off at least the higher interest loans, if not all my loans, before I finish my terminal degree, even if I max out an IRA every year.  So I thought that it would make the most sense to start investing now while I'm young (23), to give it as much time to grow as possible.  Is this logical, or should I just be throwing everything at the student loans?

Thanks! :)

dandarc

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #1 on: January 25, 2015, 10:03:21 AM »
Roth - as you've pointed out, there isn't a single dollar to save by going traditional.  Be willing to do similar analysis and change your mind in future years, when hopefully your income is so high you would save lots of taxes by going traditional.  As far as prioritizing - 6.8% is pretty high, even simple interest, but not like we're comparing two bad choices here - either way.  You are correct that the retirement savings credit does not apply while you are a full-time student.

teen persuasion

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #2 on: January 25, 2015, 10:06:36 AM »
If you don't owe any federal income tax, then put it in the Roth IRA.  If you put it in the traditional IRA, you would owe tax on the future withdrawals, whereas the withdrawals from a Roth are tax free.

This is the situation we are in.  Maxing an HSA plus putting lots in DH's 401k, and having children to claim, gets us to zero taxable federal income.  No need to contribute to a traditional IRA to lower our income further.  We get a bunch of refundable credits (EITC, CTC, and college credits), and our state matches those at varying rates, so I turn around and use the refunds to contribute to Roths for DH and myself.  Mostly free (all tax free) going in, free coming out.

caliq

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #3 on: January 25, 2015, 12:21:29 PM »
Thanks guys, I just wanted to check since it's my first rodeo :)

Edit: And I definitely will re-evaluate on an annual basis, though I think the situation is unlikely to change until I graduate professional school.  I'm certain I'll be using the traditional after that though!
« Last Edit: January 25, 2015, 12:24:01 PM by caliq »

Joel

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #4 on: January 25, 2015, 12:26:56 PM »
I would even argue that you should be making roth retirement contributions throughout the 15% tax bracket, as you likely expect most of your future income to place you in the 25% tax bracket.

caliq

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #5 on: January 25, 2015, 12:38:04 PM »
I would even argue that you should be making roth retirement contributions throughout the 15% tax bracket, as you likely expect most of your future income to place you in the 25% tax bracket.

I actually have a bit of an odd situation, because my husband is a disabled veteran, so we get a significant amount of tax free income from the VA.  He's unlikely to ever return to full time work and honestly I'd be happy just if his medical conditions can be treated to get him to the point where he could be a kick ass SAHD.  So, I'll be married filing jointly from now on, but never a two income household for tax purposes.  Since his disability is enough for us to live modestly on, my plan is to immediately max out my 401k, my IRA and a spousal IRA for him, and hopefully an HSA.  Doing that will keep me in the 15% bracket, as I expect my income to be around 100k.  Obviously there's a chance I'll get past the point where I can deduct us down into the 15% bracket, but I don't really want to be working for 30+ years so I may never accumulate that many raises :) 

Besides, isn't it better to contribute to a Traditional if you can use it to lower taxes, and then convert to a Roth using the ladder and get the tax free withdrawals? 

LadyStache

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #6 on: January 25, 2015, 12:49:29 PM »
Besides, isn't it better to contribute to a Traditional if you can use it to lower taxes, and then convert to a Roth using the ladder and get the tax free withdrawals?

It depends. If you invest in a traditional now, when you eventually roll over funds from the traditional to the Roth, you will need to pay tax on the amount being rolled over. If you invest in a Roth now, the money will grow tax-free and you will have tax-free withdrawals because you already paid the tax on it now.

If you're paying 0% tax now and you expect to pay 15% tax in the future, you would definitely want to invest in a Roth now.

caliq

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #7 on: January 25, 2015, 01:11:30 PM »
Besides, isn't it better to contribute to a Traditional if you can use it to lower taxes, and then convert to a Roth using the ladder and get the tax free withdrawals?

It depends. If you invest in a traditional now, when you eventually roll over funds from the traditional to the Roth, you will need to pay tax on the amount being rolled over. If you invest in a Roth now, the money will grow tax-free and you will have tax-free withdrawals because you already paid the tax on it now.

If you're paying 0% tax now and you expect to pay 15% tax in the future, you would definitely want to invest in a Roth now.

Yes, I'm definitely doing Roth for 2015. 

In terms of the rollover, you're talking about the fact that any withdrawals (even for rollovers) from traditional IRAs/401ks are taxed as regular income, right?  But the benefit is that any future gains aren't taxed once you rollover into the Roth? I feel like I might have missed something in all the reading I did about the conversion ladder but I just went back to MadFientists' article and now I'm confused. :/

LadyStache

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #8 on: January 25, 2015, 02:41:10 PM »
Besides, isn't it better to contribute to a Traditional if you can use it to lower taxes, and then convert to a Roth using the ladder and get the tax free withdrawals?

It depends. If you invest in a traditional now, when you eventually roll over funds from the traditional to the Roth, you will need to pay tax on the amount being rolled over. If you invest in a Roth now, the money will grow tax-free and you will have tax-free withdrawals because you already paid the tax on it now.

If you're paying 0% tax now and you expect to pay 15% tax in the future, you would definitely want to invest in a Roth now.

Yes, I'm definitely doing Roth for 2015. 

In terms of the rollover, you're talking about the fact that any withdrawals (even for rollovers) from traditional IRAs/401ks are taxed as regular income, right?  But the benefit is that any future gains aren't taxed once you rollover into the Roth? I feel like I might have missed something in all the reading I did about the conversion ladder but I just went back to MadFientists' article and now I'm confused. :/

When you do a rollover from traditional to Roth, the entire value of the amount you are rolling over (contributions + gains) is taxed.

