The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Jack on January 15, 2013, 01:27:37 AM
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I've been doing some tax planning, and it seems like, due to the fact that my wife and I were each only employed part of the year, our adjusted gross income is right in the range where if we make all our 2012 IRA contributions Traditional then we get the 50% Saver's Credit, but if we make them all as Roth we only get the 10% Saver's Credit (in other words, we'd get a $2000* credit vs a $400 credit). More specifically, maxing our Roth IRAs would make our AGI ~$43k while maxing our traditional IRAs would make our AGI ~$33k and the cutoff between the 50% and 20% saver's credit is $34,500.
First of all, am I understanding this right, or is there some catch where I'm calculating 1040 line 32 wrong (and I can't deduct the whole amount of the traditional contributions)?
Second, generally Roth IRAs are supposed to be "better" when you expect to be in a higher tax bracket in retirement (and I do, especially given my crazy low AGI this year). Does the increased Saver's Credit change that in this case?
*We wouldn't get a $2k credit, we'd get a ~$1500 credit because it's the lesser of the credit and our tax liability... but you know what I mean.
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Anybody have some advice? I'm trying to decide whether I need to make an estimated tax payment today, or if I can put that money towards something else.
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Can you go on-line to one of the free tax prep sites and run the numbers both ways? I think most of the big tax software companies have these.
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You're correct on both counts. What I would do is do as you've said and contribute to a traditional IRA for 2012, then convert it in 2013 to a Roth, as long as it won't push you into the 25% tax bracket.
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It would also depend on how far away retirement is for you, since you aren't taxed on Roth growth. When do you plan on withdrawing funds from the IRA?
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It would also depend on how far away retirement is for you, since you aren't taxed on Roth growth. When do you plan on withdrawing funds from the IRA?
I'm 28, so I'd start drawing on the IRA 35-40 years from now. "Retirement" would be a lot sooner, though!
I've been doing the math on my own (the old-fashioned way -- with paper IRS forms and a calculator). It seems to work out when I estimate it using the IRA contribution worksheet in the 1040 instructions, but I haven't had time to calculate it "the right way" using Publication 590.
I think the immediate 10%+ return I'd get just from the saver's credit by itself (completely separate from the reduction in taxes due to lower AGI) is enough to make traditional superior for me this year, but I just want to make sure.
The total difference seems to be ~$3500 taxes owed (including my wife's self-employment tax) with Roth contributions vs. ~$1200 taxes owed with traditional (because the saver's credit would completely zero out everything but the self-employment tax). Since I've had ~$1600 withheld, it's also the difference between being due a $400 refund later when I file vs. a ~$900 quarterly estimated payment being due today (which I have on hand, but I'd rather put in my Vanguard account instead).
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I love the Saver's Credit (my husband and I are using it for 2012 since we were gone traveling the world and converted enough of our 401K to a Roth to have our AGI just under the cutoff).
Looks like your numbers are right re: the Saver's Credit, but don't forget to take into account the likelihood of paying taxes on the money you take out of the traditional IRA at some point.
Traditional now: save ~$1000 in taxes, but may very well pay at least 10% on $10,000 = $1000 down the road, plus taxes on interest earned
Roth now: pay an extra $1000 now in taxes, but no taxes down the road on that money, plus all the extra returns/interest tax free, plus the added flexibility of a Roth (can take out principal at any time, no forced distributions)
I would probably lean towards the Roth, but a lot depends on when you plan to retire and what exactly your financial plans are. If you are planning to retire soon and the Saver's Credit is still around later, you could do a traditional now and then convert into a Roth during a low-income year with no federal tax liability and have the best of both worlds.
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Oops, your last post mentions the extra self-employment tax your wife would also have to pay so the difference would be more like $2000. I just went by your first post re: tax savings ($400 vs. a $1500 credit) to get my $1000 figure. Just substitute the right numbers into my last post.
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I think I'm going to go for traditional contributions this year and then will roll them over to Roths next year. I'll have much more income in 2013 (assuming no job loss), but I think I'll be able to avoid the 25% bracket. Does that sound like a good plan?
Edit: actually, what I'm going to do is make just enough traditional contributions to maximize my saver's credit, then make the rest as Roth.
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I think I'm going to go for traditional contributions this year and then will roll them over to Roths next year. I'll have much more income in 2013 (assuming no job loss), but I think I'll be able to avoid the 25% bracket. Does that sound like a good plan?
Edit: actually, what I'm going to do is make just enough traditional contributions to maximize my saver's credit, then make the rest as Roth.
Getting as much into a Roth seems like a good idea. I'm 25 and am shoving as much as I can into a Roth. I have no idea what income taxes will be in 40 years, but I'm guessing they could be a lot higher if history is an indication.
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I've just had an epiphany: even though I wasn't eligible for my employer's SIMPLE IRA in 2012, my wife was self-employed and therefore eligible for a SEP IRA or Individual 401k (or something like that). Maybe instead of making the rest of my IRA contributions as traditional, I should open one of those accounts, make traditional contributions to it, and increase the Roth part of the IRA contributions by the same amount?
E.g., I was planning to put $9,000 in my and my wife's traditional IRAs and $1000 in our Roth IRAs, but maybe I should put $2,000* in an SEP IRA for my wife, $7000 in me and my wife's traditional IRAs, and $3000 in our Roth IRAs?
Would I be allowed to open an SEP IRA or individual 401(k) for tax year 2012 even though it's January 2013 already?
Edit: better yet, if I chose the Individual 401k, does that mean I could contribute a full $10,000 to it (because the "employee" portion contribution limit seems to be a straight $17000, without being limited to a percentage of income)? That would mean I could contribute enough traditional to get the whole Saver's Credit while also maxing our Roth IRAs! Well, if I can save enough money to get all the contributions in before April 15th, anyway...
(*$2000 would be the max because we can only contribute 20% of her $10,000 earnings.)