Author Topic: I don't think I understand IRAs. Help me out.  (Read 2283 times)

chloe1733

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I don't think I understand IRAs. Help me out.
« on: March 07, 2016, 03:47:48 PM »
I see a lot of people say they max out their 401k then their IRA on these boards.

My hubby and I both do the first step - we max out our 401k contribution limits at work. But as our AGI is above the $116k limit, we aren't eligible for a Roth, and we wouldn't be able to deduct anything off our taxes if we put in a regular IRA...right?

Is there any advantage to investing in an IRA if you're above the income limit for deductions? We tend to dump our extra into the mortgage and/or buy index funds instead. Is there any reason we should change that strategy?

Bracken_Joy

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Re: I don't think I understand IRAs. Help me out.
« Reply #1 on: March 07, 2016, 03:52:56 PM »
It enables backdoor Roth strategies, and it allows dividends to be tax deferred. At least, that is what I understood from the following: http://www.fool.com/retirement/iras/2015/02/22/nondeductible-iras-worth-the-hassle.aspx

Someone please correct me if I'm wrong =)

4alpacas

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Re: I don't think I understand IRAs. Help me out.
« Reply #2 on: March 07, 2016, 03:54:58 PM »
I see a lot of people say they max out their 401k then their IRA on these boards.

My hubby and I both do the first step - we max out our 401k contribution limits at work. But as our AGI is above the $116k limit, we aren't eligible for a Roth, and we wouldn't be able to deduct anything off our taxes if we put in a regular IRA...right?
True, but you can do a backdoor Roth IRA contribution.
Quote
Is there any advantage to investing in an IRA if you're above the income limit for deductions? We tend to dump our extra into the mortgage and/or buy index funds instead. Is there any reason we should change that strategy?
https://www.bogleheads.org/wiki/Backdoor_Roth_IRA

nereo

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Re: I don't think I understand IRAs. Help me out.
« Reply #3 on: March 07, 2016, 03:58:43 PM »
Hi Chloe

If you are married, filing jointly and you earn <$186,000 in 2016 you can contribute up to the limit for a ROTH ($5500 each for you and your spouse).

If you are married, filing jointly and your MAGI is between $98,000-$118,000 and have a 401(k) then you get a partial deduction on a tIRA.

As Bracken_Joy said, funding a tIRA (regardless of whether you are able to deduct it) allows you to do a backdoor ROTH strategy later. 

see: https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Amount-of-Roth-IRA-Contributions-That-You-Can-Make-for-2016

chloe1733

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Re: I don't think I understand IRAs. Help me out.
« Reply #4 on: March 07, 2016, 04:07:48 PM »
We exceed all income limits on either Roth or Traditional. So then maybe a better question would be:

Is funding a backdoor Roth a better use of funds than contributing to Index Funds now? With a Roth, we'd still be subject to age limits for withdrawing without a penalty, for one thing. It seems the tax-free dividend growth is really the only benefit...

Bracken_Joy

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Re: I don't think I understand IRAs. Help me out.
« Reply #5 on: March 07, 2016, 04:12:42 PM »
We exceed all income limits on either Roth or Traditional. So then maybe a better question would be:

Is funding a backdoor Roth a better use of funds than contributing to Index Funds now? With a Roth, we'd still be subject to age limits for withdrawing without a penalty, for one thing. It seems the tax-free dividend growth is really the only benefit...

You can access funds prior to the age limit without penalty. See the following discussion:
http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

nereo

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Re: I don't think I understand IRAs. Help me out.
« Reply #6 on: March 07, 2016, 04:36:45 PM »
We exceed all income limits on either Roth or Traditional. So then maybe a better question would be:

Is funding a backdoor Roth a better use of funds than contributing to Index Funds now? With a Roth, we'd still be subject to age limits for withdrawing without a penalty, for one thing. It seems the tax-free dividend growth is really the only benefit...
[/b]
what Bracken_Joy said... plus... tax-free dividend growth can be really important.

seattlecyclone

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Re: I don't think I understand IRAs. Help me out.
« Reply #7 on: March 07, 2016, 04:42:20 PM »
We exceed all income limits on either Roth or Traditional. So then maybe a better question would be:

Is funding a backdoor Roth a better use of funds than contributing to Index Funds now? With a Roth, we'd still be subject to age limits for withdrawing without a penalty, for one thing. It seems the tax-free dividend growth is really the only benefit...

Also, please be aware that a Roth IRA is just a bucket you put money into, not an investment as such. You don't have to choose between an IRA and index funds. You can put money into an IRA and then invest that money in an index fund.

As to the taxation piece, tax-free growth is a great thing, especially if you plan to be working for a while and/or you don't expect the 0% dividends/capital gains rate for lower tax brackets to last forever. Backdoor Roth contributions can generally be withdrawn at any time with no tax or penalty due, it's only the earnings that are more constrained until "normal" retirement age. I tend to think that constraint on withdrawing the earnings is well worth the benefit of tax-free growth. Everyone's situation is different though.