Clearing up IRA confusion + strategy for young investor?

[PinkFrugalRunner]

So, from a lot of the advice given in this forum and http://www.madfientist.com/traditional-ira-vs-roth-ira/, it seems that a traditional IRA is better than a Roth if you plan on reaching FI at a younger-than-average age. My question is, which is better (Roth or traditional IRA) if you do not know what your tax bracket will be when you are "retired?"


My gross income for 2014 was roughly $33k and will be $45k in 2015. In 2016, it will jump to $160k as I will be starting a law firm job in fall 2015. In late 2014, I opened a Roth IRA with Vanguard and put in $5,500 - thinking I would do this for two years and then switch to a traditional IRA to contribute to alongside my employer 401k/match plan.

I chose a Roth because my income will be low enough for just the two years, and they are recommended for those who anticipate a higher tax bracket in retirement. My tax bracket for 2014 and 2015 will be 15%, thereafter it jumps to 28%. But I do not plan to stay at this job/level of income forever, in fact I intend to save as much of this very high "starting" salary as I can to achieve FI earlier. I'm young, so I am just not sure exactly what my horizon will be (and I'm sure getting married, choosing a new place to live, etc may factor into the equation in unforeseeable ways).

Evidently, income can be high in "retirement" and taxes still low:
http://forum.mrmoneymustache.com/investor-alley/agi-of-$91-752-and-a-tax-bill-of-zero-here's-how-it's-done/msg252003/#msg252003

And if I want to switch that Roth IRA to a regular IRA I have until April to do it:
http://forum.mrmoneymustache.com/investor-alley/too-much-income-for-a-roth-ira-now-what/

My question for all of you is...should I?

(Also noting: I put most of my additional salary from 2014 into VSATX ($15k), with a small portion allocated to VGTSX ($3k). The Roth is currently holding $550 in the Target Retirement 2055 fund simply for allocation purposes).

[GGNoob]

If you will be in the 25% tax bracket in 2015, you could contribute to a Traditional IRA to get the 25% tax reduction on your $5,500 contribution. But in 2016, it doesn't matter. You can no longer take deductions because of your high income. So in 2016, you would contribute to a backdoor Roth IRA (contribute to a non-deductible Traditional IRA and immediately convert to a Roth IRA).

[DrF]

In the scheme of things it seems pointless for you to worry about 2 years worth of tax savings on such a low salary.

Maybe if those savings compounded over the next 40 years, but if you follow through with FIRE then you could realistically be retired in 5-10 years.

Bottom line, I wouldn't worry about it. Keep it in your Roth and learn everything you can about the backdoor Roth.

[skyrefuge]

As Logan said, if you're going to be making $160k a year from now, and expect to be making around that much (inflation-adjusted) for your whole working career, your only IRA choice at that point would be a Roth IRA, and in particular, a Backdoor Roth IRA.

In order for a Backdoor Roth IRA to make sense, it's best to have no pre-existing tax-deductible assets in a Traditional IRA. Otherwise you are taxed on those existing assets each time you make a Backdoor Roth contribution.

From that perspective, I would say to just keep your IRA money as a Roth, for 2014 and 2015, and then you can continue to do Backdoor Roth contributions for all future years.

I don't know, maybe it's more optimal to have your money in a tax-deductible, Traditional IRA for a year or two, then convert it (and pay taxes on it) in the year before your income goes up, and do Backdoor Roth contributions for all future years. But even if it is, the numbers are aren't going to be very different, and especially compared to the amounts you'll be saving in the future, your 2014/2015 IRA contributions will be relatively inconsequential in the whole scheme of things.

But yeah, even in your high-income case, if you're planning on retiring early, with expenses much lower than your income, then Traditional would be preferred over Roth. The only reason you'll be doing Roth is because a Traditional IRA won't be possible, but for the same reason you should max out a Traditional 401(k).

[PinkFrugalRunner]

If you will be in the 25% tax bracket in 2015, you could contribute to a Traditional IRA to get the 25% tax reduction on your $5,500 contribution. But in 2016, it doesn't matter. You can no longer take deductions because of your high income. So in 2016, you would contribute to a backdoor Roth IRA (contribute to a non-deductible Traditional IRA and immediately convert to a Roth IRA).

The higher income level will be starting in 2016 as the job won't start (and neither will the income) until mid-autumn 2015. So I'll only have a few months of income during 2015, and pro-rating the $160k for those 3 months I think it will be around $40-45k for 2015.

But from all this, it seems the consensus is to do the Roth IRA for 2014/2015, and starting in 2016 do the traditional IRA/rollover to Roth immediately?

[brooklynguy]

I don't want to overcomplicate matters for you, but if the "Mega Back Door Roth" option will be available to you, you will be able to contribute up to $35k per year to your Roth IRA without running into the issue created by having preexisting traditional IRAs that skyrefuge described.  The availability of the Mega Back Door Roth depends on the characteristics of your particular employer's 401k plan -- I work in biglaw and it is available at my shop.  The Mad Fientist has a nice summary of the Mega Back Door Roth here.

[PinkFrugalRunner]

I don't want to overcomplicate matters for you, but if the "Mega Back Door Roth" option will be available to you, you will be able to contribute up to $35k per year to your Roth IRA without running into the issue created by having preexisting traditional IRAs that skyrefuge described.  The availability of the Mega Back Door Roth depends on the characteristics of your particular employer's 401k plan -- I work in biglaw and it is available at my shop.  The Mad Fientist has a nice summary of the Mega Back Door Roth here.

I'm not sure what the 401(k) plan is, but when I find out I'll look into this. As of now, I'll keep the Roth for 2014/2015, and plan to start contributing to a t-IRA and doing the rollover in 2016. Just one more question for you folks: since you can hold no pre-tax IRA money to do the conversion, the current Roth I have will not count as "pre-tax IRA money" since it's already been taxed, correct?

Thanks!

[skyrefuge]

Just one more question for you folks: since you can hold no pre-tax IRA money to do the conversion, the current Roth I have will not count as "pre-tax IRA money" since it's already been taxed, correct?

Correct, any money in a Roth IRA is "post-tax".

Money in a Traditional IRA can be either "pre-tax" or "post-tax", depending on whether you were able to take a tax deduction for the contribution.

Finally, when doing a backdoor Roth conversion, it's not that you can't have pre-tax IRA money, it's just that you'll then have to pay some amount of taxes on your backdoor Roth conversion that you otherwise would not have to pay, and that makes the backdoor less palatable.