Author Topic: IRA worth the trouble?  (Read 5025 times)

positronic

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IRA worth the trouble?
« on: February 12, 2014, 06:30:42 PM »
Hello, we are a young married couple that is new to FIRE and extra-new to investing. We are at about a 64% savings rate this year, and that should be even higher over the next few months  after we downsize our apartment. No debt. Just started an index fund in January. Our goal is to reach FI in about 7 years.

It's tax time. I am self-employed, and we've heard that a smart move can be to invest in a Traditional IRA to lower my taxable income now, then rollover to a Roth IRA and withdraw at a lower tax bracket once we're FI. We're in the 25% tax bracket now, and would hopefully be in 15% after FI.

Husband ran the numbers on me maxing out the IRA at $5500 each year for 7 years, and found that the savings in the end were about $4k.  I didn't make enough in 2013 to contribute over $5500 to a SEP IRA. I should make more in the future, but with my income we would probably only save about $10k total there.

The IRA investment/rollover/wait/withdrawal process seems complicated, and as new investors we're afraid of messing something up along the way. We'd also have to adjust our FI timeline to account for the earnings on the Roth that we can't touch until age 59 without a penalty.

From our perspective, it seems like a lot to keep track of in exchange for what is basically the equivalent of hitting FI a couple of weeks or a month early.

So I guess our question is: Is Traditional IRA worth the hassle for a short-term FI goal? Or did we miss something and our math is way off? (The latter is a definite possibility, there is so much we don't know yet!) We're trying to make a decision before we file our taxes for this year.

Thanks!

GlassStash

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Re: IRA worth the trouble?
« Reply #1 on: February 12, 2014, 07:16:40 PM »
I can't comment on the math, as I'm not sure how your husband ran his numbers. I do recommend that you read this blog post http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/ regarding early withdrawals. It outlines how to go about the Roth IRA conversion ladder and also SEPP payments. The bit on SEPP payments is in the comments section, but is well worth the read. One could argue that SEPP payments are much easier to deal with and provide similar benefits to the ladder. YMMV.

Cheddar Stacker

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Re: IRA worth the trouble?
« Reply #2 on: February 12, 2014, 11:28:50 PM »
You will be kicking yourself later if you don't do it now. Read more on this forum and the places the readers link to, and once you do you will realize how much of an impact this can have.

It seems overwhelming right now, so you just need to know this: This will not accelerate your path to FI by a few weeks or a month, it will accelerate it by a year or two, and all you have to do is put your savings into a tax deferred savings account rather than a post-tax one. Do it for sure, even if you don't fully understand why just yet.

Read the link GlassStache posted, then read this one as well: http://www.madfientist.com/retire-even-earlier/

Also, you are in a great position with the SEP IRA as you can do 20% of SE income up to $50K ish. There are other vehicles as well, and if you read enough here you will learn them.

beltim

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Re: IRA worth the trouble?
« Reply #3 on: February 12, 2014, 11:49:35 PM »
You will be kicking yourself later if you don't do it now. Read more on this forum and the places the readers link to, and once you do you will realize how much of an impact this can have.

It seems overwhelming right now, so you just need to know this: This will not accelerate your path to FI by a few weeks or a month, it will accelerate it by a year or two, and all you have to do is put your savings into a tax deferred savings account rather than a post-tax one. Do it for sure, even if you don't fully understand why just yet.

Read the link GlassStache posted, then read this one as well: http://www.madfientist.com/retire-even-earlier/

Also, you are in a great position with the SEP IRA as you can do 20% of SE income up to $50K ish. There are other vehicles as well, and if you read enough here you will learn them.

Most of the benefit on JLCollins post was due to a 5% employer match that the OP won't be eligible for due to self-employment.

Positronic - it is possible that your math is correct and the tax advantage is small enough to not be worthwhile. Without checking your math, it seems like a figure of only A few weeks difference is too small. Have you looked at establishing a solo 401k? The higher contribution limits may help you significantly.