When you do a withdrawal from a Roth, you do not have to pay tax on your contributions or any gains from those contributions (because the contributions were taxed before they were deposited into the Roth and are allowed to grow tax-free in the Roth).

So let's say you deposit $100 in a traditional IRA and it grows to $150 by the time you're ready to roll it over to your Roth IRA. When you roll it over, you're going to have to pay tax on $150.  Then you let it sit in the Roth for a few years and it grows to $200. When you withdraw from the Roth, you get $200 tax-free.

caliq

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #9 on: January 25, 2015, 02:49:25 PM »
Besides, isn't it better to contribute to a Traditional if you can use it to lower taxes, and then convert to a Roth using the ladder and get the tax free withdrawals?

It depends. If you invest in a traditional now, when you eventually roll over funds from the traditional to the Roth, you will need to pay tax on the amount being rolled over. If you invest in a Roth now, the money will grow tax-free and you will have tax-free withdrawals because you already paid the tax on it now.

If you're paying 0% tax now and you expect to pay 15% tax in the future, you would definitely want to invest in a Roth now.

Yes, I'm definitely doing Roth for 2015. 

In terms of the rollover, you're talking about the fact that any withdrawals (even for rollovers) from traditional IRAs/401ks are taxed as regular income, right?  But the benefit is that any future gains aren't taxed once you rollover into the Roth? I feel like I might have missed something in all the reading I did about the conversion ladder but I just went back to MadFientists' article and now I'm confused. :/

When you do a rollover from traditional to Roth, the entire value of the amount you are rolling over (contributions + gains) is taxed.

When you do a withdrawal from a Roth, you do not have to pay tax on your contributions or any gains from those contributions (because the contributions were taxed before they were deposited into the Roth and are allowed to grow tax-free in the Roth).

So let's say you deposit $100 in a traditional IRA and it grows to $150 by the time you're ready to roll it over to your Roth IRA. When you roll it over, you're going to have to pay tax on $150.  Then you let it sit in the Roth for a few years and it grows to $200. When you withdraw from the Roth, you get $200 tax-free.

Thanks! I was understanding it properly but seeing an example with concrete numbers definitely helped solidify it :)

SaintM

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #10 on: January 25, 2015, 03:44:11 PM »
A bit off topic: as a disable vet (and I assume he has a significant disability rating), can't he get health coverage through the VA so you don't have to have high deductible health insurance and a HSA?

After your Roth IRAs are maxed out, another option is to put money into a 529 account. The max contribution limits vary by state but are ridiculously high and the income is tax free if used for college. Contributions are not taxed when withdrawn regardless what you use the money for. This is why Obama wants to get rid of them. Vanguard sells its plan through Nevada.  The cost is a little higher than a regular Vanguard fund because the state gets a cut.

caliq

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #11 on: January 25, 2015, 04:33:55 PM »
A bit off topic: as a disable vet (and I assume he has a significant disability rating), can't he get health coverage through the VA so you don't have to have high deductible health insurance and a HSA?

After your Roth IRAs are maxed out, another option is to put money into a 529 account. The max contribution limits vary by state but are ridiculously high and the income is tax free if used for college. Contributions are not taxed when withdrawn regardless what you use the money for. This is why Obama wants to get rid of them. Vanguard sells its plan through Nevada.  The cost is a little higher than a regular Vanguard fund because the state gets a cut.

He has full healthcare coverage from the VA, but I don't and neither will future children, hence the HDHP & HSA.  That was just me speculating at the future though, I'm currently covered by my parents until I turn 26, after which I'll have to get insurance through my university (which is actually a really good deal -- if my parents didn't already have to pay the family rate because of my little sister, I'd have switched already). 

Unfortunately I don't think I'll have enough surplus to max out both Roth IRA's and then have any left to contribute to a 529.  Plus, I would feel pretty anxious about putting my "school" money into the markets because I need it semi-annually for the next five years.  I also don't think you can pay back student loans with a 529.  Thanks for the suggestion though; they are on my list for when I eventually get a legit job :)

Joel

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Re: If you already owe $0 tax, Roth or Trad IRA?
« Reply #12 on: January 25, 2015, 04:48:08 PM »
I would even argue that you should be making roth retirement contributions throughout the 15% tax bracket, as you likely expect most of your future income to place you in the 25% tax bracket.

I actually have a bit of an odd situation, because my husband is a disabled veteran, so we get a significant amount of tax free income from the VA.  He's unlikely to ever return to full time work and honestly I'd be happy just if his medical conditions can be treated to get him to the point where he could be a kick ass SAHD.  So, I'll be married filing jointly from now on, but never a two income household for tax purposes.  Since his disability is enough for us to live modestly on, my plan is to immediately max out my 401k, my IRA and a spousal IRA for him, and hopefully an HSA.  Doing that will keep me in the 15% bracket, as I expect my income to be around 100k.  Obviously there's a chance I'll get past the point where I can deduct us down into the 15% bracket, but I don't really want to be working for 30+ years so I may never accumulate that many raises :) 

Besides, isn't it better to contribute to a Traditional if you can use it to lower taxes, and then convert to a Roth using the ladder and get the tax free withdrawals?
Given your spouses situation, and the unlikelihood of you ever being in the 25% tax bracket then it does make sense to make traditional retirement contributions while in the 15% tax bracket. Once you are below that, roth all the way.

My comment was mostly for someone early on in their career that was single and may only be in the 15% tax bracket for a few years. As it is, with 23k in earnings that can be manipulated to traditional or roth, it's a relevant considerstion who expects a majority of future income to be in the 25% tax bracket.