Also, if you're worried about a Roth Ira pipeline I'd suggest looking into substantially equal periodic payments (SEPP or 72t distributions).  It may increase slightly your time to FI but provide substantial additional peace of mind due to not counting on a loophole in the tax system.

MissPeach

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Re: IRA worth the trouble?
« Reply #4 on: February 13, 2014, 11:36:18 AM »
What type of work is the business? I ask because I was trying to see if it was something that could be turned into a S or C corp. If so, I would use that to lower your taxes. The IRA would help but not like a corporation would.

First you can pay yourself a salary and deduct the FICA using pretax money rather than after tax as SE income. You can also create a 401K for your company and offer yourself a very generous match to further reduce your taxable income. There are ways to set up simple 401K accounts as a self employed person. If you do this correctly, you can probably move into a lower tax bracket. There are other tricks but these are the most basic ones using a corporation.

Cromacster

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Re: IRA worth the trouble?
« Reply #5 on: February 13, 2014, 01:31:35 PM »
The way I look at it.....I'd gladly pay you Tuesday for a hamburger today.

1.  It's really not that much trouble
2.  Keep as much of your money as possible from the government
3.  Use every tax advantaged account that you have available to you

You don't say how calculated 4k.  If thats straight dollars in dollars out sure.......but that neglects to factor in the added growth potential your money has, plus the money you save on taxes now.

Jamesqf

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Re: IRA worth the trouble?
« Reply #6 on: February 13, 2014, 01:38:21 PM »
I would suggest that you forget about the conversion of IRA to taxable.  You're saving/investing quite a bit more than what you would put in the IRA, right?  Then if you ER at say 40, you live off your taxable investments until you hit 59 1/2 or whatever age you can make IRA withdrawals, at which point you can live off the IRA that's grown tax-free all those years.

foobar

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Re: IRA worth the trouble?
« Reply #7 on: February 13, 2014, 02:32:57 PM »
I think you husband did the math with the assumption that you would pay 15% tax on the IRA. That is unlikely. You are more likely to pay 0 or 10%. But also realize we are talking about 40-60k dollars total (7 years at 5500+some earnings). 4k would be almost 10% more money. But lets say you don't care about 4k. So now it is 7 years later and you have 2 choices. You can either have 40k in a roth ira or 40k in your taxable account. In theory they are worth the same but the ROTH is so much more flexible. In 20 years you have to worry about capital gains  in the taxable account. In the Roth you don't. Want to rebalance your portfolio, that is easy to do in a tax deferred account.

And lets make sure we understand the complexity we are talking about
a)funding stage
1) opening an account
2) sending them a check every year

b) rollover stage
1) decide how much you want to take out and fill out the form

We are talking like 2 hours a year at most.
Hello, we are a young married couple that is new to FIRE and extra-new to investing. We are at about a 64% savings rate this year, and that should be even higher over the next few months  after we downsize our apartment. No debt. Just started an index fund in January. Our goal is to reach FI in about 7 years.

It's tax time. I am self-employed, and we've heard that a smart move can be to invest in a Traditional IRA to lower my taxable income now, then rollover to a Roth IRA and withdraw at a lower tax bracket once we're FI. We're in the 25% tax bracket now, and would hopefully be in 15% after FI.

Husband ran the numbers on me maxing out the IRA at $5500 each year for 7 years, and found that the savings in the end were about $4k.  I didn't make enough in 2013 to contribute over $5500 to a SEP IRA. I should make more in the future, but with my income we would probably only save about $10k total there.

The IRA investment/rollover/wait/withdrawal process seems complicated, and as new investors we're afraid of messing something up along the way. We'd also have to adjust our FI timeline to account for the earnings on the Roth that we can't touch until age 59 without a penalty.

From our perspective, it seems like a lot to keep track of in exchange for what is basically the equivalent of hitting FI a couple of weeks or a month early.

So I guess our question is: Is Traditional IRA worth the hassle for a short-term FI goal? Or did we miss something and our math is way off? (The latter is a definite possibility, there is so much we don't know yet!) We're trying to make a decision before we file our taxes for this year.

Thanks!

positronic

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Re: IRA worth the trouble?
« Reply #8 on: February 13, 2014, 11:08:57 PM »
I think you husband did the math with the assumption that you would pay 15% tax on the IRA. That is unlikely. You are more likely to pay 0 or 10%.

Ding ding ding! In our calculations, we forgot that the standard deduction exists. Can you see why we're afraid of messing up supposedly simple things? =)

Thanks to everyone for encouraging us to go ahead with the IRA. That made us do more research, find our errors, and better understand the process. We have a new spreadsheet now and can definitely see the huge benefits!

For our 2013 taxes, we will max out a Traditional IRA for me. Hopefully next year I'll make enough to do SEP instead, and we're going to max out the husband's 401k next year for sure. Thanks again for all of the helpful advice, we can use all the help we can get.

Now I have a new question. After maxing out my 2013 IRA, we'll still have about $10k of savings that have been accumulating that we were just going to put into index funds. Is there anything else we should use that for instead to improve our 2013 taxes?


(Notes to questions from other posts: My self-employment is freelance web design. I'm sort of "on board" doing regular contract work for one client, and then odd design jobs here and there. Not sure where I would begin learning about whether that is eligible to be an S or C corp.

Also, we are 26 and 27 years old, so there will hopefully be a non-trivial gap between FI and age 59.)


Cheddar Stacker

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Re: IRA worth the trouble?
« Reply #9 on: February 13, 2014, 11:23:20 PM »
Now I have a new question. After maxing out my 2013 IRA, we'll still have about $10k of savings that have been accumulating that we were just going to put into index funds. Is there anything else we should use that for instead to improve our 2013 taxes?

You didn't mention making an IRA contribution for your husband. Is he eligible for a deduction? I don't have the cutoff handy, but it's somewhere around $90-95K in taxable wages (so that would be net of any 401K contributions) for it to be deductible. I think that's the only other potential to reduce taxes for 2013. If he can't do that, you can do a back door Roth IRA contribution. It might not be the best idea if you guys are saving for a house, but it will grow tax free and you withdraw the funds tax free.

However, if you can't do that you might as well fund the 2014 IRA while you have the cash available. Get it in there and let it grow. No need to wait until this time next year.

positronic

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Re: IRA worth the trouble?
« Reply #10 on: February 14, 2014, 12:07:57 AM »
I believe we're in the "partial deduction" category. We've been working with a tax specialist, and she said he could only get a $200 deduction for IRA. He only worked 10 months in 2013, so he'll definitely be ineligible for any deductions in 2014.

Is there an advantage to having money in the 2014 IRA now over having that money in an index fund now?

Cheddar Stacker

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Re: IRA worth the trouble?
« Reply #11 on: February 14, 2014, 08:21:56 AM »
Tax free growth. You aren't building up income with dividends and unrealized capital gains.

MissPeach

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Re: IRA worth the trouble?
« Reply #12 on: February 14, 2014, 07:39:53 PM »
With a corp you can pay the FICA or self employment tax with pre tax versus after tax money like you would as a sole proprietor. There are some places it gets challenged though. Usually you have to be able to pay yourself a low salary (and be able to hire at a comparable wage) while billing a higher amount.

For example a lawyer might make $50/hour at a job but is able to bill at $200/hour. You could pay wages based on the $50/hour. Besides SE taxes, there are some write offs available to corporations and you can also set up and contribute significant matching 401k contributions and claim it against your business' profitability. So if you can legally write off a lot more your taxable income is less.

With an s corp you wind up reporting on schedule c so it's great for many sole proprietors. The difference in the accounting is usually helpful for making the tax rates lower for an s corp than a sole proprietor.